British Economic Policy of the 1960s and the Euro

Written by admin on May 24th, 2011

scheme was as follows:

The foreign currency proceeds of a foreign currency loan raised by a nationalised industry would all be converted into sterling through the Bank of England at the going rate in the ordinary way. The authorities would undertake that all the foreign exchange needed subsequently from time-to-time for the service of the loan would be sold to the industry against sterling at this rate , and in return the industry would undertake to acquire all its foreign exchange for servicing the loan from the Bank of England at this rate. In return for this exchange cover, the industry would be expected to pay a half-yearly charge, which it is intended should be calculated as the difference between the “all-in” cost of the foreign borrowing (including all initial as well as recurring management expenses) and what it would cost to borrow an equivalent sum from the National Loans Fund at the same date and according to the normal rules for Government lending to the industry concerned, less a margin normally of ¼% a year. Thus the industry would neither lose nor benefit from subsequent changes in exchange rates; and the interest rate margin of ¼% a year should encourage the industries to borrow in this way .

The Act, which gives an industry power to borrow abroad also, requires specific Treasury consent for each loan of this kind. Moreover, the industries would no doubt wish, and foreign lenders expect, a Treasury guarantee of the kind, which is normally provided in respect of market borrowing by these industries. This guarantee would protect the lender in case of default of payments of capital and interest. The Treasury would need to be satisfied that the terms and conditions, including the currency, size and timing of the borrowing are appropriate, both in relation to the UK’s balance of payments and to the prevailing conditions in these international and foreign capital markets .

The scheme described applied only to borrowing in currency of a country outside the sterling area. It did not apply to borrowing in a country of the sterling area, or through a sterling area country. This borrowing would not be an additional source of finance, which would allow the industries to exceed the approved investment programme. Foreign borrowing was an alternative source of finance, not a way of increasing investment .

These arrangements were brought to the attention of the industries concerned, and had encouraged them to take advantage where appropriate. The process of obtaining powers to borrow in foreign currencies was not complete, as these powers were being acquired by those industries that asked for them, as the opportunity arised – generally when borrowing powers were increased . The industries that already possessed powers were:

• The Electricity Council

• The Gas Council

• The North of Scotland Hydro Electricity Board

• The South of Scotland Electricity Board

The Air Corporations also had power to borrow in foreign currencies. Under exchange control arrangements, they had been expected to borrow abroad to finance expenditure overseas and for the purpose of foreign aircraft. It was agreed that powers would be taken for the British Steel Corporation, and the National Coal Board had shown considerable interest in acquiring them. It was important to choose suitable opportunities for nationalised industry borrowing in international capital markets, and the issues by British public corporations would had to be properly “marshalled” and managed. It was for this reason that the timing as well as the terms of issue would be subject to control. If a corporation was contemplating proposals to borrow abroad, they would make contact with the UK Treasury at a very early stage. The UK Treasury at the same, would immediately bring the Bank of England into the discussions. It would also be essential for any industry contemplating this kind of borrowing to use the services of a City house or houses of first class standing and experience in this field .

E. The philosophy behind the UK’s Government’s Economic Policy

In the case of the public bodies, it was one thing to have the necessary powers to borrow abroad, and another to persuade the industries to use them. The main obstacle was the absence of an exchange guarantee. Hence, the margin between the cost of borrowing overseas, and the cost of borrowing from the National Loans Fund, was not sufficient to safeguard the industries against the exchange risk for which, they would otherwise have had to carry. In general, it was clear that the UK government agreed that foreign currency borrowing was desirable and “had” to be encouraged. The following two frameworks of argument were put forward by the Treasury which underpin this very policy:

Framework One:

In formulating the foreign currency borrowing philosophy the natural starting point is the shadow foreign rate and the rate of return on marginal domestic investment. The former shows the extent to which the UK is willing to lower the present trading ratio between domestic and foreign resources to obtain scarce foreign exchange. For the sole purpose of this analysis, the rate is taken to be 20%, and the marginal return on UK domestic investment to be 8%. Now that we have the preference rate implied by the shadow foreign exchange rate and the marginal return on domestic investment, we have an implicit time preference rate for foreign exchange. For the basis of this conceptual approach the implicit rate of discount is 10%.

Having obtained this figure, we need to consider now the implication for foreign currency borrowing policy. In simple terms, it seems to be this. Foreign currency borrowing will benefit the nation as a whole provided that the effective borrowing rate (i.e. the actual market rate plus any allowance we want to make for possible exchange rate changes) is less than 10%, and that the domestic investment project which the switched funds will finance promises a marginal return of not less than 8%. So taking this into account, it seems difficult to consider the question whether exchange guarantees should be given to encourage this borrowing until there is fairly general agreement that this or some other similar criterion is the right one. Assuming that this criterion is substantially “correct”, we start with the obvious argument that it will be worthwhile to give an exchange guarantee if, without such a guarantee, the public bodies concerned are unwilling to borrow, even though the relative rates fall within the criterion specified above. There are, of course, then to be considered the contrary arguments, in particular the view that much damage could be done by what will be taken as a vote of little confidence in the stability of present exchange rates by the UK public sector. The argument may of course be exaggerated, and may carry much less weight after the Basle arrangements. But it seems to be that this question of exchange guarantees is logically secondary, and that we must first decide what is at stake (i.e. how much we want this foreign currency borrowing).

To conclude this framework, it is in the national interest that foreign borrowing take place when the implicit discount rate on foreign exchange exceeds that on domestic resources and when the interest rate differential between abroad and at home is less than the differential between the implicit discount rates. If the implicit discount rate for foreign exchange is 10% and that for domestic resources is 8% while the domestic interest rate is 7½%, foreign borrowing would be preferable from the national point of view so long as the foreign interest rate is less than 9½%. (the foreign interest rate should be calculated to include an allowance for any danger of foreign revaluation). So long as foreign borrowing is likely to be by foreign-currency borrowing. The fact that domestic borrowers will borrow where the interest rate (including allowances for brokerage charges and exchange rate fears) is lowest means that they will borrow sub-optimal sums in foreign currency issues when-ever the discount rate for foreign exchange exceeds that for domestic resources. There is therefore a case for giving a subsidy of up to the amount of this differential. The case for an exchange guarantee is that it is the best, or the only feasible, method of giving such a subsidy, and that the benefit of giving this subsidy will outweigh the possible dangers to confidence in the stability of the monetary unit.

Framework Two:

The second framework possesses a completely different argument than of framework one. The Public Records contains proof that the existence of a premium on foreign exchange (a shadow exchange rate) does not in itself imply that the discount rate on foreign exchange exceeds that on domestic resources (as stated in framework one). That, as long as the reference rate is constant over time, the two discount rates are identical. The implicit discount rate on foreign exchange exceeds that on domestic resources when, but only when, the preference rate for foreign exchange is falling over time.

This means that the case for subsidizing foreign currency borrowing is critically dependent upon the expected future values of the preference rate. For example, assuming that the policy of the late 1960s were to work with a 20% current preference rate and a 10% rate in the more distant future, this would justify a subsidy of up to about 1% per annum on a 15-year bond. The Government Economic Advisors would reconsider these preference rates, and it would entirely be possible that this would lead to modifications of the recommended values. As, it was

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