The international role of sterling before the EU: Britain operated a captive market for sterling (NR Online Session 1)

By Maylis Avaro (Graduate Institute, Geneva & University Libre de Bruxelles)

This research is due to be presented in the first New Researcher Online Session: ‘Finance, Currency & Crisis’.

Pre-EU sterling was of a zombie international currency, maintained by British authorities through threats and controls on the Commonwealth countries.

Post-Brexit Britain is looking for new partners to build new special relationships and replace EU single market. Eurosceptics from the Conservative party have urged the UK government to focus on the British Commonwealth[1]. But my research shows that pre-EU monetary relations between the UK and Commonwealth countries were built at the advantage of the British economy and investment in sterling assets inflict losses to Commonwealth central banks. Post-WWII international role  of sterling in the sterling area was artificially maintained by British authorities through capital controls, commercial threats and economic sanctions. Commonwealth countries fought to disentangle themselves from the UK economy and sterling. At the light of these new results, it seems difficult to make the sterling area rise from the ashes.

A zombie international currency

Sterling was the dominant international currency in the 19^th century but lost it to the dollar over the course of the 20^th century. Post-WWII, Western economies lost interest in sterling which remained mostly a regional currency, used in the sterling area – a network of countries tying their currencies to sterling, including most of Commonwealth, British Empire, and newly independent colonies.

The regionalization of sterling was immediate after the war, as reflected in its presence within central banks’ reserves portfolios displayed in Fig.1. In Western European central banks, sterling represented less than 20% of their reserves while sterling area countries kept more than 50% of their reserves in sterling throughout the fifties and sixties.

Countries who could access alternative foreign exchange reserves, such as Western Europe held only very limited amounts of sterling because the UK didn’t have the economic fundamentals of an issuer of international currency: its GDP per capita was growing slower than the rest of Europe, its share in world trade was going down, its central bank ran low reserves and it faced military defeats in its collapsing Empire.

The sterling area as a captive market

If sterling was a bad investment, why would Commonwealth and Middle East countries central banks keep most of their reserves in sterling? I argue that British authorities operated the sterling area countries as captive market for sterling. They artificially maintained holdings of sterling through capital controls, commercial threats and economic sanctions. Exiters of the sterling area, such as Egypt in 1947 or Iraq in 1959 faced a full freeze of their assets held in London, imposition of new tariffs or a limitation of access to the London capital market. Large sterling holders, such as Australia or Ireland tried to decrease their exposure to sterling by secretly converting some of their sterling reserves.

By preventing free convertibility out of sterling, British authorities could maintain an over-evaluation of sterling as the Bank of England ran very low reserves after the war. British policymakers described the sterling area as a bank with insufficient assets to meet its deposit liabilities. The area eventually collapsed after the 1967 sterling devaluation and Britain adhesion to EEC.

My study on the decline of sterling suggests that, at the time of Britain accession to the EEC, economic links with its former colonies had decreased dramatically, in spite of British efforts. Britain’s next ‘special relationship’ partners may not lie among them.

Notes

[1] “Theresa May to offer Commonwealth post-Brexit bonus” https://www.ft.com/content/2fbb7964-3e3c-11e8-b9f9-de94fa33a81e

Maylis Avaro

maylis.avaro@graduateinstitute.ch

Twitter: @M_Avaro

Website: maylisavaro.info