Sterling’s Been a Much Traveled Currency

August 8, 2016

From $1.5019 in Far Eastern trading early on June 24th just before the Brexit referendum result was known, the pound fell as much as 14.3% to a low on July 7th of $1.2878. It’s unlikely that the drop has run its course. Much will depend on the details of Britain’s departure from the European Union are hammered out.

Sterling was the dollar’s predecessor as the dominant international currency and worth considerably more than now during its glory days. In World War I, its value was around $4.70. The exchanged rate strengthened to $4.87 in 1925, was briefly even more pricey at $5.00 in 1934, and held steady at $4.03 from March 1940 until 1950. After being reset at $2.80 in 1950, it fluctuated narrowly around that level until November 1967, when it devalued to $2.40.  In the early 1970s following two general devaluations of the dollar, the U.S. currency was delinked from gold and allowed to be determined by market forces from March 1973 onward.

Currencies with large offshore holdings, relatively high inflation, and large current account deficits like the dollar and sterling come under heavy strains in the early 1970. After an initial U.S. dollar devaluation in December 1971, several countries in Europe formed an EC snake with narrow 2.25% trading bands among on another’s currencies. Sterling joined that arrangement on May 1, 1972 but had to leave just six weeks later on June 23rd, a day that was to take on added infamy exactly 44 years later.

In the modern floating exchange rate era, the pound has undergone some very impressive swings that dwarf its move since the voter preference for leaving the EU was handed up some seven weeks ago. Sterling traded as high as $2.65 in 1973 but fell sharply in 1976, bottoming in October of that year at $1.55.  In December of 1976, the U.K. submitted a Letter of Intent for an IMF loan requesting help with its economic problems. Conservative Margaret Thatcher came to power in May of 1979.  Sterling benefited from the switch of government and the development of North Sea oil production at a time when oil prices had risen sharply.  A high of $2.4550 was touched in October 1980, around the time when the Federal Reserve under Paul Volcker was implementing an all-out assault on excessive growth in the money supply, bank reserves, inflation, and a generally weak dollar. When the dollar peaked eventually on February 26, 1985, the pound at $1.0345 was dangerously close to breaking below parity.

The wild swings of the dollar in the 1970s and 1980s had persuaded British officials to orient macroeconomic policies toward stabilizing the pound against the monies of Continental Europe, and an informal policy of limiting movements against the members of the Exchange Rate Mechanism (ERM) — a joint float of other currencies anchored around the German mark that served as the group’s anchor.  In October 1990, sterling joined the ERM with a central parity of DEM 2.95. By early September 1992, sterling was worth $2.0075 but under immense strain against the mark and other ERM members. A series of interest rate hikes to defend the British currency and immense forex intervention only egged on the speculation, and sterling left the ERM on September 16, 1992, forevermore known as Black Wednesday. Against the dollar, sterling tumbled 29.3% to $1.4189 over the ensuing five months.

Leaving the joint float of European currencies was an enormous humiliation for politicians but a good turn of events for the British economy, which often performed better than its continental rivals.  Some fifteen years after Black Wednesday, the pound was trading as high as $2.1160 on November 9, 2007 in the early days of the U.S. subprime mortgage loan crisis. By November 23, 2009, it had dropped some 36% all the way to $$1.3505, not far from its current level.

The above capsuled history highlights the volatile nature of the sterling-dollar exchange rate through the ages. The pound has never dipped below $1.00, but its first-ever slide under $2.00 in March 1976 became a catalyst for a frenzy of selling.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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