Up and down with the money market

Press, 10 November 1981, Page 16

Up and down with the money market

Dollar wise

Diana-Shand

On Saturday October 31, “The Press” headline dramatically announced “Drastic Government Move Will Affect Money Market.” For the vast majority reaction went something like this: “What do they mean?” “How will it affect me?” Visions of a lumbering government forces bearing down on a market place full of startled coinchanges caught mid-haggle may have assailed some of us ... but most were simply nonplussed by the terms. Inflation is by now understood by most — most clearly when replacing last week’s emptied tin with this week’s more expensive one. We don’t like it, and we should never accept it. Nor should any government. It has a moral if not an elected duty to try and stabilise our economy. Modem understanding finds the government has some major tools for control. First is the evidence that inflation is linked to the amount of money in the economy (referred to as the money supply) and also to where this money is concentrated and being used. Money goes round and round in a flow between households and business enterprises. The government itself can regulate the flow by the very size of its own spending and withdrawals through taxes. Consequently, the Government, by its very actions, can have a marked effect on national income, output, and so employment.

When the Government spends more than it receives from taxes it has a budget deficit, like any other business. If it receives more than is spent, it has a surplus. Should the budget balance? Not necessarily, if putting the economy on a better footing is more important. If the economy is getting “overheated” it usually means the whole situation is getting out of hand and inflation is taking off like a frisky cow — soon to be seen as a rampaging bull maddened by the lashes of its own flailing tail.

How do we cool the situation down? One of the methods of control is by fiscal policy — using changes in taxes and/ or changes in government spending to bring the level of national income down, and so to cool the pace of inflation. Surpluses and deficits are used as tools without bowing to balancing needs unduly. Some fiscal tools are working all the time to automatically stabilise things. Taxes, for instance, act like a drag; taking money out of the economy and increasing government surpluses if a boom is producing too much inflation. Monetary policy (advocated by monetarists and followers of the American economist, Milton Friedman) is based on a belief that if you can influence over-all demand, you can control the economy. Demand is directly affected, they say, by the amount of money available. Some monetarists argue the main target should be the actual money supply, others the interest rates. Changing either of these, it would seem, affects demand. Several methods of monetary policy can be pursued. The government can — by “open market operations” — remove money or inject money into the money supply by selling or buying stock. It can change the reserve requirement banks must abide by when loaning out, that is. it can say that more

or less of the actual loan amount must be actually held in the bank instead of just being an entry in a book. The government can change the bank rate, which is the amount of interest it will charge trading banks for lending them money. It can shake a big stick, if cajoling won’t work, and order the banks to reduce or raise their interest rates.

In the past year we have seen several examples of monetary policy being used. In April, the Prime Minister (Mr Muldoon) said he wanted the bank interest rates down. High interest rates were affecting many sectors of the economy — from businesses needing financing to individuals needing mortgages. The response was apparently not enough, so the Government went into big scale buying ot commercial bills. This was meant to release so much money into the money supply that, by the laws of supply and demand, the price (interest rate) of money would drop. Unfortunately, this move also proved inadequate because general inflation continued to drive interest rates up. (Lenders, as much as any of us, want to get a return on their investment that will at least maintain their money’s buying power and make a little profit besides.) The longer-term effect of more money being pushed into the money supply was continued inflation.

More Government cajoling was insufficient, and so in October we saw a change in monetary policy. The Government left interest rates aside and entered the’moneymarket in order to take some of the, “excess" cash out of the money supply. The Government announced it will sell premium stock with returns which make it a rather attractive two to four year investment. It also raised the ceiling on Inflation Indexed Bonds — long one of the best investment buys around if you are more than 60 and can forego your money for five years.

The results of these actions were as follows. Lots of money from the money marketplace has gone out of circulation and into the government coffers. We are left with bits of script - and neither we nor the banks have that money available for lending or as cash to spend in other ways. This means lending will be curtailed, and the housing boom could well be stopped in its inflationary tracks. Interest rates will probably soon shoot up as banks, firms and individuals compete for money. But because there is less money around business operations, and buying and selling gendrally, must slow down sooner or later. Inflation will then slow down too. At least, that’s the theory. As a private investor you may wonder how this affects you. It is likely that property investment will be closed to some, and become burdensome to others. Be careful — don’t buy something a tight money situation will make difficult to sell (liquidate) unless you can afford to hang on. Transactions or circumstances that require credit, overdrafts or loans could be tricky — your overdraft ceiling may be reduced soon, your loans called in or difficult to refinance. Higher interest rates do seem likely, so many people may be hanging on to their money in expectation of this — forcing higher rates to become a fact as others become desperate for finance. This could drain shares from business investments (stocks and shares) into the lending institutions which are competing for the available money. However, the share market is at present quite stable. This probably reflects people’s understanding that many shares are, if anything, undervalued, and that investment in company equity is investment in solid and often undervalued assets. An interesting situation. Consult your own investment advisers ... I just work here.