The Agony of the Pound

(See Cover) It was 9:33 p.m. on a cold and foggy Saturday in Britain when the word first came. Much of the country was sprawled in stuffed chairs watching an old Doris Day movie (Midnight Lace) on the BBC. First there was a fragmentary bulletin that broke into the movie, then a delay in the scheduled 10:25 news while scriptwriters scram bled to get together details. In millions of living rooms up and down the length of Britain, people watched transfixed while a gay Latin American dance rhythm blared from the box, which went blank except for a slide advising:

"The News Is Coming Soon." The news came all too soon for once-proud Britain. After a week in which the long agony of the British pound reached a writhing climax, Prime Minister Harold Wilson's Labor government announced a cut in the pound's exchange value from $2.80 to $2.40--a 14.3% devaluation.

Despite all the headlines and all the talk during a long and hard week, Britons--and many others in the Western world--experienced a deep sense of shock at the news. Until the last minute, there were hopes and rumors that Britain would be able to free herself, at least temporarily, from the heavy pressures on the pound by getting a massive loan from its Western allies. After all, the pound is one of the two international reserve currencies (with the dollar), and its devaluation was bound to throw the West into a severe monetary crisis. Still, there it was. Growing crowds booed the police outside 10 Downing Street, and London's newspapers stopped their Sunday editions on the presses. It was Britain's biggest and worst news in many years.

"It is a black day for all of us," said John Davies, director general of the Confederation of British Industry, after emerging from No. 10. The Observer called devaluation "a brave act," but most of the British press took off after Harold Wilson's scalp. "This is D-day for Britain without the flags," said the Sunday Mirror. "The 'D' this time stands for disaster and disillusion as well as for devaluation." Since Wilson had consistently denied that he would ever devalue the pound, many Britons felt betrayed as well as disheartened. "I am quite shocked," said Sir Patrick Hennessy, chairman of Ford Motor Co. "I have personally told my business friends abroad that it would not happen. I could not believe that the government would go back on its statements."

And there was more bitter medicine to swallow than devaluation. In order to back up devaluation with financial muscle, Britain not only had to go hat in hand to the International Monetary Fund (to which it already owes $1.4 billion) to ask for a fresh drawing of $1.4 billion, but also had to arrange a multinational loan of $1.6 billion from its partners, thus creating a new $3 billion support package in order to prevent the total collapse of the pound. To back up its action, the government raised the interest rate from 61% to 8% in order to attract foreign deposits, ordered British banks to limit their loans to priority borrowers, issued restrictions on installment buying and credit and announced plans to cut $240 million from Britain's $5.3 billion defense budget. It ordered all banks and money markets in the country to keep their doors closed on Monday of this week to reduce speculation before final I.M.F. approval of the new support funds for the pound.

Cheaper Exports. When Clement Attlee's Labor government last devalued the pound in 1949 (from $4.03 to $2.80), 23 nations followed by devaluing their own currencies. This time, several countries--Ireland, Denmark, and Israel--almost immediately followed Britain's move by devaluing, and others are sure to follow this week, particularly within the British Commonwealth. The Common Market countries immediately decided not to follow Britain's lead, and the U.S. lost no time in announcing that it has no intention of devaluing the dollar. In a White House statement, President Johnson said that he could "reaffirm unequivocally the commitment of the U.S. to buy and sell gold at the existing price of $35 an ounce."

Devaluation will make Britain's exports cheaper and more attractive abroad, thus helping to lessen its huge balance-of-payments deficit, one of the chief causes of the pound's trouble. In the arcane, gentlemanly confines of the world's money managers, Britain has long been considered a naughty boy. In such circles, a nation's currency is its honor, and Britain's has been constantly imperiled by the country's inability to earn its own way in the world. The decision of the major powers not to devalue works to make the British move more effective, since a me-too devaluation by everybody would largely cancel out whatever benefits Britain hopes to reap from its drastic move.

Angry Sheiks. Last week's turmoil began with the disclosure of Britain's trade figures for October, which showed a gross deficit of nearly $300 million, the worst such monthly gap in the country's history. That in itself was certainly ominous enough, but the context in which the deficit emerged made the figures far worse.

Britain's endemic deficits are usually largest in times of expansion, when Britons, fully employed and flush with cash, step up their purchases of goods from abroad. This time, however, Britain is in the trough of a government-imposed slowdown now 18 months old, a belt-tightening period of austerity imposed by Wilson's government after another sterling crisis in 1966.

The tightening clearly failed to work, partly because Britons kept right on buying more foreign goods than the country could afford. There were other reasons for the failure that were largely beyond Britain's control. The Arab-Israeli war in June moved angry sheiks to pull more than $100 million out of London banks and deposit it elsewhere. It also closed down the Suez Canal, costing Britain some $600 million a year in higher shipping costs for its exports and higher prices for the fuel and other raw materials it imports. Wildcat dock strikes in London and Liverpool cost another $180 million in exports not shipped abroad. And Wilson's austerity squeeze started at a time when world trade generally was slowing down, making it difficult for Britain to increase exports in the dramatic way that was needed to bring its trade figures into balance.

The massive trade gap, coming atop the long series of sterling crises, touched off a flurry of pound selling. Holders of sterling balances rushed to their telephones to trade their pounds for gold, dollars or any other hard currency they could buy. With the supply of pounds so much greater than the demand, the price of sterling inevitably was driven downwards, until on Friday it slipped under the government-support level of $2.7825, to $2.7822.

In the City, London's financial district, bewilderment and confusion ran rampant. Bowler hats hobbled after every rumor, as wave after wave of massive selling hit sterling. Exactly how much gold and foreign-currency reserves the government had to use up to keep the pound afloat was a state secret as vital as any kept by England, but estimates ran as high as half a billion dollars for the week, half of Britain's expected 1967 payments deficit and one-sixth of its total reserves. The scene was much the same on markets in Paris, Zurich and New York. Alone and without devaluation, Britain could not have saved the pound. In New York alone, the Federal Reserve absorbed an estimated $300 million in unwanted pounds each day last week, and on frantic Friday the U.S. helping hand may have reached $500 million or more in a support of the foreign-exchange market not seen since the day of John Kennedy's assassination.

The Economic Doctors. Bank of England Governor Sir Leslie O'Brien had gone to Basel over the weekend to negotiate a loan from the Bank for International Settlements. The pound steadied on the news of a new loan, then weakened when the amount turned out to be only $250 million--just enough to cover an installment on a loan owed the International Monetary Fund and due on Dec. 1. The Economist last week tartly referred to this loan as "an hors d'oeuvre." At midweek the BBC reported that Wilson was going to get a loan of $1 billion from the Group of Ten, the free world's leading financial powers, whose representatives were then meeting in Paris' elegant Chateau de la Muette. Next day the pound struggled upward, only to nosedive once more when Chancellor of the Exchequer James Callaghan, speaking in the House of Commons, refused to confirm or deny the rumor. As the week drew to a close and the Group of Ten's delegates disbanded and went home with nary a public promise of help for Britain, the Friday panic in money markets around the world inevitably resulted.

Furtively Bruited About. While all this was going on Harold Wilson and his ministers were bent on a course that they had tried desperately to avoid ever since he took over as Prime Minister three years ago. Two weeks before, Chancellor Callaghan had gone to Wilson and reported that the Treasury's quarterly forecast showed that the outlook for 1968's balance of payments looked even worse than had been expected, and in fact suggested that there would be no improvement at all over the current year. In July, Callaghan had said publicly: "Those who advocate devaluation are calling for a reduction in wage standards of every member of the working class in this country." Now, he told Wilson, he had concluded that Britain would have to devalue, that "there's a point at which determination becomes obstinacy"--and that he had now passed that point. Exports were hardly rising, he told his boss, and yet enough wage increases had crept past the barrier of the Labor Party's price and income squeeze so that rising demand kept imports growing at an alarming rate.

The subject of devaluation began to be furtively bruited about among small groups of Wilson's ministers for the next several days, but it was not taken up at a formal Cabinet meeting until last Thursday. At the meeting the government made its decision to devalue.

That afternoon, Callaghan had to go before the Commons to answer questions about rumors that Britain had made international loan arrangements. He did not confirm that there were such negotiations for a good reason: there had not yet, in fact, been any. It was not until after the Cabinet meeting that the government went out and started looking for loans on the basis of its decision. The Bank of England's O'Brien went to work calling up his central bank counterparts in Europe and in the U.S. The whole deal was finally arranged by Saturday afternoon.

The I.M.F., which must approve devaluation of any of its members, was notified of the plan on Friday night, and at 8 a.m. Saturday each of its directors received a telephone call summoning him to a meeting that morning in Washington. The directors gave tentative approval to Britain's plan (they are to vote formally on the matter this week), and that approval was received in London about 5 p.m. Some four hours after that, having worked out a few more details, Chancellor Callaghan made his historic announcement.

The Once Proud Workshop. How did Britain, where the Industrial Revolution was born, fall to such a beggar's estate among the industrial nations of the world? There is scarcely a segment of British society or an element of British tradition that is not in some way responsible for the impoverishment of the once proud workshop of the world.

The ability of a nation to earn its way in the world rests primarily on its productivity: its capacity to marshall its human and mechanical resources to produce goods that can compete with those of other nations in the world marketplace. Only then does it earn enough income to buy the things it imports. For most of the postwar years, Britain's productivity has failed to keep pace with that of its competitors. Among the major industrial nations, Britain since 1951 has had the slowest rise in productivity, the lowest rate of investment in private enterprise and the largest rise in its export prices. In its case, the equation is doubly exacting; poor in natural resources, Britain must import much of its food and the raw materials for the goods it makes.

Both British management and successive governments are to blame for not pumping enough of the right kind of investment into industry to modernize it or, in spite of all the export campaigns, for not really getting out and hard-selling British goods. The job of salesman holds little status in Britain and, for that matter, business itself still tends to be looked down upon as the domain of the hustling parvenu or the disdainful "gentleman amateur."

Needing Every Penny. Labor, too, with its fierce class antagonisms still smoldering and its "I'm all right Jack" attitudes, has stoutly resisted any modernization of British industry that infringed on shop-hardened rituals. The unions' push for wages, backed by a proclivity for wildcat strikes unmatched in any country, sent hourly earnings soaring some 40% from 1960 to 1966. While Britain's productivity grew by only 18%, West Germany's was rising 29% and Italy's 40%. The result was that British goods were priced out of the market, while Britons used their money to buy more and more foreign, imported goods.

Britain's pretensions to playing the role of a great power added to her trade-imbalance difficulties. She still keeps fairly large worldwide defense commitments, last year gave $630 million in foreign aid. For most countries, their money is their own, to use as they wish abroad. But the British pound, as a reserve currency, is used much like an international money by traders and central banks the world over. The U.S. can afford to let its money be used by others; Britain, needing every penny it mints, no longer can, but has long insisted on continuing to try. The result is that when the Bank of England is driven to the wall to defend sterling, it may discover that as much as 75% of the supply of pounds extant is in the hands of foreigners--and out of reach.

No Panacea. Only twice before in the 20th century have Britain's economic troubles required a devaluation of the pound, and both times the step was taken by Labor governments. Britain's first devaluation was in 1931, when it went off the gold standard in the midst of the Great Depression; that move forever tarnished Labor Prime Minister Ramsey MacDonald's image in his party. The second was Attlee's in 1949, when none other than Harold Wilson, then head of the Board of Trade, took a major part in planning the devaluation. Properly done, a devaluation can turn a nation's trade deficit into a surplus practically overnight. It is not, however, a politician's panacea, since it means initially a sharp reduction in the standard of living of the devaluing nation's citizenry as manufacturers' profits decline and the cost of what a workingman buys goes up.

Last week's devaluation forever shattered an article of faith, solemnly sworn to by governments on both sides of the Atlantic, that unilateral devaluation was no longer possible, since it would dismember the many fragile and intricate international monetary mechanisms that have developed since 1949. Keeping those mechanisms oiled and balanced is the task of the international banking community's senior members, who are usually referred to as The Club. The Club works with the International Monetary Fund in Washington and the Bank for International Settlements in Basel, the official bankers to countries.

No country has kept The Club busier or given it more nightmares than Britain, whose economy has palpitated in maddeningly regular intervals through a dozen sterling crises in 18 years. The pattern soon became all too familiar: a period of expansion leading straight to the brink of bankruptcy for sterling at $2.80, then a rescue loan to buy time while the government damped down the economy. Once a spell of austerity built up Britain's reserves anew, governments invariably felt politically impelled to relax restrictions and let the whole expansion-to-the-brink process begin again.

"To Save the Pound." When Prime Minister Harold Wilson and the Social ists took power late in 1964, the pound was in one of its deeper malaises. Before he took office Wilson had warned the Commons that "devaluation would be regarded all over the world as an acknowledgment of defeat, a recognition that we are not on a springboard but a slide." Still, there were those who argued, and last week saw their arguments vindicated, that Wilson's first act as Prime Minister should have been devaluation. He could justifiably have laid the blame on 13 years of Tory mismanagement and cleared the slate for the fundamental overhaul of the economy needed to make his Socialist dreams of progress for the country at least feasible.

Instead, to the profound dismay of Labor's left wing and the trade unions, he set in motion the classic Tory remedies for the "stop" part of the stop-go cycle and, moreover, set them in motion awkwardly. First came a 15% surcharge on imports, a small tax incentive to exporters and a vague plan for regulating wage increases. When that failed to stem the run on the pound, Wilson raised the bank rate from 5% to the "crisis level" of 7%. The panic only increased, so Wilson appealed to the Club. Bank of England Governor Lord Cromer and the professionals of the U.S. Federal Reserve Board got on the transatlantic phones. Working all through one night, they secretly rallied their central banker colleagues around the world and came up with $3 billion in pledges to rescue the pound.

The speculators were beaten off, and the pound gradually recovered, until the next expansion-fueled strain on sterling's resources. It came in July of last year. To meet it, Wilson took, as he told President Johnson, "steps that have not been taken by any other democratic government in the world." He froze wages and prices for six months, to be followed by another half-year of "great restraint." Government-investment programs were slashed by $370 million, indirect taxes raised 10% and another 10% surcharge slapped on higher income brackets. Wilson told the British people that the massive austerity was required "to save the pound."

Hitlerian Mistakes. The pound, as it turned out last week, was not to be saved this time, despite nearly 18 months of Wilsonian deflation that has pushed unemployment up to 555,000 in a work force of 20 million, slowed the country's industrial growth to a meager 1.5% and created widespread dissatisfaction with Wilson's stewardship as Prime Minister. A Gallup poll published last week, before devaluation, found Wilson's "the most unpopular of all postwar governments" in Britain. Another poll a week earlier indicated that an election now would produce a landslide Tory victory, installing Edward Heath as Prime Minister with a 150-seat majority in the House of Commons. In the past 18 months Labor has lost six of eleven by elections, as many as Harold Macmillan's troubled Tory regime dropped in five years in office.

Wilson is in almost as much trouble within his own party. The Utopian Socialists condemn him for sacrificing theory to the hard facts of economic life. The leftists and unionists suspect him of endorsing "a permanent pool of unemployment" to encourage holding wages in check. When National Coal Board Chairman Lord Robens announced two weeks ago that mine employment would drop by 80% in the next twelve years, angry groups of mineworkers threatened to pull out of Labor and start a new political party. Major business leaders that Wilson had drawn into government service have been resigning, and the predictable fire from the Tory business community at a Socialist Prime Minister has been heavier than normal. Imperial Chemical Industries Chairman Sir Paul Chambers recently accused Wilson of making the same economic mistake as Hitler.

Purely Domestic. Having sworn so long to defend the pound against even the idea of devaluation, Harold Wilson gave plenty of new ammunition to the Tories when he broke his word. Tory Leader Ted Heath greeted the news by saying, "I utterly condemn the government for devaluing the pound," but Quintin Hogg, the Tories' shadow Home Secretary, made a more telling thrust: "People are angry and humiliated by this decision," he said. "At last they will realize that the Labor government cannot govern with its financial policies."

Still, few feel that Harold Wilson is about to lose his job. Though the Tories would certainly demand a censure vote, Wilson, with Labor's 80-plus seat majority, would almost as certainly win it. And unlike Attlee, who devalued in 1949 with only a few months of his term left, Wilson has until 1971 before he must call a general election. If devaluation at last begins to set Britain on the road to economic health, Wilson could go to the country by then with less trepidation.

The question in Britain, and around the world, was whether the devaluation would really work. The bankers of The Club are understandably a skeptical lot where British promises are concerned. Early last week several dismissed talk of devaluation. "A temporary respite," said the Deutsche Bank's Hermann Abs. "Not a real solution," observed Swiss Union Bank Chairman Dr. Alfred Schaefer. "Devaluation alone would only be a temporary measure," said Bank of America President Rudi Peterson. The British are well aware that devaluation alone is not enough. Chancellor Callaghan indicated that the government would couple it with enough muscle at home to ensure a turnabout into the black in the balance of payments of "$1.2 billion a year." The giant Trades Union Congress was due to meet this week to discuss voluntary wage restraints, essential to ensure that a new round of wage and price in creases does not quickly nullify the gains of the devaluation. But the feeling abroad was that Wilson had devalued as a purely domestic political move, being unwilling to suffer the political consequences of imposing the strict economic reforms that the world banking community is convinced Britain needs.

The Larger Market. The ripples of the pound's plunge inevitably reach far beyond Britain. The U.S. had long pressed massive loans on Wilson in lieu of devaluation because it feared the effect on the dollar. "If it can happen to sterling," observed one Treasury consultant, "people are sure to ask, can't it happen to the dollar too?" Some probing speculation against the dollar this week seemed likely.

Perhaps the most positive effect of devaluation could be on Britain's application for Common Market membership.

Most economists believe that Britain's final economic salvation lies in a larger market. In devaluing, Britain has fulfilled one of Charles de Gaulle's--and the Common Market Commission's--two stated requirements for entry. The other is the gradual dropping of sterling as a reserve currency, which Wilson's emissaries to Europe have already agreed to consider. Devaluation thus constitutes a major step toward meeting Europe's conditions. The real question, though, is whether Harold Wilson will follow it up with the toughness and tenacity that will be required if Britain is really to reap any lasting benefit from last week's disturbing step.

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