A Long View of Sterling

June 6, 2012

Before the dollar assumed the role of international currency hegemon, the British pound commanded that position and was worth around 4.85 U.S. dollars over several decades bridging the 19th and 20th centuries when the major economies of the world operated on the gold standard.

Gold standard rigidities were an important contributing factor to the Great Depression.  Britain in September 1931 abandoned the gold standard, which had obligated it to back money by gold and to exchange paper currency freely for the yellow metal.  The United States took longer to give up the old monetary regime and paid a price for that choice, suffering a more severe and prolonged economic contraction than did Britain.

Early in World War II, the sterling’s dollar value, also known as cable, was at $4.86, similar to its parity in the gold standard years.  But Britain was a battleground of the war and emerged weakened, whereas the United States was strengthened.  The Bretton Woods agreement of 1944 fashioned a new monetary system of fixed dollar exchange rates that encased the U.S. currency as the world’s preeminent international reserve currency.  In 1949, the pound’s central parity rate was set at $2.80, and sterling stayed there until it was devalued to $2.40 in 1967.

The United States suspended dollar convertibility in August 1971, devalued the dollar in December that year and a second time in February 1973.  The Bretton Woods system was out of gas and replaced by a system of floating exchange rate in the following month. 

Extremely elevated inflation and chronic fiscal and external deficits made sterling vulnerable in the 1970’s.  U.K. inflation crested above 25% in 1975 and above 27% in 1979.  It didn’t help, either, that the government rather than an independent central bank set monetary policy, and union power subjected the country to crippling strikes and excessive labor costs.  The pound posted sequentially weaker average values of $2.4510 in 1973, $2.3393 in 1974, $2.2218 in 1975, $1.8051 in 1976, and $1.7453.  In the autumn of 1976, a record low of $1.55 was reached, and Britain in deep humiliation went to the IMF for financial aid and outside direction for a program of economic reforms. 

The infamous exit in 1992 of sterling from the euro’s predecessor, the Exchange Rate Mechanism, wasn’t the first failed attempt to constrain the currency’s movement against other European currencies.  After the dollar devalued initially in late 1971, a group of countries formed a band, known as the “snake” within a “tunnel” that allowed even less fluctuation among members than allowed against the new dollar parities.  Sterling joined the snake on May 1, 1972 but was forced to exit just six weeks later on June 23, and it proceeded to float downward against European currencies as well as the dollar.  It was an early lesson of the impossibility of binding currencies with widely different economic fundamentals together by force. 

Former Prime Minister Thatcher’s conservative policies and increased North Sea oil production gave sterling new life.  Britain was able to end interferring exchange controls by October 1979, and sterling still climbed to a crest of $2.4550 on October 24, 1980.  Alas, that advance didn’t last either.  In less than 4-1/2 years, sterling fell by 58% to $1.0345.  And from 5.1287 marks on February 11, 1981 to 3.1914 marks on March 3, 1986, it lost 38% of value against Europe’s lead currency, the German mark.

Sterling shadowed the Exchange Rate Mechanism in the latter 1980’s and formally joined in October 1990 with a central parity of DEM 2.95.  That episode lasted just short of two years and solidified later political distrust of the euro.  When the euro began existence on the final day of 1998 without Britain, the pound was worth $1.6628, and the euro was worth 0.7055 pounds.

But here’s an irony.  Even without being in the European Economic and Monetary Union, sterling’s average values since December 31, 1998 of $1.6721 and EUR/GBP 0.7230 have been very close to the levels when the euro was born.  Over this period of about 13-1/2 years, cable has ranged from a high of $2.1160 on November 9, 2007 to a low of $1.3505 on January 23, 2005 and against the euro from a high of EUR 0.5688 on May 3, 2000 to a low of EUR 0.9803 on December 30, 2008.  The widths of those trading bands, 56.7% against the dollar and 72.3% versus the euro have been less than prior to 1999 in the case of the dollar but wider in the case of other European currencies. 

Although Britain does more business with Europe than the U.S., it’s currency is a closer soul mate of the dollar than the euro.  This continues to be true in 2013.  The pound as of Wednesday afternoon this week was a mere 0.4% softer than its end-2011 level against the dollar and 2.8% firmer against the euro.

Copyright 2012, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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