as 1965).59 Foreign loans issued in the UK during the period were also almost exclusively to the Sterling Area.
The result of all this is that for the 1950s and early 1960s, the UK is best understood as a regional economic power
and sterling as a regional reserve currency.60 Yet all these measures didn’t fix the problem that the UK owed too
much money and was uncompetitive, so it didn’t earn enough money to both pay its debts and pay for what it
needed to import. Rearrangements were essentially futile stop-gap measures designed to hold back the changing
tide. They helped keep the pound stable between 1949 and 1967. Still, sterling needed to be devalued again in
1967.
By the mid-1960s, the average share of central bank reserves held in pounds had fallen to around 20%,
while international trade was overwhelmingly denominated in dollars (about half). However, many emerging
markets and Sterling Area countries continued to hold about 50% of their reserves in pounds and continued to
denominate much of their trade with each other and the UK in sterling. This effectively ended following a series
of runs on the pound in the 1960s. As in many other balance of payments crises, policy makers used a
variety of means to try to maintain the currency peg to the dollar, including spending down reserves, raising
rates, and using capital controls. In the end they were unsuccessful, and after the UK devalued by 14%
versus the dollar in 1967, even Sterling Area countries were unwilling to hold their reserves in pounds,
unless the UK guaranteed their underlying value in dollars.
Throughout the 1960s, the UK was forced to defend the peg to the dollar by selling about half of its FX
reserve holdings and keeping rates higher than the rest of the developed world—even though the UK
economy was underperforming. In both 1961 and 1964, the pound came under intense selling pressure, and the peg
was only maintained by a sharp rise in rates, a rapid acceleration in reserve sales, and the extension of short-term
credits from the US and the Bank of International Settlements. By 1966, attempts to defend the peg were being
described by prominent British policy makers as “a sort of British Dien Bien Phu.”61 When the pound came
under extreme selling pressure again in 1967 (following rising rates in the developed world, recessions in
major UK export markets, and heightened conflict in the Middle East),62 British policy makers decided to
devalue sterling by 14% against the dollar.
After the devaluation little faith remained in the pound as the second-best reserve currency after the dollar. For the
first time since the end of World War II, international central banks began actively selling their sterling reserves (as
opposed to simply accumulating fewer pounds in new reserve holdings) and instead began buying dollars,
deutschmarks, and yen. As you can see in the chart below on the left, the average share of sterling in central bank
reserve holdings collapsed within two years of the devaluation. At the same time the UK was still able to convince
Sterling Area countries not to diversify away from the pound. In the Sterling Agreement of 1968, Sterling Area
members agreed to maintain a floor on their pound reserve holdings, as long as 90% of the dollar value of these
holdings was guaranteed by the British government. So although the share of pound reserves in these Sterling
Agreement countries like Australia and New Zealand remained high, this was only because these reserves had their
value guaranteed by the British in dollars. So all countries that continued to hold a high share of their reserves
in pounds after 1968 were holding de facto dollars with the British bearing the risk of a further sterling
devaluation.63