FIDUCIARY NOTE ISSUE

HC Deb 31 March 1976 vol 908 cc1511-37

1.50 a.m.

Mr. Nigel Lawson (Blaby)

I beg to move, That the Fiduciary Note Issue (Extension of Period) Order 1976 (S.I., 1976, No. 232), dated 17th February 1976, a copy of which was laid before this House on 20th February, be withdrawn. This motion is known to the procedural experts, of whom I am not one, as an out-of-time Prayer. Although my right hon. and hon. Friends and I put down a Prayer to annul the Order at the earliest possible opportunity, the usual channels were unable to find time to debate it before the statutory 40 days ran out yesterday. Moreover, had they not run out, we should not have been able to debate the matter even now, at this uncivilised hour, since the iniquitous 11.30 p.m. rule would have applied. Although I do want to detract from the great importance of the issue which the House has been debating for the past three hours or so, the treatment afforded to a matter as important as this Order is a negation of the power of Parliament. I know that it applies to all legislation subject to the negative resolution procedure, but it seems particularly scandalous when applied to an Order as important as this.

Orders like this are laid every two years, but since, surprisingly, this is the first time that one has been debated since 1962, it might be as well to preface the argument for its withdrawal with some explanation.

The 1954 Currency and Bank Notes Act, which was the successor to a number of earlier Acts of much the same name, ostensibly limited the size of the fiduciary note issue to £1,575 million. In fact the fiduciary note issue, which to all intents and purposes means the total note issue—although it is as well to be reminded by the word "fiduciary" that the value of the notes represents the faith and confidence that we have in the Government—now stands at about £6,000 million, almost four times the prescribed size. This has come about because the Act allows the limit to be exceded by Order for a renewable period of two years, subject only to Treasury minutes, which we can neither debate nor vote upon. Each of these minutes is valid for a maximum of six months, although this seems rather academic.

I shall be putting a number of questions to the Financial Secretary, of which perhaps the least important, although still not without interest, is this. How many of these Treasury minutes have been issued under that Act during the past 12 months? The researches of our admirable House of Commons Library suggest that there have been about 90, implying that each has an average life of four days. That shows how far we have already departed from the thinking behind the 1954 Act.

Be that as it may, the sole theoretical power of Parliament is that once every two years we can reduce the note issue—not by 1 per cent. or 2 per cent. or 5 per cent. or 10 per cent.—but to the 1954 figure of £1,575 million. Today, that would imply a reduction of about 75 per cent. It is a power so inflexibly Draconian as to be virtually unusable. So much then for the pretence in which Treasury Ministers persist, that Parliament has retained control over the growth of the note issue.

But the 1954 Act was in many ways an anachronoism at the time that it was made law. Before the First World War, when we were on the gold standard, the size of the fiduciary note issue at least measured the extent to which the Government of the day departed from that, on the whole, highly beneficient standard. It was right that Parliament should be required to approve the scale of any such departure. But by 1954 we had long since left the gold standard, and the extent of the Government's departure from it was no longer susceptible to measurement because it was total. That in no way abated the importance of monetary policy, above all if inflation were to be avoided, and the note issue was obviously the most basic form of money, so that it was wholly logical that during the brief Committee stage of the 1954 Bill my right hon and noble Friend, Lord Boyd-Carpenter, then the present Financial Secretary's predecessor by several removes in that important position, discussing the sort of Order we have before us, should have said: … an Order of this kind may give a considerable opportunity for debate in either House, not with the intention of solemnly reducing the size of the fiduciary issue by an arbitrary act, but to allow analysis of the policy of the Government. That would be most conveniently effected on this Order."—[Official Report, 26th January 1954; Vol. 522, c. 1691.] That is our purpose tonight—to ask some fundamental questions about Government monetary policy. It is a striking fact that despite the undoubted importance of monetary policy, which is conceded, at least in principle, by the Chancellor of the Exchequer, there is no other significant opportunity to debate it in the entire parliamentary calendar. This is the only time we have.

Thus, for example, in 1971, when the Bank of England promulgated, with the approval of the Treasury, the crucially important new doctrine of Competition and Credit Control, so far as I know it was not debated in this House, nor, incidentally, if I may say so, did the Labour Party take the opportunity presented by the 1972 predecessor to the present Order to instigate any kind of debate on monetary policy in general or on Competition and Credit Control in particular.

But before raising the wider issues, we should pause for a moment to consider the views of the small but dogged minority who hold that inflation could be brought under control simply by curbing the size of the note issue itself. In its most logical and literal sense, that proposition is palpably mistaken. If, overnight, all who worked were paid by cheque and all who went shopping paid by credit card, there would be a sharp drop in the demand for banknotes demand and this is the size of the note issue, but inflation would be in no way abated.

The orthodox view that the size of the note issue is essentially a symptom rather than the cause of inflation is strictly correct, but the standard Treasury objection to the note issue school is surely overstated, because it is hard to hold that the note issue is of no importance whatever and then to maintain, as was maintained by Lord Boyd-Carpenter on Second Reading of the 1954 Bill, on 3rd December 1953 that the consequences of the annulment of a Treasury order raising the level of the note issue could be very serious. It is, of course, clear that if we were to allow such a thing to happen it might cause quite a considerable dislocation of business."—[Official Report, 3rd December 1953; Vol. 521, c. 1379.] Therefore, it does not seem that the note issue is of no importance whatever. It is clear that if that sort of thing is a consequence, it is something which might lead a Treasury and a Government to think twice before inflating the money supply.

It seems to me that the real reason for the persistent Government hostility to parliamentary control of the note issue is, at bottom, a hostility to any parliamentary control over any form of monetary policy. Parliamentary control over monetary policy means in practice that the policy would be expected to follow certain rules, whether they be rules of the gold standard or rules for a certain increase in the money supply as propounded by Professor Friedman or in the ideas of Professor Hayek. Parliament would be asked to approve derogations from these rules in exceptional circumstances.

The question at the bottom of this is whether the Government are prepared to accept any external constraints on their actions on monetary matters. That probably applies to a wide area than just monetary policy. However, if the desirability of parliamentary control were conceded, the problem of the inadequacy of the note issue as the prime method of control could of course be met.

The Macmillan Report in 1931 said, in paragraph 323, an expansion in the active note issue is likely to be a result of active trade ensuing with an apppreciable interval after an expansion in the Bank's —that is the Bank of England— deposits. Thus it is the latter which is now the factor of dominating importance, and the somewhat anomalous position arises that while the Bank is not regulated by law in respect of its deposits it remains so regulated in respect of the note issue". There is nothing to stop the Financial Secretary suggesting that perhaps it might be the clearing bank deposits with the Bank of England which should be subject to regulation because that is a more important kind of cash than the note issue. Perhaps the hon. Gentleman will give us his views on that policy and on the alternative suggestion put forward on the Second Reading of the Currency and Bank Notes Bill by the right hon. Member for Battersea, North (Mr. Jay) who is a distinguished former City editor. I am sure that the Financial Secretary believes that as such the right hon. Gentleman should be listened to. He said, We cannot, of course, in this Bill establish the same Parliamentary control over bank credit as we have over the note issue. But I cannot help thinking that the whole question of the control of bank credit is one which Parliament may have to examine in the future."—[Official Report, 3rd December 1953; Vol. 521, c. 1375.] The Treasury has had a little over 22 years since then to think over the ways in which Parliament might exercise this control. I should be grateful if the hon. Gentleman would give us the benefit of the Treasury's ponderings on this matter.

At present control of the money supply is left entirely at the discretion of the Government. The case for the motion is that the Government have failed to come clean about their intentions on how they propose to exercise that discretion and by what rules and guide lines. We do not know what the Government are seeking to control. We know that they are concerned with controlling the money supply—or so they say—but we do not know whether they are satisfied with the control of bank credit.

Many people have looked at this matter very carefully. Professor Laidler is one. I draw the Financial Secretary's attention to the evidence which he gave on 7th April last year to the Expenditure Committee when he said that the absence of control—I shall paraphrase his words in order to save time—of bank deposits through the old cash ratio, and its replacement by a much more complicated system, led to a much reduced control of the creation of money in the banking system by the Bank of England. He felt that a monetary policy and control of the money supply could not be regained until we had something much closer to the old system of cash ratio control of the joint stock banks.

Indeed, that is considered as very important in the United States where it is sometimes called high-powered money or the monetary base. I know that the hon. Member for Stoke-on-Trent, Central (Mr. Cant) is an expert on this matter, and he will no doubt contribute to the debate and tell us more about it.

I should like to know whether the Government believe that this form of money—high-powered money, which is basically the notes in private circulation and the banks' deposits at the Bank of England—is what needs to be controlled. Indeed, is the Financial Secretary satisfied with the present system of controlling the money-creating mechanism of the clearing banks?

If the hon. Gentleman does not consider that a worry, the question still remains—what do the Government believe is the most important of the monetary aggregates? Is it Ml? Is it M3? Is it M2, which is not even published, although I notice that Messrs. Greenwells, in their latest bulletin, say that it is the most important and that it should be looked at and, indeed, published? Is it a mixture or an average of the three? By what yardstick do the Government judge whether their monetary policy is right or wrong? Do they look at the growth of the money supply in monetary or in real terms adjusted for the rate of inflation?

In the United States the Federal Reserve is required by law to publish its precise monetary objectives both in general and for the coming year. That might not be a bad idea here, too.

In the meantime, will the Financial Secretary tell the House what the Government's objectives are in precise terms? What is the target rate of growth of the money supply for the coming year? If the hon. Gentleman is not prepared to tell the House—I hope that he will—I feel sure that, before long, he will be asked to spell it out to the International Monetary Fund.

Does the sharp increase in the growth of the money supply last month to between 8 per cent. and 16 per cent. at an annual rate, depending on what monetary aggregate one takes, represent a change of policy? Is this rate of growth of the money supply to be continued? If not, what is to happen?

I think that Parliament is entitled to put these questions and to have them answered. We are talking about something of central importance. We are talking about the Government's monopoly to print money, which is of the essence of sovereignty and nationhood. We are talking about parliamentary control of the creation of money, which is the historic essence of Parliament's power and the traditional source of that power. Indeed, we are talking about the struggle against inflation, which I think right hon. and hon. Members on both sides of the House are agreed is the most important issue facing this country at present.

I think that we would be entitled to answers to all these questions at any time, but particularly now when we have an unprecedented public sector borrowing requirement. I do not know what it will be, but it looks as though it will be at least £10,000 million in the year that is now drawing to an end and probably about £12,000 million next year. This huge borrowing requirement is the inflationary, money creating, potential in the system. The frightening point is that how much of that is financed by genuine borrowing and how much is financed by the creation of money is, to a large extent, outside the Government's control.

Although the Government may genuinely say that they are prepared, whatever the conditions, to borrow sufficient to pursue a non-inflationary money supply policy, that may mean pushing up interest rates to such a level that they would not be able to go through with it, and, even if they were to go through with it, the policy would totally kill any hope of private investment. They are therefore in a situation that is fundamentally out of control, and out of control because of this vast inflationary overhang which the PSBR represents.

I have asked a number of questions. I hope that the Financial Secretary will answer them as precisely as possible. As for those that he cannot answer—and there may be one or two—it is essential that they are answered, and in terms, by the Chancellor of the Exchequer, fortified by his 38 votes, in the Budget Statement on Tuesday. I hope that the Financial Secretary will ask his right hon. Friend to answer any questions that he himself may be unable to answer tonight, because if there is to be any confidence, either at home or overseas, that the Government know what they are doing in the all-important battle against inflation, Parliament must be given an answer to these questions, which hitherto we have not received.

2.12 a.m.

Mr. R. B. Cant (Stoke-on-Trent, Central)

I am an extremely moderate and reasonable man. I always find the speeches of the hon. Member for Blaby (Mr. Lawson) so charming and attractive, but tonight I cannot bring myself to start my speech in the way that I would have liked. To put it mildly, it is a piece of gross impertinence on the part of the hon. Member to make the statement that he has made, although it has been learned, comprehensive and so forth, without reminding the House that to a very large extent our troubles in the context of general inflation, as well as in other economic ways, have arisen because of the policies, which I suppose we can call only by the phrase "dashes for growth", undertaken by Conservative Governments in 1963 and in 1971–72.

I say that because I think that history teaches us that once certain things happen in social and economic history, it is difficult to recover the past. This happens in connection with such things as levels of social expenditure, whether these are associated with wars, or general periods of rising expectations, and so on. We can reach the peaks, but we find it extremely difficult to descend from those in terms of expenditure. Similarly, it is so easy to generate a level of inflation and it is so difficult to get back to any sort of normal experience in this context.

Having said that, I want to make the point that for some years now I have been one of an esoteric band of people who have attached some significance to the fact that money stock, defined in one way or another, is important in the development of an economy. I know that this presents all sorts of difficulties of definition, and I do not want to enter into any detailed discussion of these particular questions. I merely accept the fact that if one argues that money stock is relevant, one must go on to talk about the importance, if one is arguing in a positive and dynamic sense, of the money supply being related not only to inflation but to the whole level of production and economic activity. This brings into question all sorts of problems relating to the velocity of circulation, monetary lags and whether or not at any given moment certain developments are significant for the money supply. Difficulties are presented, to which the hon. Gentleman has referred, as regards M1, M2 and M3.

In our postbags this morning we received a rather primitive graph from an organisation called RSI which was well designed to prove a certain point. It demonstrates in basic figures that since 1954 the cost of living index has increased three and a half times and that the issue of bank notes, whether they be fiduciary or any other sort, has also increased three and a half times. It may be the most obvious conclusion that there is a fundamental relationship to which we should cling and that we should not get involved in all the later developments. Clearly those developments pose problems.

Is it adequate to think in terms of M1 and M3? Even they tell us a different story from time to time. Some say that we should expand. Some of the City institutions have indicated that we should introduce M2 because in these days the measure of liquidity that is implicit is much more significant and, therefore, much more relevant.

We have also to decide exactly what we are to do about bringing into the equation the impact of our balance of payments experience and our overseas borrowing. Learned people can prove that most of those matters, including the financing of balance of payments deficits and external borrowing, do not have a bearing on the money supply unless the person holding the debt of a current transaction happens to want it repaid in foreign currency. But without doubt that introduces another dimension into the whole area of the discussion if we are thinking about the impact of money supply on the development of the economy.

Mr. Ron Thomas (Bristol, North-West)

Will my hon. Friend say a little more about the velocity of circulation? Most of the studies that have been carried out suggest that there are difficulties in predicting what the velocity is or will be and in trying to predict the range. The difficulties are such that it becomes an economic tool which is not useless but pretty close to being useless.

Mr. Cant

This is one of the problems. There are certain purist exponents of the theory who argue that the velocity of circulation in the light of the history of some countries, especially of the United States, would appear to be much more of a constant than it is in other areas. That is a fascinating and rather crucial consideration when we are thinking of the relevance of this point. However, in view of the late hour, I shall move on to one other point.

Even in this country where it is difficult to apply monetary data, I believe that we should try to follow the Americans a little more closely than we do in regard to the announcement of monetary targets. I realise that there are great difficulties in that respect for a reason which I shall mention in a moment. But if we do not do so, our policy will be apt to get into a state in which we shall not know where we are going.

A number of hon. Members mentioned our old friend, the public sector borrowing requirement. There is not the slightest doubt that we have a problem in that respect. If we assume that part of the problem is pure capital financing and assume that another part of the public sector borrowing requirement is related to this period of "slump-flation", a phenomenon that will disappear when we get out of these difficulties, we shall still have half of the £12 billion to which the hon. Member for Blaby referred as the inflationary overhang.

Again, without doubt, the Chancellor of the Exchequer is sustained in his battle against inflation by the peculiar savings ratio which has emerged in most industrial countries—surprising economists because they are still trying to find a reason for it. If there were any significant change in the situation, the Chancellor's problems would be very much greater. When he was asked about this on television or radio recently, he said "If that happened, I would feel very much like somebody who saw his mother-in-law driving his new car over the cliffs of Dover. It would be as frightening an experience as that." Yet in the immediate future this is something that might be of considerable importance.

What will my hon. Friend the Financial Secretary do about the situation? How far is it true that the increase in the February figures is due to the fact that the Chancellor of the Exchequer ran into a situation where he did not know what to do? He decided to stop issuing gilt-edged securities for a considerable time, but then in February he increased his borrowing through the banking system. Is there any connection between the increase in bank borrowing and the increase in money supply—or was this a calculated risk in which he wanted to see the pound sterling depreciated? Was one of the ways in which he thought he might achieve that end—apart from the bungling by the Bank of England, not by the Treasury, of course—to let the rate of interest fall?

The Chancellor faces a fundamental dilemma. This is a great problem. One does not just pursue one target rigorously and devotedly in money supply, saying "There is another aspect of the problem. We must either reduce the rate of interest or lean on it to get it rather higher so that our public sector borrowing finance will be eased". I shall not continue on that score because I know that many other hon. Members wish to take part in the debate.

We should thank the Opposition for this debate because it is one of the rare occasions on which we can discuss more fundamental matters than merely adjusting tax rates up or down a little, even though social justice requires such action. We are faced with a difficult situation, but one thing is certain. If the future unfolds in such a way that the money supply increases beyond our control, that future will be less happy and bright than it would otherwise have been.

2.25 a.m.

Mr. J. Enoch Powell (Down, South)

The thoughful and expert speech of the hon. Member for Stoke-on-Trent, Central (Mr. Cant) has revealed that, once we turn over the stone of the fiduciary issue, we uncover one of the entrances to the underworld of not merely monetary but also economic policy and management.

Before I descend one or two steps into that underworld, it would be wrong of me to allow the occasion to pass without an acknowledgement of the appearance at the Dispatch Box of the hon. Member for Blaby (Mr. Lawson) to deliver a characteristically lucid and interesting speech. I am sure that it is because of his speech that, even at this hour, there is a attentive, if small, attendance. I trust that his appearance at that Box, even at this hour, is not due to the proverbial fact that when the cat is away, the mice play, but rather portends something of a more permanent character which we may be able to enjoy at what are conventionally described as more reasonable hours.

As the hon. Member for Blaby pointed out, this occasion is somewhat of a curiosity in a number of respects. The fact that we are praying against an Order out of hours is another reminder of the manner in which the House has addled its procedure by a Standing Order first adopted in 1954. The present Lord Boyle of Handsworth and I argued against it then on the ground that, by snatching at an apparently attractive means of lightening our burden in the late or early hours, we should find sooner or later—and we have found it so for many years now—that the House was solemnly enacting a power to pray against subordinate legislation and then, by that Standing Order, depriving itself of the practical possibility of doing so, or at least depriving itself of that possibility with the able co-operation of the Government Whips. Sooner or later—and better sooner—we shall have to review the rather self-insulting manner in which we find ourselves unable to provide the opportunity envisaged by statute for debating and, if necessary, coming to a decision on subordinate legislation.

This Order is a curiosity in other respects. Long years have passed since anyone in this House held that the control exercised over the fiduciary issue had any practical leverage effect upon inflation, the economy or the operations of the Treasury. The hon. Member for Blaby pointed out the grotesque fact that, having 6,000 million currency notes in circulation, we solemnly consider every two years whether we ought to revert to a circulation of 1,500 million notes. This is based on legislation from 1954, and one is brought up sharply by the realisation that in 1954 it did not seem so grotesque to envisage that inflation might not be an on-going, accelerating phenomenon, but might be a fluctuating phenomenon.

The implication behind the provision which presents us with this Order is that upon the whole one would expect that the increase in the money supply would be a fluctuating rather than an on-going phenomenon, so different has experience in the last 22 years been from the environment in which one can recall we were still living in the first half of the 1960s. The year 1954 is not far from 1957. The Financial Secretary to the Treasury is to reply to the debate, and in 1957, as Financial Secretary to the Treasury, I was a member of what the hon. Member for Blaby in a slightly different context called a small but dogged minority who asserted, amid peals of mocking laughter from all the best people, that perhaps money supply had something to do with inflation. This was dismissed as mere illiteracy. Presently the Radcliffe Report appeared, to explain that as velocity "V" was infinite there was no point in worrying about "M".

That tune is not played nowadays. Misusing that much misused model phrase, one might almost venture to say that we are all monetarists now, at any rate at some times and to some extent. One of the many new monetarists—one of the classic new monetarists—is the Prime Minister who, to his very latest moment, has rejoiced on Tuesdays and Thursdays in reminding the House of Commons that under the previous Conservative Administration, with disastrously inflationary consequences, the net borrowing requirement which they had allowed to emerge was financed by printing money. No one is a more strict monetarist than is the outgoing Prime Minister when he is engaged in that hunt.

In the fiduciary issue, this tiny proportion of the total sum of money, however defined, we are contemplating the tombstone of past inflation. We are contemplating the outer ring upon the sand of the advancing tide of inflation. How apt was the hon. Member for Stoke-on-Trent, Central when he reminded us of the wretched phenomenon—with which we seem to live in this aspect, as in so many aspects, of modern experience—of a one-way pendulum in public expenditure, net borrowing requirement, perhaps the money supply, inflation itself. It seems to swing only in one direction.

No one would seriously imagine that, summoning the utmost resources of opposition, we would go into the Lobby tonight to force the fiduciary issue back to the £1,500 million limit of 1954 with the notion that that would be a limit and control upon inflation. One might as well try to turn a flood back to its source by baling out the furthest drops as it flowed down to the foot of the hills, for the fiduciary issue is the ultimate deposit of the initial causes of monetary expansion. That is why the debate has, rightly, brought us to the question of the cause and the mechanics of monetary expansion.

Adding to the tasks which have already been prescribed for the Fiancial Secretary, I hope that he will give a brief child's guide to the real mechanism which lies behind the process which we all gaily describe and think we understand as "printing money". "They printed money", says the Prime Minister, pointing a minatory finger at the Opposition. The net borrowing requirement brings with it, we all say, a constant threat that the Government will be forced into printing money.

There ought to be a little clearer understanding, even in this place, of the process of the monetisation of debt—the process whereby the borrowing of Government from the banking system produces ultimately the result of an expansion of money, and proportionately of the fiduciary issue. It ought to be better understood, and more often explained from the Treasury Bench, than it is.

May I, incidentally—and coming again to a point made by the hon. Member for Stoke-on-Trent, Central—say that the hon. Member's observation, anent the graph which so many of us have—that we might almost as well have done the exercise on the fiduciary issue as bother about Ml, M2 or M3—is very pertinent. Probably it is related to the fact that there is a fairly constant relationship between the cash requirement and the total money stock. Still, it is curious, and perhaps humbling, that this crude and visible evidence of monetary expansion seems quite adequately to obey the relationships which would be expected of much more subtle magnitudes measured with much greater difficulty.

The hon. Member for Blaby, having acknowledged, as we all acknowledge, that this antiquarian Order is no way for this House to control the immensely important factor of money, proceeded to ask where, then, this House ought to exercise control, for we would hardly say that we are successfully exercising it. Maybe we would have opted for inflation even if we were exercising control, but we all know that we did not opt. We all knew and know that we have not been exercising control. At what point, therefore, ought we to seek to exercise it?

Next week the Chancellor of the Exchequer will come forward with the revelation, only vouchsafed once or at most twice a year, of the anticipated net borrowing requirement. But between the net borrowing requirement and the monetisation of debt, which lies at the fountain of the money stream, there lie quite a number of variables—and not only the variable of "V", velocity, which, I quite agree with the hon. Member, will not always remain as dormant as it has conveniently been for almost the whole of the time since the Radcliffe Committee hailed it as another version of infinity—including the ability of the Government, unforeseeable, as the hon. Member for Stoke-on-Trent, Central said, almost from one week to another, to borrow otherwise than from the banking system. That is another factor by which that gap is populated.

It seems to me that, if we are to seek to exercise a rational control, many ancient and hallowed conventions about what the Treasury will and will not discuss have to go by the board. We are all indoctrinated with this attitude, and every Financial Secretary to the Treasury is warned about telling people in the House of Commons anything about the prospects of borrowing money. "Why, we do not even dare to tell you", they say, "in case you might blab it out in the House of Commons. If those people in the House of Commons were to get to know, and it spilt out of the House of Commons into the outside world, Heaven help us. We might not be able to borrow at all, or at least we might be so gravely impeded in the secret processes—so complex, so expert, so top-hatted, that we could hardly bring an understanding of them to the comprehension even of the Financial Secretary—that all these processes might be reduced to ruin. So we had better say nothing about it."

All the year long, from one Budget to another, month after month, amid all the rumours of £3,000 million more or £3,000 million less, the Treasury, the Chancellor of the Exchequer and the Bank of England remain totally mum as to what is really going on. We discover only ex post facto, and long post facto, that they have been able to borrow, apparently, from the public and perhaps from the sheikhs on a far huger scale than they themselves had anticipated.

The correct answer to the crucial question which the hon. Gentleman posed lies somewhere in this area. If there is to be any control by this House over the processes which cause inflation, whether we want it or not, and if, therefore, those processes are to be understood by those whom we represent—for our function is not least a function of explanation, of manifestation—these secret areas, these hidden realms of what is going on in the Government's finances, have to be exposed to parliamentary scrutiny and have to be continuously kept under review.

I am not convinced of this disaster which would follow if we were to know what the Bank of England knows about the way in which, from week to week and from month to month, the root causes of the expansion of money and, therefore, of inflation are moving, one way or the other. All the time, from one century to the next, the House of Commons, having got its grip on one aspect of government, then discovers that that aspect has lost its importance and it has therefore lost its grip upon government and goes searching for what really matters in the new era so that it can shift its grip into that area.

I hope that this debate, which is rather a historical one retrospectively, may also be a historial debate prospectively, in that from now onwards in our various ways—we have our channels and our methods in this House—we can resolve that, not in this formal, meaningless, ineffective way, but effectively by getting to grips with the upper end of the monetary mechanism and by insisting that this cannot be kept secret from the House of Commons, since it is of the essence of the monetary and economic experience of the nation, the House of Commons shall regain a power of control which it has lost.

2.44 a.m.

Mr. Ron Thomas (Bristol, Northwest)

I agree with the closing remarks of the right hon. Member for Down, South (Mr. Powell) about this House and its lack of control or investigatory powers vis-à-vis the Treasury. I am one of those who find the working of the Bank of England and the Treasury to be completely outside any kind of democratic control or democratic inquiry.

I find that in the Bank of England's handling of sterling and the depreciation of sterling, which cuts living standards by hundreds of millions of pounds, there does not seem to be any opportunity in this House to discuss reasons, to discuss who does it, the involvement of the Chancellor of the Exchequer in that, and so on. At the same time, I have found this debate very interesting. I hope that we will have a further opportunity to go into some of these arguments about what generates inflation in much more detail.

I listened to the hon. Member for Blaby (Mr. Lawson) with some interest. If he does not mind my saying so, I tend to think that he seems to have a faith in simple models of what does and does not create inflation. He mentioned, for example, the gold standard. As far as I can judge the studies I have read on this, they simply add up to a statement that the gold standard worked because it did not operate in the way that everyone said it would or should.

The hon. Member raised the question of credit creation prior to the changes which led to competition, and so on, in this area. Anyone who has studied economics knows of the simple model of the liquidity ratios of the banks and their ability to create credit 12½ times those liquidity ratios. I am one of those cynics who believe that that simple model was about as helpful as the simple model we had for the gold standard.

The right hon. Member for Down, South mentioned the Radcliffe Report on velocity of circulation. I am sure that we could have a long debate on that subject. I remind the right hon. Member, respectfully, that the Radcliffe Report also suggested that, within limits, however much we attempt to reduce the money supply, those who require the funds will get them from somewhere. As I remember the Radcliffe Report, it had a lot to say about trade credit and a reduction in money and credit supply in the general sense. I do not know whether people have suggested that expansion of M1 or M3 has anything to do with inflation. I get the impression that what people have said is that it does not play the kind of primary role that the right hon. Member says it plays.

Taking the difficulties of definition of what we mean by M1 and M3 and the difficulty of trying to predict in terms of velocity of circulation, which can change quickly, and bearing in mind what I have tried to say about Radcliffe suggesting that other forms of funds, whether credit or loans between buyers and sellers would be found if we restricted the money or credit supply, we are not offered a valuable economic tool. I know that it will be said "OK. If you squeeze the money supply sufficiently something is bound to happen." It is a bit like the Phillips curve on unemployment. First, Phillips was telling us that 800,000 unemployed would reduce wage claims. Now I suppose that Phillips would tell us that it needs perhaps 3 million or 4 million. If we push it far enough and everyone is unemployed, I take it that wage claims will stop altogether.

I am glad that my hon. Friend the Member for Stoke-on-Trent, Central (Mr. Cant) raised the question of the public sector borrowing requirement. If we are making a comparison between two periods I suggest that it is legitimate to up the public sector borrowing requirement in terms of inflation anyway.

We have a crazy, indefensible, economic capitalist system which is paying out £3,000 million or £4,000 million a year to keep people unemployed. It is strange that when the public sector—which accounts for between 42 per cent. and 45 per cent. of the gross domestic capital formation—borrows money to do it, it is regarded as wrong, but if the private sector borrows money everyone claps his hands. If we read tomorrow that ICI wanted to borrow £500 million to build a power station, everyone would say "Damned good show" and "Good luck to them." A high proportion of the public sector borrowing requirement is for capital investment. It is not legitimate to condemn that and to applaud it when it happens in the private sector.

I hope that we shall have a further oportunity to discuss monetary policy and its effect on inflation, because the mechanism of the relationship between the creation of money and inflation has never been satisfactorily explained to me. I can understand that when the pound is devalued by about 34 per cent., import prices, the cost of raw materials and production are pushed up. I can understand that firms work below capacity when unit costs rise, because of the capital they have to service. But I have never heard a satisfactory explanation of the mechanism of the relationship between the fiduciary issue and the level of inflation—between credit expansion and the level of inflation, and of the effect on real resources, increases in imports, and so on.

2.54 a.m.

Mr. Nicholas Ridley (Cirencester and Tewkesbury)

I add my congratulations to my hon. Friend the Member for Blaby (Mr. Lawson) who made his first appearance on the Front Bench, albeit it is April Fools' Day. I am certain that we will hear more from him from that position. I agree with everything he said in his excellent speech.

The debate has been mainly about monetary policy, with which I wish to deal. I must add a word of protest about the mechanism available to us to deal with the control of the fiduciary issue. Now that inflation has been running at much higher levels—it is going down now, but it may become much worse in the future—it is not satisfactory to pass an Order, at nearly 3 o'clock in the morning, allowing the Treasury two more years free of any control over the money it prints.

If we used that treatment for public expenditure—the idea of an Order every two years providing that the Treasury may spend as much over the Estimates it it likes, provided it obtains another Order in two years' time—it would not be control, and this is not control. The House was wrong to be lulled into accepting the procedure in the 1954 Act. It is necessary to think deeply about the question where the controls should lie. The right hon. Member for Down, South (Mr. Powell) said a certain amount about this.

One opportunity for control was provided by the debate on the Public Expenditure White Paper. The curious thing about that was that the Government were defeated, by a strange alliance of some who wanted public expenditure to be higher and some who wanted it to be lower, but nothing happened.

We must have some form of control. I believe that the Government are seeking more and more to have "take note" motions, and motions not directly giving control to the House. Control should start with an insistence on motions which have effect if passed, and with hon. Members using their votes to secure that they are passed; otherwise, we shall allow this sort of sloppy procedural device to go through.

The Order is being debated on a sloppy procedural basis, because even if the motion were carried it would not control the fiduciary issue. It is just a statement of opinion that the Order should be withdrawn. It does not mean that it would be withdrawn if passed, or that the Order would have to be negatived, in any sense. It is not a control mechanism; it is simply a peg upon which to hang a debate.

The question how many notes are printed is often assumed to be almost irrelevant, because it is only one factor in the growth of the money supply. We are told that the number of notes that have to be printed is simply a matter of how many will be demanded by the public—that whatever they require we must supply. I am not sure that that is entirely true. I think that there can be some control on the note issue. I hope that the Financial Secretary will say something about the inter-relationship between inflation caused through the printing of notes and inflation caused through the extension of bank credit.

I imagine that the much greater use of cash for paying wages and contracts throughout society, in order to help people to avoid their taxes, is one of the reasons why the note issue is so high. If the hon. Member for Stoke-on-Trent, Central (Mr. Cant) studies the graph he will see that the tendency has been for the note issue to exceed the growth of the retail price index.

One of the things that frighten me is that it does not matter which candidate wins the Labour Party leadership election, because as far as I can work out their constituencies are equi-distant from the new Royal Mint, so that there is likely to be heavy pressure for extra employment in that area from the new Prime Minister, which could produce a much greater fiduciary note issue.

I come to the main argument about the relationship between the increase in the money supply and the way in which it causes inflation. I should like to answer the question of the hon. Member for Bristol, North-West (Mr. Thomas).

The right hon. Member for Down, South asked the Financial Secretary to explain the process. That was naive of the right hon. Gentleman. One should never expect a Treasury Minister to explain anything. That is the last thing a Government would undertake to do. That would destroy their whole secret case, which the right hon. Gentleman described so accurately. I must therefore take it upon myself to explain this for the Financial Secretary, because I am sure that he will not do it for us.

If, today, the Government require £50 million because their expenditure is heavier than their income, they must seek to borrow what they can. Perhaps they borrow £10 million. They borrow the net deficiency of £40 million from the banks, giving the banks an IOU of some sort in exchange. They spend it. The money goes to every sort of person, all over the economy—to teachers, road builders, suppliers of weapons, civil servants. They either spend it in shops or they bank it. If the former, the shops bank it. Wherever it goes, it is banked. Within 48 hours that £40 million has found its way from the banks to the Treasury, back into the private sector and back into the banks again.

So the banks are no worse off. The £40 million they gave to the Government has come back into the banks and, in addition, they have a piece of paper which says, "IOU £40 million: Signed Denis Healey." Upon that they may then extend credit to the private sector to an equivalent amount, depending on the ratio. That is the answer to the hon. Member for Bristol, North-West.

Whether we consider our present system of credit extension, or the printing of notes, or the cutting of corners off gold and silver coins—which is how it was done in Roman times, and earlier—we see that this has been a standard practice throughout all history. The method adopted is a mere technicality.

We cannot stop inflation by controlling the money supply, simply because the causes of inflation are infinitely more political and deep-seated than some mere technical device. The technical mechanism is easy to understand, but it is not part of my case that simply by not doing this in some curious way one can succeed. First of all we must face the fact that on that day £40 million is going out which does not exist. That is the cause of inflation. It is not the fact that the credit base has to be extended. The cause of inflation is trying to use resources that do not exist.

I do not know what the hon. Member for Bristol North-West did a fortnight ago on the public expenditure White Paper, but I suspect that he may have been one of those who did not give it his full support. Perhaps he would like to keep quiet about that; we can always look it up. But whatever his position, it was the hon. Members who sat on the Government Benches that night who voted for a higher rate of inflation. It was Opposition Members who tried to say that the expenditure was too great—who were voting for a reduction in inflation.

Mr. Ron Thomas

There still seems to me to be a gap left. When we talk of inflation we mean rising prices. [HON. MEMBERS: "No."] We do not mean rising prices? If this £40 million is coming out and prices do not alter or fall, we have an inflationary situation. I always thought that inflation was defined as rising prices. I wonder how the extra £40 million the hon. Member spoke of has pushed up prices?

Mr. Ridley

The problem is that inflation is not rising prices but falling value of money—the price of an article going up with the depressed value of money. The gap arises from the extra credit created at the bank which is used by people to buy things, thereby putting up the price because there is more money about.

Mr. Durant (Reading, North)

Does my hon. Friend agree that the IOU for £40 million is also used by the Government again?

Mr. Ridley

I do not entirely agree with that, except that they do this every day—but perhaps we shall hear the Financial Secretary's comments on that situation, although I doubt whether those comments will be as full and as frank as mine.

3.7 a.m.

The Financial Secretary to the Treasury (Mr. Robert Sheldon)

I had hoped to be as full and as frank as time permitted, but the time available is not enough to do as much as I should like, let alone as much as hon. Members opposite would wish. I shall start by saying something about the fiduciary issue. [HON. MEMBERS: "No."] I understand that reaction, but for the sake of the record and for hon. Members who may follow the example of the hon. Member for Blaby (Mr. Lawson) in looking up references in Hansard, one or two comments should be enough.

First, I congratulate the hon. Member for Blaby on his first appearance at the Dispatch Box. It is fitting that he should be talking on this subject.

The only thing that I want to say about the fiduciary issue is that, as I see it, it is there merely to reflect the demand of individuals and companies for the cash they require. If authorisation were not to be given in the way that the Order provides, and the bank notes consequently were not made available, that cash would be made available in other ways. Cheques would circulate instead of cash and their mechanisms would bypass the ordinary mechanisms we have. It is a fitting comment that banknotes have been called the small change of the monetary system. That is what they are. There used to be gold in the Issue Department before the war to back part of the note issue, but now all the gold is in the Exchange Equalisation Account and the fiduciary issue is to all intents and purposes equal to the total note issue.

That is all I wish to say on fiduciary issue, because I see from the comments of the hon. Member for Blaby, where he brought into play the comments of Lord Boyd-Carpenter, that he sought some respectable justification in the analysis of policy which Lord Boyd-Carpenter, when he was Financial Secretary, gave, in calling for a wider debate on these matters.

I might start by saying something about the various definitions of money. M1 was not mentioned much, and I was a little surprised, because, after all, it was the right hon. Lady the Leader of the Opposition who, on one occasion in particular, referred to poor figures in M1 in one quarter and based her comments on that. I am sure that the hon. Member for Blaby is more sophisticated in his economic knowledge and understanding of these matters than she was on that occasion, and this discussion has been largely based on M3, with one or two comments on M2.

I did not hear many comments on Ml, and for very good reason. Although it represents money in its most tangible form, that is not enough, and M3, which represents notes and coin plus bank deposits in general, is a much better guide to money supply. The Conservatives have been casting anxious looks at the way in which we restrict the definitions of money to these one or two methods of computation. M2 should be excluded. It is unrealistic to leave out deposit accounts in general, and once that point is passed it will be difficult to draw the line.

I was surprised that my hon. friend the Member for Stoke-on-Trent, Central (Mr. Cant), whom I always respect in these matters, did not discuss the merits of M4 and M5, but there are difficulties here. Clearly the deposits in building societies and trustee savings banks have their effect, and it is difficult to find one measure of monetary stock to meet all requirements. M3 is probably the best we shall have for quite a while, although I note its limitations.

The hon. Member for Blaby talked about the high level of the public sector borrowing requirement and the difficulty of making room for investment. We had a discussion on this in the debate on the public expenditure White Paper. One of the main reasons for the reduction in the increase in public expenditure is to make room for that level of expenditure in investment. That point, as it applies to a number of other factors, will be discussed in the Budget Statement and in the debates upon that statement next week.

Mr. Lawson

What are the Government's monetary objectives in the sort of terms that the Federal Reserve is required by law to spell out in the United States'.' As the hon. Member for Stoke-on-Trent, Central (Mr. Cant) said, it would be highly desirable for this to be revealed.

Mr. Sheldon

I find it difficult to make the kind of comparison with the United States that many others seem to make so readily. Our system is different, but in terms of the objective—no doubt my right hon. Friend the Chancellor will be dealing with this next week—there are no fixed rules—[Interruption.] If hon. Gentlemen want fixed rules they must accept a fixed indicator, too, to provide the definitions they want. I have tried to point out the deficiencies of these various indicators. There are no fixed rules determining the maximum growth in the money supply which is compatible with avoiding inflationary pressures. As my right hon. Friend said in his Mansion House speech in October 1975: However, I would not want to see that growth over any sustained period exceed the rate at which money GDP was increasing. This is what has been happening. In the period February 1975 to February 1976, M3 grew by 9 per cent. That is well below the increase in money GDP. From February 1973 to February 1974, M3 grew by 27 per cent. That was the printing of money which was universally deplored, not least by my right hon. Friend the Prime Minister.

Mr. Lawson

Not at the time.

Mr. Sheldon

The printing of money takes a little time to permeate the consciousness of us all. I do not think that anyone knew precisely at the time that money was being printed.

Mr. Ridley rose—

Mr. Sheldon

The hon. Gentleman took up so much of my time that, as I have only three minutes left, I shall not give way to him. A number of questions were put to me. Therefore, I think that I have at least the right of reply and perhaps the chance to answer some of those questions.

The right hon. Member for Down, South (Mr. Powell) asked for some simple definitions. One such attempt was made by the hon. Member for Cirencester and Tewkesbury (Mr. Ridley). I shall attempt another. My definition or explanation of the process of printing money is that the money is provided by the banks in the form of loans. The Government allow the banks to lend money—and in effect that is printing it—by borrowing from the banks the residual amount needed to finance the public sector borrowing requirement. Looking at the monetary theory, we see a whole dependence on liquidity and the relevance of it to spending decisions.

The definition is concerned with what constitutes liquidity. We know that people with money in their pockets tend to spend more than if they have little money in their pockets. The precise relationship between people's spending and the amount of money they have in their pockets and in their banks and reserves is a complex matter. We are discussing some sociological phenomena of extreme importance, and there is difficulty in understanding the connection in the way propounded by my hon. Friend the Member for Bristol, North-West (Mr. Thomas).

I think that we are all, to a greater or lesser extent, convinced by the monetary theory in so far as we believe that the amount of money we possess has some influence on our actions. There are those who are divided on the one side by the knowledge of this influence, but who are unable to ascertain the precise relationship which others see more readily and base their theories upon.

The hon. Member for Blaby asked for a definition of the mechanism between the creation of money and inflation. The only definition that I can give is the one that I have attempted so far—the one which guides Government policy—which is to increase the level of money stock in broad line with the increase in money GDP. I do not think that I can go very much further than that.

The hon. Member for Cirencester and Tewkesbury said that the public expenditure White Paper was "a sloppy procedural device". I have given my interpretation of that device on a previous occasion. These are matters for the House to decide.

The right hon. Member for Down, South talked about the difficulty of controlling even the note issue because of the way in which we organise our procedures. I take note of the fact that the Government are setting up some examination of our procedures, from which we shall be hearing in due course—

It being one and a half hours after the commencement of proceedings on the motion, the debate stood adjourned.