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Dear Eddie
Our advice this month, as last, is to reduce interest rates by 2% and use every effort available to you to get the exchange rate down, both against the Dollar and more particularly against the Euro. Inflation is no problem and no justification for rates as high as this. Growth is inadequate and slowing. Sterling remains substantially overvalued.
There is no reason at all why our interest rates should be so much higher than those in the Single European Market of which we are a part. It would be a useful exercise if the MPC thought out and published any justification it can muster for the fact that our interest and exchange rates are both so much out of line with the EU`s at a time when our inflation rate is lower than most.
We are persuaded to these conclusions, not only by the immediate situation of low growth leading to low productivity gains and a failure of investment all produced by sustained overvaluation and the consequent damage to production, but also by the wider review of the economic situation which we have undertaken over the summer. This points in the same direction and we hope that the members of the MPC can take this wider perspective on the consequences of their past decisions into account.
First. Inflation has consistently undershot your target which means you had a long leeway for greater expansion and more sustained growth than we have achieved. Why has this consistent undershoot been so long maintained? It may have been beneficial to the interests of Finance but it is damaging to those of manufacturing.
Two. The main inflationary pressures recently have been rising asset, and particularly house, prices and the rise in oil prices. The first are not part of the MPC`s rubric and it can do nothing about the second. Indeed, to attempt to do so by putting up interest rates simply increases other costs in the economy.
Three. Pressure on inflation has been mainly through the old-fashioned discipline of a high exchange rate making imports cheap and forcing manufacturing to cut back and hold wages. We don`t say that the high exchange rate has been used deliberately but nevertheless it has been the main weapon and the effects of this are as damaging now as they were in previous deflationary exercises.
Four. The whole approach can only be explained by an unrealistic set of assumptions. One is that the British economy, for some particular reason known only to financial institutions, is incapable of faster rates of growth. Britain has gone through a massive restructuring exercise and huge efforts to shed burdens and become more competitive, yet despite this, we are viewed as incapable of growing at the same rate as France, Ireland or the USA without horrendous inflationary consequences.
Another such conventional assumption is that inflation is caused by wage pressures, particularly in manufacturing which must, therefore, be unequivocally disciplined. Yet such wage pressures as there are come from the financial and services sector, particularly the City, and higher executive remuneration. Again, the policies applied as a result of these two mindsets benefit the interests of Finance and damage those of Manufacturing.
Five. In fact, the best way to low inflation over the long term is the German way of high production leading to lower unit costs, high investment and high productivity. These were the bases of German success right up to the Nineties and had damaging consequences for the other European economies joined with Germany in the ERM because the only way they could get down to German levels of inflation was by deflation, damaging their own economies.
Thanks to the high interest rate policies of the last eight years we have done the opposite of all this. The trade situation has turned sour despite oil exports thus bringing back the balance of payments constraint which choked British expansion for so long. Production has increased only minimally and is not much higher than in the three day week (something true of no other economy). Productivity gains are small, growth pathetic by the standards of our competitors and investment low, and getting worse.
Six. This pathetic performance on the interest rate plateau is throwing away the best opportunity of growth Britain has had. Inflation is low. The American market is booming. Europe has been held back as a competitor by all the difficulties generated by the post-Maastricht deflation. Yet we have failed to seize the great opportunity to grow fast and long, to expand to new higher levels and to the self-sustaining growth which every competing economy has enjoyed at some stage. Remember the great opportunity oil was supposed to offer Britain with its chance to invest and ride out balance of payments problems. Ask now what has actually been done with it and how much the MPC has contributed to the failure to seize it.
Seven. Britain is being relegated to limping along in a faster growing world. The production/exporting sector is exporting only at levels of profit insufficient to finance, investment, training, research, design, product development, innovation and all the other keys to success in increasingly competitive markets.
Eight. So we are deeply vulnerable if, or rather when, the world turns sour. Cautious policies could be justified if they were preparing us for hard eventualities. These only pave the way for a situation in which such difficulties will hit us harder than most because we have neither prepared nor built up strength by investment. On the contrary we have wasted the good times by using deflationary weapons leaving no resort except more of the same bad medicine in bigger doses when things turn bad.
Nine. The main threat to the happy world scenario probably comes from the USA. A soft landing (if Greenspan manages it) or a hard one, would both have adverse consequences for us. The realistic assumption must be that the new paradigm/new economy is not an economic miracle but a bigger than usual bubble, financed by escalating asset prices and ever increasing capital inflows to invest in it. Neither can go on. Indeed, the NASDAQ is down 30%, the broad market 8%, and both have a way to go. Prices and flows must both run into hard realities. The first is an unsustainable balance of payments deficit, currently 4.5% of GDP. The second is the possibility that as the US slows and Europe and S.E. Asia revive the short term capital parked in the US will flow back putting pressure on the US to put up interest rates to finance the trade deficit. Either or both must bring the Dollar down without necessarily pushing the Euro up, except relatively, but posing a threat to the Pound which has its own, unsustainable, balance of payments deficit. The MPC must ask itself now how it will respond to a fall in Sterling. The rational response must be to let the Pound fall, the bigger the fall the better, and garner the benefits in new competitiveness, economic growth and a sustained boost to British production. Indeed, the fall will need to be substantial because overvaluation and the two preceding recessions have produced a major shift in Britain from production to importing at all levels, not only finished goods but part finished, components to be assembled here, technology (mobile phone parts from Japan, computers from Ireland) processes put out to other markets, sale of British firms to foreign firms, putting other considerations first etc. etc. This dependency produced by overvaluation is like drug dependency: hard to break and requiring ever tougher doses of cold turkey. We fear that the more likely response to difficulties given the mindsets outlined above and the expectations the MPC has itself created will be the opposite of what is necessary.
We fear that interest rates will go up to defend the Pound and avoid the (assumed) inflationary consequences from of all. The Bank and Government have both failed to educate the public and particularly the punditry, to the benefits of growth and exchange rate competitiveness, a failure which will lead to an entirely predictable clamour for higher interest rates and "defending Sterling" compounding the problem which has been so damaging for so long.
We would encourage the MPC to think on a longer time scale and about wider, long-term needs rather than the short-term factors which have appeared so crucial up to now. Britain has had eight slow-growing years in which a low growth rate was welcomed as a miracle because it was in such sharp contrast with the deflations and failure before.
It is only by thinking long-term about where this leads and if it is sustainable in the light of likely eventualities elsewhere, that the work of the MPC and its impact on the wider economy can be properly assessed. Your own assessment will concentrate on the rate of inflation. Yet this is conditioned by the long term success or failure of the British economy. Inflation is not something which can be singled out and treated independently from macro economic policy. The MPC is now the dominant influence in that policy because it controls the basic levers of management. It should, therefore, not only think ahead, but also publish the assumptions on which it is working. It will fear this as giving hostages to fortune but it is in fact the only way to make the running of the economy more rational, bring all its assumptions into the light of day and allow interested public opinion to judge on the basis of real information rather than the intermittent bursts of groundless and the socially mindless speculation which have so far been the main debate surrounding the MPC`s work. The MPC must tell the people what it`s doing and why and accept its responsibility as the main agency of macro management. |
