The international role of sterling before the EU

This Blog is based on a paper presented to the  Economic History Society’s  annual conference in 2021  (session NRIG).  Mayliss Avaro was also awarded a New Researcher prize

by Maylis Avaro (St. Hilda’s College, University of Oxford)

Prior to Britain’s membership of the European Economic Community (subsequently the European Union), which became effective from 1973,  sterling was a zombie international currency.  The  international role  of sterling in the sterling area was artificially maintained by the British government  through capital controls, commercial threats, and economic sanctions.

In the post-Brexit era, Britain is seeking new partners to replace the European Union’s single market.  Eurosceptics within the Conservative party have urged the British government to focus on the British Commonwealth.[1]  But such yearning overlooks the fact that prior to 1973, despite close political links (Figure 1),   monetary relations  benefitted  Britain but imposed losses on the central banks in other parts of the Commonwealth.

Sterling was the dominant international currency in the nineteenth century, but it gradually lost its premier position  to the US  dollar during the twentieth century.  After 1945,  Western economies were much less inclined  to hold  sterling which was effectively relegated to a mostly regional currency used in the sterling area.

The regionalization of sterling was reflected in the reserve portfolios of central banks.   Sterling represented less than 20 per cent of the reserves of Western European central banks, compared to 50 per cent or more of the reserves held by central banks in the sterling area (Figure 2).

Countries with access to alternative foreign exchange held limited amounts of sterling because Britain did not possess the economic fundamentals necessary to be an issuer of international currency: its rate of growth of GDP per capita lagged behind Europe’s; its share of world trade was declining rapidly, and  the Bank of England held  low reserves.

If sterling was a bad investment, why did central banks in the  Commonwealth and Middle Eastern countries  hold most of their reserves in sterling?  My research demonstrates that  the British government managed sterling in such a way that  countries belonging to the sterling area became captives to this currency.   Countries wishing to exit the sterling area – Egypt in 1947, Iraq in 1959 – were confronted with the freezing of their London assets, imposition of new tariffs, or restrictions on their ability to access the London capital market.  Countries with large holdings of sterling, for example, Australia and Ireland,  tried to reduce their sterling exposure by secretly converting this currency.

By preventing free convertibility, the British government ensured that sterling  was over-valued. Policymakers in Britain described the sterling area as a bank with insufficient assets to meet its deposit liabilities. This area eventually collapsed following the devaluation of sterling in 1967, and Britain’s  accession to the EEC.

My research on the decline of sterling suggests that, by the early 1970s, Britain’s economic links with its former empire had decreased dramatically with repercussions for the  international standing of sterling.  Consequently, in the post-Brexit era, it is difficult to believe that Britain will succeed in rekindling its ‘special relationship’ with Commonwealth countries.

To contact the author:

maylis.avaro@graduateinstitute.ch
Twitter: @M_Avaro
Website: maylisavaro.info

References

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