STERLING RECESSIONAL U.K. SETS “NO GREAT STORE” ON £ AS RESERVE CURRENCY

Press, Volume CXI, Issue 32635, 17 June 1971, Page 10

STERLING RECESSIONAL U.K. SETS “NO GREAT STORE” ON £ AS RESERVE CURRENCY

(Reprinted from the "Economist" [June 12.1971] by arrangement) Not with a thunderclap, but with some gentle soporifics, a British Government this week at last almost admitted the awful but obvious truth that the so-called special status of sterling has hardly ever mattered a tupenny damn. Mr Geoffrey Rippon announced that Britain did not set store by the reserve role of sterling, and would be quite happy to discuss ways of replacing the sterling balances by something else; and the Six wisely agreed that detailed plans should not be immediately laid for this, perhaps because they would not conceivably work.

But the worried reaction of M.P.s on Wednesday aome of them clearly suspected Mr Rippon of selling Britain's prosperity down the river—showed how deeply entrenched Is the corrosive myth that has befuddled a whole generation of political non-econofnists on this subject. The myth has taken three wildfy conflicting forms, sometimes simultaneously but more often consecutively. Right-wing people have alternated between claiming that sterling’s reserve currency status is the crucial prop of the City’s or even the world’s prosperity, and then going to the other extreme of regarding the sterling balances as huge debts which will have to be repaid and which make it impossible or improper for Britain to have any economic growth at all; while left-wing people have increasingly blamed all Britain’s quite easily analysable economic troubles on the grandiose folly of somehow trying to run a world currency (without knowing quite what that meant). In the last quarter of a century, the prevailing fashion about each of these mistaken views has surged forth in three waves. Debt fallacy In 1945 gloom about the “grave burden of debt" was in fashion because Britain had emerged from the war “owing" £3500 million of sterling balances to countries like Egypt, India and Argentina whom we had paid in 1939-45 for the privilege of defending them. It was then seriously argued that this debt would oblige Britain to pile up a large balance-of-payments surplus every year tor two generations, because our “unrequited exports" to these countries would be paid for by their drafts on these balances.

In the event, Britain has hot exactly notched up a permanent balance-of-paymenta surplus, and yet the sterling balances held by overseas countries have obstinately and almost incredibly remained at between £3OOO million and £4OOO million every year: even although overseas countries’ holdings of dollars (which in 1945 were expected to be "permanently scarce”) have risen to over 5U526.000 million in official hands, and to far more in private hands, by 1971. With the value of world trade often increasing at over 10 per cent a year, countries have needed to hold more foreign exchange reserves; and it has therefore generally proved fairly easy for key currency countries to persuade foreign central banks who hold their currencies to go on holding them either by the device of offering slightly better interest rates, or “in extremis" by threatening big official holders of sterling that if they brought about a new sterling devaluation by running away into dollars or gold, then it would rather naturally be the value of their existing holdings of sterling that would suffer. By the end of the 1950 s the sterling balances were no longer regarded as a burden for Britain, but almost as a status symbol for it.

American build-up The Americans meanwhile built up the world’s dollar balances after 1945, at first by the granting of Marshall and other aid (which proved a cheap form of aid so long as it was held in balances and not used), and then by heavy private American investment abroad (giving rise to the European complaint that “we are lending money to the Americans to enable them to buy us”). However, for most of the time the outside world was very glad to add these dollars to its reserves, and also glad to attract the new management and technological ideas which American investment brought with it.

In this period Britain was diverting overseas investment by its companies discriminatorily towards countries which agreed to hold a lot of sterling; this generally (although not always) meant to the countries that had recently been the least profitable areas, because that was sometimes one reason why they had less dollars than sterling in their reserves. But the fact that debts were not having to be repaid led some right-wing Britons to suppose that there was a great glory in their being, one of the world’s bankers.

There was a strange confusion between the City of London’s important role in international finance—stemming from the efficiency of the City’s financial institutions—and the fact that some of them did get custom from handling investment of these debts that Britain owed to other countries. At the time of Britain’s first application to join the E.E.C. in 1962, there was therefore a tendency to say that we were bringing the community the great gift of a world reserve currency.

French argument The French, who had previously been exaggerating what the Americans were supposed to be gouging out from operating a world reserve currency, now went right to the other and equally wrong extreme: what Britain was really bringing to Europe,

they said was £3500 million of debts which would one i day all be spent by Britain’s 1 creditors, in a huge and inflationary rush on the resources of a Britain in the E.E.C. Moreover, this view happened at the time to be gaining some support from left-wing Britons, who were beginning wrongly to say that all our woes sprang from trying to run a world currency. The root trouble here was that by the beginning of the 1960 s sterling was visibly overvalued. From then until devaluation was at last accepted in 1967, there were bound to be runs out of the pound. It did seem rather logical to suppose that runs out of the pound would be accelerated by the fact that there were then more than £3OOO million of official sterling balances still lying around to run out of. In fact, the logic proved wrong. The great speculative movements for and against currencies come from movements in private funds and are not really altered by whether a currency is a reserve currency or not: witness the thousands million dollar* that flowed in a torrent into D-marks—which are not a reserve currencyin the course of 35 minutes on May 5 last. Almost incredibly, and under the usual pressure, official holders of sterling actually increased their sterling balances from £3200 million to £3BOO million between 1962 and 1967.

It is true that on many mornings after the 1967 devaluation the Governor of the Bank of England was apt to find a different Afro-Asian client in his office, complaining that he had lost over 16 per cent of the value of his sterling reserves, and saying that the Governor must do something about it. Hence the Basle Agreement of 1968 that those who hold a certain amount of sterling can have a guarantee that its dollar value will not be allowed to depreciate; it is not very onerous to promise to write up in sterling a starling balance that is not being spent.

Lessons of experience The real points to emerge from this experience are: (1) A “key currency" country may gain something if the rest of the world really is willing to hold more and more of its currency despite the fact that it is going into deeper and deeper deficit.

America may have had this advantage recently. In moit of the po»t-w*r period Britain hat had this advantage only in the rether negative sense that the world has not been eager to cause chaos by dumping the balances in sterling which it already holds. However, in the years just before 1967, sterling did get some more positive—and undesirable additional "support" of this kind; with the disastrous result that we tried to keep sterling at its overvalued level for too long. The next lesson is therefore important. (2) A “key currency” country will lose if the fact that it operates a reserve currency , foolishly makes it feel that it must delay devaluing (as Britain did in 1960-67) or that it must distort its foreign investment towards countries that are especially willing to [hold its currency (as Britain has also intermittently done). But neither of these mistakes has any logic behind it whatever. Tidier method sought (3) Certainly, it would be slightly to Britain's advantage (and also to most other countries’ advantage) if the sterling balances were sen- . sibly transformed into special drawing rights or other liabilities of (say) the International Monetary Fund or some E.E.C. central hank: ; with the International Monetary Fund or that bank taking over, on the countervailing assets side of its accounts, the holdings of British Treasury bills and other British government securities at present held by the owners of these balances —but being willing, as a transnational central bank should be, to vary the holdings into or away from British government securities when intelligent management i of world monetary condition* I made this seem desirable. This week Mr Rippan said that Britain would be willing to envisage an orderly reduction of the sterling balances , on the three conditions that sterling holders get an acceptable alternative reeerv* asset, that the new system does not impose an unacceptable burden on Britain's balance of payment*, and that the new device promotes the stability qf the international monetary system. In other words, Britain would welcome it if somebody would set up some tidier method of managing the world’s monos in this way. As Mr Heath also showed, that it is virtually all there is to it.