Lewis Baston is author of Reggie: The Life of Reginald Maudling and several books about British general elections. He is a consultant on politics, elections and constituencies.
AutumnL the nights draw in, the temperature drops…and sterling has a bad time on the foreign exchange markets. These few months seem to be the most difficult part of the year for the value of the pound, with the crucial moments of the sterling crises of 1931, 1949, 1967, 1976 and 1992 all happening in the period from September to November.
I am perhaps particularly conscious of sterling at the moment, because I shall spend the week of the presidential election in the United States, and I had the dubious privilege of witnessing ‘Black Wednesday’ in 1992 from Washington DC. It is fun going on holiday abroad when one’s home currency is overvalued; at £1 to $2 the British visitor can swagger around the United States and buy up Bloomingdale’s, while at $1.21 – which is worse than parity when one goes to a restaurant, given American tipping etiquette – a trip to McDonald’s may feel a bit of an extravagance. I may be (selfishly) peeved by present circumstances, but what does history tell us about the more important consequences of a falling pound?
Perhaps the first point to make is that foreign exchange regimes come in different types. In a technical sense, “devaluation” really only means a change to a currency’s exchange rate within an international system of fixed rates, as happened in 1949 and 1967. But although not technically devaluation, being forced out of a monetary system because of downward market pressure amounts to much the same thing. This happened to the pound in 1931 (Gold Standard) and 1992 (Exchange Rate Mechanism), and on a smaller scale in 1972 when fluctuations made it impossible for sterling to stay within the European Currency Snake. Despite its “The Day Today” name, the Snake was a serious attempt to limit the fluctuations of European currencies relative to each other. After several currencies were forced off, people started calling the remainder “the Worm”.
What amounts to a crisis depreciation in a system of floating exchange rates is a matter of opinion, but most people would consider falls in sterling in 1920, 1939, 1976, 2008 and 2016 to count. The 1976 crisis – which started with the Bank of England attempting to manage sterling downwards and rapidly got out of hand – ended up being as severe as a full-scale devaluation. But the pound’s low point against the US dollar in early 1985 was more a matter of the dollar being drastically overvalued than the pound having any particular problem, although its rate with other currencies did slip in a soft depreciation in 1985-86 as the oil price collapsed.
The political impact of a devaluation will vary depending on a number of factors. Perhaps strangely, the size of the devaluation itself is not one of them. The biggest devaluation by far was by Attlee’s government in September 1949, from $4.03 to $2.80, or over 30 per cent. But it made barely a ripple on political life. Voters seemed to accept it as a necessary part of readjusting to a new post-war order, and living standards were on the way up after a period of severe austerity. There was also the precedent of having sacrificed post-1918 recovery on the altar of a strong pound to be avoided. The devaluation was also masterfully handled by the Treasury, and planned in concert with US and Canadian bankers over the summer; astonishingly, the plans managed to stay secret. Big downward movements in sterling, of themselves, did not make much political difference in the early 1970s, mid-1980s and during the 2008 crash, when there was enough else going on. Much smaller falls in 1967 and 1992, however, proved political disasters.
Political problems are much greater with ‘hard’ devaluations in fixed systems, and when a currency is forced out of a fixed system. The underlying symbolism of a strong currency can get tied up with national pride and even ideas of virility, making devaluation all the more psychologically painful for politicians and the public. Even as late as 1992, some around John Major felt that “devaluations are what Labour governments do”, and that a forced float of sterling would be better for the Government’s image. It wasn’t.
Harold Wilson in 1967 and John Major in 1992 suffered worst because they had gone furthest in tying their own credibility to the successful defence of an exchange rate. These two governments went on to endure the most ferocious cases of mid-term unpopularity in recent British history. Wilson compounded the damage by making a complacent and patronising broadcast after devaluation in which he told the electorate that ‘the pound in your pocket’ had not been devalued. Labour’s poll ratings fell from 41 per cent in September 1967 to 30 per cent in February 1968, and Major’s Tories plunged from 43 per cent to 32 per cent between July and November 1992.
The more severe the pressure, the more uncompromising and explicit the government needs to be about its commitment to the existing exchange rate. “There is something about fixed exchange rates that turns politicians into liars,” as one of Major’s officials told Anthony Seldon. Governments and central banks have to say that they have no plans for devaluation because it isn’t going to happen, and must be as good as their word – or else very confident about being able to keep the contingency plans secret. In 1964-67, Wilson banned his ministers from discussing devaluation, with the result that there were occasional, confidential, non-specific conversations about ‘The Great Unmentionable’. Major proclaimed in 1992 that “We will stay in the exchange rate mechanism of the European Monetary System whatever happens”. It lasted another five days.
Another factor influencing the political effect has been the severity of the measures taken after the devaluation. The benefits of devaluation can easily be dissipated in a domestic inflationary spiral fuelled by more expensive imports. Devaluation is therefore often associated with counter-inflationary economic policy such as wage restraint (1976), tax rises and public spending cuts, or high interest rates. Adjustment was particularly severe in 1967 and 1976; it was less brutal in 1993, but did still involve tax rises and spending cuts contrary to the message on which the Conservatives had won the 1992 election. In 1976 the process involved a loan from the International Monetary Fund (IMF) which was in itself a humbling moment that damaged the government’s standing. In 1931 the pattern was different: the incumbent Labour government baulked at a set of austerity measures that had been recommended to it by the May Committee on National Expenditure, the Cabinet split and a coalition was formed to implement austerity. Despite all this, the coalition ended up devaluing anyway, but the outgoing government bore the taint of the crisis.
Devaluation often seems to open up benign economic vistas, sometimes after a year or two of painful adjustment and sometimes more or less immediately. The decade after a devaluation has sometimes been a fairly pleasant period in UK economic history, particularly following the devaluations of 1949 and 1992. But devaluation does not always work well. Big movements in the value of sterling often come when the whole international system is unstable, as it was following 1920, 1931 and 1967, meaning that the competitive advantage is short-lived. Others usually want to reap the same benefit; by the mid-1930s competitive devaluations had eroded the effect of sterling leaving the Gold Standard in 1931. There also needs to be a tradeable sector that can respond to the currency movement, and here the evidence for any positive effect from the pound’s falls in 1992 and 2008 on manufactured trade is weak at best – services and capital flows seem to be the main channels.
The medium to long term political benefit of a devaluation is only rarely reaped by the party that presided over the crisis. The prestige and adjustment costs are usually too high. In 1992-97 they crippled the government for the rest of its term. In 1976-79 things went well until November 1978, but the pressure to keep wage rates and inflation down led to the Winter of Discontent and therefore defeat in the 1979 election. Wilson nearly managed a conjuring trick in 1970 – he asked to be judged on the effect of the balance of payments, which entirely predictably was swinging into surplus by the time of the election. But alas! The poorly-timed purchase of three jumbo jets produced a blip back into deficit for the monthly figures produced during the election, and the trick went a bit Tommy Cooper.
But is there a political price to be paid for an increasingly overvalued currency? A “strong” currency has often been taken as a symbol of the strength of the nation as a whole. Margaret Thatcher tended to regard the strength of sterling as being an international vote of confidence in Britain and her policies, and Reagan revelled in 1984’s dollar surge.
Strong currencies have real-world merits as well. They bear down on import prices and therefore inflation, and make pay packets go further: fuel, food and imported technology all get cheaper. Comparatively, a strong currency makes a country richer rather than poorer. Strong currencies, even overvalued ones, therefore do not usually have a big direct political downside. Their political consequences are felt through their effect on tradeable sectors of the economy, never more so than the manufacturing slump of 1979-8, although the slow growth and high unemployment after 1925 also resulted in unrest and class conflict. While the first Thatcher government rode out the economic consequences of overvaluation, the 1924-29 Baldwin government lost the May 1929 general election.
Devaluation is therefore a chancy strategy, uncertain in its economic benefits and often accompanied by political turbulence – although this can be managed. The massive devaluations of 1931 (24 per cent) and 1949 (31 per cent) did the least political damage, in part because they were governments taking decisive action rather than blundering chaotically, and there were other factors clearly in play. These were also the only occasions when devaluing governments went on to win the next general election – by a landslide in 1931 and a squeak in 1950 (Thatcher also won re-election following the soft slide in the pound in 1985-86).
However, devaluations where there is an air of panic and chaos, and a government forced to bow its knee to the markets, are the ones that do the political damage – acute in the immediate term but with bleeding continuing for several years afterwards. No government has been re-elected following one of those – Harold Wilson, Ted Heath, Jim Callaghan, John Major and Gordon Brown all lost the election after the sterling slide.
The pound is down over 16 per cent so far in 2016. The first stage, the plunge in June, looks like the sort of thing governments have survived before – a big, quick adjustment to a new reality. The slide in October has more ominous historical echoes for Theresa May and Theresa Hammond. But from my Washington vantage point, the pound in my pocket devalued, I may yet see the United States Trumping our own little local difficulties.