The crisis comes home to the City MONEY

NICHOLAS DAVENPORT

Only a fortnight ago I was describing the re- cycling of hot money as the most pleasurable of Central banking games. I had no idea that the recent hot money flow into Deutsche marks — in the vain anticipation of an up-valuation — would reach the stupendous total of around $4,500 million. Yet the central bankers at Basle last Sunday decided to re-cycle the whole lot home—back to the countries whence it came —by means of short-term loans. The big ques- tion in this game is whether sterling will fall off Its bike.

My guess is that it will keep its balance for the time being in spite of the bad trade figures just reported. As far as I can gather from the financial lobbies about two-thirds of the out- flow of hot money was accounted for by dollars and Euro-dollars. This would leave $1,500 million for the European currencies of which sterling and the franc would take the lion's share. From this dissection it would seem that the sterling outflow is manageable with the credit resources we haVe at hand. But I wish Sir Leslie O'Brien, the Governor of the Bank of England, who is now noted for his mala- propisms, had not said on returning from Basle: 'Our work today will do the pound good.'

Speculation in currencies is a bore and I hope that the hot money merchants who organised

this last escapade—the second in six months—

will take a big enough loss to make them re- strain themselves in the ftiture. (The loss arises chiefly from the high cosi of the loan money.)

But while the international monetary system allows these currency distortions to persist—

in the absence of any political agreement for another 'Bretton Woods' conference to meet and realign all exchange parities as the Ger- mans suggest—there is bound to be a continual shifting of liquid funds. The total of funds in the Euro-dollar market is now estimated at $25,000 million and the total of central bank 'swap' facilities at $16,000 million. While the fixity of exchange rates remains a political decision and the movement of international money a private business decision there is bound to be a play between the two. And it is a game which the central banks could lose.

What alarms the businessman is the dampen- ing effect upon trade which follows when the politicians apply their various restrictive mea- sures to protect their fixed exchange rates. The most serious is perhaps the steep rise in interest rates which has become universal. Even West Germany is succumbing to the fashion. Penal loan rates must in the end kill industrial invest- ment.

The surplus on Germany's current trading account was close on $3,000 million in 1968, with exports in the second half of the year rising at the rate of 30 per cent per annum. If this goes

on, the IMF can theoretically invoke its 'scarce currency rule' against Germany which will allow its members to put special import taxes on German goods. At the sine time the French government has imposed strict 'exchange controls which have had the reverse effect of stimulating the flight of capital. (As a-free transfer of French funds is allowed do the African franc areas there are many

ways of evading the exchange controls.) The result has been to encourage the slowing down of domestic trade in France brought on by the political uncertainty.

The British government is in the worst posi- tion of all. It has already incurred vast debts abroad in the defence of sterling which will be increased by the recent flight into the mark to the extent of perhaps $650 million. The IMF credit overseers have already insisted on de- flationary budgets to curb our domestic spend- ing and if they impose fighter and tougher conditions for the new standby credit of $1,000 million, which the Chancellor is said to have negotiated to ease the quarterly repayments of $200 million to the IMF, there is a prospect of recession in the IA economy.

The signs of it are already appearing in the statistics. The building trade is on a downward trend. The motor trade, which is responsible for nearly 15 per cent of our exports, is head- ing for recession. In the first four months of this year home sales of new cars were down by not less than 30 per cent. Other consumer durable trades are reporting a decline and the textile boom is coming to an end. No govern- ment can exact additional taxation of around £1,500 million in a little over twelve months without destroying business morale. The budget last month with extra taxation of £340 million and a disallowing of tax relief on loans other than for houses was the last straw which broke the business camel's back.

No wonder prices are slumping on the Stock Exchange. On Tuesday there was an 11 point drop in the index bringing it down to 428 which is nearly 20 per cent below its high point of 520. Readers of this column will remember that I began attacking the high level of equity shares last autumn and again in January this year. Recently 1 thought a decline of 20 per cent would make many shares a reasonable 'buy' for a number of growth equities which are sell- ing at around fifteen to seventeen 'price/earn- ings ratios. Ict is nqw on a 16.6 price/earnings ratio.

I now have my doubts. If the Chancellor is to be squeezed further by our credit over- seers then the UK economy will lose its modest growth momentum. In his Budget speech Mr Jenkins had warned us 'that the prospect for the economy after the changes I have to propose Is a rate of growth of almost 3 per cent.' If he is going to throw it back to 24 per cent then business morale v, ill vanish and industrial in- vestment will decline. This will surely upset the Finahce Secretary wbo is a confessed expan- siOnist. Small wonder, I repeat, that the Stock Exchange is nervously waiting on the publica- tion of the letter of intent for the new loan.