British Economic Policy of the 1960s and the Euro

Written by admin on May 24th, 2011


A. Introduction

On the 11th May 1965, the Chancellor of the Exchequer announced that local and central Government spending was to decrease in order to restore the balance of payments to equilibrium, and to enable the nation to live within its income.

Within five months from the statement of the Chancellor of the Exchequer, Mr. Berne of the British Embassy in Germany stated that, a German newspaper Neue Zurcher Zeitung (NZZ) on the 12th October 1965 produced a lengthy analysis of the sterling crisis, and clearly pointed to the reason why the UK turned to the Euro-dollar market to relieve the Chancellor of the Exchequer of his financing problem . The view held was that, that the source of the crisis of confidence lay primarily with the UK rather than with foreign companies, most of whom had kept their sterling holdings down to the minimum since 1961, and what happened in the autumn of 1964 was a panic flight from sterling by domestic holders of it. The newspaper assumed that the UK had about one thousand million pounds to re-pay as a result of the various arrangements made since December 1964, and that of this about 10% had to be repaid by May 1965, a third by December 1967, and the rest by May 1970. About five hundred million pounds would be regained though the reversal of “leads and lags” and other positions, and it would be possible, if the economy could be brought reasonably into balance, for the UK to recover the remaining five hundred million pounds by 1970. However, although it was possible for the UK to re-pay these amounts, the article quoted that the UK’s reserves were so low that the UK will remain under heavy strain. The article further discussed that there were talks of some transfer of UK sterling debts to the IMF, but this was not appropriate since the sterling debts were of a normal commercial nature. The conclusion was that the logical course was a long-term foreign loan and that the UK would probably, seeks such a loan. That, the main priority was first, to overcome the short-term disturbances, and secondly to have achieved some success in the introduction of long-term policies .

It soon became apparent that borrowing abroad by local authorities and the nationalised industries and the interest shown by the LCC’s (London County Council) proposal to raise a loan in Euro-dollars, was a way to relieve the Chancellor of its financing problem. Various possibilities of Long-term borrowing, were examined as a means of assisting the UK balance of payments. However, the benefit to the reserves would only accrue if the proceeds of external borrowing was applied to financing expenditure which had to be made in any case, and not used as a basis for additional expenditure .

However, it was not until 1967 (the second half of the 1960s), that the UK government actually began to investigate the possibility of its nationalised industries and public authorities borrowing on the Euro-dollar market. This argument was further developed by the Treasury by 1969, which had for some time been arguing that it would be useful for the UK reserves, if the UK could, in some form, borrow abroad. However, the UK government itself could not borrow as, although the other governments have borrowed in the European capital market, these have tended to be the less developed countries, and thus a move by the UK would have been regarded with suspicion. It was suggested therefore, that the Government encourage local authorities and nationalised industries to borrow abroad (most obviously where interest rates are low) by operating through the Exchange equalisation Account, and giving the local authority an exchange rate guarantee, in return for which a small charge would be made. In view of this proposition, Mr. Macdonald (MP Labour – Chislehurst) asked the following question to the Chancellor of the Exchequer, on the 14th February 1969 in the House of Commons , with the proposed reply:

Question: Whether the Chancellor of the Exchequer is aware that borrowing in overseas capital markets by the nationalised industries would benefit the balance of payments, and what steps he proposes to take to encourage such borrowing?

Answer: The Chancellor agreed that there would be advantage to the balance of payments if those nationalised industries who have the power to do so were to borrow at medium and long-term in these markets. The Treasury is therefore prepared to give consent to such borrowings and, in addition, in appropriate cases, to make special arrangements to relieve the industries of the associated exchange uncertainties.

B. The Euro-dollar market

City corporations of both European and other countries had borrowed US dollars in the foreign currency market (e.g. Milan, Amsterdam, Oslo, Tokyo, Yokohama). Only UK local authorities had not borrowed externally except by taking sterling deposits directly or indirectly from non-residents. One of the most significant developments in the Euro-dollar market in 1963 has been the growth of long-term deposits. In 1963, for instance, deposits of up to three years’ maturity were rare; in 1964 they were common. Paul Einzig (in the September issue of the Journal of Finance) in 1964, argued that Arab recipients of oil royalties owned most of the long-term deposits . This source of funds to the market had been growing greatly in 1963, and had compensated for withdrawals of officially owned funds. This development was welcomed in the market by the Euro-bankers, which meant that they were no longer at the mercy of changes in official policy. The ease with which the market had adjusted for withdrawals of official funds was witnessed by the stability of interest rates in 1963 and 1964. Apart from Arab investors, American corporations have been lending increased amounts in 1963 to the market. Not only had the amounts increased, but also the length of deposit. Einzig also attributed the increased volume of long-term lending by American corporations to fears of possible exchange controls in the US. Given the increased maturities of deposits, the Euro-bankers were enabled to lend for longer periods. Five-year loans were increasing, while three-year loans were commonplace. Also, Euro-funds were being used to subscribe to issues of foreign bonds in the London capital market.

Hence, the Euro-dollar market (or dollars in London) had developed into not only a short-term borrowing market, but to dollars available in London for borrowing for longer periods. Nevertheless, deposits of dollars were occasionally offered in London for periods of two years or more, but enquiries by the Bank of England suggested that these had become very rare. Apart from this market, there had been the growth of the business of floating longer-term dollar loans in London at around 15-years or more . Mainly continental subscribers had taken these up.

C. Financing the balance of payments deficit (up to the end of 1966)

The deficit on the current and long-term capital account of the UK was in the order of £200m in the second half of 1965, and £350m in 1966. There were three elements which constituted a strain or relief for the reserves: first, the balancing item, secondly the balance of payments of the overseas sterling area, and short-term capital flows to and from the non-sterling area .

The balance of payments of the overseas sterling area was deteriorating and the reserves of these countries as a whole were being reduced. The countries with large expected deficits (e.g. Australia and Malaysia) had large reserves of sterling to draw upon, whilst the oil states, which were expected to be in surplus, were not likely to accumulate the proceeds in sterling as they used to do. Short-term capital flows to and from the non-sterling area were unpredictable . Interest differentials were not favourable to such inflows, and a large outflow was always possible if there was a further weakening of confidence and that no appreciable relapse was likely without favourable differentials and some restoration of confidence.

D. Proposal of Foreign Currency Borrowing from the Treasury

On the 10th February 1969, Ministers had decided that the nationalised industries should be encouraged to cover a proportion of their borrowing needs from international capital markets . The Treasury had been examining some of the implications of this decision.

Read more articles
The Contribution of the Euro-dollar Market to the Modern Financial World
Importance of the Euro-dollar Market to Sterling
UK Tax Policy and the Euro-dollar Market
The History of the Eurodollar Market in the 1960s

It was not envisaged that anything but a small proportion of the borrowing needs of the nationalised industries could be met through borrowing abroad. Medium and long-term borrowing in the Euro-bond and other overseas capital markets would, however, provide a significant and useful benefit to the balance of payments. During 1969, such borrowing would offer an interest rate advantage to the nationalised industries compared with borrowing from the National Loans Fund, but the nationalised industries might be deterred from using the facilities offered by these markets because of the exchange uncertainties. In order to overcome this obstacle, the Chancellor of the Exchequer had approved a scheme whereby in appropriate cases the Government would be able to relieve a nationalised industry of the exchange uncertainties associated with borrowing in foreign currencies . The

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