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By Root 830 0

sterling arose not only because of short-term trade imbalances but because of the global imbalance between the total sterling reserves held outside Britain and the dollar and gold reserves available inside Britain to redeem those external balances. In the mid-1960s there were about four times as many external sterling claims as internal reserves. This situation was highly unstable and made Britain vulnerable to a run on the bank if sterling holders tried to redeem sterling for dollars or gold en masse. A variety of techniques was orchestrated to support sterling and keep the sterling bears off balance, including international lines of credit, swap lines with the New York Fed, a UK austerity package and surprise currency market interventions. But the problem remained.

Three minor sterling crises arose between 1964 and 1966, but were eventually subdued. A fourth sterling crisis, in mid-1967, however, proved fatal to sterling parity. Numerous factors contributed to the timing, including closure of the Suez Canal during the 1967 Six-Day War between the Arabs and Israel and the expectation that the UK might be required to devalue in order to join the European Economic Community. Inflation was now on the rise in the United Kingdom as it was in the United States. In the UK, inflation was rationalized as necessary to combat rising unemployment, but its impact on the value of the currency was devastating. After an unsuccessful effort to fend off continued selling pressure, sterling formally devalued against the dollar on November 18, 1967, from $2.80 to $2.40 per pound sterling, a 14.3 percent devaluation.

The first significant crack in the Bretton Woods facade had now appeared after twenty years of success in maintaining fixed exchange rates and price stability. If the UK could devalue, so could others. U.S. officials had worked hard to prevent the devaluation of sterling, fearing the dollar would be the next currency to come under pressure. Their fears would soon be realized. The United States was experiencing the same combination of trade deficits and inflation that had unhinged sterling, with one crucial difference. Under Bretton Woods, the value of the dollar was not linked to other currencies but to gold. A devaluation of the dollar therefore meant an upward revaluation in the dollar price of gold. Buying gold was the logical trade if you expected dollar devaluation, so speculators turned their attention to the London gold market.

Since 1961, the United States and other leading economic powers had operated the London Gold Pool, essentially a price-fixing open market operation in which participants combined their gold and dollar reserve resources to maintain the market price of gold at the Bretton Woods parity of $35 per ounce. The Gold Pool included the United States, United Kingdom, Germany, France, Italy, Belgium, the Netherlands and Switzerland, with the United States providing 50 percent of the resources and the remainder divided among the other seven members. The pool was partly a response to an outbreak of panic buying of gold in 1960, which had temporarily driven the market price of gold up to $40 per ounce. The Gold Pool was both a buyer and a seller; it would buy on price dips and sell into rallies in order to maintain the $35 price. But by 1965 the pool was almost exclusively a seller.

The End of Bretton Woods

The public attack on the Bretton Woods system of a dominant dollar anchored to gold began even before the 1967 devaluation of sterling. In February 1965, President Charles de Gaulle of France gave an incendiary speech in which he claimed that the dollar was finished as the lead currency in the international monetary system. He called for a return to the classical gold standard, which he described as “an indisputable monetary base, and one that does not bear the mark of any particular country. In truth, one does not see how one could really have any standard criterion other than gold.” France backed up the words with action. In January 1965, France converted $150 million of dollar reserves into gold