The Retirement of Sterling as a Reserve Currency after 1945: Lessons for the us dollar?

Sterling Reserves of State Institutions 1945-1973

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Sterling Reserves of State Institutions 1945-1973

500

1000

1500

2000

2500

3000

3500

4000

194

195

196

197

3

£ m

illion

Nominal

Real

Privately held reserves of sterling were a fairly steady 3%-4% of world trade during

the 1950s but then fell steadily to below 2% by 1969 after the confidence crises of

the early 1960s.

Within the nominal stability of sterling reserves in the sterling area, Figure 7 shows

that there was a dramatic geographical shift. At the end of the war, the Indian

Subcontinent accounted for 58% of total sterling liabilities to the overseas sterling

area. These assets were accumulated during the war in lieu of payment for war-

related expenditure in the region.

Almost immediately, however, the dominance of

these balances was challenged by accumulations in Australia/New Zealand and by

colonies in the Far East and Africa so that by the end of 1952 the Indian

Subcontinent accounted for only a quarter of sterling area balances. From the mid-

1950s oil sales in the Middle East and economic growth in East Asia led to a further

redistribution of sterling’s reserve role so that by November 1968 Hong Kong was

largest single official holder of sterling, followed closely by Australia and then Kuwait.

These three examples show some important determinants of sterling’s persistence

by the end of the 1960s: empire still mattered (Hong Kong was still a colony with a

colonial monetary system), inertia and size mattered (Australia was historically the

largest sterling area country, although it did diversify its reserves), and denomination

of commodity trade mattered (Kuwait, and later Nigeria and Saudi Arabia

accumulated huge sterling royalty payments from oil companies).

B.R. Tomlinson, ‘Indo-British relations in the post-colonial era: The sterling balances

negotiations, 1947-49’, Journal of Imperial and Commonwealth History 13(3), 1985, 142-62.

For the important case of Hong Kong’ sterling, see C.R. Schenk, ‘The empire strikes back;

Hong Kong and the decline of sterling in the 1960s’, Economic History Review, 2001.

-

Figure 7 Distribution of OSA Sterling Balances 1945-73

20%

40%

60%

80%

100%

1945 1948 1951 1954 1957 1960 1962 1965 1968 1971

Other

Far East

Middle East

E/W/Central Africa

Caribbean Area

India/Pak/Ceylon

Aust/NZ/Safr

Table 1 shows that many independent members of the sterling area diversified their

reserves in the 1950s, mainly through accumulation of USD assets (and gold in the

case of South Africa).

Table 1 Share of Sterling in Total Reserves, percent

1950 1951 1952 1953 1954 1955 1956 1957 1958

Iraq 95 80 81 86 91 84 80 71 66

Ceylon

89 73 78 67 73 67 56 53 47

Australia

82 66 65 70 64 49 58 65 55

Pakistan

78 79 52 57 59 62 53 50 44

India 73 69 69 97 97 98 56 44 33

New

Zealand

64 61 62 73 69 61 72 63 66

South

Africa

24 22 23 8 19 7 8 - -

Source: CR Schenk, Britain and the Sterling Area, Routledge, 1994, p. 30.

However, this process was reversed by some sterling holders in the 1960s so that

as Table 2 shows, by 1964 New Zealand held 98% of its reserve in sterling and

Australia 79%.

Table 2: Proportion of sterling in official reserves

Australia

New Zealand

Malaysia Singapore

Hong Kong

1964

100 99

1965

98 99

1966

93 99

Jun-67

74 99

Oct-67

50 99

Dec-68

44 99

Source: Bank of England Archives [Hereafter BE] OV44/116. 1968 from TNA

T312/2811, T312/2804, T312/2649, T312/2312.

As we shall see below, the share of sterling in the reserves of the sterling area

countries as a whole increased further after 1968. Thus, although the share of

sterling in global reserves fell, the pound remained the primary reserve currency for

a range of (mainly developing) countries until the mid-1970s.

These developments all show that the distribution of sterling reserves in the

1950s was profoundly affected by the pattern of economic development on the

geographical edges of Britain’s former formal and informal empire. Over the next

decade the decline in sterling’s share of global reserves slowed as the plans for

reforming the system as a whole gathered pace.

Sterling and the Reform of the Global Reserves System: Delaying the Tipping

Point

A vital feature of the management of the retreat of sterling was the continuing effort

to engage the rest of world’s economic leaders in resolving the problems that the

reserve currency role of sterling appeared to pose for domestic UK economic policy.

Indeed as the 1960s progressed, waiting for a global solution to weaknesses in the

international monetary system emerged as a corner-stone of British sterling strategy,

allowing ministers to postpone unpalatable decisions about achieving this on their

own. Their success is evident in the range of schemes designed to postpone the

tipping point for sterling until a permanent solution to the problem of national

currencies as reserve currencies could be agreed.

1. 1961-1964 Bilateral Concerté: G10+1 central banks offer support coordinated

through the BIS to a range of countries (3 month bilateral swaps). UK

episodes included $1 billion in September 1964 ($7 billion in current dollars),

half of which came from the Fed, and $3 billion in November 1964, one third

from the Fed.

The arrangement of systems of multilateral support for the international monetary

system was developed during the exchange crises of 1960-61 when pressure on

Current dollars

valued by CPI from Samuel H. Williamson, "Six Ways to Compute the

Relative Value of a U.S. Dollar Amount, 1790 to Present," MeasuringWorth, 2008. URL

http://www.measuringworth.com/uscompare/

sterling led to concerted efforts by European central banks to support existing

exchange rates. In March and June 1961 the UK garnered bilateral support totaling

$904 million from European and US central banks in what became known as Basle

arrangements. As Toniolo relates, the Bank of England and the US Fed were

enthusiastic about the ability of the combined forces of central banks to forestall

short term speculative pressure and sought to extend or formalise the arrangements

on an inter-governmental basis. Creditors in Europe were less enthusiastic about

extending the system and the initiative was instead formalised through the BIS.

Credits would remain bilateral but the BIS would inform each creditor of the details of

the total operation, in what was termed ‘bilateral concerté’.

In March 1963,

September 1964 and November 1964 Britain negotiated a series of lines of credit

under the bilateral concerté scheme to cover short-term speculative attacks on

sterling.

The UK juggled short term credits to support sterling, drawing on them to

intervene in the exchange market and also publicizing the packages to stem

speculation. By moving between multilateral support from Europe, the USA and IMF

facilities, the Bank of England managed to keep the speculators at bay.

While these short term facilities were successful in supporting sterling through

a series of confidence crises, they did not amount to a long term solution, which

Britain’s creditors increasingly preferred.

In mid-September 1965 Bank of England

Governor Cromer rejected proposals made at a BIS meeting of central bankers to

‘fund’ sterling reserves into a longer term and more predictable debt, effectively

curtailing their liquidity and ending the reserve role. He explained that it was

volatility in private sterling holdings rather than in overseas central banks’ holdings

that contributed to the UK’s balance of payments problems. More fundamentally, the

UK’s creditors in the sterling area would not accept shifting their existing liquid

sterling exchange reserves into less remunerative and less liquid long-term assets,

G. Toniolo, Central Bank Cooperation at the Bank for International Settlements, 1930-

1973,Cambridge University Press, 2005, pp. 381-85.

MJ Thornton (BoE) to Conolly, 22 September 1964. BISA GILB9 7.18(23).

For discussions during this period see Toniolo, Central Bank, pp. 391-94.

and the UK did not want to replace a debt that might never need to be redeemed for

a certain liability.

While ‘funding’ was out, the Bank of England hoped that support might be found

through the BIS network to cover the eventual diversification of sterling reserves.

Rather than preventing the liquidation of sterling assets, these proposals sought to

protect the UK reserves from the switch to the USD based on the model of short

term support already agreed under the Bilateral Concerté. In this way, the

international community would ease the impact of the decline of sterling as a reserve

currency on the UK. After a series of negotiations the first Group Arrangement for

sterling was concluded in June 1966.

2. BIS Group Arrangement I June 1966 – January 1971: $1 billion in 3-month

renewable swaps to cover 12 months ($6.6 billion in current dollars).

The First Group Arrangement moved on from the bilateral concerté to included a

more formal relationship to the reserve role of sterling; the UK was allowed to draw

on the credit up to an amount of 50% of the drop in UK reserves attributable to a

decline in sterling reserves overseas.

The aim was to prevent a devaluation of

sterling due to diversification of official reserves, but the hope was that the

announcement of the agreement itself would forestall that process by enhancing

market confidence in the value of sterling and by reducing the first mover advantage

of shedding sterling reserves. A decline in sterling reserves was now less likely to

prompt a devaluation of sterling. As it turned out, the Arrangement was not enough

to forestall a sterling devaluation by 14.3% in November 1967. This crisis step was

not due to diversification but to Britain’s own chronic balance of payments problem

Cromer to Ferras (and copied to other Central Banks), 16 September 1965. BISA LAR2

F01 7.18(14).

The support was triggered after a net reduction in overseas official holdings of sterling

below a base level of £4300m due to factors other than the UK’s own balance of payments

problems (the total at the time was £4500m).

and a collapse in confidence in the Labour Government’s ability to restore British

competitiveness. Figure 8 shows how the facility was used during this crisis.

Figure 8 Outstanding Drawings on the First (1966) and Second (1968) Group

Arrangements

Outstanding Drawings on First (1966) and Second (1968) Group Arrangements

100

200

300

400

500

600

700

-67

t-67

-6

-68

t-68

-6

b-6

-69

g-6

-6

r-7

t-7

-70

Ist Group Arrangement

2nd Group Arrangement

In March 1968, when speculative pressure against the USD prompted the end of the

fixed price of gold and the entire reserves system seemed in peril, the British

government sought to garner further support for sterling’s international role, asking

for $5 billion in longer term credit to fund any further diversification away from

sterling. They were turned down, but did collect pledges from central banks ($1.175

billion) to add to existing facilities of $1.436b from bilateral and previous Basle

facilities, plus $1.4b in IMF standby to make up a headline total of support of just

over $4b (c. $25 billion in current dollars valued by CPI).

With this huge credit

looming, Britain’s creditors sought a longer term (and final) solution.

3. BIS Group Arrangement II (Basle Agreement) and Sterling Agreements

(1968-1974): The G10 central banks agreed to provide a safety-net line of

credit of $2b ($12.4 billion in current dollars) on which the Bank of England

could draw if total sterling reserves fell below £3080m (the level at 11 June

1966). As a quid pro quo, they insisted that the UK negotiate bilateral Sterling

Agreements to commit countries holding sterling in their reserves to keep a

minimum proportion of their reserves in sterling over the term of the Basle

Agreement. In return, the UK offered a guarantee of the USD value of 90% of

each of these countries’ official sterling reserves so long as the minimum

sterling proportions were met. Countries could break the agreement and

diversify, but they would lose the USD exchange guarantee. The goal was to

limit the diversification away from sterling as a reserve currency through these

agreements, with a guarantee underpinned by the $2b safety-net if global

reserves as a whole fell sharply.

The Sterling Agreements were the most important part of this arrangement since

they further reduced the exchange risk of holding sterling and thus reduced the

incentive for countries to abandon sterling. The arrangements thus transformed the

nature of sterling as a reserve asset from a voluntary portfolio choice to a formal

contractual commitment. However, during the late 1960s and early 1970s the

problem was not a decline in sterling assets held overseas but how to contain an

increase in these UK liabilities. A further complication was the devaluation of the

USD against gold and sterling in 1971, which undermined the value of the guarantee

Note for the Record by RJ Wiles, 19 March 1968. TNA T318/191. See also telegram

Armstrong to Chancellor of the Exchequer, 17 March 1968. BE OV53/38.

since the trigger point was not changed.

Thirty-four agreements with sterling

holders were negotiated between July and September 1968 in process that was a

considerable embarrassment for the UK has negotiators were left kicking their heels

waiting for agreement from a range of developing states, many former colonies. The

bitterness of some countries stemmed from the 1967 devaluation, which had created

a sense of betrayal and a new balance of power between Britain and these mainly

Commonwealth countries. The negotiations also identified the range of issues that

complicated Britain’s relations with these countries, including the applications to the

EEC, development aspirations, and (post)imperialism. The range of minimum

sterling proportions (from 100% in East Africa to 13% in India) is presented in

Appendix I.

Figure 9 shows the overall proportion of sterling in reserves of those who signed

a sterling agreement. This shows the recovery of sterling in the first year of the

agreements and then again from the time of the primary product boom in 1971, and

the steadily rising guarantee obligation if sterling depreciated.

The exchange guarantee was set to be invoked if sterling fell below $2.376, but the

Smithsonian rate increased the sterling/USD exchange rate from $2.40 to $2.60 making it

much less likely that the guarantee would be invoked since the exchange rate could fall

8.5% before compensation would need to be paid.

Figure 9 Sterling Share of Reserves of Sterling Agreement Countries

Sterling Agreements

1968 III 1968 IV

1969 I

1969 II 1969 III 1969 IV

1970 I

1970 II

1970 III 1970 IV

1971 I

1971 II 1971 III 1971 IV

Per

cen

t

500

1000

1500

2000

2500

3000

£

m

ill

ion

Share of Sterling in Official Reserves LHS

Amount of Sterling Guaranteed RHS

Source: BE EID15/7.

The Agreements were successfully renewed in 1971, 1973 and 1974 (except for

Libya and Malaysia, who opted out and diversified in July 1972 after sterling floated)

with reductions in the minimum sterling proportions by 10% each time.

Whether

the agreements were binding is doubtful. Most countries retained a substantial

cushion of sterling above their minimum commitment, although seasonal variations

in reserves required many to keep precautionary sterling reserves to avoid falling

below the minimum, as shown in Figure 11.

For the case of Malaysia see, C.R. Schenk, ‘Malaysia and the end of the Bretton Woods

system 1965-72: Disentangling from Sterling ‘, Journal of Imperial and Commonwealth

History, 36 (2), June 2008, pp. 197-220.

Figure10 Sterling Agreements Countries Sterling Reserves 1968-73

Sterling Agreements Countries Sterling Reserves 1968-73

0.5

1.5

2.5

3.5

4.5

III

196

8 IV

196

69 I

III

196

9 IV

197

0 II

III

197

1 II

III

197

1 IV

197

72 I

III

197

2 IV

197

3 II

£ m

illi

on

64

Pe

rc

e

n

t

Sterling LHS

Sterling % RHS

Figure 11 Excess Holdings of Sterling above Minimum Sterling Proportion

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