Jerry Mushin, Victoria University of Wellington
One of the consequences of the economic crisis of 1929–33 was that a large number of countries abandoned the gold standard. This meant that their governments no longer guaranteed, in gold terms, their currencies’ values. The United Kingdom (and the Irish Free State, whose currency had a rigidly fixed exchange rate with the British pound) left the gold standard in 1931. To reduce the fluctuation of exchange rates, many of the countries that left the gold standard decided to stabilize their currencies with respect to the value of the British pound (which is also known as sterling). These countries became known, initially unofficially, as the Sterling Area (and also as the Sterling Bloc). Sterling Area countries tended (as they had before the end of the gold standard) to hold their reserves in the form of sterling balances in London.
The countries that formed the Sterling Area generally had at least one of two characteristics. The UK had strong historical links with these countries and/or was a major market for their exports. Membership of the Sterling Area was not constant. By 1933, it comprised most of the British Empire, and Denmark, Egypt, Estonia, Finland, Iran, Iraq, Latvia, Lithuania, Norway, Portugal, Siam (Thailand), Sweden, and other countries. Despite being parts of the British Empire, Canada, Hong Kong, and Newfoundland did not join the Sterling Area. However, Hong Kong joined the Sterling Area after the Second World War. Other countries, including Argentina, Brazil, Bolivia, Greece, Japan, and Yugoslavia, stabilized their exchange rates with respect to the British pound for several years and (especially Argentina and Japan) often held significant reserves in sterling but, partly because they enforced exchange control, were not regarded as part of the Sterling Area.
Following the 1931 crisis, the UK introduced restrictions on overseas lending. This provided an additional incentive for Sterling Area membership. Countries that pegged their currencies to the British pound, and held their official external reserves largely in sterling assets, had preferential access to the British capital market. The British pound was perceived to have a relatively stable value and to be widely acceptable.
Membership of the Sterling Area also involved an effective pooling of non-sterling (especially U.S.dollar) reserves, which were frequently a scarce resource. This was of mutual benefit; the surpluses of some countries financed the deficits of others. The UK could perhaps be regarded as the banker for the other members of the Sterling Area.
Following the gold standard crisis in the early 1930s, the Sterling Area was one of three major currency groups. The gold bloc, comprising Belgium, France, Italy, Luxembourg, Netherlands, Switzerland, and Poland (and the colonial territories of four of these), consisted of those countries that, in 1933, expressed a formal determination to continue to operate the gold standard. However, this bloc began to collapse from 1935. The third group of countries was known as the exchange-control countries. The members of this bloc, comprising Austria, Bulgaria, Czechoslovakia, Germany, Greece, Hungary, Turkey, and Yugoslavia, regulated the currency market and imposed tariffs and import restrictions. Germany was the dominant member of this bloc.
In September 1939, at the start of the Second World War, the British government introduced exchange controls. However, there were no restrictions on payments between Sterling Area countries. The value of the pound was fixed at US$4.03, which was a devaluation of about 14%. Partly as a result of these measures, most of the Sterling Area countries without a British connection withdrew. Egypt, Faroe Islands, Iceland, and Iraq remained members, and the Free French (non-Vichy) territories became members, of the Sterling Area.
There were three main changes in the Sterling Area after the Second World War. First, its membership was precisely defined, as the Scheduled Territories, in the Exchange Control Act, 1947. It was previously unclear whether certain countries were members. Second, the Sterling Area became more discriminatory. Members tended not to restrict trade with other Sterling Area countries while applying restrictions to trade with other countries. The intention was to economize on the use of United States dollars, and other non-sterling currencies, which were in short supply. Third, war finances had increased many countries’ sterling balances in London without increasing the reserves held by the British government. This exposed the reserves to heavier pressures than they had had to withstand before the war.
In 1947, the Sterling Area was defined as all members of the Commonwealth except Canada and Newfoundland, all British territories, Burma, Iceland, Iraq, Irish Republic, Jordan, Kuwait and the other Persian Gulf sheikhdoms, and Libya. In the rest of the world, which was categorized as the Prescribed Territories, controls prevented the conversion of British pounds to U.S. dollars (and to currencies that were pegged to the U.S. dollar). Formal convertibility of British pounds into U.S. dollars, which was introduced in 1958, applied only to non-residents of the Sterling Area (Schenk, 2010).
Following the 1949 devaluation of the British pound, by 30.5% from US$4.03 to US$2.80, much of the rest of the world, and almost all of the Sterling Area, devalued too. This indicates the major international trading role of the British economy. A notable exception, which did not devalue immediately, was Pakistan. Most currencies’ sterling parities did not change, so this destroyed the intended effect of the British devaluation.
The world economy had changed by the time of the next sterling crisis. The immediate international impact of the 1967 devaluation of the British pound, by 14.3% from US$2.80 to US$2.40, reflects the diminished significance of the Sterling Area. In marked contrast to the response to the 1949 devaluation, only fourteen members of the International Monetary Fund devalued their currencies following the British devaluation of 1967. A significant proportion of Sterling Area countries, including Australia, India, Pakistan, and South Africa, did not devalue. Many of the other Sterling Area countries, including Ceylon (Sri Lanka), Hong Kong, Iceland, Fiji, and New Zealand, devalued by different percentages, which changed their currencies’ sterling parities. Outside the Sterling Area, a small number of countries devalued; most of these devalued by percentages that were different to the British devaluation. The effect was that a large number of sterling parities were changed by the 1967 devaluation.
The Sterling Area showed obvious signs of decline even before the 1967 devaluation. For example, Nigeria ended its sterling parity in 1962 and Ghana ended its sterling parity in 1965. In 1964, sterling was 83% of the official reserves of overseas Sterling Area countries, but this share had decreased to 75% in 1966 and to 65% in 1967 (Schenk, 2010). The role of the UK in the Sterling Area was frequently seen, especially by France, as an obstacle in the British application to join the European Economic Community.
The reserves of the overseas members of the Sterling Area suffered a capital loss following the 1967 devaluation. This encouraged diversification of reserves into other types of assets. The British government responded by negotiating the Basel Agreements with other governments in the Sterling Area (Yeager, 1976). Each country in the Sterling Area undertook to limit its holdings of non-sterling assets and, in return, the U.S.dollar value of its sterling assets was guaranteed. These agreements restrained, but did not halt, the downward trend of holdings of sterling reserves. The Basel Agreements were partly underwritten by other central banks, which were concerned for international monetary stability, and were arranged with the assistance of the Bank for International Settlements.
In 1972, the UK ended the fixed exchange rate, in U.S. dollars, of the pound. In 1971 or in 1972, most other Sterling Area countries ended their fixed exchange rates with respect to the British pound. Some of these countries, including Australia, Hong Kong, Jamaica, Jordan, Kenya, Malaysia, New Zealand, Pakistan, Singapore, South Africa, Sri Lanka, Tanzania, Uganda, and Zambia, pegged their currencies to the U.S. dollar. The minority of Sterling Area members that retained their sterling parities included Bangladesh, Gambia, Irish Republic, Seychelles, and the Eastern Caribbean Currency Union. Other countries in the Sterling Area introduced floating exchange rates.
Also in 1972, the UK extended to Sterling Area countries the exchange controls on capital transactions that had previously applied only to other countries. This decision, combined with the changes in sterling parities, meant that the Sterling Area effectively ceased to exist in 1972.
In 1979, when it joined the European Monetary System, the Irish Republic ended its fixed exchange rate with respect to the British pound. Membership of the EMS, which the UK did not join until 1990, required the ending of the link between the British pound and the Irish Republic pound. Also in 1979, the UK abolished all of its remaining exchange controls.
The Sterling Area was a zone of relative stability of exchange rates but not a monetary union. It did not have a single central bank. Distinct national currencies circulated within its boundaries, and their exchange rates, although fixed with respect to the British pound, were occasionally changed. For example, although the New Zealand pound was devalued in 1949 by the same percentage as the British pound, it was revalued in 1948 and devalued in 1967, both relative to the British pound. The other important feature of the Sterling Area is that capital movements between its members were generally unregulated.
The decline of the Sterling Area was related to the decline of the British pound as a reserve currency. In 1950, more than 55% of the world’s reserves were in sterling (Schenk, 2010). In 2011, the proportion was about 2% (International Monetary Fund).
In addition to the UK, the vestige of the Sterling Area now consists only of Falkland Islands, Gibraltar, Guernsey, Isle of Man, Jersey, and St. Helena, and is of purely local significance. No other countries now fix their exchange rates in terms of the British pound. Since 1985, no members of the International Monetary Fund have specified fixed exchange rates in British pounds. In one generation, the British pound has evolved from a pivotal role in the world economy to its present minor role.
References and other important sources:
Aldcroft, Derek and Michael Oliver. ExchangeRate Régimes in the Twentieth Century. Edward Elgar Publishing, Cheltenham, 1998.
Conan, Arthur. The Problem of Sterling. Macmillan Press, London, 1966.
Day, Alan. Outline of Monetary Economics. Oxford University Press, 1966.
McMahon, Christopher. Sterling in the Sixties. Oxford University Press, 1964.
Sayers, Richard. Modern Banking [7th ed]. Oxford University Press, 1967.
Scammell, W.M. The International Economy since 1945 [2nd ed]. Macmillan Press, London, 1983.
Schenk, Catherine. The Decline of Sterling: Managing the Retreat of an International Currency, 1945–92. Cambridge University Press, 2010.
Tew, Brian. The Evolution of the International Monetary System, 1945–88. Hutchinson and Co, London, 1988.
Wells, Sidney. International Economics. George Allen and Unwin Ltd, London, 1971.
Yeager, Leland. International Monetary Relations: Theory, History, and Policy [2nd ed]. Harper and Row Publishers, New York, 1976.
Jerry Mushin can be reached at email@example.com.