It’s Wednesday and I just finished a ‘Conversation’ with the Economics Society of Australia, where I talked about Modern Monetary Theory (MMT) and its application to current policy issues. Some of the questions were excellent and challenging to answer, which is the best way. You can view an edited version of the discussion below and…
I am now using Friday’s blog space to provide draft versions of the Modern Monetary Theory textbook that I am writing with my colleague and friend Randy Wray. We expect to complete the text during 2013 (to be ready in draft form for second semester teaching). Comments are always welcome. Remember this is a textbook aimed at undergraduate students and so the writing will be different from my usual blog free-for-all. Note also that the text I post is just the work I am doing by way of the first draft so the material posted will not represent the complete text. Further it will change once the two of us have edited it.
Case Study – The British IMF loan in 1976
[CONTINUING – NOTE I AM PIECING THIS TOGETHER FROM A RANGE OF PRIMARY HISTORICAL DOCUMENTS AND IT IS VERY TIME CONSUMING. THE TASK IS TO DISTILL THE MASSIVE DETAIL AVAILABLE IN THE VARIOUS OFFICIAL DOCUMENTS TO PROVIDE AN ADEQUATE BACKGROUND TO WHAT HAPPENED IN THE MID 1970s. WITHOUT THAT BACKGROUND ERRONEOUS CONCLUSIONS ARE EASY TO MAKE]
Post War Period to the 1976 crisis
Soon after the Bretton Woods system was introduced there were major failures in agricultural harvests in Europe (and hence exports) as a result of adverse weather.
Many European nations were particularly vulnerable to these fluctuations, not the least because their external reserve position (holdings of gold and currency reserves) was fragile in the face of Balance of Payments deficits.
The Marshall aid plan began in 1948 partially helped European nations to fund their balance of payments deficits while still engaging in the reconstruction effort.
But the reserve losses were still substantial during this period. The Bank of England, for example, started 1946 with 2,696 million dollars worth of gold and dollar reserves and by 1949 this had dropped to 1,668 million dollars. The United Kingdom endured large reserve losses in 1947 but drew on the “Anglo-American loan”.
As recognition for the losses Britain endured prosecuting the war effort and the late entry of the North American nations into that conflict, Keynes had negotiated the Anglo-American loan whereby the US and Canadian governments provided a low cost loan to Britain (from 1946), which allowed the British government to maintain its financial commitments to the sterling-area nations (principally the Commonwealth countries) without having to cut back infrastructure renewal in Britain.
The loan arrangement also required the British government to provide sterling convertibility into dollars and many nations that held sterling as reserves sought to exchange them for US dollars thereby worsening the loss of reserves arising from the external deficits.
Britain also received aid under the Marshall Plan which helped offset the assistance that Britain was providing to the Commonwealth nations and had the effect of allowing these nations to increase government spending on infrastructure development “beyond what would otherwise have been possible” (BIS, 1950, page 29).
[Reference: Bank of International Settlements (1950) Twentieith Annual Report, Basle]
Convertibility under the Anglo-American loan was abandoned in 1947 as the reserve crisis increased. Britain responded by introducing contractionary domestic policy.
The crisis came to a head in early 1949 as a result of a US recession, which significantly reduced the demand for US imports from Europe (particularly food and raw materials).
As a result of the deteriorating trade balance (less exports), British gold and dollar reserves fell to $570 million between April and June 1949.
To avoid a complete loss of reserves, the pound was devalued on September 18, 1949 by 30.5 per cent, which led to similar devaluations in the non-dollar currencies in Europe and the sterling-area.
Soon after the US recession ended and British reserves recovered somewhat due to the dual impacts of increased competitiveness arising from the devaluation and the short-lived nature of the US economic downturn.
Throughout this period, Britain was running large sterling surpluses within the sterling-area but large dollar deficits overall.
It funded the deficits in several ways: drawing on its gold and dollar reserves; drawing on the Anglo-American loan; drawing on the Canadian loan, and in 1947, 1948 and 1949 the sterling-area countries borrowed from the IMF. A once-off gold loan from South Africa and the ERP aid also helped.
The drawings mentioned actually allowed Britain to increase its gold and dollar holdings in 1947, 1948 and 1949.
The 1949 devaluation was in response to the shortage of reserve and to some extent reflected the teething problems in the newly created Bretton Woods system.
[SECTION HERE ON 1950s up to the mid-1960s leading up to the 1967 DEVALUATION …. NEXT WEEK]
The November 1967 Devaluation
The November 1967 devaluation did little to improve the external position even though exports surged. Domestic policy was tightened to slow down the growth in imports.
In June 1969, Britain entered a new stand-by arrangement with the IMF, which allowed the UK to draw up to $1 milliard (equivalent to $US1 billion) over the next 12 months. In return, the British government indicated they would further contract fiscal policy to achieve a balance of payments surplus in 1970. This was more than achieved
At this point the perennial debate about wages policy became relevant. The British government sought to lock-in the external competitiveness gains from the devaluation by introducing an incomes policy aimed at suppressing domestic wages growth. Workers had an incentive to seek higher nominal wage gains to restore the real losses created by the devaluation (higher import prices).
Trade unions rejected the demands by the government for wage restraint, which would have effectively forced labour to absorb most of the real losses.
[SECTION HERE ON EARLY 1970s – WAGE-PRICE STRUGGLES … NEXT WEEK]
The demise of the Bretton Woods system
The Bretton Woods system finally collapsed in August 15, 1971, when the US government curtailed convertibility in the wake of an on-going external deficits which precipitated unsustainable gold losses.
The Group of Ten nations responded by agreeing to a new system of pegged exchange rates. The initial decision was to devalue the US dollar and increasing the band around which exchange rates could fluctuate. There was no taste at that time for a freely floating system of currencies.
Interestingly, the die was cast with the large devaluations in 1949 of the sterling and other European currencies against the US dollar. Prior to that the US economy had run large external surpluses, not the least because its productive system was undamaged by the Second World War.
After 1949, the US started to run external deficits (mainly due to net outflows of capital) and progressively lost reserves. The rest of the world looked on this favourably as the net outflow of US funds provided nations with US dollar reserves.
However, in the second-half of the 1960s, with domestic inflation pushing up as a result of the military spending associated with the Vietnam War, the external competitiveness of the US fell (particularly against Japan) and the trade surplus narrowed as imports boomed and export growth moderated.
While the US dollar was at the heart of the Bretton Woods system, it became increasingly clear that it was overvalued through the 1960s. The rather large decline in the US trade surplus in 1968 provided a clue to this assessment.
[SECTION HERE FINISHING OFF THE DEMISE OF THE BRETTON WOODS SYSTEM AND THE IMPLICATIONS FOR BRITAIN STRUGGLING WITH ITS EXTERNAL POSITION AND DOMESTIC LABOUR RELATIONS]
The first OPEC crude oil price hike
The crunch started in mid-October 1973, when the Arab oil-producing nations, in the face of the on-going military conflict in the Middle East, decided to cut crude oil production and increase prices.
The Organisation of Petroleum Export Countries (OPEC) cartel initially increased the crude oil price by 70 per cent. A further price rise of 127 per cent followed soon after (December 1973). In three months the price of crude oil had risen from $US3.01 per parrel to $US11.65 per barrel.
The initial worry was that oil would be in short supply given the announced cut backs in production. Nations initially introduced rationing in anticipation. But OPEC reversed that decision and crude oil output was soon back to its September 1973 level albeit at a much higher export price.
Many nations were highly dependent on imported crude oil with Japan highly exposed. In 1973, around 8 per cent of Britain’s imports comprise crude oil, which represented about 1.9 per cent of Gross National Product.
The oil price rise had four initial effects. First, it represented a real loss to each importing nation and more of their national income had to be devoted to purchasing energy. Deflationary effects soon emerged with car sales plunging in many nations.
Second, there was a major substitution away from oil-using technologies (large cars, oil heating etc), which provided domestic investment opportunities. The mid-1970s saw the advent of the small four cylinder car as the norm in most nations as consumers abandoned the larger cars that had been commonplace in the Post War expansion.
Third, the crude oil hikes introduced cost inflation as producers and other firms tried to pass on the higher raw material costs onto consumers and thus avoid squeezing real profits. At the same time, trade unions sought to defend the real wages of their members by seeking higher nominal incomes.
Fourth, the international balance of payments was dramatically altered with oil dependent nations experiencing large increases in the value of imports and, in some cases, nations that typically ran external surpluses were forced into external deficit. The mirror image was that the OPEC nations started to run up very large current account surpluses.
Britain entered the crisis with Z years of balance of payments deficits and had already experienced financing pressures.
[TO BE CONTINUED]
NEXT WEEK WE WILL CONSIDER THE LEAD UP TO 1976.
THIS WILL PLACE THE BRITISH REQUEST TO THE IMF IN ITS CORRECT CONTEXT.
The Saturday Quiz will be back again tomorrow. It will be of an appropriate order of difficulty (-:
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.