In the City
Dollar despair
Nicholas Davenport
Far be it from me to dim the mounting lustre of our political correspondent but when he has lived as long as I have in the monetary world he would know that when an international reserve currency like the dollar gets into real trouble — and becomes almost despised and rejected in the market —some thing has to be done. The capitalist system is in danger, world trade is in danger. An attempt to create a new reserve currency through a European Monetary Union is not therefore 'an ultimately pointless scheme'. (That was his phrase which really upset me.) It is a pointed attempt to help the trading. world use another reserve currency to fill the gap if it declines to use the dollar. Ask the rich OPEC ministers, who are seeking an alternative to the dollar for their reserves and are now threatening to raise the price of oil to compensate for the dollar's fall, what they think. They would tell you that there is a real crisis of confidence in the exchange markets. No one believes that President Carter can handle the crisis without the intervention of the IMF with a huge line of credit. The American President lost the opportunity which I and some others presented to him many months ago of mopping up the surplus of unwanted dollars by issuing gold convertible bonds when gold was under $200 an ounce. Gold has now risen to $245 an ounce.
It is not going to be easy to create another reserve currency but it seems to me essential to set up a European Monetary Fund as a start. If it were fortified with sufficiently large reserves it could begin to intervene on the foreign exchanges and establish a stable ECU-dollar rate. At the moment the individual European central banks have to do their own interventions and it is causing them a lot of trouble. The German mark has been driven up to D.M. 1.72 against the dollar which has lost 16i per cent since the beginning of the year. Sterling is now quoted at $2.10 to the consternation of our exporters. Clearly it would be fairer for EEC members if the interventions in the exchanges were centralised through an EMF so that individual countries' exchanges and reserves did not jump up and down so frequently and so violently to the detriment of international trade.
These exchange interventions have a disturbing effect 'upon the internal money supply. When the Bank of England buys dollars with sterling it has less sterling to finance the Government's borrowing requirement. It therefore has to borrow sterling domestically — mainly through the issue of Treasury bills which 'are taken up by the banking system. Both the money supply and the banks' reserve asset base are thereby increased. To offset this the Bank of England has to sell more gilt-edged stock outside the banking system and/or tighten up the banks' corset and call for special deposits. This fear has lately been worrying the gilt-edged market which is in a state of fearful doldrums, expecting daily the issue of more 'tap' stocks. But its fears turned out to be groundless when the Bank of England recently published new figures on the amount of gilt-edged sales this financial year. These showed that the funding of the debt is actually ahead of schedule (which is about £500 million a month), largely because of an increase in savings investment outside the market 'tap' issues. But the market is still woriying— this time because it fears that some new innovation is about to be made in the methods of selling the 'tap' issues (such as the tender or auction techi que). Next month Mr Healey is to announce the new money supply target but no one 15 expecting him to be more restrictionist. The money supply has lately been running below ts present target (8 percent to 12 percent). The idea that a stricter money supply target is going to make the trade unions more responsible in their free collective bargaining is a piece of political nonsens of ' o course, the refusal of the TUC to accept the 5 percent pay guide is a worrY, but it is worrying the equity share market at the moment more than the gilt-edged. The FT index fell 17 points last week and at 484 is at its lowest level for three months. Six weeks ago it was at 535. A 10 percent fall from its year's high does not indicate that a bull market has reversed itself into a bear market; 10 percent or more is a normal correction for a bull movement in equities which has merely reflected the recovery in the consumer trades. This recovery was generated by the much higher real incomes after tax which workers are now enjoying. (Witness the sparkling profits of Marks and Spencer). But we must watch out for the reversal of this bullish influence. This could come about by the action Of either the American or the British government or both.
It is pathetic that the Americans have had to resort to the conventional dear moneY regime to stop an escalation in their 8 percent rate of inflation. The prime rates of the American banks have now risen to over 10 percent and going higher. Soaring interest rates, remarks the Economist, will push their slowdown into a slump. And an American slump slows down world trade. President Carter's appeal to the nation .td maintain a voluntary pay and price restraint _ 7 percent for wages and 5i percent for prices —fell flat. The labour boss — Mr MeanY _described it as 'a cruel joke'. But the President had an ingenious proposal — that workers who were members of a group that met the 7 percent pay guide line would have a tax rebate if inflation exceeded 7 percent. (Mr Callaghan will no doubt be taking LIP this idea with the trade unions who have rejected his 5 percent pay guide line.) ivlY reading of the American monetary crisis IS that world trade is bound to suffer but it will be 1979 before we shall know whether a further rise in oil prices will be an additional cause for alarm.
If on the top of a recession in world trade we might experience a slowing-down of the consumer boomlet in Britain — partlY because of monetary restrictions imposed in answer to a minor or major pay explosion then we could be seeing the end of the bull market in equities. It need not happen if the world trading nations took concerted acti0r! to drive out their inflations but a world, monetary consensus seems impossible and at home no government is capable of break. ing trade union power. Only rising unent. ployment could do that. Trade unions only learn by suffering.
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