Sterling in Decline

Few events in the economic life of a nation and its policymakers are so profoundly affecting as currency devaluation. With the advent of managed floating in the 1970s, exchange rate fluctuations were rendered commonplace and robbed of much of their drama. Things were far different under the classical gold standard and the Bretton Wood system. In those days, if a nation was forced to devalue the competence of its policy-makers was called into question. Devaluation was a symbol of defeat: it reflected the authorities’ failure to contain market forces and to provide a stable basis for economic growth. On the few occasions that governments elected to devalue of their own accord, the event provided an opportunity for them to reassess their approach to managing the economy and marked a turning point in the formulation of economic policy. But regardless of the circumstances, devaluation was an event of great moment, which occurred amidst controversy, publicity and impassioned debate.

The pound sterling occupies a unique position in the history of the world economy. From the middle of the nineteenth century to the first quarter of the twentieth, no national currency rivalled sterling’s role in international transactions – as a unit of exchange, a means of payment or a temporary store of value. For almost a century, sterling remained the dominant vehicle currency in international trade. Considerable quantities of trade that neither touched British shores nor passed through the hands of British merchants were invoiced in British currency. Transactions the world over were settled with the transfer of sterling balances between accounts maintained in London. The imperial banks’ that provided commercial credit throughout the British Empire, and many European and American banks as well, habitually held sterling balances for transactions purposes. When Dominion central banks were established in the 1920s they adopted similar practices. Commercial traders found it convenient to maintain working balances in London not just to facilitate transactions, but because their funds could be lent when idle with minimal risk and at competitive interest rates through the facilities of the British money market. With the possible exception of the dollar in the three decades immediately after the Second World War, no other national currency has achieved a comparable position in the international economy.

The 1931 devaluation of sterling ended a decade of financial struggle. It marked the collapse of an international financial order that had served the world for generations and had been reconstructed at considerable expense following the First World War. The gold standard parity of sterling, officially re-established in 1925, was a reference point for exchange rate stabilization by a number of countries: France in 1926, Italy in 1927, Norway in 1928, and Portugal in 1929, to name but a few. Thus the pound’s devaluation in 1931 symbolized a radical change in the structure of international economic relations.

To those who took part in it, the devaluation of sterling in September 1949, from $4.03 to $2.80 to the pound, was one of the most dramatic episodes in the post-war history of the United Kindom. It seemed likely at the time that it would also prove one of the most important in terms of its effects. There might be room for disagreement as to the need, the purpose, the wisdom or even the significance of the devaluation. But it was unmistakably a turning-point. So rare and startling an event as a fall of 30 per cent in the parity of sterling, the currency in which well over a quarter of the world’s commerce was conducted, could not fail to exercise a powerful influence on international transactions of all kinds.²

Long before 1967, the possibility that sterling might have to be devalued was widely entertained, though not often discussed in public. It came up from time to time in the 1950s, but without any indication that it had ever been seriously considered by the government. The Tribunal inquiring into alleged leaks before the raising of Bank rate to 7 per cent in September 1957 heard evidence from financial journalists that the Chancellor had told them of his intention ‘to represent most strongly’ at the Annual Meeting of the IMF in Washington that ‘the Government had no intention of devaluing the pound or allowing the margins of the rate to be flexible’.¹ Harold Macmillan, musing on the economic situation at the beginning of 1962, reflected that if wage inflation continued ‘we might have to devalue’;² and in writing to the Queen in March 1963 he described to her the school of thought that advocated a policy of ‘“Boom and do not mind busting”, i.e. devalue the pound or alternatively let it float’.³ But the only form of devaluation that he was willing to contemplate was a move to raise the price of gold, in default of action by the United States, by means of a concerted devaluation of the pound, mark and franc in the interests of increasing international liquidity.⁴

It is scarcely possible to exaggerate the extent to which our three devaluations of sterling differed from one another. Indeed, the differences are so striking that it sometimes seems as if the only thing these three devaluations had in common was their coincidence on each occasion with an eclipse of the moon.¹ None the less, a comparison of the three episodes reveals a surprising number of similarities – significant enough, in any case, to encourage us to attempt to generalize regarding the causes and effects of the three devaluations.