Britain and European Monetary Cooperation, 1964-1979

Kiyoshi Hirowatari

• Publisher: Palgrave Macmillan
• Year: 2016
• Print ISBN:
  9781349554980
  9781137491411
• eBook ISBN:
  9781137491428
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

The collapse of the Bretton Woods system in the early 1970s resulted in a transition to fluctuating rather than fixed currency system. This brought sterling into the turmoil of the world currency markets, and by the end of the 1970s, sterling had quietly ended its role as an international currency. Sterling-dollar diplomacy collapsed, bringing to an end what had hitherto been considered Britain's prime relationship. Britain and European Monetary Cooperation, 1964-1979 provides a unique perspective on these events, shedding light on the complexities of the historical context of British monetary diplomacy and exploring the country's attempt at a European approach to sterling in the 1960s and '70s. The book describes the political and economic approach Britain took at the turn of the 1970s, and explains how the country became restricted by the burden of the sterling balances. In this book, the author illustrates how these developments offered opportunity for both cooperation and conflict in the light of monetary diplomacy. He demonstrates how Britain's struggle to achieve exchange rate stability, twinned with controversy over European Economic Community membership, finally prompted serious reconsideration of economic policy-making. This book challenges the commonly-held perception of the decline of sterling, and explains that, although Britain's attempt at a European approach failed, the decline of the currency was more complicated than a 'managed decline'.

Part I

The Conservatives and European Monetary Cooperation

Introduction

Chapter 1 explores the implications of the 1968 Basle Agreement for the Conservative Party and leading UK officials and considers the way the Heath government addressed the EEC’s project for European monetary cooperation. In this regard, the Basle Agreement fostered a sense that the UK was losing monetary sovereignty. Chapter 2 provides a detailed discussion of how the Conservatives and Heath understood the issue of monetary sovereignty in their accession to EEC membership. Finally, Chapter 3 examines the way the UK monetary authorities considered a European approach to sterling in the light of external economic policy and concludes with a summary of Part I.

1

The Conservatives and European Monetary Cooperation

The Conservative MP Edward Heath was elected Leader of the Opposition in July 1965 and subsequently led the party to victory in the 1970 general election. This period witnessed a tidal wave of currency speculation, which swept across Britain from 1965 to 1967. While Britain was finally forced into the 1967 devaluation, the exigencies of the sterling crisis in the mid-1960s urged furtherance of an international credit facility – the 1968 Basle Agreement. This had the intended effect of stabilising sterling, but seriously undermined its standing as a reserve currency, prompting leading Conservatives and UK officials to address European monetary cooperation when the Conservative Party returned to power. The agreement, it seems, was a major tipping point which drove the Conservatives from the rhetoric of sovereignty over sterling towards realistic policy options.

Schenk argues that in the 1960s there was a fundamental shift in Britain’s attitude towards sterling, ‘from encouraging the use of sterling as a reserve currency, to managing its decline’. The Chancellor of the Exchequer, Reginald Maudling, noted in 1962: ‘I regard it as a major aim of policy to free the UK economy from the inhibitions of reserve currency status’; in 1964 Fforde at the Bank of England recorded: ‘I do not think that at the highest levels in the Bank there would be dissent from the proposition that to get rid of reserve-currency status while maintaining our trading currency position would be a most desirable achievement.’1 This notwithstanding, what ensued was a reorientation in the opposite direction: restoration of sterling as a reserve currency. What Britain had in mind was a rosy picture: ‘a good case for preserving a reserve currency’.2 Britain indeed thought it was ‘a sensible strategy’, particularly ‘in the context of the EEC negotiations’3 at the turn of the 1970s when the EEC was envisaging economic and monetary union. The story thus seems more complex than a linear account of sterling’s decline allows.

This chapter starts by considering the economic background to the 1968 Basle Agreement and its implications and repercussions for the Conservatives.

1.1

The 1968 Basle Agreement: its implications and repercussions

The picture that can be gained from the 1960s, in retrospect, is a curious hybrid: domestic exuberance and external disaster. Certainly, the economic performance of the 1960s was outstanding, inter alia in terms of GDP: ‘Over the decade as a whole (1959–69), GDP increased by over 38 per cent compared with 28 per cent in the previous decade and 25 per cent in the decade following.’4 While faster economic growth, coupled with the expansion of private consumption and a rise in capital investment, gave rise to inflation, it contributed to high employment, with unemployment rates never exceeding 2.5 per cent at any time in the 1960s.5 Over-buoyant domestic demand, on the other hand, caused the external balance to deteriorate markedly. Even so, what led to the 1967 devaluation is not easy to explain, especially in the light of the current account. While the current account in 1965–66 showed an improvement after a large deficit of £382 million in 1964, 1967 again saw a deficit of £316 million.6 However, the crucial fact was that, in spite of wide fluctuations in the UK balance of payments on the current account, 1964 and its aftermath showed a marked worsening of the capital account over this period. The deficit in the capital account running at £99 million in 1963 soared to £301 million in 1964 and continued to rise, reaching £578 million in 1966 and £495 million in 1967.7

The 1967 devaluation ‘was forced by a speculative crisis rather than by any crisis in trading account’.8 The speculative pressure on sterling accelerated leads and lags in the speed of foreign exchange transactions, thus widening the deficit of short-term capital flows, but the basic fact behind it was a substantial rundown of the sterling balances. In the mid-1960s there was a sharp decrease in the overseas sterling balances held by both official and private holders: the balances, running at around £3,863 million at the end of 1962, had fallen to £3,380 million by the end of 1968.9 The 1960s, as Christopher McMahon suggested, witnessed sharp movements in the sterling balances when sterling was under pressure, with the balances greatly exacerbating the repeated sterling crises.10 The background to this was the reintroduction of convertibility for sterling, which had started in the 1950s, as well as ‘the perennial weakness of the UK economy’.11 Furthermore, those crises were seen as a threat to international monetary stability, for ‘any pressure on the reserves coming from the sterling balances would be a threat to the sterling parity’.12 At the same time, a strongly embedded relationship prevailed between the dollar and sterling: the devaluation of sterling would become contagious and lead to the erosion of confidence in the dollar and, in turn, to ‘a large rise in the market demand for gold, as well as in central-bank conversions for gold at the U.S. Treasury’.13 This fostered overseas central banks’ willingness to cooperate with Britain in supporting sterling.14

The Basle facility dates to 1961, when, after the dollar crisis culminated in the revaluation of the DM, market pressure shifted from the dollar to sterling. The agreement in March 1961 was ‘simply a public statement of intentions by central bankers’ designed to stabilise ‘an overheated foreign exchange market’,15 but it substantially ‘consisted of a series of ad hoc bilateral support deals between the Bank of England, on the one hand, and the other main central banks and the BIS, on the other’.16 The crucial point was the Bank of England’s reaffirmation of its commitment to the $2.80 sterling parity,17 and this ‘principle of an exchange guarantee for a reserve currency’ was ‘an important departure’ from the position, hitherto taken by Britain, that no such guarantee was needed, leading to the BIS offering ‘further ammunition’ to shore up sterling.18

The 1966 Basle facility can be seen as a further development of the 1961 Agreement. Unlike central bank lines which had been available previously, the 1966 Basle Agreement was related specifically to the problem of the sterling balances.19 It addressed sterling as a reserve currency in the sense that the facility was ‘not an ad hoc response to a sudden emergency situation, but rather an attempt to provide a stabilising buffer for sterling’.20 Under the facility eleven central banks agreed to set up short-term agreements totalling about $1 billion (largely three-month swap facilities) with the Bank of England, which were designed to help smooth fluctuations in the sterling balances.21 Nevertheless, pressure on sterling did not abate, culminating in the 1967 devaluation. A series of linked developments between 1967 and 1968 made new and more comprehensive arrangements to give greater stability to the sterling system an imperative,22 since, after the shock of devaluation and the gold crisis in March 1968 (the introduction of the dual price system), the sterling balances of the Overseas Sterling Area (OSA) fell sharply, from £3,110 million in March to £2,786 million in June.23 Thus, on 25 September 1968, the second Basle facility was concluded. In the new facility the safety net provided by twelve central banks amounted to $2 billion, enabling the Bank of England to ‘draw US dollars or other foreign currencies as, and to the extent that, the sterling area countries’ sterling balances, both official and private, fell below an agreed starting level, which was set at £3,080 million’.24

The main purpose of the Basle Agreement was to induce sterling balance holders not to diversify their balances. Britain, however, had to agree in a situation in which ‘the OSA countries now wished, as a matter of policy, to diversify their reserves in order to make themselves less dependent on a single currency’.25 Britain’s objective, therefore, was to persuade its BIS partners ‘not merely to offset fluctuations’, ‘but to underwrite potentially large-scale diversification’.26 The crux of the matter was whether the ‘$2 billion facility would be enough to cover any prospective reduction in the OSA balances’.27 The BIS partners could not agree with Britain’s assertion that the facility was sufficient, so Britain had to enter into negotiations with the OSA countries in order to ensure its relevance. That was an intractable situation, and nicely timed to moderate it was ‘a good deal of nudging from the central bankers at their meetings in Basle’.28 This offered ‘some special inducement’ to encourage the OSA countries to keep the minimum sterling portion of their total official reserves, which took ‘the form of guaranteeing the value, in terms of dollars, of the bulk of the OSA official sterling reserves’.29 The main focus of the second Basle facility was directed at the management of the official sterling balances held mainly by the OSA countries.30

The two factors – the 1967 devaluation and the second Basle facility – brought temporary respite from the recurrent sterling crises for the next few years until the middle of 1972, when sterling withdrew from the Snake. The 1967 devaluation certainly led to an improving balance of payments on current account, with visible trade increasing from a deficit of £682 million in 1968 to a surplus of £261 million in 1971 and the balance on current account soaring from a deficit of £242 million to an exceptional surplus of £1,150 million (Table 1.1). With a balance of payments surplus acknowledged from 1969, sentiment towards sterling improved and a sharp swing of capital flow took place: the balance of investment and capital transactions moved sharply from a deficit of £759 million in 1968 to a surplus of £1,791 million in 1971 (Table 1.1). This entailed a substantial net inflow of foreign funds on an uncovered basis ‘because the bulk of the sterling area’s official holdings were guaranteed, there was little need for forward cover’.31 1970 was in stark contrast to earlier years, since sterling was now strong enough to withstand turmoil in the Middle East, a general election and a dock workers’ strike. This lasted until 1971, when the dollar came under heavy pressure. Erosion of confidence in the dollar triggered a large inflow of liquid funds to the Continent, leading to a realignment of currencies, including a float-up of sterling. ‘Sterling was itself inherently strong because Britain was heading for its third, and biggest, consecutive year of balance of payments surplus.’32

As McMahon suggests, ‘the dollar guarantee arrangements had the desired effect of helping to stabilize the [sterling] balances, but in a sense worked too well’.33 The OSA official balances rose from £1,506 million in September 1968 to £2,760 million in September 1971.34 Furthermore, there was a huge inflow of ‘hot money’ or ‘volatile funds’ which were mainly in private North American and Western European holdings, and ‘central banks of some of the oil-producing countries outside the sterling area, which normally kept little sterling, also increased their holdings’.35 These developments temporarily restored sterling as a reserve currency, a development accelerated by an exodus from the dollar. The dollar’s decline as the key currency in the short term masked the vulnerability of sterling as a reserve currency amid massive turmoil in world currency markets.

Table 1.1 UK ...

Table of contents

• Cover Page
• Half Title Page
• Title Page
• Copyright
• Contents
• List of Tables
• Preface
• Acknowledgements
• List of Abbreviations
• Chronology
• Introduction
• Part I: The Conservatives and European Monetary Cooperation
• Part II: Labour and European Monetary Cooperation
• Conclusion
• Appendices
• List of Names
• Notes
• Bibliography
• Index