British Economic Difficulties : Currency Issues

Financial investment into Britain was not only deterred by a combination of Barber induced Demand-Pull inflation in 1962, but also by a wildly fluctuating currency.

In July 1944, the Bretton Wood’s agreement was signed. Fostered by John Maynard Keynes, one of the agreements was the setting up of the Bretton Woods Currency Exchange System. This meant that all signatory countries were to adopt a monetary policy that would encourage a more stable currency exchange, as currencies were now tied to the value of gold. At the time, this was advantageous to the United States, as they controlled two thirds of the world’s gold resource in Fort Knox, hence the stability of all signatory currencies predominantly relied on the stability of the US dollar. Effectively, signatory currencies were pegged to the US Dollar, creating a global fixed currency system.

This benefited the US whilst they ran a trade surplus, but as their development became more import driven, it became clear that the relationship between the US Dollar and the price of gold was unsustainable. Due to the provision of financial aid, FDI, and military expenditure in Vietnam, there was a surplus of American Dollars on the Foreign Exchange Markets, creating a devaluing currency. America did not have sufficient gold in Fort Knox to artificially maintain the value of the Dollar, hence the currency that the world was pegged to was quickly becoming overvalued. This was exacerbated by the fact that America was facing rising unemployment reaching 6.1%, whilst inflation was rising at 5.8%.  Therefore, in 1971 Richard Nixon “severed” the link between the Dollar and the price of gold, as part of the notorious “Nixon Shock”, effectively signalling the end to the Bretton Woods Currency Exchange System.

Therefore, Sterling could no longer rely on a stable global currency to be pegged to. This meant that the new floating exchange rate would be decided by the demand of the free market, meaning that due to the low level of demand for British export, the pound sterling experienced further depreciation. This led to increased volatility for the pound, which in turn created further investor under confidence.

As investor confidence fell, Britain did not have the capital necessary to escape the negative output gap. Indeed, even if the British government did have the revenue necessary to boost growth, it would be unlikely that British households would increase consumption greatly, as the volatility of the currency meant consumer confidence was also low. This meant that the multiplier effect was reduced by a growing propensity to withdraw. Therefore, Britain sank further into recession.

In my next post, I will evaluate the impact of growing Trade Union powers on British productivity levels. Throughout the 70s, an upward political pressure on wages was ultimately not justified by an increase in productivity, resulting in detrimental effects for British manufacturing export competitiveness.

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