When Labour narrowly won the October 1964 election they were greeted by dismal balance of payments figures. An external deficit in the region of £800 million was forecast, twice what had been expected (although the actual figure has since been revised down to £372 million). The government attempted to manage the crisis by a package of measures centred in the short term on a 15 per cent tariff on manufactured goods and fiscal measures to help exporters; in the longer term it aimed for growth in exports via agreement with both sides of industry, both on improvements in productivity and on restraint in wage and price rises. These steps, together with a mildly deflationary budget which more than offset welfare benefits (notably the abolition of prescription charges and higher old age pensions) by tax increases, did not satisfy the City of London and its friends in the international financial community. A wave of speculation began in November, much of it based on the assumption that the government would shortly be forced to devalue the pound.
Labour did not devalue sterling. Instead it negotiated a massive rescue package, worth $3 billion, from the central banks of the Group of 10. Prime Minister Harold Wilson ruled that the subject of devaluation was not to be mentioned in Cabinet. Further crises in 1965 and 1966 were ridden by more external assistance in return for which Labour introduced a wages’ freeze and cut back its planned increases in public investment. The centrepiece of its strategy to modernise the British economy, the National Plan, designed to foster economic growth per annum of 3.8 per cent, was abandoned. Yet despite all these sacrifices sterling had to be devalued in November 1967, from £1=$2.80 to £1=$2.40. When Labour left power in 1970 the average annual growth rate for its period in office was just under 2.5 per cent. It all amounted to a severe disappointment and this anticlimactic saga certainly played its part in creating the impression that Labour could not be trusted to run the economy competently, a view frequently promoted thereafter by the Conservative Party and then, in the 1990s, by ‘new’ Labour.
The criticisms from the right were reinforced from the left by arguments that Wilson, his Chancellor Jim Callaghan and George Brown, the Secretary of State for Economic Affairs (directly responsible for the National Plan), should have devalued immediately. This view was advocated at the time by Nicky Kaldor and Robert Nield, both distinguished economists advising the Treasury, and by Tony Crosland, the Minister of State at the Department of Economic Affairs. The pro-devaluation line was supported by contemporary commentators such as Fred Hirsch and Michael Stewart. The latter maintained that failure to devalue was ‘catastrophic’, condemning the economy to three years of siege by international speculators. Sterling crises occurred each time the balance of payments figures were disappointing, or when dockers or seamen went on strike, or there was a middle eastern political upset. The government was driven to apply for a series of rescue packages from foreign central bankers and from international financial institutions. The price of these, ultimately futile, rescue operations was deflation, slow growth and wage freeze.(1) In recent years this depressing picture has been given more detail by the diaries of the Chief Economic Adviser at the time, Sir Alec Cairncross, which show an administration and in particular a Prime Minister without a strategy and therefore driven from one improvisation to another. (2)
Historians should be careful not to fall for these arguments. The evidence of Treasury and Prime Ministerial files, released in the last few years, suggests (a) that the government did consider devaluation; (b) that there was no strong case for it; and (c) that it did possess a strategy for managing external financial crises. It is worth taking each of these points in turn.
Devaluation?
The conventional wisdom is that Wilson, Brown and Callaghan met very shortly after the election results and agreed not to devalue. The subject then became ‘the unmentionable’. Prior to November 1967 it surfaced again only once in July 1966, at the insistence of senior Cabinet members. This is a distortion of the record. What really happened was this. The government came under pressure from Lord Cromer, Governor of the Bank of England, to put up the Bank rate, deflate and abandon its key welfare and public investment priorities in order to satisfy the international markets. There were some awkward meetings between the Governor and the Prime Minister, the stormiest of them occurring on Tuesday November 24 1964. Despite a 2% increase in Bank Rate announced by the government at the start of the week sterling was still being sold. That day the reserves had lost $213m (£60m); at this rate the reserves would run out in the absence of either highly orthodox measures to restore ‘confidence’ or an adjustment in the exchange rate. Given the Bank’s historic commitment to sterling’s role as an international reserve and transactions currency, the first of these options was preferable. Wilson however fought back. He told Cromer that
‘….if central banks and their governments were going to impose a situation in which a demo-cratically elected government was unable to carry out its election programme then he would have no alternative but to go to the country. He would expect to win overwhelmingly on that xenophobic issue and then would be free to do what he liked devaluation included….’
Later on the Prime Minister suggested that a floating rate might be an option. If the Governor wanted to avoid what he clearly regarded as a disaster he should set about organising support for the forward sterling rate in the foreign exchange market and attempt to raise a substantial rescue package from the international financial community.(3) It was in response to these threats that Cromer did embark on an intense round of telephone conversations with his opposite numbers in the leading industrial economies. By the late afternoon of 25 November the $3 billion lifeline had been secured. That evening there was champagne in 10 Downing Street.
Wilson was not bluffing. On 21 November there had been an emergency meeting at Chequers involving Wilson, Brown, Callaghan, Gordon-Walker (Foreign Secretary), Healey (Defence Secretary) and Bottomley (Commonwealth Relations Secretary). Ministers had agreed on the 2 per cent rise in Bank Rate and had also concluded that should this not quell speculation against sterling it would be necessary to ‘go to the country’ and then take action on the rate. The document does not mention devaluation (although this is strongly implied) but it does state that studies would be required ‘of a widening of exchange parities (including introducing a floating rate)’.(4) One of the economists involved in this exercise was Donald MacDougall, previously adviser to the 1951-55 Churchill government, Economic Director of the NEDC from 1962-64 and then Director General of the Department for Economic Affairs. He later wrote that on 24 November he had been called with some of the other economic advisers to Downing Street where Wilson was having his showdown with Cromer. The Prime Minister told them that ‘he was thinking of floating the pound and refusing to slash public expenditure’. (5) MacDougall and Robert Nield from the Treasury were asked to prepare a paper on the relative merits of devaluation or floating while Tony Crosland went away to find out what the opinion polls had done in the wake of the 1949 sterling devaluation. Of course Cromer’s success in raising the $3 billion made a change in the exchange rate unnecessary but what does now seem clear is that Wilson would have approved one if the Governor had failed. And by the end of 24 November no one could have been sure that he would be successful the following day.
No clear case
Hindsight suggests that it might have been better if Cromer had indeed failed. But at the time the arguments in favour of devaluation were by no means persuasive. The case would have to rest on the existence of a fundamental disequilibrium in the British balance of payments, caused by cost and price levels higher than those prevailing in other advanced industrial states. The effect would have been visible in an overactive domestic market, diverting production away from the manufacture of exports and attracting rising volumes of imported goods. It is true that the external account was unhealthy by the time Labour came to power. But it was not clear that the explanation for this lay in a ‘fundamental disequilibrium’. Even advocates of devaluation like Fred Hirsch admitted that British costs were in fact competitive. A 1966 survey showed that total UK wage costs per unit of output rose between 1958 and 1964 by 11% while they were going up by 12% in Japan, 12% in Italy and 22% in West Germany.(6) The index of industrial production had flattened out during the summer after starting the year on a rising curve. Within the Treasury by October 1964 it was accepted that that demand was high but expanding ‘much more slowly than had been anticipated earlier in the year’. (7) Six weeks later Callaghan was advised that ‘on the whole the deflationary action taken in the Budget seems fairly adequate for the time being’; in other words even the rise in the Bank Rate for which Cromer was pressing did not seem appropriate and was ultimately adopted in an effort to calm down the markets rather than because the state of the economy required it. (8) A review of the evidence in the 1990s by economists Tony Thirlwall and Heather Gibson concluded that the deficit which emerged in 1964 was not caused by ‘relative price deterioration’ but came in response to two developments, neither of which could have been corrected by a devaluation. The first was a cyclical upswing in 1963. This had been intensified by the Conservative Chancellor, Reginald Maudling, who had raised public spending and cut taxes as part of his ‘dash for growth’. The second was a worsening of the long-term capital account, caused by an outflow of investment from the UK and specifically from sterling assets, much of this stemming from fears of devaluation. The result was that Britain’s current account deficit was (most unusually) not offset in 1964 by a surplus created by the invisible sector.(9)
Finally, no consensus existed among economists. A study by the economic historian Roger Middelton has shown that there was a diversity of views about what should be done with the exchange rate. Although there were pro-devaluationists in the government there were equally strong voices against. The Chief Economic Adviser, Alec Cairncross, did not favour what he argued would have been a forced devaluation and in any case was sceptical of the government’s willingness to accompany the measure with a tough approach to internal demand. The veteran Ralph Hawtrey, then retired but a Treasury insider for many years (his experience stretched back to the aftermath of the First World War and the debates about returning to the gold standard, on which issue he sympathised with Keynes) felt that sterling was in fact undervalued and this was the reason for what he regarded as excess demand. Others such as Roy Harrod, former Conservative Prime Minister Harold Macmillan’s favourite economist in the late 1950s and early 1960s, was an ‘elasticity pessimist’ (in other words did not feel that an alteration in the rate of sterling against other currencies would have a positive effect on demand for British goods) and therefore doubted that devaluation would have any beneficial value. Over the next couple of years this view received backing from heavyweights such as John Hicks, Lionel Robbins and Joan Robinson – all Keynesians, albeit each one of a different political shade and outlook. Robinson argued that given the current state of full employment, devaluation would be likely to raise the demand for labour while more expensive imports would feed through into ‘pressure for higher money rates’, with the result that any competitive advantage resulting from devaluation would soon be lost.(10) Wilson himself, although prepared to contemplate devaluation if stringent deflation was the only alternative, pointed out that it offered no comfortable way forward. First of all there would be a detrimental effect on the government’s standing in the foreign exchange markets which might leave sterling exposed to more pressure on the basis that further downward adjustments could be expected. Secondly expansion would not follow from devaluation since resources would have be transferred to production for exports and given full employment this would have involved holding down domestic consumption.(11) In view of all these doubts and qualifications it is hard to see why the government should be blamed for choosing external assistance in preference to devaluation.
The Strategy
It has frequently been alleged that the government had come to power without any plans to turn around Britain’s poor external position (12) and that it lurched from one improvisation to another with no clear strategy.(13) These accusations are unfair. First, Labour had been aware for months prior to the election that the country’s balance of payments difficulties had serious implications for macroeconomic policy. While still in opposition Wilson and Callaghan had discussed the likelihood of support for sterling with Al Hayes, President of the Federal Reserve Bank of New York,(14) and had been assured that it would be forthcoming. Secondly, during the summer of 1964 Callaghan had made serious efforts to impress on colleagues who would be likely Cabinet Ministers in the event of Labour victory at the coming election that spending commitments would have to be scaled down; while some of the more ambitious, notably in the defence and aerospace sectors, would have to be reviewed. Thirdly, Labour sought to keep British costs in line with levels prevailing among international competitors and within two months of Labour’s election the Department of Economic Affairs had successfully negotiated the ‘Joint Statement of Intent on Productivity, Prices and Incomes’ with both sides of industry.
It was also aware that much of the pressure on sterling was speculative and followed from the increasing volatility of the international financial markets (a function of the late 1950s’ abandonment of wartime and post-war controls on currency convertibility throughout the advanced capitalist world). These were the early days of the Eurodollar market, with estimates suggesting that it had expanded from very little at the end of the 1950s to $16 billion by 1966.(15) Even by 1964 it was clear that the new Eurodollar funds, initially fed by US banks and multinational corporations seeking to avoid regulations at home, could move across national boundaries in the search for a profitable investment. In these circumstances it was clear that market psychology and ‘confidence’ had as much if not more to do with the pressure on sterling as the fundamentals of the British economic position.(16) It therefore made sense to take the fight to the markets by clear demonstrations that they would never be able to profit from selling sterling ‘short’ (betting on its devaluation). This could be achieved partly by the international support operations which mobilised resources beyond the speculators. Such operations could be reinforced by intervention in the forward market for sterling: here, the Bank of England would counter selling of sterling at a discount in the forward market by guaranteeing to honour the currency’s parity (then £1= $2.80) three or six months down the line. The Bank had initially not been happy about making this commitment but Wilson pressed Cromer to do so in November and thereafter forward market intervention became almost routine. At the same time, the insistence that devaluation itself be ‘unmentionable’ was completely rational given the susceptibility of the markets to rumour.
These actions were, however, more than improvised piecemeal measures. The trend to multinational production (the term ‘multinational corporation’ had in fact first been used in 1960) and financial liberalisation posed a general challenge to national economic sovereignty. The USA had itself been buffeted by speculative forces in the early 1960s. Britain was especially vulnerable. It had liabilities, or balances, of £4 billion. These were three or four time the size of the gold reserves. They had been attracted to the City of London because of its traditional freedom from regulation and because of sterling’s long history as a trading and reserve currency. Their volatility was a major concern; a rapid withdrawal of these funds in a bear market precipitated by devaluation – or just suspicion that devaluation was imminent – would lead to a banking crisis in the UK.
It made sense from the perspective of the national interest to restore some stability to the external economic environment, and international financial co-operation in the cause of exchange rate stability, along with forward market intervention, reflected an attempt to reconcile the increasing internationalisation of finance and production with the post-1945 search of the nation-state for growth, full employment and price stability. The government did not stumble into this: it had come to power committed to reforming the international monetary order. In particular it supported and built on the efforts of the previous, Conservative administration to secure, in co-operation with the USA, an increase in international liquidity. This would be available through the IMF to assist members suffering from serious balance of payments fluctuations: it would be particularly useful to states like the UK or the USA where there was an imbalance between short-term assets and liabilities.(17)
A rational approach
Given the evidence at its disposal about the state of the economy, Labour’s approach to the 1964 sterling crisis was rational. There seemed to be no ‘fundamental disequilibrium’. There were good reasons for preferring external support, intervention and long-term international monetary reform, along with supply-side measures at home, to devaluation. Labour was prepared to consider altering the sterling-dollar rate in November as well as October 1964, but given the risks involved in devaluation not to mention the distinct absence of widespread enthusiasm for a change, there had to be very compelling reasons for preferring it to a rescue package. These were not present in November 1964.
The fact that sterling was devalued in the end has strengthened the view of critical commentators that the government should have done it earlier. Did Britain devalue in 1967 because it had failed to do so before? The evidence does not support such a post hoc ergo propter hoc argument. Thirlwall and Gibson point out that the balance of payments did improve after 1964: there was a fall in import growth while export volume increased by nearly 7 per cent each year. The balance of payments on current account diminished and by 1966 was in surplus. In 1967 demand appeared to be falling and the indications were that the country would end the year in the black on current and long-term capital account. This promising situation was transformed by a series of events beyond the government’s control. First of all export growth was checked by a global slowdown. All the same by mid-summer the external position was still healthy. At this point two factors destabilised it. The first was the Six Day War and the closure of the Suez Canal, which stimulated heavy selling of sterling. The bear market in sterling was intensified by an increase in short term interest rates in the USA and in the Eurodollar market. A set of disappointing trade figures for June did not help and in the third quarter the balance of payments went back into the red. Confidence began to evaporate once more, a development reinforced by dock strikes in London and Liverpool which hit shipments of exports. By November the speculation was out of control.(18) A rescue package was available but the government rejected the terms as too deflationary, and devalued.(19) This time there were compelling reasons in favour of devaluation.
Yet, as in 1964, the crisis itself was ultimately a speculative one. There was no insurmountable problem with Britain’s trading position (indeed in 1969 it was found that this was substantially better than appreciated at the time, thanks to the discovery of a mistake in the recording of the export statistics (20)). The real story of the Labour Governments from 1964-70 revolves not around their economic incompetence or lack of a strategy for dealing with external financial problems. Rather it is about the difficulties created for social-democratic administrations by the increasingly powerful forces of global capitalism. Here, as with industrialisation, Britain was a pioneer, forced as a result of its own relatively open economy to confront problems that would in time become common to most of the advanced industrial world: de te fabula narratur (change the name and the story’s about you) as Marx would have said.
Notes
[1] Fred Hirsch, The Pound Sterling: a polemic (London: Victor Gollancz, 1965); Michael Stewart, The Jekyll and Hyde Years: Politics and Economic Policy since 1964 (London: Dent, 1977) pp. 27-30
[2] Alec Cairncross, The Wilson Years: a Treasury Diary 1964-69 (London: The Historians’ Press, 1997)
[3] See PRO PREM 13/261, report of a meeting between the Prime Minister and the Governor of the Bank of England, 24 November 1964.
[4] PRO PREM 13/261 ‘Top Secret Annex’ to minutes of a Ministerial meeting at Chequers of 21 November 1964.
[5] Donald MacDougall, Don and Mandarin: memoirs of an economist (London: John Murray, 1987), pp. 155-6.
[6] A. P. Thirlwall and Heather Gibson, Balance of Payments Theory and the United Kingdom Experience, fourth edition (Basingstoke and London: Macmillan, 1992), p. 234.
[7] PRO T171/758, briefing by Alec Cairncross, ‘The Economic Situation 5 October 1964.
[8] PRO T171/769/17 (ii) minutes by Armstrong and Nield, 16 November 1964.
[9] See Thirlwall and Gibson (note 6), p. 238.
[10] Roger Middleton, Charlatans or Saviour? Economists and the British Economy from Marshall to Meade (Cheltenham: Edward Elgar, 1998), p. 262; Thirlwall and Gibson (note 6) p. 236.
[11] Harold Wilson, The Labour Governments 1964-1970. A Personal Record (London: Weidenfeld and Nicholson and Michael Joseph, 1971), p. 6.
[12] Scott Newton and Dilwyn Porter, Modernization Frustrated: the politics of industrial decline in Britain since 1900 (London: Unwin Hyman, 1988), pp. 151-2.
[13] Alec Cairncross and Barry Eichengreen, Sterling in Decline: the devaluations of 1931, 1949 and 1967 (Oxford: Basil Blackwell, 1983), pp. 164-66.
[14] James Callaghan, Time and Chance (London: Collins, 1987), p. 159; Stephen Dorril and Robin Ramsay, Smear! Wilson and the Secret State, (London: Fourth Estate, 1991), p. 80.
[15] Scott Newton, The Global Economy 1944-2000: The Limits of Ideology (London: Arnold, 2004)
[16] PRO PREM 13/866, report of June 1966 by Lord Kahn, ‘Enquiry into the Position of Sterling, 1964-66’.
[17] See PRO FO371/178909/W2/198, ‘International Liquidity’: brief for Washington talks, 27 November 1964.
[18] See Thirlwall and Gibson (note 6), p. 240.
[19] See Harold Wilson (note 11), pp. 252-4.
[20] Roy Jenkins, Life at the Centre (London: Macmillan, 1991), pp. 278-9.