MONEY The liquidity crisis

NICHOLAS DAVENPORT

The body economic is sick enough: there is no need to make it sicker by prescribing clan,

gerous quack medicines devised by too clever monetary doctors. Because a wage-cost infla- tion epidemic broke out in many western industrial nations the monetary authorities, egged on by a persuasive but fanatical Pro- fessor Friedman in Chicago, applied a squeeze of the money supply of such sever- ity that they have not only held up growth in both the us and the (ix but brought on the highest levels of unemployment seen since the war. They have also induced a liquidity crisis in the company world of an unprecedented order. The chairman of one of the big five banks said to me last week that he did not see how he could prevent some of his good customers asking for a receivership. Bankruptcies have swept through the smaller trading companies and even some great household names, like Rolls- Royce, have found themselves in grave financial trouble. In America the biggest railroad—Penn-Central—went bust and rum- ours spread that Lockheed, the aircraft giant, was next on the bankrupt list.

Now there is talk of King Resources trouble, the company which tried to rescue los. No wonder the bear market in Wall Street was driven to its lowest depths since the early 'sixties. The recent recovery has been prompted by the assurance of Mr Arthur Burns, the chairman of the Federal Reserve, that they would not allow a deep recession to develop and would meet 'excep- tional liquidity demands'. One may therefore hope that the monetary crisis has passed its peak but while lunacy remains in official monetary circles one cannot be sure. The present Bank of England request to the joint stock banks to slow down the rise in their advances is a cause for some alarm.

It was good to have a gust of fresh air brought into this poisonous monetary atmos- phere by Professor Kaldor in the last issue of Lloyds Bank Review. While the Fried- manite school in Chicago have won over the Federal Reserve Bank of St Louis, the re- search staff of the IMF and at least an expert or two at the Bank of England. as I suggested in this column a few weeks ago, they have not been able to capture the top academics in this country. With the exception of Pro- fessor Harry Johnson our leading econo- mists reject Professor Friedman's basic doc- trine that money supply (cash and bank money) determines money expenditures, in- comes and prices with a time lag. (The Fried- manite equations show that peaks and troughs in the money supply in the United States have regularly preceded peaks and troughs in the GNP with a variable lag of two to six quarters). As Professor Kaldor pointed out in his lecture delivered at University Col- lege. London, which Lloyds Bank Review reprints, none of Friedman's arguments prove that money supply plays the causal role— that it determines the level and rate of growth of money incomes or expenditures. You might as well argue that because cash in the hands of the public shoots up at Christmas, this is the cause of the Christmas buying spree Incidentally, if the authorities tried to prevent that spree by refusing to supply coins or notes there would simply be a rush to make use of credit cards or *hits' sup- plied by employers.

The Friedmanite theories (as Kaldor re- minds us) are a revival or resurrection of those of the Hayek school of the 'twenties and early 'thirties which captured a few fanatics in this country. (I knew the actuary of one of the great life companies in that period who was obsessed with these money supply theories: his directors wisely refused to let him attend their board meetings.) The computer age was bound to see a revival of them but it is extraordinary that these

theories should have taken such firm hold of the IMF. It will be remembered that when Mr

Roy Jenkins borrowed his last billion from

the IMF he was forced in his 'letter of intent' to limit the net: (Domestic Credit Expansion) to £100 million a quarter. The net; is not the

same thing as the money supply because it does not include money in the hands of non- residents but in his last budget speech Mr Jenkins went out of his way to limit himself to an increase of around 5 per cent in the money supply. What has been the result?

The attempts of his officials to control the money supply have been farcical. The last Bank of England bulletin revealed that the

nee in the financial year 1969-70 contracted by £625 million instead of expanding by £400

million and that the money supply_instead of expanding by around 5 per cent increased by only 2 per cent. And none of this con- traction stopped the wage and price inflation.

For the calendar years the rate of increase in the money supply fell from 9.8 per cent in 1967 to 6.6 per cent. in 1968 and to 2.9 per cent in 1969 when there was a dramatic turn- round in the balance of payments. This, says Professor Kaldor, is claimed as a feather in the cap for the Friedmanite monetarists but they ignore the fact that in the same period there was a dramatic turn-round in the net borrowing requirement of the public sector —from over £2,000 million in 1967-68 to minus £600 million in 1969-70. As he says. the short-run variations in the money supply —relative to trend—are largely explained by the variation in the public sector's borrow- ing—or non-borrowing—requirement.

It is obvious that the imposition by Mr Jenkins of extra taxation of £1,340 million, coupled with the-severe monetary restraints of dear money and restricted bank advances, would cause a recession in trade. (In real

terms the GNP was slightly down in the first half of this year.) The resulting fall in the cash flows of companies commited to fixed investment expenditures subjects them to a liquidity crisis and if the conventional money supply is restricted by Friedmanites and the banks are unable to come to their aid, some of these companies will end up in the bank- ruptcy court. Indeed, the bankruptcy of one of the great international corporations could send shock waves of trouble throughout the - western industrial world. The ios liquidity crisis has already been the cause of stock market slumps.

It was only two weeks ago that the Cm warned the late lamented Chancellor about

`the grave liquidity problems with which in. dustry is faced'. This is especially serious, it said, for small firms with limited resources and is leading to 'an ever-increasing number of failures among these firms.' The new Chancellor must now be giving these warn. ings very serious consideration. He will be aware that his monetary advisers, preoccu- pied with Friedmanite theories, gave his Labour predecessor wrong advice, namely, that the wage explosion would give a boost to the economy which a restricted money supply would have to correct. Price rises followed so quickly on wage rises that no boost occurred He should therefore drop these lunatic monetary theories and apply his own common sense. And the first step should be to instruct the Government broker to support the gilt-edged market when it is necessary and allow a gently rising market trend to bring down the absurdly high (Friedmanite) rate of interest which is stop- ping not only industrial investment but houses being built.

It was the intention, I believe, of lain Macleod to cut down swollen government staff and even halve the staff of his experts, although it would not necessarily follow that this would reduce by half the number of economic and monetary mistakes. I appeal to Mr Anthony Barber to send back his Fried- manite advisers to Cambridge for a course of lectures from Professor Kaldor,