In May 2023, when the British Office of National Statistics (ONS) released the March-quarter national…
This blog continues the discussion of the British currency crisis in 1976. Today we discuss the growing discontent within the British government over the need to negotiate the IMF loan in 1976. While it has been held out that Britain had no alternative but to impose austerity and allow the IMF to dictate policy, the fact is that an alternative was proposed which would have been a superior option.
The pound starts sliding
By early March 1976, financial investors with sterling-denominated assets began selling the currency as a statement that they considered further depreciation was inevitable.
The sell-off saw the pound drop from 2.0239 US dollars at the start of March, to 1.915 US dollars by the end of the month – a depreciation of 5.4 per cent.
Through April and May, the currency continued to ebb down, nothing sharp or sensational, just a slow decline in value against the US dollar. By the end of May, the pound had depreciated by 13.1 per cent against the US dollar.
The opposition within Cabinet increases
The Cabinet met on June 10, 1976 and considered amendments to the much contested Aircraft and Shipbuilding Industries Bill, which would eventually see the nationalisation of the two sectors and the creation of two publicly-owned corporations, British Aerospace and British Shipbuilders and honour the February 1974 election commitment.
The amount of opposition to the Bill from the corporate sector and the conservative politicians (not to mention from within Labour’s own ranks) was an example of how vexed the British political situation was in 1976.
At that meeting, the Cabinet also considered the exchange rate situation, especially after the pound had slid a further 3.4 per cent in the week since May 27. On June 2, 1976 alone the pound fell from 1.7528 US dollars to 1.7229.
The Chancellor told the Cabinet that with the agreement of the Prime Minister he had addressed the nation on TV on the evening of June 2 (British Cabinet, 1976x: 5) “in an attempt to reassure the market”.
[Reference: British Cabinet (1976x)Conclusions of a Meeting of the Cabinet, CM(76), June 10, 1976, TNA CAB/128/59/8.]
Denis Healey also told the Cabinet that he had arranged a 3-month currency swap arrangement if $US5,300 million, through the Group of Ten, with additional support from the Bank fo Switzerland and the Bank of International Settlements, to give the Bank of England funds necessary to support the pound in foreign exchange markets.
Essentially, central banks such as the US Federal Reserve Bank stood by to provide “the additional foreign exchange reserves whenever the Government wished, but would attract no payment of interest unless spent, at which point the interest would be at the United States Treasury bill rate, currently 51/2 per cent” (p.5).
The arrangement would also allow Britain to draw on IMF reserves to repay the swaps if they were unable to do so from their own reserves.
Prime Minister Callaghan summed up the meeting and urged Cabinet members to support early cuts in the fiscal deficit to (p.6) “avoid a continuing slide in the exchange rate which compelled them to make panic cuts in public expenditure.”
He clearly did not want the exchange rate to float, would not consider capital controls, and had accepted the erroneous proposition that Britain was now hostage to the currency speculators.
Ludlum (1992: 714) argued that “the Labour cabinet faced actual and potential creditors of monetarist persuasion, among them stronger states whose view boiled down to the advice of the under-secretary of the US Treasury to his British counterparts to cut public spending in order to ‘get your people back on the reservation’.”
[Reference: Ludlum, S. (1992) ‘The Gnomes of Washington: Four Myths of the 1976 IMF Crisis’, Political Studies, XL, 713-727.]
Britain thus refused – for reasons of ideology or ignorance – to challenge the behaviour of the speculators by locking their funds behind capital controls and blocking imports. Instead, it chose to punish its own citizens by deliberately pushing the unemployment rate up through public spending cuts.
This was pure ideology – falling into line with the growing Monetarist mantra, which also was tied up in the IMF trying to reinvent itself in the new world of floating exchange rates – given that its previous role under Bretton Woods was now redundant.
Through the IMF, new guidelines were agreed in June 1974 and specified that nations with floating exchange rates “should refrain from introducing restrictions for balance-of-payments purposes on current account transactions or payments” (IMF, 1974: 112).
[Reference: IMF (1974) Annual Report 114, Washington.]
This opposition to restrictions on trade and financial flows did not represent a rejection of restrictions in terms of their effectiveness – quite the opposite. Rather, it reflected a distaste for them as part of the shift in ideology away from regulation.
The guidelines also urged nations to intervene in foreign exchange markets to maintain stable currency values, which was inconsistent with the ‘free trade’ rhetoric and reflected the fact that nations were still not up to speed on the advantages that the floating currencies could offer.
As part of these new guidelines, nations approaching the IMF for standy-by arrangements had to specify their policies with respect to trade and capital flows to ensure they were consistent with the growing ‘free trade’ mindset.
In that regard, in the so-called ‘Letter of Intent’, that Denis Healey sent to the IMF to set up the credit facility in December 15, 1976, he eschewed any notion that Britain would move to restrict capital flows or trade. He wrote:
The Government remains firmly opposed to generalised restrictions on trade and does not intend to introduce restrictions for balance of payments purposes … The Government does not intend to introduce any multiple currency practices or impose new or intensify existing restrictions on payments and transfers for current international transactions.
He told the Commons on the same day that the Government was firmly wedded to achieving a broad money growth target – a principal element of Monetarist doctrine – and would achieve the adjustments necessary through significant cuts to public spending.
Political commentator Peter Riddell wrote in 1983 that all the elements of what would become Thatcherism were “contained in the Letter of Intent sent by Denis Healey as Chancellor of Exchequer to the International Monetary Fund in December 1976” (1983: 59).
[Reference: Riddell, P. (1983) The Thatcher Government, Oxford, Martin Robertson.]
But we are getting ahead of ourselves here.
It is significant that the central banks which participated in the swap agreement were also acting “from a degree of self-interest” (p.5) given that they were worried their currencies would appreciate more than they cared and erode the export competitiveness of their respective nations.
The Cabinet discussion made some interesting points, which continue to have applicability in the present day. It was noted that “The exchange rate had received an excessive coverage in the media in recent weeks, and its importance had been grossly over-emphasised … in a way which helped to induce an unjustifiably nervous state in the foreign exchange market.” (p.6)
The current trend of the financial media making profits with sensationalised headlines and erroneous stories of nations such as Japan running out of money is nothing new.
The Cabinet also noted the favourable reports of North Sea gas and oil reserves, which would later provide a significant source of growth for Britain and allow Margaret Thatcher to gain undue credit despite putting a wrecking ball through British industry.
If only the Cabinet in 1976 had realised that the doom and gloom that the financial media was selling, which pressured the Government into ill-advised austerity, was not an accurate reflection of the outlook for the nation.
The IMF comes into the frame – along with the Americans
In the Letter of Intent, Healey specified that the IMF-preferred measure of money supply growth – Domestic Credit Expansion (DCE) – would be constrained to “create monetary conditions which will encourage investment and growth and will help to control inflation” (House of Commons, December 15, 1976.
He said that in the year to April 20, 1977, “DCE will be kept to £9 billion in the year up to 20th April 1977 and £7.7 billion in the year ending 19th April 1978, and I expect a further reduction in the following year to £6 billion.”
This would be achieved by reducing the fiscal deficit so that “the public sector will be making a smaller demand on savings in the next two years”.
[Reference: House of Commons Hansard (1976) ‘Domestic Monetary Effects’, HC Deb 15 December 1976 vol 922 c1534 – LINK.]
One couldn’t find a more precise statement of the erroneous narrative that Monetarism promulgated at the time than Healey’s claims to his colleagues in the Commons as he presented the Letter of Intent.
But it wasn’t new for him. He had taken the step to introduce money growth targets earlier in 1976. The April 6, 1976 ‘budget’ statement had emphasised the control of the money supply as part of the Chancellor’s strategy to control inflation. On July 22, 1976, Healey publicly announced that they would target a 12 per cent increase in the broad money aggregate (M3) for the 1976/77 fiscal year at the same time as it was pursuing harsh public expenditure cuts.
David Dutton (1991: 74) concluded that the shift in emphasis away from fiscal policy under Healey and Callaghn meant that “the control of inflation had overtaken the maintenance of full employment in the hierarchy of economic objectives”.
[Reference: Dutton, D. (1991) British politics since 1945 : the rise and fall of consensus, Oxford, Blackwell].
Colin Thain and Wright (1995: 19) concur and state that “the Labour Government explicitly abandoned the full employment objective” and that “Chancellor Healy downgraded the role of fiscal policy” such that “Control of spending was elevated as a policy goal in its own right”.
[Reference: Thain, C. and Wright, M. (1995) The Treasury and Whitehall: The Planning and Control of Public Expenditure, 1976-1993, London, Clarendon Press.]
On July 1, 1976, the Chancellor provided a note the Cabinet – Public Expenditure to 1980-81 – which outlined the scale of the public spending cuts proposed as part of the Government’s approach to the currency depreciation.
The Chancellor said that “It was therefore necessary to do as much as possible by public expenditure cuts” (p.2).
[Reference: British Cabinet (1976y) Public Expenditure to 1980-81 Note by the Chancellor of the Exchequer, CP(76)40, TNA, CAB/129/190/15.]
Widespread cash limits were applied to public expenditure programs and the fiscal retrenchment would be biased towards public expenditure cuts rather than tax increases. The standard (neo-liberal) IMF handbook approach!
The proposed cuts were discussed at the next Cabinet meeting on July 6, 1976 where the Chancellor had claimed that the “main problem …. was one of financing the country’s external deficit over the next two years” (British Cabinet, 1976w: 2).
The Chancellor noted that the exchange rate stability that had come after the $US5,300 million standby arrangement facilitated by the US government was not sustainable unless the fiscal deficit was significantly reduced. But, as it stood, Britain would struggle to pay back the funds to the US (and others) and attract more funding given the projected external deficits for the next two years.
Over the 1976 summer, the British government had drawn $US1.6 billion of the $US5,300 million standby funds and it had to repay those funds by December 1976.
Of course, these concerns about the lack of foreign reserves were all in the context of their commitment to sustain a given level of the pound. The ‘funding’ concerns would have vanished had the Government allowed the currency to fully float.
[Reference: British Cabinet (1976w) Conclusions of a Meeting of Cabinet, July 6, 1976, CM(76) 13th, TNA, CAB/128/59/13.]
He told his colleagues that financial support from the nation’s overseas lenders would only be forthcoming if they were “satisfied about the viability of the country’s economic strategy”. He also claimed that the IMF and other nations from who “we might borrow – were concerned about the growth of the money supply with a high public sector borrowing requirement” (p.2).
The fetish against fiscal deficits was now widespread and the Chancellor claimed that Britain could not sustain a deficit, as growth returned’ because “the United States, France and Germany were all planning to cut or eliminate their deficits” (p.2).
This comparison clearly ignored the different trading capacities of these nations and the implications of that for the need for domestic policy to support high levels of employment. Germany, by now, was a trading powerhouse with a central bank that continually manipulated the mark to ensure its external competitiveness was maintained. Its need for fiscal deficits was less as a result than a nation such as France, which was running trade deficits more or less continually.
Cabinet solidarity regarding the proposed course of action was challenged by the Secretary of State for Energy, Tony Benn who challenged the basic notion that Britain would face a “crisis of confidence” unless harsh fiscal cuts were introduced (p.3).
He hinted that Healey was just ramming through ideologically-motivated cuts given that the Cabinet (p.3):
… had seen no specific financial forecast of the likely size of the public sector borrowing requirement, and no quantitative forecast of the extent to which it would fall as economic recovery proceeded.
He believed that the Tories were fermenting discontent by “aligning themselves with the markets to shake confidence in the Government” (p.3).
The financial press, firmly conservative, also played a major role in this white-anting process.
Benn also noted that the narrative kept changing. First, the workers were told that wage restraint was necessary to control inflation. Then, with wage restraint evident, they were told that strikes were causing havoc among international investors. Then, with industrial action “now at a very low level” (p.3) they now were told:
… that there would have to be further public expenditure cuts?
The danger was that the austerity would undermine the Social Contract and jettison all the good work the unions had done in moderating their behaviour.
Benn urged the Government to consider alternative approaches to the external deficit without cutting public expenditure in any significant way. Among the policies he floated were:
1. “expand industrial capacity by concentrating imports on industrial re-equipment and restraining imports for consumption” (that is, import controls) (p.4).
2. Increase taxes on “goods with a high imported content” (p.4).
3. Ensure higher profits that arose “from the relaxation of the Price Code were in fact devoted to industrial investment” (p.4).
4. Divert public money into areas of high unemployment (p.4).
Nothing concrete was agreed at this stage.
After a few months of stability, the pound started depreciating again in early September 1976 and by the end of that month it stood at 1.6681 US dollars, a depreciation of 17.6 per cent since the start of the sell-off in March 1976.
The US Government and West Germany were increasingly of the view that Britain would have to negotiate an arrangement with the IMF to gain the funds necessary to finance the external deficits without further depreciation of the pound.
The US Congress report (1977) said that (p.4):
Both the U.S. Treasury Secretary Simon and the Schmidt Government had long been critical of what they considered to be Britain’s excessive public expenditure at the expense of the private sector, and in general, Britain’s living beyond its means. They therefore favored multilateral financing through the International Monetary Fund (IMF).
The British Government sought a $3.9 billion loan from the IMF in September 1976 because it had “exhausted its recourse to potential sources of financing other than the IMF” (US Congress, 1977: 4).
This would mean that the Government would be tapping into the so-called ‘third tranche’ of IMF support, which under the IMF rules, required a “full review of Britain’s economic policies by Fund specialists” (US Congress, 1977: 5). In other words, the IMF would presume priority over policy discretion.
It also knew that the Washington-based institution would impose harsh conditions on the credit access which would worsen the unemployment crisis the nation was already mired in.
The $3.9 billion loan was “the largest single loan ever considered by the Fund” (p.5).
The Government only had a single-vote majority and, internally, it was deeply divided on the course of action to follow.
There were thus two levels of negotiations going on:
1. Between the British government and the IMF.
2. Within the British Labour Cabinet.
The IMF position was clear. It blamed the fiscal deficits, which they claimed stimulated domestic spending (particularly helping consumer demand in the wake of high unemployment) without increasing domestic production.
As a result not only did they claim the deficits were inflationary but through the stimulus to imports, they caused the trade balance to deteriorate.
The IMF wanted the British government to cut is fiscal deficit in 1977-78 by £3 billion in what the government had projected to be an £11 billion deficit.
They claimed that the deflationary impact of the fiscal contraction would stimulate the private sector investment because the reduced public borrowing requirements would reduce interest rates and stimulate private borrowing.
This was the ‘crowding out thesis’ that had been elevated to one of those statements that can be insinuated on a conversation without any further explanation. It was a thesis that defied any evidential veracity and in the era of fiat currencies had no logical consistency.
But it was part of the powerful Monetarist narrative that seemed to accord with intuition – if the government borrows more there will be less for others. The lessons of Keynes and Kalecki – that spending brings forth its own saving – were being obliterated by the growing Monetarist Groupthink.
The Government’s position was split. James Callaghan and his Chancellor Denis Healey clearly were sympathetic to the IMF narrative.
The US Congress briefing (1977) said that they:
… had long wanted to move in the direction now being recommended by the IMF but had not been able to override the opposition of the party’s Left; they therefore secretly welcomed being put in a position of appearing to have no choice but to carry out the deflationary policies being dictated from outside Britain.
The IMF position was also supported by the Tories and its allies in the financial press (particularly the Times, The Economist and other professional journals), who considered the ills of Britain to be summarised in two ways: excessive trade union power, which stifled entrepreneurship and excessive and wasteful public spending, which forced taxes up and eroded the incentive to invest.
They wanted widespread privatisation of the nationalised industries, the elimination of budget deficits via spending and tax cuts, the retrenchment of the Welfare State, and the reduction of trade union power.
The Left-wing of the Parliamentary party, however, was opposed to the suggestions. They indicated that it was unthinkable to be advocating harsh contractionary spending cuts when unemployment had gone beyond a million and was continuing to rise.
They claimed that the British ills were rooted in the class system, which allowed incompetent people to rise into senior management positions as a result of their social networks and background.
They also pointed to the investment strategies of British capital which sought profits off-shore and undermined employment and productivity growth within Britain.
Tony Benn and Michael Foot, key members of the Tribune Group (Left faction) eschewed any dealings with the IMF and, instead, pursue and ‘alternative’ approach which would allow for import controls, higher public employment, improved planning to ensure the nationalised industries worked more effectively and eliminate the need for foreign capital inflow to shore up the public finances.
The US government’s attitude to the ‘alternative’ was captured in the US Congress briefing (1977: 7) as being a call “for a ‘siege’ economy under which selective import controls would be imposed to reduce the trade deficit and, over the longer term, national economic planning instituted to eliminate unemployment and production bottlenecks”.
One might, alternatively, represent the Left ‘alternative’ proposed by Benn and others as being a recognition of the intrinsic capacities that a currency-issuing government possessed which allowed it to advance the well-being of its citizens and eschew the prioritisation of the interests of international capital, and by 1976, in particular, the interests of the investment bankers and hedge funds.
The IMF arrangements also had implications for the Social Contract, which was the centrepiece in the Labour Government’s anti-inflation strategy.
The IMF conditions would cut across the agreement the Government had with the unions and would force the former to demand tighter wage restraint. But they would also signal to the unions that the ‘social wage’ aspects of the Social Contract – social programs designed to entice workers to accept less wage growth in return for improved public services – would be in jeopardy.
The Social Contract had been an important part of the obvious adjustment the nation was making after the 1973 oil price shocks.
But it should not be thought that it was only the Left in the Government that opposed the proposed intervention of the IMF.
When the IMF conditionality was unveiled to the British Cabinet …. 10 of the 13 speakers were against the terms and even Callaghan, himself, thought the austerity being demanded by the IMF was excessive (Callaghan, 1987: 433).
[Reference: Callaghan, J. (1987) Time and Chance, London, Collins.]
The US Congress report (1977: 8) also observed that Labour politicians “from the Center and Right also found the loan terms originally proposed by the IMF to be unacceptable”, although they didn’t demur from supporting the view that some external funding was necessary.
There opposition was essentially political, they didn’t think the Government could survive if it imposed harsh fiscal cuts and pushed unemployment up any further.
At the heart of the opposition within the Cabinet was the “one of the key questions” (Harmon, 1997: 2):
… who and what would be the determinants of British economic policy in a global economy characterized by increasing interdependence.
[Reference: Harmon, M.D. (1997) The British Labour Government and the 1976 IMF Crisis, London, Palgrave.]
It goes without saying that this question is exactly the topic of this book and we contend that the Left not only constructed the question in an errant manner but provided the wrong answer. The currency-issuing sovereign state is always in control irrespective of how ‘interdependent’ the nation is with other nations – economically or in terms of financial flows.
The Labour Party Conference in September 1976 was the next major event I will consider – both in terms of Callaghan’s speech and the way Denis Healey operated.
We are now up to Part 3 of the manuscript which will form what we are adopting as a working title “A progressive manifesto” – or something like that. It will be our idea of what a coherent Left platform should look like.
The series so far
This is a further part of a series I am writing as background to my next book on globalisation and the capacities of the nation-state. More instalments will come as the research process unfolds.
The series so far:
The blogs in these series should be considered working notes rather than self-contained topics. Ultimately, they will be edited into the final manuscript of my next book due later in 2016.
That is enough for today!
(c) Copyright 2016 William Mitchell. All Rights Reserved.