A Game of Chicken over Sterling

The story named no source and was instantly and vehemently denied by everybody involved. Nonetheless, it caused the most violent spasm yet in the seemingly endless agonies of the pound. The story, front-paged on Oct. 24 by London's Sunday Times, implied that the U.S. Government and the International Monetary Fund would insist that the British government let the pound sink to $1.50 against the U.S. dollar as a condition for a desperately needed $3.9 billion IMF loan to Britain. U.S. Secretary of the Treasury William Simon, IMF officials and British Chancellor of the Exchequer Denis Healey all protested that no detailed conditions for the loan have yet been negotiated. Even so, the pound fell 7 1/2-c-in a mere two hours of wild trading the following day and ended up at an alltime closing low of $1.59, v. $2.58 in the summer of 1973.

Did that mean that money traders believed the story rather than the denials? Not necessarily: it means that moneymen so distrust the pound's value that they will seize on almost any excuse to dump sterling. Said one banker: "No one who sold sterling believed that the story was true. They sold because they were afraid someone else would believe it." Even the rare bit of good British economic news cannot soothe these jitters. On Oct. 26 the British government reported that unemployment in September shrank by 78,000, to a total of 1,377,110. The news brought no recovery in the price of the pound.

The root cause of this nervousness is that international investors simply do not believe that the Labor government of Prime Minister James Callaghan can succeed in its economic game plan to save the pound--and the British economy. That plan calls for reducing the British inflation rate, currently 14.3% a year, by moderately cutting public spending and holding the nation's militant trade unions to a "social contract" under which they are supposed to limit wage increases to 4 1/2% a year. The government's hope is to hang on through the winter. By spring, according to its script, oil from the North Sea will flow in sufficient quantity so that Britain can begin to cut its bills for imported oil, thus reducing its towering trade deficit and slowing the movement of sterling out of the country.

Falling Pound. The threats to this strategy are numerous. The continuing fall in the pound itself is one; by making British imports more expensive, the latest drop will add about one percentage point to the inflation rate. The unions at some stage could be forced to rebel against the social contract and seek big raises to catch up with inflation. Now a new menace has arisen: the possibility that onerous conditions could be attached to the IMF loan. Talk is circulating through London that the IMF may demand, if not a $1.50 pound, then draconian cuts in social spending or a rise in the Bank of England's minimum lending rate to 18% (it is already a sky-high 15%).

The Labor government is convinced that fulfilling such conditions would mean its own downfall, since it rules largely by the favor of the unions, which would be horrified by such measures. In that case, Britain would be thrust into a bitter election campaign; though there has been talk of a national coalition government, both Tories and Laborites now seem set against it. The outcome could be a Tory government pledged to spending cuts that, according to Prime Minister Callaghan, would plunge the nation into social turmoil, or drastic cuts in British imports and the standard of living decreed by a government of whatever political complexion.

To head off those possibilities, the government is now engaged in what one Cabinet minister terms "a game of chicken." Callaghan opened the game by directly implying, in an interview on British television, that if the nation's allies insist on stern conditions for the IMF loan, then Britain will have to reduce its contributions to NATO. The country's primary contribution is the maintenance of 55,000 soldiers and airmen in Germany. The government seems to be thinking in terms of a cut of $795 million a year in defense spending, which would mean a reduction in that force to 40,000 men--later, perhaps, to 30,000. That such a threat--some might even call it blackmail--could be seriously voiced by Callaghan, one of the most pro-NATO politicians in Britain, underscores the gravity of the situation.

Even if the game of chicken succeeds and Britain gets the IMF loan with few strings, the winter is strewn with pitfalls. Shortly, Parliament will begin a debate on home rule for Scotland. If moneymen could be so shaken by an unsupported story in the Sunday Times, what will be their reaction to screams from Scottish Nationalists for control over the revenues from North Sea oil, Britain's putative salvation?

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