The 1976 Sterling Crisis: Britain's $3.9 Billion IMF Bailout

On the morning of 28 September 1976 Denis Healey sat in the VIP lounge at Heathrow with a ticket to Hong Kong and onward to Manila, where the annual meetings of the International Monetary Fund and the World Bank were due to open that week. Sterling had fallen again overnight. Somewhere between the lounge and the aircraft the Chancellor of the Exchequer decided that he could not be in the air for the better part of a day while his currency was being sold, and he walked back out of the airport.

He drove to the Treasury and announced that Britain would apply to the Fund for $3.9 billion, the largest sum any member had ever asked of it. The pound was trading around $1.65. Eighteen months earlier it had been worth $2.40.

A Currency With Nothing Behind It

Britain entered 1976 with the pound just above $2.00 and an inflation rate that had touched 24.2 per cent the previous year. Wage settlements in the public sector had been running at rates that no exchange rate could absorb. The oil shock that followed the Yom Kippur War in 1973 had quadrupled the price of a commodity Britain still largely imported, and North Sea production, though it had begun, was not yet large enough to matter to the balance of payments.

Since the suspension of dollar convertibility in August 1971 had ended the fixed parities of the postwar era, sterling had floated, and floating had removed the ritual humiliation of formal devaluation without removing the underlying problem. A currency that nobody had to defend at a published number could simply drift, and in the first quarter of 1976 it drifted badly.

On 5 March the pound broke below $2.00 for the first time in its history. What happened that week became one of the enduring quarrels of British monetary history: the Bank of England sold sterling in the market on the day the rate was already weak, and whether this was a routine smoothing operation or a deliberate attempt to nudge the rate down to help exporters has never been settled to everyone's satisfaction. Kathleen Burk and Alec Cairncross, working through the Treasury and Bank files after they opened, concluded that officials had wanted a modest depreciation and got a rout instead (Burk and Cairncross, 1992). Markets read the intervention as a signal that the authorities did not much mind a lower pound, and obliged them.

Harold Wilson resigned as prime minister on 16 March, surprising nearly everyone. James Callaghan won the leadership and took office on 5 April, inheriting a minority government, a sceptical currency market and a Chancellor who had already begun to doubt the numbers his own department was giving him.

The Loan Before the Loan

In June the Group of Ten central banks and Switzerland, working through the Bank for International Settlements, put together a standby credit of $5.3 billion for the Bank of England. Britain paid nothing until it drew, and then paid the United States Treasury bill rate, which stood at around 5.5 per cent. It looked like generosity. It was a deadline dressed as a rescue.

The facility ran for three months, renewable once for three months more, and the condition attached to the renewal was explicit: if Britain could not repay by December, it would have to go to the Fund. Washington had designed the arrangement so that the discipline would arrive on a fixed date rather than at the discretion of a British cabinet. William Simon at the US Treasury and Arthur Burns at the Federal Reserve had both concluded that Britain would not correct its finances without an external creditor standing over it, and the June facility made sure one would be.

Sterling steadied through the summer and then went again in September. Minimum Lending Rate had already been pushed from 11.5 per cent to 13 per cent during September. On Thursday 7 October the Bank raised it by a further two points, to 15 per cent, the highest rate in its history to that date. The pound kept falling anyway, reaching $1.5675 on 28 October.

The Number That Turned Out to Be Wrong

What the Fund's negotiators came to argue about was the Public Sector Borrowing Requirement, and specifically the Treasury's forecast that the PSBR for 1976/77 would come in at £10.5 billion. On an economy of Britain's size that figure implied a deficit the Fund regarded as incompatible with any stable exchange rate, and it became the basis for everything that followed.

The forecast was wrong. Public borrowing turned out far below it, and Healey wrote afterwards that the figures his own officials had supplied were grossly overstated, and that the crisis had been fought over a statistic (Healey, 1989). Britain's public finance data in the mid-1970s were assembled from returns that arrived late and were revised heavily, and the machinery for forecasting them had never been stress-tested by a currency market that read every release.

Steve Ludlam's reconstruction of the episode makes the sharper point that the argument was never really about arithmetic. It was about whether a Labour government could be made to accept a monetary framework it had not chosen, and the PSBR number supplied the occasion (Ludlam, 1992). Mark Harmon, working from the same archives, traces how the Fund's staff, the US Treasury and a group inside the British Treasury converged on conditions that several of them had wanted before the forecast existed (Harmon, 1997).

The instrument the Fund insisted on was not the PSBR itself but Domestic Credit Expansion — bank lending to the public and private sectors, adjusted for the external flow — a measure designed precisely to make a government's borrowing bite on its balance of payments. Ceilings on DCE, written into a public document, would tie a British Chancellor to a number in a way no domestic promise ever had.

Blackpool

Callaghan gave his leader's speech to the Labour Party conference at Blackpool on 28 September, the same day Healey turned back at Heathrow. The passage that outlived the conference had been drafted by Peter Jay, the economics journalist who was also Callaghan's son-in-law, and the prime minister delivered it to a hall full of delegates who had spent their careers believing the opposite.

"We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending," Callaghan said. "I tell you in all candour that that option no longer exists, and in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step."

He went further in the same speech: "The cosy world we were told would go on for ever, where full employment would be guaranteed by a stroke of the Chancellor's pen, cutting taxes, deficit spending — that cosy world is gone." A Labour prime minister had told a Labour conference that demand management had run out of road, three years before the electorate turned the party out and four before the Bank of England's counterpart in Washington began breaking American inflation with interest rates nobody had thought politically survivable.

Healey reached Blackpool two days later and was given five minutes at the rostrum, the allocation of an ordinary delegate rather than a Chancellor. He used them to say that he would negotiate with the Fund and that the terms would hurt. The conference booed him.

Nine Meetings

The cabinet argument ran through the first fortnight of December across nine meetings, an extraordinary commitment of collective time for a government also running a country with a parliamentary majority of nothing.

Tony Benn, Secretary of State for Energy, circulated papers setting out the Alternative Economic Strategy: import controls, expanded public employment, planning agreements with the nationalised industries, and no dealings with the Fund at all. Michael Foot backed him in substance. The argument was not frivolous — a country with Britain's payments position and its own currency did have the option of closing the trade account rather than deflating — but it meant an open breach with the United States and with every creditor Britain had.

Anthony Crosland led the other opposition, arguing from the centre that the cuts were economically unnecessary and that Britain should call the Fund's bluff. Callaghan broke him privately. He told Crosland, and no one else in cabinet, that he would resign if the terms were rejected, and Crosland withdrew his objection on the ground that a prime minister could not be defeated on a question of this weight. Kevin Hickson's account of the cabinet papers treats this as the decisive move of the whole crisis, made outside the room where the argument was formally taking place (Hickson, 2005).

Cabinet rejected the Alternative Economic Strategy in the first days of December and accepted the Fund's terms on 12 December, by eighteen votes to five.

The Letter of Intent

Healey signed the Letter of Intent on 15 December 1976.

Healey set the credit ceilings out in terms that left no room for later interpretation: "DCE will be kept to £9 billion in the year up to 20th April 1977 and £7.7 billion in the year ending 19th April 1978, and I expect a further reduction in the following year to £6 billion."

The Fund's Executive Board approved the stand-by on 3 January 1977. It was the largest arrangement the institution had made with any member, and the first time since its founding at the conference that designed the postwar monetary order that one of the drafting powers had come to it as a supplicant with conditions attached.

What the Money Bought

Sterling stopped falling the moment the terms were public. It was back above $1.70 before the end of December and climbed through 1977 as North Sea oil began arriving in volume and the current account turned. Minimum Lending Rate came down in stages, reaching 12 per cent by early February 1977 and continuing lower through the year.

Britain drew about half the facility and repaid it in full by 4 May 1979 — the day after the general election that put Margaret Thatcher into Downing Street. Richard Roberts's study of the episode observes that the country never needed most of the money it had fought a cabinet crisis to obtain; what it had needed was the signature (Roberts, 2016). The loan was a credibility instrument, and credibility, once restored, made the cash redundant.

The political accounting was less tidy. The cuts agreed in December fell on capital spending and on programmes that Labour's own membership had campaigned for, and the resentment they generated ran through the winter of 1978-79 and into the strikes that finished the government. Benn's faction concluded that the cabinet had surrendered to foreign creditors over a forecasting error, which in the narrow sense was true. Healey concluded that the discipline had been useful even though the number that produced it was wrong.

What survived was the framework. Monetary targets, published and quantified, became a permanent feature of British economic policy from 1976 onward, adopted first as a condition of foreign lending and later defended as a matter of principle by a government that had opposed the loan. Sterling remained the instrument through which discipline was enforced or evaded for another generation, right up to the morning in September 1992 when the Treasury abandoned the Exchange Rate Mechanism.

Healey kept the airline ticket to Manila. He never used it, and the conference he missed produced nothing anyone now remembers.