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The watershed of 1976

The watershed of 1976

Keynesian curtain may be rising again

by David Marsh and Richard Roberts in London

Wed 7 Dec 2016

Britain’s autumn 1976 financial upsets appear as a disquieting chapter from the past, yet the episode is full of lessons for today. A crucial turning point came with agreement by Prime Minister James Callaghan’s government – in an arduous 7 December cabinet meeting, 40 years ago today – on an application to the International Monetary Fund for a record $3.9bn loan to resolve a balance of payment crisis.

After weeks of heated arguments and recurrent sterling weakness, the government was forced to bow to major outside interference in the economy, part of a new and humiliating form of ‘conditionality’ imposed by foreign creditors.

The drama sent policy waves around the world. The wrenching UK debate catalysed international trends – notably a wholesale retreat from Keynesianism and a new primacy of monetary policies enacted by independently operating central banks – that only now, after four decades, are starting to lose their force.

To mark the anniversary, OMFIF Press is launching When Britain Went Bust, by Richard Roberts. The book is being launched at the UK Treasury in London on 8 December, with the participation, among others, of 95-year-old Johannes Witteveen, the IMF managing director who played a seminal part in the 1976 episode.

The political and economic theatre contains plentiful messages for 2016. Italy, marooned inside Europe’s monetary union with a two-decade record of low growth and persistent unemployment, is just the latest example of governments and central banks struggling with the painful aftermath of faulty policies and economic shocks.

For the British, all this strikes a jarringly familiar chord. The autumn of 2016 is another period of perturbation for the pound, in the wake of Britain’s June vote to leave the European Union.

Britain’s contemporary history is replete with sterling crises. The depreciations of 1976 and 2016 are just two of 10 episodes of substantial sterling decline since 1919.

Around the world, academic research shows that currency crises are bad news for incumbent administrations, doubling the likelihood of a government losing office in the following 12 months. In Britain’s case, all but two of the nine preceding sterling depreciations since 1919 were followed by the electoral defeat of the incumbent party.

There is possibly an uncomfortable lesson here for Theresa May’s administration. Despite the Conservative party’s relative opinion poll buoyancy against the internally divided Labour party, few Tory strategists could view an early UK general election with equanimity.

In the occurrences of 1976, there is no escaping a tinge of anachronism. Central banks on the whole were dependent on their governments’ bidding.

In the ensuing 40 years, with vastly greater flows of finance, very high liquidity, largely floating exchange rates and a shift in economic dynamism away from Europe and towards Asia, the IMF has lost some of its previous significance. For countries in balance of payments difficulties, the growth of international financing instruments and substantial accruals in foreign exchange reserves have made recourse to the Fund less dramatic, and less crucial.

In 1976, with the grudging compliance of the Callaghan government, the Fund brought down the curtain on post-war Keynesianism, ushering in a period of economic orthodoxy epitomised by a move away from deficit spending towards control of the money supply and central bank independence.

Now, 40 years later – not least in view of the election of Donald Trump – the curtain of Keynes may be rising again. An era where budgetary stringency was the norm nearly everywhere seems to be drawing to an end.

After much resort to central bank ingenuity since the financial crisis, monetary policy is all but exhausted – and the option of more active fiscal policy is again under serious consideration, bringing a series of fresh risks.

In manifold ways, 1976 marked new shifts in international polices; 2016 may prove to be a watershed of equal significance.

David Marsh is Managing Director of OMFIF. Richard Roberts is Professor of Contemporary Financial History at King's College London.

For more information on When Britain Went Bust and to buy the book please click here

For information on attending the 8 December book launch please click here

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