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Devaluation of the Pound

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History

A series of events led Harold Wilson, Prime Minister of the United Kingdom, to devalue the pound in 1967. This was a move that he had been reluctant to make and tried to avoid at all cost.

What is Devaluation?

Devaluation is when a government decides to deliberately adjust a country’s currency downwards in relation to another currency, group of currencies, or currency standard.

The devaluation of a currency reduces the costs of export making that country more competitive in the global market. In turn, this will increase the costs of imports. When imported goods are more expensive than domestic products, consumers are more likely to buy from domestic businesses. When export increases and import decreases, it helps to reduce trade deficits.

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.

Devaluation of the Pound Harold Wilson StudySmarterHarold 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.

The balance of payment (BoP) of a country is the difference between money coming into the country and going out into the world in a particular period.

Invisible exports are the part of international trade that does not involve the transfer of goods or tangible products. Examples are banking, advertising, and tourism.

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.

Devaluation of the Pound Clement Attlee StudySmarterClement 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.

A current account deficit is a measurement of a country's trade, where the value of the country's imports exceeds the value of its exports.

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.

A budget surplus happens when income exceeds expenditures.

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:

should function as a framework for industrial development and production, whose object would be to increase exports and replace imports.

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.

The Chancellor of the Exchequer is the government’s chief financial minister and as such is responsible for raising revenue through taxation or borrowing and is also responsible for controlling public spending.

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.

Devaluation of the Pound James Callaghan StudySmarterJames 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.

A state of emergency is an exceptional situation in which a government is able to put through policies that are normally not permitted in order to save and protect its citizens

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.

Marxism is a social, political, and economic theory that focuses on the struggle between capitalists and the working class. Marx believed that this conflict would ultimately lead to a revolution by the working class to overturn capitalism in favour of communism.

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.

IMF stands for International Monetary Fund. This is a scheme intended to prevent countries from going bankrupt. It started in 1947 and by 1990 over 150 countries had joined. Each of the member states deposited into a central fund from which it could then draw in time of need.

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:

From now the pound abroad is worth 14% or so less in terms of other currencies. That doesn't mean, of course, that the pound here in Britain, in your pocket or purse or in your bank, has been devalued. What it does mean is that we shall now be able to sell more goods abroad on a competitive basis.

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.

Devaluation of the Pound Value of pound compared to US dollar StudySmarterThe 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.

Devaluation of the Pound Performance of pound against dollar StudySmarter 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.

Devaluation - Key Takeaways

  • In 1949, Harold Wilson, Hugh Gaitskell, and Douglas Jay unanimously decided on the devaluation of the pound. The pound was devalued by a massive 30% from $4.03 to £1 to just $2.80 to £1.
  • Harold Wilson became Prime Minister in 1964 and wrongly forecasted an £800 million pound deficit. Instead of devaluing the pound, he opted for deflation and austerity strategies.
  • Despite securing a $3 billion rescue package, freezing the wages, and having some successes with the National Plan, the following events led to Wilson having to devaluate the pound:- Seamen's strike- Docker's strike- The Arab-Israeli conflict- The closure of the Suez Canal
  • The purpose of devaluation was to make exports cheaper and imports more expensive.
  • Many people believed that Wilson should have devaluated the pound sooner as it showed (in hindsight) that it created a surplus in a relatively short period of time.
  • The pound has been devaluating ever since 1967, showing that between 1967 and 2017 it has more than halved in value. Brexit shows signs of devaluation. However, it is less severe than the event of 1967 because the exchange rates are lower today.

Devaluation of the Pound

The value of the pound dropped by 14% from $2.80 to £1 to $2.40 to £1. 

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.

By 14% from $2.80 to £1 to $2.40 to £1. 

  • It creates a lower exchange rate in relation to other currencies.
  • The lower exchange rates create better terms for trading partners.
  • It can make export less expensive but imports more expensive.

Devaluation makes exports more competitive, increasing export demands.

Final Devaluation of the Pound Quiz

Question

What is the definition of devaluation?

Show answer

Answer

Devaluation is when a government decides to deliberately adjust a country's currency downwards in relation to another currency, group of currencies, or currency standard.

Show question

Question

When was the first devaluation during Harold Wilson's time in Parliament?


Show answer

Answer

1949

Show question

Question

Who became Prime Minister in 1945?

Show answer

Answer

Clement Richard Attlee

Show question

Question

What were the five financial issues that Attlee had to deal with when he became PM?

Show answer

Answer

  1. Debts of £4198 million
  2. Balance of Payments crisis. Britain had spent £750 million more abroad than it received
  3. Export of manufacturers had dropped by 60% in wartime
  4. Invisible exports had shrunk from £248 million in 1938 to £120 million in 1946
  5. Costs of maintaining overseas military commitment were quintupled (5 times greater) between 1938 and 1946

Show question

Question

What is the definition of invisible export?

Show answer

Answer

Invisible exports are the part of international trade that does not involve the transfer of goods or tangible products. Examples are banking, advertising, and tourism.

Show question

Question

Attlee left the decision-making about what to do against the pressure on UK reserves to three people. Who were they?

Show answer

Answer

  1. Harold Wilson
  2. Hugh Gaitskell
  3. Douglas Jay

Show question

Question

What was the date of the devaluation of the pound in 1949 and what was the devaluation?

Show answer

Answer

It was devalued on 18 September 1949 and it was devalued by a massive 30%, from $4.03 to £1 to just $2.80 to £1. 

Show question

Question

When did Harold Wilson become Prime Minister for the first time?

Show answer

Answer

In 1964.

Show question

Question

To battle the forecasted account deficit, Wilson chose two strategies to avoid devaluation. Which strategies were those?

Show answer

Answer

  1. Deflation
  2. Austerity

Show question

Question

What was Wilson's first grand idea to help battle the financial issues and what was it supposed to do?

Show answer

Answer

He would set up a National Plan. It would be to get more export and less import. Wilson wanted to stimulate industrial production and exports by having the government, employers, and trade unions work together. 

Show question

Question

What was established to draw up the National Plan and was the National Plan successfuly?

Show answer

Answer

The Department of Economic Affairs (DEA) was established. Only a few targets were met and the National Plan was abandoned in 1967

Show question

Question

Despite securing a $3 billion rescue package, the freezing of wages, and having some successes with the National Plan, some events led to Wilson having to devaluate the pound. Which four events?

Show answer

Answer

  1. Seamen's strike
  2. Docker's strike
  3. The Arab-Israeli Conflict
  4. The closure of the Suez Canal

Show question

Question

What does IMF stand for and what is it?

Show answer

Answer

IMF stands for International Monetary Fund. This is a scheme intended to prevent countries going bankrupt. It started in 1947 and by 1990 over 150 countries had joined. Each of the member states deposited into a central fund from which it could then draw in time of need

Show question

Question

When did Wilson announce the devaluation of the pound and what was the devaluation?

Show answer

Answer

On 18 November 1967, he set in motion the devaluation of the pound. The pound dropped 14%, from $2.80 to £1 to $2.40 to £1.

Show question

Question

What was the purpose of devaluation and what was the expected effect?

Show answer

Answer

To make exports cheaper. This should have the following effects:

  • Making export cheaper, in other words, lowering the costs of British goods, would encourage other countries to buy from Britain. This would then increase export 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

Show question

Question

Why did people say that Wilson should have devalued the pound sooner?

Show answer

Answer

Because it had created a surplus rather quickly after the devaluation.

Show question

Question

The devaluation was seen as rather dramatic, but this view could have been avoided if Wilson made a better forecast of the deficit. What were the forecasted deficits and what was it eventually revised down to?

Show answer

Answer

Wilson forecasted the deficit would have been £400 million during his campaign, he forecasted it to be £800 million when he became Prime Minister, but it was eventually revised down to £376 million

Show question

Question

Describe how the lessons of 1967 apply today

Show answer

Answer

From 1967 to 2017, the pound has more than halved in value against the US dollar. After the Brexit vote on 23 June 2016, the pound devalued about 21%.

The Brexit faced 3 problems similar to what Wilson faced in 1967:

  1. Too many imports
  2. Not enough exports
  3. Inflation


However, 2 difference between both deflation means that the Brexit deflation is seen as less severe:

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

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

Show question

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