Britain is the biggest overseas investor in the world, accounting for more than 40 percent of the world total, and draws a tenth of its national income from its foreign investments. The City of London is the world's financial and commercial center, and banking and insurance profits help make up for an adverse balance of payments.
At the outset of World War I in 1914, Britain, like most other countries, suspends gold payments, the basis of the international gold standard, preferring to husband reserves for essential war needs. Income tax is doubled, but huge war costs dwarf revenues. Britain grows dependent on loans from the U.S., and by 1918, war debts stand at more than £850 million.
Britain's financial position is devastated after the war. No longer a creditor, now it is a debtor nation. Interest payments alone consume 40 percent of government spending. Britain itself is owed vast sums by Russia and others, as well as German reparations, but receives almost nothing. In 1919 meager gold reserves and a large trade deficit result in the formal abandonment of the gold standard.
In 1925 Britain returns to the gold standard at its pre-1914 parity. Other industrial countries soon join the attempt to restore stability to a world economy racked by violent cyclical swings in prices and activity. But the gold standard makes sterling overvalued, hampering exports and excluding Britain from the boom in the U.S. and continental Europe.
Following the collapse of banks in Europe, a run on gold in British banks threatens the stability of the pound. In 1931, after the resignation of Ramsay MacDonald's Labor government, the new national government fights to save the pound against speculators, but with reserves exhausted, the pound is devalued by 30 percent and taken off the gold standard.
Following the Ottawa conference, Britain establishes the sterling block, strengthening the economic links within the empire. All dominion and colonial reserves are to be in pounds and the exchange rates of their individual currencies to be pegged against the pound. Sterling remains the number one reserve currency in the world, helping to maintain Britain's position of financial hegemony.
To pay for its war effort, Britain borrows from deposits of sterling block countries, liquidates overseas holdings, and sells gold and dollar reserves. Assets are exhausted by 1941, and only the U.S. Lend Lease Act averts bankruptcy, extending Britain a line of credit due for repayment after the war. By 1945 Britain is once again one of the world's biggest debtors.
The full total of Britain, the Commonwealth, and the Empire's debt after World War II is $30 billion. With the Lend Lease agreement over, John Maynard Keynes brokers a U.S. loan for $3.75 billion and a Canadian loan of $1.25 billion. But the U.S. loan requires that sterling be made a fully convertible currency, resulting in a run on the pound and a convertibility crisis.
The U.S. Marshall plan provides $1.26 billion of aid to help rebuild Britain. Speculative pressure increases on the pound, and in 1949 sterling is devalued by almost 31 percent, a major realignment with the dollar. The devaluation leads to an immediate rise in the cost of living and essential imports, but sets the basis for an increase in Britain's competitiveness.
The Suez crisis worries foreign holders of sterling, who fear their assets, like Egypt's, might be frozen if they step out of line. A run on the pound ensues as millions are withdrawn from sterling accounts. Britain's appeal to the IMF is vetoed by the United States, but when Britain withdraws from Egypt, the U.S. relents, and a $1.3 billion loan stabilizes the pound.
Britain's troubled economy provokes international speculation, wreaking havoc with the pound. The government tries to stabilize sterling by releasing money into the markets, running down Britain's reserves. Interest rates are raised by 2 percent, and sterling steadies, but the speculators return. Central bankers from 11 nations offer $3 billion to balance sterling against speculation.
Britain's by now usual balance-of-payments deficit and general economic crisis inspire a loss of faith in sterling and another run on the pound. Rather than accept a U.S. offer to underwrite sterling or arrange another IMF loan, Labor Prime Minister Callaghan devalues the pound by 14.3 percent. Central bankers agree to $3 billion of credits to protect the reserves against further speculation.
On February 15 Britain goes decimal, part of Prime Minister Edward Heath's modernization drive. The historic half-crown, florin, shilling, and sixpence coins are made obsolete. The pound sterling remains, but instead of 20 shillings to the pound, there are now 100 pennies. The system is logical, but for many people the transformation is bewildering.
Inflation, a record trade deficit, and rapid deterioration in the economy lead to a sterling crisis in 1972. Chancellor Anthony Barber abandons the fixed-parity agreement of 1971 and lets the pound float freely for the first time since the 1930s. It loses 8 percent of its value. Britain's entry into the EEC in 1973 marks an initial step towards monetary union.
Failure to contain public-sector borrowing and to arrest Britain's economic decline leads to another crisis of confidence in the pound. The Bank of England must reverse its secret strategy of selling sterling and buy back huge amounts to prop up the currency. Its value falls by 24 percent, and Britain is forced to go again to the IMF for a loan of £2.3 billion, the most it is allowed to borrow.
High interest rates and large North Sea oil exports lead to a rise in sterling. Margaret Thatcher argues it is impossible to have an independent monetary policy and belong to a fixed exchange rates system. The abolition of exchange controls and liberalization of the financial system helps the City boom, promoting foreign investment in Britain and British investment abroad.
Political arguments rage over Britain's relationship with the Exchange Rate Mechanism (ERM), which ties EEC currencies to the Deutsche Mark (DM). In 1985 Thatcher refuses to back Chancellor Nigel Lawson's wish to join the ERM. By the end of 1986, Lawson on his own authority pursues a policy of shadowing the DM that requires wild swings in interest rates and results in rising inflation.
Britain joins the ERM amid political infighting, in the middle of a recession, with an inflation rate topping 10 percent and a high pound. Thatcher demands that European leaders disavow the idea of a single European currency. She is ignored. Instead they agree on the establishment of a European Central Bank to control the monetary policies of all member states within four years.
Germany's economic problems compound the pound's original ERM overvaluation to put pressure on the currency. Speculation drives the pound lower, making its position in the ERM untenable, and so forces its withdrawal. But sterling's effective devaluation and its new flexibility allow for a decade of growth. In 1992 Britain secures an opt-out clause on the single currency at Maastricht.
Britain's new Labor government keeps its pre-election promise not to raise income tax. One of Tony Blair's first and boldest moves is to make the Bank of England independent, investing it with the power to determine interest-rate policy without government consultation. Joining the single European currency is hotly debated but the question deferred til after the 2001 election.
The advent of the euro diminishes the appeal of the pound as a global reference currency. Supporters of Britain's adopting the euro argue that opting out has diverted foreign investment from the UK to the euro-zone and hurt British trade. The government promises to assess its economic tests on the euro in June 2003 and to recommend whether to hold a referendum on joining.
back to top