MONEY Refloating the gilt-edged market
NICHOLAS DAVENPORT
e most significant event in the City has ,n the cheerful response of the gilt-edged iarket to the free-floating of the German lark and to the IMF meeting in Washington.
%sent up—and stayed up—with a sigh of lief. The freeing of a major European cur- even if only for a few weeks, had rokeri the ice of IMF rigidity. The market nsed that any step towards greater flexi- lity in exchange rates was an approach to eedom from the restraint of dearer money. had not forgotten that when this country decided to allow sterling to float in 1931 ancellor Chamberlain was able to convert r Loan from a 5 per cent to a 34: per cent ,,,ipon in less than one year.
Not that the IMF meeting gave anrefficial ,,sing to the idea of greater flexibility. It etended not to notice that Western Ger- any was breaking its rules. Its annual report arty stated its opposition to floating ex- ange rates -and it conveyed a hint that it d no use for the 'crawling peg'. But it did- your continuing study of 'greater flexibility the adjustment of exchange rates or of par ues'.
As we all know, the main defect of the F system is that it has no machinery for e automatic adjustment of balances when lions run into persistent deficits or sur- uses. It is left to individual governments to e action themselves either by way of flationary or inflationary measures at home by altering the exchange rates of their rrencies. And they usually take action dily and unwillingly. Mr Jenkins pointed t that in the past twenty-five years the IMF s seen sixty devaluations and only three valuations, which suggests where the chief ckiness lies. He doubted whether the nder of the IMF either envisaged the full ssibilities for growth in productivity or in ation in the developed countries or realised consequent potential for divergence in If competitive positions.
the moment we have West Germany, an and Italy piling up huge surpluses on
r balance of payments, which indicates her that their wages or prices are too low their industrial efficiency too great! It was tante that an electoral stalemate allowed
• issue to be decided by a free-floating ex- nge rate in the case of West Germany. lessor Robert Mundell of the University Chicago, who used to work at the IMF, has sed the important but awful question ether exchange rate clauses should not be tten into wage contracts. If the German rk had not been allowed to float upwards ernal adjustment, he said, would have been lewd by a 10 per cent to 15 per cent in- ase in German wages combined with an nrnmodating expansion in the money ply. One can understand non-labour ernments preferring to achieve equilib- tn through a floating exchange. If our e union mandarins are too slow to take sson from Professor Mundell they have Y to read the correspondence columns of Times. On 20 September Professor Lord ogh, in his new role of unofficial adviser the trade unions, wrote : 'If the unions
s for higher wages in a modern world of concentrated power this endeavour is defeated by price increases ... Devaluation "works" by reducing real wages and increas- ing profits. It is a device by which the value of wages which has been pushed up too fast is reduced ... The fact that price inflation in all countries seems proportional to the excess of wages over productivity increases shows the causal connection.'
Perhaps there are some home truths better left unsaid all at once, but those which Mr Jenkins thought fit to tell the IMF are greatly to be commended. He reminded them of the Basle agreement last year which guaranteed official holders of sterling against an exchange loss through devaluation and suggested that a similar_ arrangement on a wider front, affecting currencies ether than sterling, might be developed. This could be an important step, he slid, " towards combining greater flexibility in exchange rates with less risk of undesirable side effects. It was a home truth they did not greatly appreciate. The IMF meeting approved at long last the issue of Special Drawing Rights. The first allocation is to be $3,500 million on I January 1970. This is designed to remove the other main defect of the IMF system—the failure of monetary reserves to keep pace with the growth of world trade. In the past five years monetary reserves have increased by less than 2+ per cent per annum while world trade has been growing at the rate of almost 10 per cent per annum. The first issue of SDRS may well be regarded by the gilt-edged market as a milestone on the long road to lower interest rates.
Further reform of the IMF system is not going to happen overnight, and the gilt- edged market should not get too excited about such a long-term prospect, but it has some favourable short-term expectations to keep it happy. In the first place Mr Jenkins told the Labour party conference that on present trends the annual trading surplus on the balance of payments 'cannot be signifi- cantly below £450 million and might well be in excess of £500 million.' This may serve to soften any disappointment about the next trade returns on 16 October. In the second place, an up-valuation of the German mark—now thought likely to be over 6 per cent—will help our export trade and under- write the improvement in the balance of payments which Mr Jenkins anticipates. In the third place, the return flow of 'hot money' from the Deutschemark to London to take advantage of our high interest rates may cause our Treasury bill rate—now 7-8 per cent—to ease a fraction. Finally, the issue of a new long-term lap' loan—£400 million of Treasury 114: per cent 1997 at 95—is a sign that the Government expects the rise in the gilt-edged market to continue. It was only ten weeks ago that the Treasury issued £400 million of Treasury 9 per cent 1994 at 96 and with the price at over 99 this tap is now virtually exhausted. The 81 per cent coupon is the Treasury way of saying that the worst has been seen and that the next tap issue will not be offering any- thing like the present high returns.
Current yields are still astonishing. Short- dated bonds can be bought to yield 91 per cent. War Loan, which has risen 11 per cent from its low point of 36, is returning nearly 9 per cent in perpetuity. Against that must be set the annual rate of inflation and even if this is taken to be 3 per cent per annum a real yield of 6 per cent is tempting enough, especially as in the gilt-edged market there is no capital gains tax to pay if the stock is held for over a year. With such attractions even the worst government credit we have ever seen can be refloated upwards.
Previous page
