In the City
The pound in crisis
Tony Rudd
Every British government since the war has had to cope with a sterling crisis and it is now clear that Mrs Thatcher's government is going to be no exception to the rule. What made this clear beyond peradventure was the behaviour of the foreign exchange markets last week following the cabinet reshuffle and the Bank of England's action in raising official rates to around 15 per cent. Both these events were designed to reassure the world at large that this administration is determined to hold fast to its policies. It should have shored up confidence. In the event it did nothing of the kind. It was the equivalent of trying to put out a fire with petrol. The blaze only got worse.
The trouble is that the credibility gap of British economic policy under this government has fallen so far that, at the moment, the task of restoring it looks almost impossible. This is because, so far, the policies haven't worked and people don't actually believe that simply applying the same remedies in a more extreme fashion than they have been applied up to now, will necessarily turn the trick. The key issue of this kind at the moment is interest rate policy. The Bank, on behalf of Mrs Thatcher, is now in the business of defending the level of the pound with higher interest rates. In theory that is a reasonable option. But, in practice, what level do interest rates have to reach to constitute an effective defence of sterling? If the answer to this turns out to be, say, 20 or 25 per cent is the Government Willing to let interest rates go to such levels?
The markets think not. Hence their failure to be impressed by a rise in interest rates to 15 per cent. It's always very difficult for a government to accept this kind of arithmetic. At the moment the authorities probably think that they are Within a point or so, at the very worst, of having reached levels of interest rates which Will attract money back to this country. What they are failing to take account of though is the big minus factor of the Thatcher government itself. This is probably worth at least five percentage points (or as the Americans would call it five hundred basis points) and the figure may be larger. Much larger. Indeed we may be at one of those points where there is almost no level of interest rates which will restore confidence in the short term. The higher that rates are pushed the more overseas Observers will come to the conclusion that the 'Government is panicking. For the truth Is that they are selling the pound not because of an interest rate differential as between sterling and overseas currencies but because of a fundamental disbelief in the soundness of Britain. They see a failed economic policy, they look at a diminishing industrial base, they see a country facing social difficulties and lastly they read about our political situation and its new and worrying uncertainties.
It's a grave disappointment both to those in Whitehall and the City. The one thing that this Conservative government was not expected to endure is precisely what is happening now. Two factors were expected to have insulated the United Kingdom currency from a recurrence of the crisis which had plagued all previous post-war governments. First, there was the wonderful North Sea oil bonanza with its enormous contribution to the British balance of payments and secondly in Mrs Thatcher's government we had an administration committed to rightwing policies, to monetarism and to the oldfashioned virtues of free enterprise and hard work. The combination looked unbeatable. Alas for these hopes. The oil has somehow become dissipated and its contribution lost in a welter of statistics while the monetarism has failed to deliver a cure for our endemic inflation. The latter has meant that all the other policies which are needed in industry have had to be delayed because the fight against inflation has a total priority. This concentration on the single target has, we can see now, created a hostage to fortune. As it has become the single standard chosen by the Government itself by which economic suc cess is to be measured, the failure of policy to prevent inflation rising once again from the 10 per cent level (which is the latest bad news) inevitably means that official policy is branded as unsuccessful. The rules preclude looking at any other aspects of the economy, where more comfort might be found. The fact that profits and productivity could well be on a rising trend this winter, that the power of the trade unions has been brought under control to a greater degree than has been the case for at least twenty years, and the likelihood that public expenditure is still being tackled aggressively by the authorities are items that cannot score.
The implications of these events for the stock markets are bad. The gilt-edged market is clearly heading back to the low point reached at the time that Mr Healey was forced in November 1976 to borrow from the IMF to stave off his currency crisis. This time round, though, we have the further complication that the institutions have tasted indexed stocks. It may well prove that the only way the Government is going to be able to fund during the next six months is by selling indexed stocks. If that is the case the outlook for non-indexed debt is poor indeed. As for equities, last week's fall may well trigger a 'buying strike' on the part of the institutions which, given the way that the jobbing system works, could mean a marking-down of share prices by between 20 and 30 per cent before a level has been reached at which genuine trading once again resumes. In the meantime it is to be noted that very much the same thing is happening on Wall Street; although the dollar may well be holding up, American investors are clearly becoming just as nervous about Mr Reagan's economic policy as British investors are about Mrs Thatcher's.
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