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Dear Eddie
Our position remains simple and straight forward. You should reduce interest rates by an initial two per cent. You have described our views as "out of date". They are that Britain must boost growth to a substantially higher level by expanding demand, making the pound competitive and keeping it there.
Nothing outdated about any of that. Your view has been less clearly expressed because it is essentially the instinctive conditioning of central bankers who can’t give hostages to fortune by expressing it as a contestable proposition. So you have produced opportunistic arguments centred on your inflation target though, having disavowed any ability to manage the exchange rate you have been pressured a little way in our direction by talking the pound down (along with the Chancellor) and holding rates when earnings growth would have led you to put them up.
Now, however, the tension between this preoccupation with earnings plus the Deputy Governor’s simplistic attachment to ever higher interest rates on the one hand, and the realities of a slowing economy characterised by deep damage to manufacturing, is becoming more stark though the bubble symptoms which confuse perceptions now, as they did in 1989 (when we were previously in this situation). That tension will make it difficult to take decisions and incline you to leave rates where they are to wait on events in the rest of the world. No formula there for guiding expectations or giving hope to hard pressed producers. So why not use this treading water phase to raise basic questions about the unexpressed, and largely inexpressible, motives behind the Bank’s positions.
The manufacturing sector is crucial. It produces the bulk of our exports, is the main source of growth and productivity increases, and underpins the rest. So it is not something to be treated in the brutal way the bank has, as a victim of collateral damage which should be sympathised with but never helped. We want the economy run in such a way as to give manufacturing strong competitiveness so that it can boost production and exports, widen a production base which has shrunk too far, and hold inflation by increasing productivity and cutting unit costs. The Bank appears immune to these considerations and has crippled manufacturing with high interest rates and an overvalued exchange rate. As the complaints mount and the job losses rise over a quarter of a million the Bank has offered crocodile sympathy and, as you put it in your briefing to Labour MPs, an invitation to "prayer". We know no other country which would damage manufacturing in such a way, or which has contracted its industrial base as massively as ours in the last two great deflations, or where economic management is as little concerned about the fate of manufacturing as you appear to be. Taking such risks with something so central can only be justified if you have sure and confident knowledge that manufacturing is no longer crucial and that the productivity losses and the balance of payments damage can be made good by other sectors taking up its burden as manufacturing shrinks.. What we have heard from you so far implies faith, hope and a facile opportunism, but no indication that there is any alternative. If you are going to handicap manufacturing in this way, treatment which implies that it is largely responsible for inflation, then it is incumbent on you to know and prove that it is safe to shrink it. You have never done this. So the central issue remains. Is manufacturing the main prop of the economy with a unique role which merits special treatment? Or does the Bank know differently? That alone can justify the damage being inflicted on it and the risk you are taking with the national economy.
Despite all the fiddling and expensive changes the Bank has made to interest rates, inflation has been consistent and below target. The Bank always errs on the side of deflation, not growth. At a time when inflation is minimal and the world has changed this is surely perverse. We can only assume that it is because the Bank fears growth and lacks confidence in the ability of the British economy to grow as others have, and still are. Why is Britain automatically assumed to be incapable of anything more than the pathetically low growth levels of recent years which are poor even by our historic standards? Why is horrendous inflation assumed to be the inevitable consequence of growth here but not in the USA. Has the ’modernisation’ of Thatcherism and all the restructuring been for nothing?
In your counsels the Banker or monetarist view prevails. You have no manufacturers on the MPC. It does a good job of representing the interests and attitude of Finance but betrays no understanding of manufacturing. Why is no account taken of all the factors which weaken inflation in an age of very intense competition.? Why no discussion of why an economy like Ireland can have a growth rate three times higher than ours but with inflation less than double? Your views on the relationship between growth and inflation should be made explicit. As they emerge from the Inflation Report they look outdated and in need of revision. Should the four independent members of the MPC have their own independent research and advise staff so they are not dependent on the Bank’s own monetarist preoccupations and conventional banker "thinking"
We are sure, because you have told us so often, that the Bank is not deliberately using an over-valued exchange rate to control inflation. Yet, in reality, the high exchange rate has been the main reason why inflation has been kept down. Putting up interest rates and the exchange rate inevitably works that way. It disciplines manufacturing unequally because it is on the front line of competition. It makes imports cheap. The service and finance sectors, the main cause of what inflation there is, are largely immune.
So if the Bank has kept inflation rates high in historic, real and competitive terms while inflation has been naturally low it must be absolutely clear about what it will do if and when the pound comes down. You tell us it will. We doubt it but all the indications given by the Bank imply that interest rates will go up if the pound comes down because the Bank feels that exchange rate depreciation is inflationary. Indeed the Deputy Governor has put a figure on this, apparently that a 25% fall in sterling would lift inflation by 2- 3%, though this hasn’t been the case with previous devaluations and his figures give no indication of when. This misguided view is not born out by the facts of any previous devaluation. If it is not disavowed markets will believe that interest rates are going to go up, giving them an argument for staying in sterling in an uncertain world. This will keep the pound higher than it would otherwise be. At some stage markets must bring the pound down and push the Euro up. Will the Bank treat both developments as the same? Will it attempt the dangerous feat of trying to buck the markets by propping the pound up?
Along with the Chancellor you have dismissed intervention and implied that it doesn’t and can’t work. We wonder if you have done research on this or considered the consequences of what followed Plaza agreement, the difference between intervention to bring the currency down, and the Bank’s more usual efforts to keep it up, or the opportunities for intervention which it goes with the grain of the markets as it now would. It is, in any case, no use dismissing the plan we have put to you to buy EU public debt as if it were simply intervention by buying other currencies. Euro debt not only pays a higher rate of interest than ours, but will appreciate with the Euro. If you are as confident as you say that the Euro will go up and sterling down, what is the problem in putting your money where your mouth is?
From time to time you have expressed the view that the pound will come down, perhaps as a result of the prayer you have also advocated. You should explain why this will happen. The productive economy definitely needs some hope of relief and multinationals need some guide to prospects. It has come down slightly against the dollar, as US interest rates peaked and the Euro has also struggled up a little from the floor but these glimmerings are possibly temporary, and certainly nothing to base a policy on. Sterling’s real overvaluation is 30% or more and that against both dollar and Euro. Look at the Non EU trade deficit which has emerged so rapidly and massively. Look, too, at the deficit with Europe still running at £1 billion last month despite the oil effect. Such deficits are a clear measure of the overvaluation. Both will get worse because of the effects of overvaluation. Both will take time to come through as manufacturing struggles to keep markets at the expense of profits.
The Bank likes to clutch at transient reasons to justify it decisions. After three years it should give an explanation and justification for what it has done over the long term. It is now necessary for sound policy reasons to explain what and how it has done. It must also formulate views on what the degree of overvaluation is and what level of exchange rate the Bank would regard as competitive. Only this can give a clear intellectual basis for long term policy, rather than feeding speculation and half truths which make current policy a process of short term improvisation and magnify speculation .
The view is sometimes expressed that when interest rates converge on the same level exchange rates will be in a more rational relationship to each other. Rates won’t converge, of course, because economies will remain out of kilter and we will move with the Americans, not Europe. Yet, even if they did our exchange rate will remain higher than is desirable for industrial competitiveness. Remember that Britain’s is more of a rentier economy than any other and the inward flood of dividends and profits will keep the pound up, whereas manufacturing economies like Germany and Japan will always keep their exchange rate competitive. In our economy Finance is the dominant interest. It always wants dearer money and a higher exchange rate than manufacturing. It always gets both.
The Bank’s policy this month is likely to be "wait and see". Treading water while we wait to see whether the American economy and the dollar with which we are so closely allied, have a hard or soft landing, and whether Euroland is able to get its exchange rate up is an abdication, not a policy. The economy is slowing badly and the experience of the very similar situation in 1989-90 indicates that when turn arounds come they come very quickly. The British economy needs boosting. Its manufacturing base needs defending not further weakening. You have slack to use with inflation below target. So reduce interest rates now instead of waiting, worrying, wringing your hands and advocating prayer. |
