Sterling Crisis: Money must be funny in a rich man's world: From Leipzig to Leicester . . . the fate of businessmen hung on the words of just 18 men. Andrew Marshall on the chain-gang
This is interdependence. In an age when it takes seconds for financial information to travel thousands of miles, everyone is aware that actions taken in Frankfurt, New York and Tokyo affect financial markets in London. But interdependence runs deeper than that. When change happens, it is felt everywhere in a global economy.
Last week, the chains of interdependence pulled tight as European interest rates suffered a spasm. The strain originated deep in the German economy; in the British economy it was felt no less strongly. Let us follow one chain through the economic machine.
Johannes Jacob is a bubbling 66-year-old who, with German reunification, has got back his family textile business in Leipzig, in the former East Germany. The sudden exposure of the company to the free market has been a shock. There was only one way to withstand it - throw out all the clapped-out old machinery and install computer-driven equipment. This costs money, 2m marks to be precise.
But it is possible, thanks in part to people such as Bernd Lepping. Mr Lepping, once a West German, is now head of the Leipzig office of Industrie und Kredit Bank, which specialises in financing small- and medium-sized firms. In the east, it has hit the jackpot. Credit handouts to budding eastern capitalists, or western firms moving into the east, jumped by 20 per cent between 1990 and 1991, reaching DM2.5bn. This year the bank expects a 30 per cent increase. 'Demand outstrips our ability to deal with it,' laments Mr Lepping. Mr Jacob and his textile firm are among his thrusting customers.
But Mr Jacob's modernisation plans have been made possible not just by loans from the bank, but because over a third of the investment was covered by government subsidies. In some cases these incentives can rise to nearly 50 per cent. It is costing the Bonn government, and the taxpayer, a fortune, but Chancellor Helmut Kohl considers it essential.
All this was in the minds of the 18 men who met last Thursday at the Bundesbank headquarters near Frankfurt. Their task, as it is every fortnight, was to review German interest rates, the stability of the mark and inflation. It was the last meeting before the summer break, and the central bankers were worried. Inflation was too high by their standards. They would prefer it to be zero.
More to the point, the amount of money in circulation and short- term bank deposits was overshooting the Bundesbank's targets and the main reason was the boom in subsidised credit for the east. Should the central bank curb this monetary expansion by a further twist of the interest screw? It is no exaggeration to say that the rest of the world was anxiously awaiting the verdict.
The debate on Thursday went on for four-and-a-half hours, far longer than planned, as the 18 men discussed the fates of hundreds of millions of home-owners, businessmen and governments well beyond the frontiers of Germany. In the end, they bowed to international pressure and opted for a move which would restrict credit mainly on the domestic German market.
The Bundesbank raised its discount rate, which places a floor under German market rates, by three quarters of a point, to 8.75 per cent. But it left the more internationally sensitive Lombard rate, the ceiling, unchanged at 9.75 per cent. The Bundesbank president, Helmut Schlesinger, said that the measure would hurt in Germany, but everything had been done 'to avoid any big problems for our partner countries'.
The decision was felt first in the currency markets. On Thursday at 12.15GMT, hundreds of people were clustered around green screens. At 12.18, the numbers began to change as dealers digested the news. With German interest rates up, the mark became more attractive to investors, but not as attractive as it would have been had the Lombard rate changed.
Enter the next figure in our chain, Dr Jim O'Neill, one of Britain's leading currency market analysts, who heads the financial research department at Swiss Bank Corporation. He had told his currency traders to expect a half percentage point increase in the discount rate. 'We thought that would mean that downward pressure would come off the European bond and currency markets, including those in Britain.' When the result came through - a three-quarter point rise, so a little higher than expected - he told his dealers to expect downward pressure after all, 'but it should be pretty limited'.
The reactions of Dr O'Neill and his colleagues were the subject of concern elsewhere in London. As the Bundesbank council met in Frankfurt, Norman Lamont, the Chancellor, and his top officials had also held an urgent meeting. Would they have to ask the Bank of England to increase base rates at a time when economic confidence was increasingly fragile? They would wait to see what happened.
In the event, the Chancellor was let off the hook, although there were a few sweaty moments. Through lunchtime on Thursday there was still concern that a British interest rate increase might be needed to hold the pound steady, and it was early afternoon before the Chancellor could relax: the markets were stabilising.
His relief was shared in Leicester, where our chain reached its end in Britain. For Brian Rhodes, an interest rate hike would have been a disaster. He is the finance director of Moss Machine Tools, which makes specialist equipment, mainly for car manufacturers. 'The last 18 months have been dreadful,' he says. 'We're looking at a comparison with the Thirties rather than the early Eighties.'
The work-force at Moss has been cut from 120 to 70. Sales last year were less than pounds 3m, against almost pounds 5m in 1990; the company slipped from profit to loss. And the gloom has continued. Like most small- and medium- sized firms, it is being financed solely by an overdraft. Moss's overdraft is 'hundreds of thousands of pounds', which means that a 1 percentage point rise in interest rates would cost thousands of pounds. Even though the rate has been falling, the company's losses mean that the overdraft is heading upwards.
The real question for Moss is 'whether Joe Public will go out and buy a new car', says Mr Rhodes. The answer so far has been a resounding no.
Like most people in his position, Mr Rhodes is all too aware of the chain that links him to the global economy. And, like them, he is doubtful about Britain's ability to keep its interest rates low: 'Germany has put its discount rate up to 8.75 per cent: we have been struggling to get our rates down to that level.'
The chain that links Mr Rhodes to Mr Jacob is a long one, but it is unmistakably there, and there is no slack in it. Mr Rhodes's best hope is that he can build another chain, and, ironically, it is one which may stretch in the same direction. 'We're sending people out to Europe and the US looking for work,' he says. 'Some of the most hopeful signs are coming from German customers.' Perhaps Mr Rhodes and Mr Lepping should talk.
WHO WANTS DEVALUATION?
Baroness Thatcher, the former prime minister, says: 'You will not get economic recovery while this interest rate stays as high . . . A policy which is right for Germany is causing increasing unemployment in this country.' She supports a realignment in the exchange rate mechanism (ERM) allowing Britain to cut interest rates. This could mean a devaluation of the pound alone or along with some other European currencies. She is reported to have warned at a private dinner for businessmen that the Government was heading for a 'financial accident'.
Wynne Godley, of the Cambridge Economic Policy Group, has unwaveringly supported a substantial devaluation since the 1970s. A former Treasury official, the 'Cassandra of the Fens' says the Government's policies condemn Britain to 'endemic depression and rising unemployment'.
'Nothing could be more destructive than for a British government to spend the next year fighting to maintain an unrealistic exchange rate for sterling, only to be forced into an eventual devaluation. It is better to face reality and devalue immediately.'
Max Hastings, the editor of the Daily Telegraph, told the Government from his leader columns: 'The most sensible course for Europe at this stage is a general realignment downwards against the mark.' When the Chancellor dismissed this option in a recent speech, the Daily Telegraph said his speech had been 'courageous, articulate and important', but warned darkly of 'serious flaws' in his arguments. The Daily Mail may soon be taking a markedly more critical line on the Chancellor's policy. Paul Dacre, who has replaced Sir David English as its editor, is no fan of the ERM.
The business leader
Howard Davies, the new director- general of the Confederation of British Industry, wants to see a concerted European devaluation against the mark. 'We recognise that that is not something you can do unilaterally, and that it would depend on agreement from both the Germans and the French,' he says. Norman Lamont has said this is 'not on the agenda'. Mr Davies also argues that the Government should do more to persuade the foreign exchange markets that British interest rates were higher than they needed to be to meet our domestic inflation targets.
Neil Kinnock, the former Labour leader, wants the Government to press for an agreed devaluation of non- German ERM currencies against the mark. This would reduce inflationary pressure in Germany and allow 'other ERM countries, Britain in particular, to avoid the heavy costs which loss of credibility would impose on any unilateral devaluation'. Mr Kinnock's words no longer constitute formal Labour policy. John Smith, the party's new leader, has yet to state clearly his opinion, but he appears to be leaning in a similar direction.
Neil Shaw, the chairman of Tate & Lyle, is more concerned with the pound's exchange rate against the dollar than the mark. He believes the pound is overvalued against the US currency, damaging the ability of British firms to compete with American rivals. Mr Shaw is the exception rather than the rule among leading business people. Although many believe we joined the ERM at too high an exchange rate, most think we should learn to live with it. And most of those who support devaluation emphasise a preference for concerted European action - effectively a revaluation of the mark.
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