Devaluation of the Pound

Harold Wilson and the Devaluation of the Pound

Harold Wilson was involved in both the devaluation of the pound in 1949 and 1967. Both times things did not go as planned.

Harold Wilson in Parliament

Harold Wilson became a member of Parliament in 1945 when the Second World War was nearing its end. He was the leader of the Labour Party from 1963 to 1976. From 1964 to 1970 he had his first period as Prime Minister. He then returned to lead the opposition from 1970 to 1974 and then returned to his position of Prime Minister from 1974–76.

Harold Wilson by unknown photographer, 1962 - National Portrait Gallery.

Devaluation of the pound in 1949

In 1945, Clement Richard Attlee, leader of the Labour Party from 1935 to 1955, became Prime Minister of the United Kingdom after Winston Churchill had to resign. He had inherited a government with massive financial problems:

• Debts of £4198 million

• A balance of payments crisis. Britain had spent £750 million more abroad than it received.

• Export of manufacturers had dropped by 60% in wartime.

• Invisible exports had decreased from £248 million in 1938 to £120 million in 1946.

• The costs of maintaining overseas military commitment were quintupled (5 times greater) between 1938 and 1946.

By 1949, the pressure on UK reserves supporting the fixed exchange rate mounted again, and since Stafford Cripps, then Chancellor of the Exchequer, was ill and recuperating in Switzerland, Attlee delegated the decision-making to Harold Wilson, Hugh Gaitskell, and Douglas Jay. They unanimously decided on the devaluation of the pound.

On 18 September 1949, the pound was devalued by a massive 30%, from $4.03 to £1 to just $2.80 to £1. At the time, this was considered a dramatic event.

This is because there are significant economic consequences to devaluing a currency:

• A lower exchange rate lowers the value of the domestic currency in relation to the currency of other countries, most notably the US dollar.

• This lower exchange rate is most significant in relation to major trading partners.

• While devaluation can assist in making exports less expensive, it also makes imports more expensive. This will deter people from buying imported goods, which leads to a decrease in imports, eventually leading to a reduction in the real income of consumers.

The outcome of this event would eventually lead to Harold Wilson being reluctant to devalue the pound again in 1967 when he was Prime Minister.

Clement Attlee by Yousuf Karsh, c. 1945, Wikimedia Commons.

Events leading up to the devaluation of the pound in 1967

There were several events leading up to the devaluation of the pound in 1967.

Deflation vs Devaluation

Harold Wilson became Prime Minister for the first time in 1964. A current account deficit of £800 million was forecast: almost twice what had been expected during his campaign. In order to save the pound, there were 2 options:

1. Deflation (a reduction of the general price level of goods and services in an economy).

2. Devaluation.

Due to the negative impact of the devaluation of the pound in 1949, Wilson was reluctant to even consider a new devaluation, even though many economists advocated for it. Wilson, however, did not want the Labour Party to become known as ‘the party of devaluation’, due to the negative implications of devaluing the currency.

On 12 July 1966, the Cabinet rejected the devaluation option and instead went for the following two strategies:

1. Deflation: a general decline in prices for goods and services. Consumer and asset prices decrease over time and purchasing power increases.

2. Austerity: a set of strict economic policies that a government imposes to control the growing public debt. It helps to bring financial health back to the government.

These measurements eventually led to a budget surplus in the first half of 1967. However, several events destabilised the economy and contributed to the strain on the sterling.

The National Plan

This was Wilson's first grand idea. He would set up a National Plan. In the words of James Callaghan, Chancellor of the Exchequer, it:

In other words, they wanted to have more exports and fewer imports. Wilson wanted to stimulate industrial production and exports by having the government, employers, and trade unions work together.

To draw up this National Plan, Wilson had the Department of Economic Affairs (DEA) established. This would promote growth and investment. The DEA would undertake long-term planning of the economy and industry, while the Treasury would determine short-term revenue-raising and financial management.

The National Plan was published in September 1965. However, it was abandoned in 1967 as few of the expansion targets were met.

James Callaghan by Christian Lambiotte 1975, Wikimedia Commons.

Tensions with the Unions

Wilson believed that inflation and Britain's balance of payments deficits were a major threat to their economic progress and that therefore wages and salary increases must be kept in check. The government wanted to keep wage increases below 3.5%.

A 6-month 'freeze' on prices and incomes was introduced in 1966 and it was the task of the Prices and Incomes Board to regulate pay settlements. This, however, did not go as planned as it lead to two strikes that caused severe issues to the country's economy.

The Seamen's strike

The National Union of Seamen (NUS) was the principal trade union of merchant seafarers in the UK from the late 1880s to 1990. On 16 May 1966, the NUS launched a strike to secure higher wages and reduce the workweek from 56 hours to 40. This strike was supported by union members and it caused great disruption to shipping.

The disruption had a negative effect on the country's economy. On 23 May, the Government declared a state of emergency but didn't use its powers. The strike ended after three months, on 1 July.

The Docker's strike

Dock work was considered a dangerous occupation. Between 1955 and 1967 around 1% of registered dock workers in Britain were absent from work due to injuries. Dockworkers wanted better pay and went on strike in September 1967. This strike had a massive effect on export and was a blow to the country's finances.

Wilson was extremely critical of both strikes, which he characterised as a deliberate attack by a group of Marxist extremists.

The Arab-Israeli Conflict

Relations between Israel and its Arab neighbours were very tense. On 5 June 1967 an armed conflict broke out that would last for six days, until 10 June 1967. It was therefore called 'the Six-Day War'. This war caused a rise in petrol prices which meant that the UK had to spend more on importing it. This then led to an increase in petrol prices at the gas stations in the UK.

Closure of the Suez Canal

After the Six-Day War, Israeli forces occupied the Sinai peninsula, including the entire east bank of the Suez Canal. Egypt did not want Israel to use the canal so they immediately set up a blockade closing the canal to all shipping.

This was a major blow to British trade. The Suez Canal allowed for faster sea transport to India, which increased Britain's long-standing strategic interest in the Eastern Mediterranean. This blockade, which lasted eight years, highlighted Britain's declining status as a world power.

The Devaluation of the pound in 1967

Wilson believed that the industrial troubles mentioned above were a key factor in increasing Britain's trade deficit. Therefore, he approached the IMF for another large loan, having already borrowed money from the IMF in 1964. The fact that this was a temporary way of dealing with the financial problem caused him to worry that the government was losing its grip on their finances.

Despite securing a $3 billion rescue package, freezing wages, and having some successes with the National Plan, Wilson had to do the one thing he did not want to do. On 18 November 1967, he set in motion the devaluation of the pound. The pound dropped by 14%, from $2.80 to £1 to $2.40 to £1. With this, interest rates rose from 6.5% to 8.0%, there were cuts to the defence budget, and banks and stock exchanges would be closed the next Monday.

Wilson had not made himself popular with this decision, and his unpopularity rose even further after his radio and television broadcast where he said:

The Purpose of Devaluation

As we already explained, the whole idea of devaluing the pound was to make export cheaper. This should have the following effect:

• Making exports cheaper. In other words, lowering the costs of British goods would encourage other countries to buy from Britain. This would then increase exports and should decrease the balance of trade deficit.

• While making export products cheaper, imported products would increase in price. The idea behind this was that this should motivate British consumers to buy British goods.

The Aftermath of the Devaluation of the Pound

The devaluation, alongside austerity measures that ensured resources went into exports rather than domestic consumption, successfully restored the trade balance to a surplus by 1969.

People have often wondered why Wilson did not devaluate the pound sooner, as it has clearly shown to work by creating a surplus in a short amount of time. However, at the time, Wilson believed that there were strong arguments against the devaluation, including the fact that it would set off a round of competitive devaluations and concerns about the impact the following price rises would have on people on low incomes.

Regardless, delaying the measure turned the whole situation into an unnecessary drama. James Callaghan stood down as Chancellor of the Exchequer and the trade unions were angry that Wilson tried to lay most of the blame for the financial struggles on the strikers.

It is now known that Wilson had grossly overestimated the seriousness of the balance of payment deficit. As mentioned earlier, he estimated it to be £800 million at the start of his term as Prime Minister, which was twice as much as he initially estimated during his campaign. In reality, however, it was revised down to 'just' £376 million.

It is possible that if Wilson had made a more accurate forecast of the deficit, he would have chosen to devalue sooner. It then would have been seen as a financial adjustment rather than a dramatic measure.

How do the lessons of 1967 apply today?

On 23 June 2016, the UK voted to leave the European Union and while the pound has lost value over the years since 1967, the difference between 1967 and 2017 is dramatic. It has fallen by as much as 21% against other major currencies.

The graph below shows that the pound has more than halved in value against the US dollar since 1967.

The value of the pound compared to the US dollar from 1967 to 2017 - Bank of England and Bloomberg, 2017.

Against some currencies, during certain periods, the pound would have been stronger, but on the whole, against major currencies such as the US dollar, the pound has been falling for quite some time.

The graph below shows the performance of the pound against the US dollar since 1791.

The performance of the pound against the US dollar since 1791, Bank of England, 2017.

Brexit and Devaluation

While Brexit is not considered a devaluation in the literal, truest sense of the word, many of the problems that Wilson faced in 1967 are similar today:

• Too many imports

• Not enough exports

• Inflation

There are two main differences though:

1. The exchange rates today are a fraction of what they were back then.

2. The lower exchange rates may help to counteract some of the negative effects of Brexit by keeping British businesses competitive and attractive to international buyers.

So, while Brexit does show signs of devaluation, it is less severe than the event of 1967. Even so, it is a clear example that devaluation, in any form, does still exist and has happened consistently for decades.