Interest Rates EFFORTS TO CONTROL TRANSFERS OF FUNDS

Press, Volume C, Issue 29505, 5 May 1961, Page 12

Interest Rates EFFORTS TO CONTROL TRANSFERS OF FUNDS

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"LYNCEUS"

o 1 tt>« •EconomUt")

(From tn* "Economist’' Intelligence Unit)

London, April 25.—A new doctrine is well on the way to being sanctified in the world of official finance —the doctrine of international coordination of interest rates. It is receiving attention, moreover, at the highest political levels. Within limits and with important qualifications, some co-ordination of interest rates in the main industrial countries is an unquestionably sensible objective. But on the crude basis in which it is figuring in current high-level discussion—that countries should stop their interest rates from rising to such levels that they draw in funds from other countries—the doctrine is dangerously half-baked. The whole question arose from the recovery of European currencies in the late 1950'5, and particularly after the moves to convertibility at the end Of 1958. In 1959 and still more in 1960. the leading European currencies were regarded, at the least, as on a par with the dollar. The practice of “insuring” all money left in Europe by covering it in the forward exchange market became less universal. More and more corporations were prepared to shift their funds or their source of borrowing to the particular centre at which interest rates were most advantageous. Late in 1959, when interest rates in London were relatively low and those in New York relatively high, that meant shifting one’s lending to New York and one’s borrowing to London. A few months later, after interest rates on the two sides of the Atlantic had moved in opposite directions, the interest differential swung in London's favour Throughout the period, interest rates in Germany have been the highest of all Outflow of Funds In 1960 this differential caused a substantial flow of funds from the United States to Europe at a time when concern was already being expressed about America’s loss of gold. By the autumn the United States authorities were sufficiently worried about the outflow of shortterm funds to check their efforts to bring down their short-term interest rates, although it was clear that the domestic recession would deepen in the winter. For the first time since the early 1930’5. American monetary policy was amended as a result of an external drain of funds. Washington, and particularly the new Administration, saw this as a major problem. President Kennedy was understandably anxious to clear aside all obstacles to ending the domestic recession, and setting the economy on the road to reexpansion. The pull of foreign interest rates, causing an “artificial” outflow of gold, was seen as a threat to that policy, an uncomfortable embarrassment Britain obliged in 1960 by making two reductions of 4 per cent, in its Bank rate, although on domestic grounds alone it would probably have made no change. But this still left a differential in interest rates in favour of London: while in Germany, in spite of reductions in the official Bank rate, market rates remained far above those in the United States and indeed in nearly all other industrial countries. Hence the call went up for co-ordination of interest rates to prevent disturbing flows of funds from country to C ? u .l 71,6 recen t meeting of the Economic Policy Committee of the Organisation for European Economic Cooperation set up a working Party to study the point. Mr Selwyn Lloyd, in his first Budget as Britain's Chancellor of the Exchequer, cited the limitations in the domestic use of Bank rate that arise m effect from obligations not to upset the international balance as one reason why new, fiscal weapons of economic regulation are needed Confusion T* ere 18 , a good deal of r aboUt 0118 difficult Problem. In one sense, coordination of interest rates is

very desirable. This is to adjust domestic interest rates when they are out of line either with domestic requirements—as measured by the level of savings and investment and the state of the economy—or with international requirements, as related to the country's position as a deficit or surplus country. Thus in the case of Germany it is plainly anomalous that interest rates should I e extraordinarily high. The country has one of the highest rates of saving and investment in the world. In no material sense is capital short. Externally, the balance of payments has been in heavy surplus for a decade. One set of influences only keeps interest rates high—the habits of the people and of the big banks. History, custom, and psychology, rather than economics, have been allowed to be the decisive factor; and from the criterion of both Germany’s own position and its role in the world economy, a reduction of interest rates is desirable there. In this case, co-ordina-tion internationally calls for no more than is desirable domestically. Britain's Problems But consider the case of Britain. In Britain, it is widely agreed, domestic investment needs to be stepped up. Certainly the balance of the external account needs to be improved. And certainly London is already, if anything, too easy a centre in which to raise money. All the natural factors point towards maintaining interest rates relatively high. In this case, co-ordination to bring them down to the level temporarily dictated in the United States during a period of weak business activity would actually intensify Britain's long-term problems. It is facile to think th.it such a course can be right. Co-ordination demands the removal of artificial differences, not the papering over of real ones. In practice, some of the differentials that arise from such real differences in interest rates result simply because the business cycles in different countries are a few months out of Phase Where such differences lead to embarrassingly large movements of money, these can be offset by international credit operations: an improvement of these should — first international priority. To try to wipe out , 1 Private movements of runds in response to interest " 1U be ta lose the baby with the bath water.