Financial crises have the potential to change history. This is obvious in regards to true depressions, like that of the 1930s, but even smaller tremors can change the way economies are managed, or are left unmanaged. One of these lesser crises was the 1976 IMF Crisis in which Britain was forced to seek a bailout from the International Monetary Fund (IMF) following a balance of payments crisis that year. The IMF Crisis changed the course of British economic policy. Arguably even more so than 1979’s Winter of Discontent and Margaret Thatcher’s electoral success that same year, the IMF Crisis was the event that set-in motion Britain’s abandonment of its dirigiste social democratic postwar project.
A defining feature of the British economy in the decades immediately following the Second World War was its relative economic decline. In absolute terms, standards of living in Britain were rising, but the pace of growth was much slower than that of the continental European economies or the United States. While Britain was experiencing an average GDP growth of 3% in the 1960s, France and Italy were growing at more like 5% during the decade-long expansion, as was the US.
By the late 1960s, GDP per capita in France and Germany surpassed that of the UK. Also, whereas British and American output per capita would have been roughly equal during the Great Depression, a 40% gap in the Americans’ favor grew during and immediately following the war. It is a gap that has only diminished slightly in the decades since. The reasons for this relative decline are often summarized as Britain’s relative difficulty in transitioning into a post-industrial economy. The nationalization of industry, relatively weak levels of post-secondary educational attainment compared to other rich countries, and the sclerotic work practices insisted by trade unions were contributing factors.
In retrospect, the excessively high exchange rate between the dollar and the pound established at the Bretton Woods Conference in 1944 likely had something to do with the postwar malaise. The fixed exchange rate at the time was slightly over $4 to the pound. A strong pound had been blamed for poor economic growth during the 1920s as well, another period characterized by relative weakness in the British economy. In theory, sufficient holdings of foreign currency reserves, capital controls, and the emergency-lending powers of the IMF would hold the Bretton Woods system together. Nonetheless, Britain devalued the pound twice during the Bretton Woods era, starting with a sharp devaluation in 1949 and followed by a smaller one in 1967. By 1970, the rate stood at $2.40 to the pound.
Still, not all aspects of Britain’s postwar economic performance were negative. The economy was still growing fast enough to simultaneously build a generous welfare state and pay down Britain’s large wartime debt. Debt-to-GDP peaked immediately after the war at 230%. It had fallen in half by 1960 and stood at 70% in 1970. Though it would be the center of the 1976 crisis, confidence was high enough in sterling that many countries still linked their currencies to it. This ‘sterling zone’ meant that the British pound remained a reserve currency in which many governments accumulated surpluses.
Strikes and Stagflation
Besides the government, the most significant institution in the story of Britain’s IMF Crisis, perhaps even more important than the IMF itself, were the trade unions. Relations between the government and the unions deteriorated under the Conservative government of Edward Heath. Much of this was due to the Industrial Relations Act of 1971 which sought to limit wildcat strikes and curb escalating labor disputes. However, the measure was controversial and it helped to make the trade unions even more confrontational. Work stoppages would grow far more frequent in the decade ahead.
The early 1970s in Britain, like in other economies, was characterized by rising inflation. Some factors driving this inflation were global in nature, such as the 1973 Arab oil embargo; others were specific to Britain. For one, the Conservative government eased fiscal policy by cutting taxes and increased credit availability by removing the lending ceilings that had been used to conduct monetary policy in Britain until then. The ‘Barber Boom’, named after then Chancellor of the Exchequer Anthony Barber, increased inflationary pressure.
Further, there had previously been an ‘incomes policy’ in Britain intended to limit inflation by regulating prices and wages. These measures were partially abolished by the Conservative government which also presided over the end of Bretton Woods and took the decision to float the pound in 1972, abandoning fixed exchange rates altogether. In 1974, the year the Conservative government left office to be replaced by a Labour one, annual inflation had surpassed 15%. However, the economic troubles extended beyond inflation. The mid-1970s was also marked by a prolonged recession, which began in mid-1973 in Britain and would not end until two years later. The recession discouraged the new Labour government, elected without a firm majority, from adopting contractionary policies to stop inflation, which would peak in 1975 at annual rate of 23%.
Adding even further to the problem and owing to weak exports, Britain’s balance of payments was rapidly deteriorating during this period. A sizable trade deficit replaced the roughly balanced current account that existed in 1971. The trade deficit grew rapidly to 5% of GDP in 1974, though it would rebound to only a 2% deficit by 1976, the year Britain had to be bailed out by the IMF. The many conflicting economic trends prevented decisive government action. The hope of the Labour government was that it could do a deal with the trade unions to stop inflation. The government would repeal the Industrial Relations Act of 1971 and enact price controls and subsidies and in return would get the unions to reduce wage demands, reducing future inflation. Essentially, the government would try to fight inflation with increases in public spending, rather than cuts.
As such, the growing trade deficit was complemented by increased fiscal deficits. In 1974, much of the Labour Party strongly opposed spending cuts; they saw things in Keynesian terms and paid more attention to rising unemployment than to rising inflation. Public spending grew 12% in real times in the first year of the Labour government amid flat economic growth. The budget deficit peaked at 6% of GDP in 1975. However, that year marked a shift in the government’s focus to inflation and the deficit began to fall from there. By many objective standards, the government was hardly that negligent. The rapid fall in the public debt relative to output following the Second World War had halted but not reversed altogether.
However, the pound was under pressure regardless. Up until the early-1970s, the British pound was still a world reserve currency. During the oil embargo, the newly enriched petrostates of Saudi Arabia, Kuwait, and Nigeria, parked some of their surpluses in pound-denominated assets, thus financing British trade and fiscal deficits. Those three countries alone accounted for two-thirds of the sterling reserves held by global central banks and governments and they were a fickle bunch. By the 1970s though, the status of the pound as a reserve currency was already being threatened. Foreign holdings of the pound were sinking and nations whose currencies had been pegged to sterling were abandoning it. Even Hong Kong, a British possession, switched from a sterling-peg to a US dollar-peg in 1972, the year the British government applied some capital controls.
The twin deficits, and the hitherto ineffective response to them, led to a gradual abandonment of the pound as a reserve currency. From there, the effect was pressure on sterling. The pound fell 20% in value against the dollar between 1972 and the start of 1976, and would fall still more from there. Further, an effective policy response became increasingly unlikely as the Labor government lost its majority in the summer of 1976 but remained in power as a minority government. Support for further cuts in public spending, supported by the Labour Chancellor of the Exchequer Denis Healey, was low. Some Labour politicians proposed alternative solutions to the balance of payments crisis, including capital controls and import quotas. However, those were unacceptable as long as Britain remained a member of the General Agreement on Tariffs and Trade and the European Economic Community, which between them barred such policies.
In 1976, though the British economy began to improve, downward pressure on sterling had not abated. Defending the currency was depleting foreign currency reserves. In June of that year, the UK entered a $5.3 billion swap facility with the central banks of other G10 countries (save for Italy, which was facing a similar crisis) and Switzerland. The money was to be used to purchase sterling. Other governments had come to believe that the pound had fallen more than was necessary to make British exports competitive and thought it in their interest to prevent it from falling further.
The loan was for three months, renewable for another three months at most, with the understanding that Britain would have to go to the IMF if they had trouble repaying the credit by December. It was a standby facility; Britain paid no interest until it drew on the facility, at which point it paid the US Treasury bill rate, then 5.5%. Despite purchases of sterling by the British government made on borrowed money, the currency continued to fall. Though it had stood at $2.30 when Labour came to power in March 1974; it had had fallen to $1.67 by the autumn of 1976.
The pound had not stabilized by the time the $5.3 billion facility was close to expiring. Though Britain could repay the sum it had drawn from the facility, it would mean undoing the market interventions of the past few months, selling sterling to fulfill its pledge under the swap. Taking this route would put even further downward stress on the currency. Thus, Britain went to the IMF and received the largest bailout in its history to that point, $3.9 billion. The amount was essentially a refinancing of the facility extended by the G10 over a longer term. Of course, the nations that financed the IMF were essentially the same as those who had extended credit earlier but this time policy concessions were demanded. The assistance was conditional on higher interest rates and cuts in public spending, specifically £2.5 billion in spending cuts over the following two years.
The IMF intervention, which provided longer term financing than the earlier G10 facility, did buy the British government time to enact policy reforms and hold out until the economy improved further. The loan halted the pound’s fall and the British economy did improve. In fact, the projected deficits turned out to be £2 billion smaller than expected. Exports rose, eliminating the trade deficit, and within a few months the balance of payments crisis that shook Britain in 1975-6 was quickly fading into history.
The improving economy allowed some easing of the public spending cuts and within a couple years, Britain was facing a new problem. A strengthening pound, partially the result of exports of North Sea oil, caused export industries to suffer. By 1980, the pound had returned to its 1974 level, $2.40. Regardless of the economic recovery, Britain’s management of its economy has never been the same since. Much of this would be the product of the so-called ‘Winter of Discontent’ in 1979 and the election of Margaret Thatcher’s Conservatives that spring. However, the IMF Crisis nonetheless marks a turning point in Britain’s economic history; the crisis shattered the faith people and politicians alike had in the state’s ability to manage the economy.
The IMF Crisis did more than end political careers; it changed the way people framed economic problems. Dealing with weak output and employment at the same time as rising inflation proved too much for the country’s economic policymakers. The crisis revealed the dangerous effects of years of economic divergence, a period when strong global growth left Britain behind, unable or unwilling to change course. However, the lessons of 1976 go beyond Britain. The IMF Crisis revealed that critical institutions, or rather the people who ran them, had become too accustomed to an old paradigm, one that was less relevant in an increasingly globalized and financially tempestuous time.
1. Bogdanor, Vernon. Lecture: The IMF Crisis, 1976. Gresham College, 19 Jan. 2016.
2. Coyle, Diane. Review – ‘When Britain Went Bust’. Financial Times, 9 Jan. 2017.
3. IMF Annual Report 1977. International Monetary Fund, 1977.
4. “IMF Crisis.” The Cabinet Papers, The National Archives, Kew, Surrey TW9 4DU, 30 Dec. 2008.
5. Schenk , Catherine R. “The Retirement of Sterling as a Reserve Currency after 1945: Lessons for the US Dollar?” May 2009.