The Sterling Crisis

December 14, 1964

Never before has any British Government made so many economic blunders in so few weeks in power. First, the new Prime Minister, Harold Wilson, announced the imposition of a “temporary” 15 percent surcharge on imports and tax incentives for exports. The effect was to injure and disrupt the exports to Britain of all other countries, even of its six economic partners in the European Free Trade Association, and to provoke murmurs of retaliation everywhere. Worse, the action was accompanied by “assurances” that Britain had “no intention” of raising its bank rate—in other words, that it had no intention of taking the first indispensable action toward curing its balance-of-payments problem.

Of course this provoked distrust of sterling, and a rescue operation had to be undertaken. So on Nov. 7 ten of the world’s leading financial powers agreed through the International Monetary Fund to extend $1 billion in aid to Britain. But Wilson shook confidence further by announcing his determination to renationalize the steel industry. He hinted at new punitive taxes against corporations and investors, including a capital-gains tax. He increased pension and other social-welfare benefits.

THE ‘SPECULATORS’

Sterling weakened again. Wilson gave new reassurances. Central banks and others thought there would at last be an increase in the British bank rate at the regular weekly meeting on Thursday, Nov. 19. It didn’t occur. The run on sterling started. Hurriedly, over the weekend, the British Government raised the discount rate from 5 percent to the crisis level of 7 percent. A Swiss banker made the premature declaration that “7 percent will drag money from the moon.” He forgot that it won’t do this if lenders are afraid they won’t get their principal back. The run continued, and wasn’t stopped until Nov. 25 when eleven nations announced that they had put together a record $3 billion rescue package of currencies to defend the pound.

So the pound, once more, is rescued, and is presumably safe for at least the next three months. But what then? The notion so widely circulated in the press that the whole crisis was caused by a group of wicked speculators, “the gnomes in Zurich,” is simply childish. It is hard to imagine any group of speculators foolish enough to imagine that they could permanently depress sterling by their own short sales. The “speculators” in sterling were the holders of sterling all over the world—central banks, commercial banks, exporters, importers, and investors everywhere. They were scared by the Wilson blunders. They wanted to get out. They wanted to protect themselves against being swindled as the holders of sterling were swindled by the devaluation of the pound from $4.03 to $2.80 in September 1949.

THREE CHOICES

The total $4 billion or so of credit at best gives the British Government a breathing spell. Otherwise it solves nothing. The future of the pound depends on the policies that the British Government follows.

It has three possible courses. First, it may try to save the pound by more of the same kind of controls as the 15 percent import surcharge and the export subsidy. It may resort to exchange controls, investment controls, import quotas and licenses, compulsory exports, price and wage controls at home, and all the rest. But the world, and particularly the British, have become disenchanted with these methods. They would mean a return to inconvertibility, and at least two prices for sterling.

Secondly, the British could devalue the pound or, through the IMF, try to get a world devaluation of currencies in terms of gold.

Finally, Wilson could stand by tight money, and stop the printing presses that have been turning out a glut of paper pounds. But this might lead to credit contraction and, particularly if the British unions continue with their usual demands, to a slump and unemployment. This violates all the policies that the Labor Party has been preaching for the last twenty years.

The problems of the dollar are different in urgency, but not in nature, from the problems of the pound. The fool’s paradise of budget deficits, cheap money, and printing-press currency cannot go on forever.