Bretton Woods at $2.80. The inevitable revaluation away from $2.80 was stalled by various support packages but by 1967 (18 November) it was finally recognised that sterling was fundamentally overvalued and that the economy could not support the rate and so a devaluation of 14.3% was arranged. This reduced the parity rate from $2.80 to $2.40.
1970s
The sterling demise had been coming for some time; rising deficits, rampant inflation, political gridlock and industrial unrest on a grand scale (for example, the miners’ strike) had become features of the 1970s. In December 1973 Idi Amin, the Ugandan dictator, launched a Save Britain Fund and even offered emergency food supplies. Unemployment was also rising and in January 1975 breached the psychological barrier of one million.
The events of 1976 that lead up to the sterling collapse can provide useful insights into the situation facing European economies in the early years of the 21st century: attempting to control public deficits while supporting demand. A lesson then, as now, was that material changes in policy may not arrive soon enough to placate the markets. The problems in Ireland, Greece, Spain and the UK, to name but a few, did not appear overnight but politicians, the financial press and economists were slow to conclude that previous policies were unsustainable and this was the same in 1976.
In the 1976 crisis the turning point in policy came as late as the beginning of 1975. As the then Chancellor, Denis Healey, wrote: “I abandoned Keynesianism in 1975.” As we saw with Ireland and Greece, action was forced on them as borrowing costs rose to extreme heights; and for Greece in particular borrowing was nearly impossible. A common trait of politicians both this century and the last is that they are loathe to admit to any crisis and so policy shifts are inevitably late in coming. Edmund Dell captured this speaking after the February 1974 election. He said: “Some ministers seemed unconscious of the economic crisis that had struck the country. Their attitude resembled that of characters in Jane Austen’s novels who carried on their lives undisturbed by the Napoleonic Wars.”
Crises tend to build on small events. In the 1976 crisis the cracks started to appear on 9 March 1976 when Nigeria announced its intention to diversify its foreign exchange reserves, which for historical reasons were heavily weighted towards sterling. The following day the Labour government lost a House of Commons vote on public expenditure cuts designed to win support from the IMF (the UK had made an application to the IMF for a standby facility). Despite winning a confidence vote on 11 March 1976 the Prime Minister decided to resign a few days later on 16 March. Sterling was now on the run despite intervention, and interest rates reached 15% on 6 October. The scale of the sterling collapse was immense. GBP/USD fell from above 2.40 in April 1975 to just below 1.60 in November 1976 and GBP/DEM (Deutschmark) from 6.10 to around 3.90 over the same period.
On 7 June the UK announced a $5.3bn six-month credit facility from other central banks, $2bn of which came from the US central bank. However, the US imposed a payment deadline of 9 December 1976. The UK was unable to meet this condition, which prompted the application to the IMF for a standby loan of $3.9bn on 29 September 1976. The US position was hardly supportive but has echoes of Germany today – they were unwilling to bail out a country with flawed economic policies. Cuts in UK public spending inevitably followed.
The notion that Ireland or Greece would have been saved by devaluation is an illusion. Their debt levels were extremely high and their ability to borrow extremely low. As was graphically seen in 1976, a falling currency severely impacts on inflation and any flexibility on domestic monetary policy.
1980s
The impact of the current account and interest rates on the exchange rate was never so clearly demonstrated as from 1978 to 1981. During this period sterling rose by over 20% against a basket of currencies. The arrival of North Sea oil in 1976, coupled with the second oil crisis of 1978-79, had turned a traditional deficit on the oil account into a substantial surplus; sterling was now viewed as a petro-currency. At the same time the UK was experiencing a boom, which, despite the oil surplus, contributed to a deficit in the current account that was countered by a sharp rise in interest rates attracting speculative flows.
From 1978 to 1980 the bank interest rate rose from 6.5% to 17%. This inevitably led to a sharp fall in manufacturing production and imports, which led to record surplus in 1981. Two factors mitigated against even greater sterling gains: the abolition of exchange controls in November 1979, which prompted large investment outflows, and Bank of England intervention. By 1981 sterling started to ease back but the damage had been done and British manufacturing had been dealt a blow it would never recover from.
The European Union at this time was looking for greater political and monetary union and in 1979 the European Monetary System (EMS) was established. The most important component of this system was the Exchange Rate Mechanism (ERM). Member countries agreed to peg currencies within a 2.25% band of a weighted average of European currencies; this weighted average was called the European Currency Unit (ECU). The early period was characterised by regular re-alignments – from 1979 to 1987 there were 11. The usual pattern was for low inflation, low surplus countries such as Germany and Holland to revalue and for high inflation, high deficit countries such as France and Italy to devalue. This arrangement is known as a ‘currency bloc’: a group of currencies fixed in value against one another but floating against all others.
During the 1980s the primary UK policy objective was the control of inflation through essentially the targeting of money supply growth. This met with mixed results and it was felt by Chancellor Lawson by the mid-1980s that joining the ERM would impose a low inflation discipline. Prime Minister Thatcher refused but nonetheless the Chancellor pursued a policy of shadowing the Deutschmark, a beacon of post-war low inflationary growth. However, this coincided with strong economic growth, popularly known as the Lawson boom. In 1986 the current account deficit was £2.3bn, by 1988 this had risen to £17.5bn and inflation was on the rise despite tagging the Deutschmark (DM).The exchange rate policy was abandoned and interest rates were raised from 7.5% in May 1988 to 15% in October 1989, providing support to the pound.
While the deficit started to contract inflation was stubborn and in September 1990, with a view to further deflating the economy, the UK joined the ERM at DM 3 to the pound. Even at the time this was considered too high an exchange rate. By 1991 inflation started to fall and the UK economy was in recession. UK inflation was still high relative to its main trading partners and sterling was unable to devalue sufficiently to restore competitiveness because of ERM membership. By 1992 the current account deficit had increased to £10.1bn, a remarkable level given the scale of the recession. The government wanted to cut rates but sterling was trading close to the lower end of its trading band within the ERM. An exit from the ERM and an ensuing devaluation was discounted on fears of reviving inflation. There was also a considerable amount of political capital invested in staying within the system.
1990s
In July and August 1992 sterling came under intense selling pressure, which prompted the Bank of England to intervene to keep sterling above the lower band. The most famous seller was George Soros. On 15 September, Black Wednesday, interest rates were raised to 15% but the selling continued and Chancellor Norman Lamont was forced to announce that the UK was leaving the ERM the next day. The pound fell 10% immediately. The scale of intervention is not known but it ran into billions. It is believed that no losses were incurred. These transactions were turned for a profit in later years.
The importance of these events cannot be overstated. If sterling had weathered this attack it probably would have entered the euro in 1999. Instead, it reinforced the euro sceptic camp and floating rate advocates. The UK would not again attempt to control the value of sterling. For the Conservative government it was a total disaster and arguably resulted in the party losing its reputation for financial soundness on the dealing room floor.
What
