Origins and Measurement of Financial Repression: The British Case in the mid-20th Century

Garrick Hileman Cambridge Centre for

Alternative Finance

Financial History Workshop, Brussels, 27 May 2016

OriginsandMeasurementofFinancialRepression:TheBritishCaseinthemid-20thCentury

GarrickHileman

Abstract: A disagreement has emerged over whether advanced countries such asBritainengagedinfinancialrepressionfollowingtheSecondWorldWar.Areviewofthe historical and archival evidence shows that policies associated with financialrepression played an important role in sustaining post-war Britain's record-settinglevels of public debt. In Britain, eleven pieces of legislation and sixteenpolices/directivesareidentifiedthatsupportedfinancialrepressionduringthisperiod.A critiqueof two leadingmethods formeasuring financial repressionhighlights theneed for additionalmeasurement tools, suchas aproposed composite indicatoroffinancialrepression.ThepaperdiscussesvariousaspectsofBritishfinancialrepression,suchasinterestratepolicy,capitalcontrols,directedlending,andtheconscriptionoftheBritishbankingsystem.FreemarketbondyielddataareusedtocalculateBritishgovernment savingsattributable to financial repressionofover8%ofGDP in1948,whichismorethandoublepreviousestimatesforBritainandsignificantlygreaterthanestimatesfordevelopingcountriesduringthe1970s-80s.JEL:H63,E58,E61,E62,H12,H27,P24Keywords:financialrepression,capitalcontrols,sovereigndebt,debtsustainability,inflation,Britisheconomichistory,Britishbankingsystem,interestrates,financialregulation,macroprudentialregulation

1Introduction

Financialrepressionhasreceivedrenewedacademicandpublicattentioninrecent

yearsaspartoftheongoingeconomicandpolicydebateoverhowbesttoachieveeconomic

growthwhilesustainingpublicdebts.Therenewedinterestinfinancialrepressionhasbeen

promptedinpartbythehighestlevelsofpublicandprivatesectordebtsinadvanced

economiessincetheSecondWorldWar,theperiodwhichsomescholarsarguewasthelast

timeadvancedcountriespracticedfinancialrepressiononawidescale.

Untilrecentlyproblemsposedbyunsustainablelevelsofsovereigndebtwerenearly

exclusivetodevelopingeconomies.Accordingly,emergingmarketshavebeenthefocusof

sovereigndebtresearchandpolicymakersoverthelastfourdecades.However,debt

sustainabilitymeasuresthataretypicallyemployedbydevelopingcountries,suchas

repudiationandinflation,areviewedasimpractical,undesirable,orevenimpossibleformany

advancedeconomiestoimplement.Atthesametime,outstandingdebtsanddeficitsarelarge

enoughthatothertraditionalmechanismsforachievingfiscalbalance,suchasreductionsin

governmentexpendituresorassetsales,areviewedbymanyasinsufficienttomakeamaterial

impactonsovereigndebtsustainability.Ifadvancedeconomiesareultimatelyunableto

achievesufficienteconomicgrowthtomaketheirdebtssustainablethenfinancialrepression

maybethemostcompellingpolicyoption.

AdisagreementemergedbetweenReinhartandSbrancia(2011)andTaylor(2011)over

theevidenceofwidespreadfinancialrepressioninthepost-SecondWorldWarperiod.1The

disagreementisexploredinmoredepthlaterinthepaperbutcanbesummarizedasfollows:

ReinhartandSbranciastatethatthedeclineintherealvalueofpublicdebtisprimafacie

evidenceoffinancialrepression,whileTaylorcounteredthatthetruereasonswhyrealyields

ongovernmentdebtmayturnnegativearenotalwaysclear.

1(C.M.Reinhart&Sbrancia,2011;Taylor,2011)

Thispapermakesthreecontributions:first,existingmethodsformeasuringtheeffects

offinancialrepressionarecritiqued,revealinganumberofmethodologicalissuesand

limitationsthatcanbeaddressedinpartthroughaproposedcompositeindicator(composite

index)offinancialrepression.Second,thedisagreementovertheexistenceoffinancial

repressioninpost-SecondWorldWarperiodisexploredbyexaminingtheBritishcasein-depth,

andawiderangeoffinancialrepressionpoliciesemployedbyBritainareidentified.Last,an

alternativemeasureofBritishfinancialrepressionispresentedusingfreemarketbondyield

data;Britishfinancialrepression‘savings’arecalculatedatover8%ofGDPin1948,whichis

significantlygreaterthansavingsestimatesforothercountriesduringthepost-SecondWorld

Warperiod.

Theremainderofthepaperisstructuredasfollows:section2coversthedefinitionand

historyoffinancialrepression.Section3comparestwoleadingmethodsformeasuringfinancial

repression.Section4exploresthecaseofBritishpost-SecondWarfinancialrepression.Section

5concludes.

2Literaturesurvey

Beforeanystudycanbeundertakenitisusefultohaveaprecisedefinitionofthetopic

tobestudied.However,arrivingatbothaclearandgenerallyagreedupondefinitionofthe

termfinancialrepressionisproblematic;awiderangeofpoliciesandpracticescanbe,and

oftenare,placedunderitsbanner.Thetermfinancialrepressionisfrequentlyemployedasa

pejorativetocriticizeparticularpolicies,evokingstrongreactionsinacademicandpolicy

discussions.Addingfurthertroubleistheinterchangeableusebysomescholarsoftermslike

fiscalrepressionwithfinancialrepression,sometimesinthesamepaper.2Overlapcanalsobe

foundbetweenpoliciesassociatedwithfinancialrepressionandthepoliciesthatfallunderthe

moreagreeablytermedmacroprudentialregulation.3Forexample,increasedreserve

requirementsandholdingmore‘safe’governmentdebtinlieuofothercapitalisconsidered

bothprudentorthodoxyforachievingfinancialstabilityaswellasacorecomponentoffinancial

repression.

Financialrepressioncanbedefinedasanymeasuretakenbycentralauthoritiesthat

directslendablefundstowardsthesovereign’spubliclyissueddebt,oftenonattractiveterms

(belowmarket).Inotherwords,intheabsenceoffinancialrepressionthegovernmentwould

havetopayahigherrateofinteresttoenticelenders;otherwisethegovernmentwouldrisk

losingsignificantinvestorfundstootherfreemarketinvestmentsthatgeneratehigherratesof

return.Hereweseeoneofthedifficultiesinidentifyingfinancialrepression,whichisthe

relianceonthecounterfactualthateconomicactorswouldbehavedifferentlyifcertainpolicies

werenotinplace.

Thecorepolicyelementsoffinancialrepressioncanperhapsbebestgroupedintotwo

categories4–capitalcontrolsanddomesticfinancialregulation:

2(Drelichman&Voth,2008)3Forfurtherdiscussionsee(C.Reinhart,Kirkegaard,&Sbrancia,2011)4Frameworkadaptedfrom(C.M.Reinhart&Sbrancia,2011,p.6)

1. Captivedomesticcreditproviders,whichtypicallyincludethebankingsystem,pension

funds,insurancecompaniesandotherinstitutions(e.g.,governmentagencies).Such

entitiescanbeownedordirectlyoperatedbythegovernmentunderaregimeof

financialrepression.Alternatively,firmscanalsoberegulatedornudgedthroughmoral

suasion.Publicdebtfinancingfromtheseentitiesisoftendirectedbythegovernment

viathefollowingmechanisms:

a. Reserverequirementsthatgovernboththepercentageandtypeofcapital(e.g.,governmentdebt)andmustberetainedbythebankingsysteminreserveagainstdeposits.

b. Exchangeandcapitalcontrolsthatrestrictbothinstitutionsandindividualsto

domesticsavingsandinvestmentvehicles,therebypreventingthemfromtakingadvantageofpotentiallymoreattractiveoffshorereturns.

c. Preferentialtaxtreatmentforgovernmentdebtoverothercompetingfinancial

instruments,suchasequities.5

d. Restrictionsonholdingcertainassets(i.e.,foreigncurrency,gold),includingprohibitingtheownershipofgold,orlimitationsonthesaleortransferofgoldwithinorbeyondthedomesticmarket.

2. Interestratecapsintheformofrateceilings,orotherindirectmeasuresthathelp

maintainlowinterestrates.Lowratescanbothreducegovernmentdebtexpenseand

influencethedemandforgovernmentdebt.Forexample,savingsdepositsthatare

regulatedtopayalowerrateofinterestthangovernmentdebtwillincentivizethe

migrationofcapitalintogovernmentdebt.

Theabovedefinitionoffinancialrepressionisbynomeanscomprehensive.Indeed,a

myriadofmeasuresareoftensuggestedasaformfinancialrepression.Forexample,

governmentrestrictionsontheactionsofcreditratingsagencieshasbeencharacterizedas

financialrepression.6Insum,whilethebroadconceptoffinancialrepressionisgenerallywell

5Formoreonthisspecificareasee(Campbell&Froot,1994)6(Evans-Pritchard,7July,2011)

established,thereisroomfordebateoverpreciselywhichpoliciesoractionsshouldandshould

notbeconsideredfinancialrepression.

2.1Historicaloverviewoffinancialrepression

Tomoreclearlydefineandunderstandfinancialrepressionitishelpfultoexamineits

origins.Somepoliciesassociatedwithwhatcametobecalledfinancialrepressioninthelatter-

halfofthe20thcenturyhaveexistedlongbeforethetermwasinvented.Restrictionsoninterest

andusurydatebacktoatleast1800B.C.andtheBabylonianCodeofHammurabi.7Lending

withinterest,orinterestratesconsideredusurious,haveoftenbeenframedinmoraland

religioustermsandarechastisedinboththeKoranandOldTestament.Forexample,Jews,like

Christians,wereingeneralnotsupposedtolendmoneyatusuriousratesofinterest,butthe

OldTestamentbookofDeuteronomycontaineda‘get-outclause’forJewslendingtogentiles.8

Morerecentlyasystemofcompulsorygovernmentfinancecalledprestitiwasin

operationin14thand15thcenturyVeniceandFlorence.9Restrictionsonthefreemovementof

capital,suchastheexportofspecie,areseenasearlyas16thcenturySpainandtheNapoleonic

period.10However,exchangecontrols,astheyarecommonlyunderstoodandpracticedtoday,

arguablyfirstcameintowiderexistenceduringtheFirstWorldWarwhenGermanyintroduced

exchangeregulationsshortlyafterhostilitiescommenced.11On3April,1918Francefollowed

suitandenactedexchangecontrolstolimitcapitalflight.Britain,undertheguidanceofathen

youngemployeeoftheExchequernamedJohnMaynardKeynes,practicedalighterversionof

capitalcontrols,whichincludedlicensingimportsandplacingrestrictionsonthewayinwhich

warloanscouldbespent.12Later,inhis1936GeneralTheory,Keynesexpressedhimselftobeat

leastasometimeproponentofinterestratecaps,stating:

7(Lane,1937)8(Ferguson,2008,pp.35-36)‘Untoastrangerthoumayestlenduponusury;butuntothybrotherthoushaltnotlenduponusury’9(Blitz&Long,1965)10(Cooper,Tarullo,&Williamson,1999,pp.6-7)11(Dulles,1929,p.223;Moulton&Mcguire,1923,p.166)12(R.F.Harrod,1951,pp.204-205)

“…therateofinterestisnotself-adjustingatalevelbestsuitedtothesocialadvantagebutconstantlytendstorisetoohigh,sothatawisegovernmentisconcernedtocurbitbystatueandcustomandevenbyinvokingthesanctionsofmorallaw.”13

Whilecapsoninterestcanpreventmonopolistoroligopolisticlendersfromabusingtheir

pricingpower,capsalsobringdownthecostofborrowingforgovernment.

GurleyandShaw(1955,1960)werethefirsttoarticulatethebroadereconomicsystem

offinancialrepression.14In1973ShawandMcKinnonsimultaneouslycoinedtheterm‘financial

repression’intheirrespectivebooksontheroleofthefinancialsectorineconomic

development.15McKinnonandShawfocusedontwochannelsfortransmittingfinancial

repression:first,thereductionintheefficiencyofthebankingsectorinallocatingsavings,

meaningbankersoperatinginafinanciallyrepressedenvironmentareunabletomanagecredit

accordingtomarketratesandprices.Second,maintainingartificiallylowinterestratesreduces

thesavingslevel,whichinturncanreducecapitalaccumulation.16

Thetermfinancialrepressionbecamesomewhatofacatch-alldescriptionforexcessive

financialregulationindevelopingeconomiesbypromotersofthe‘Washingtonconsensus’,

whichwasasetofpoliciesassociatedwiththepushformarketliberalizationinthe1970s-

1980s.McKinnon,Shawandsubsequentscholarsfocusedtheirresearchontheeconomic

developmentbarrierscreatedbyfinancialrepressionforlessdevelopedeconomies.

13(Keynes,1936,p.351)14(J.G.Gurley&Shaw,1955;JohnG.Gurley,Shaw,Enthoven,&BrookingsInstitution.,1960)15(McKinnon,1973;Shaw,1973)16(Shaw,1973,Ch.2and3)

2.2Economicimpactoffinancialrepression

SinceGurleyandShaw'sgroundbreakingworkinthemid-1950s,anumberofresearch

studieshavefoundthatfinancialrepressionhasanegativeimpactoneconomicgrowth.17A

morespecificcriticismoffinancialrepressionisthenegativeimpactithasonthemarginal

productivityofcapital;controlssuppressinginterestratesbelowtheirequilibriumlevelcause

projectswithotherwisepositivereturnsoninvestmenttogounfinanced.18Financial

developmentislikelytosufferundersuchconditionsasthelowreturnonfinancialassets

reducestheincentiveforsavingstobeallocatedtothefinancialsystemforintermediation.19

Theresultingdragoncapitalaccumulationundercutsentrepreneurshipandeconomic

development.

Capitalmobility,whichisrestrictedbyfinancialrepression,helpschannelresourcesto

theirmostproductiveusesbothlocallyandworldwide.CapieandWood(2002)studiedthe

effectsofBritishcapitalcontrolsandfoundthattheyresultin‘deadweightlosses’,meaning

higherprices,reducedproduction,andincreasedbureaucraticandadministrativecosts.20

Capitalcontrolscanalsobedifficulttoabandononcetheyareinplace,andtheycannegatively

impactacountry’sattractivenessasadestinationforforeigncapitalbyreducingthe‘free

market’credibilityofthenationsthatimplementcapitalcontrols.Exchangecontrolscanalso

createwhatamountstoaquotaonimports,thustriggeringanincreaseinrelativedomestic

prices.21Foreignexchangerationinghasalsobeenshowntohaveanegativeimpactonoutput

andemployment.22

Boththeempiricalandtheoreticalliteratureclearlysupportthecasethatfinancial

repressioncannegativelyimpacteconomicgrowth.However,itmustbenotedthatrobust

17Seeforexample(Easterly,1993;Galindo,Micco,Ordoñez,Bris,&Repetto,2002;Lanyi&Saracoglu,1983;Roubini&Salaimartin,1992;WorldBank,1989)18(Goldsmith,1969)19(DelaTorre,Gozzi,&Schmukler,2007)20(Capie&Wood,2002)21(Agénor,1992,p.11;Bhagwati,1978;Greenwood&Kimbrough,1987)22(Austin,1989)

economicgrowthandfinancialrepressionmaynotbemutuallyexclusive.Forexample,manyof

thecountriesthatReinhartandSbranciaargueashavingactivelyengagedinfinancial

repressionfollowingtheSecondWorldWaralsomanagedtogenerateoutsizedeconomic

growth.From1948to1973therealGDPofWesternEuropegrewtwiceasfastasduringany

otherperiodofcomparablelength,beforeorsince.23Inotherwords,ifReinhartandSbrancia

arecorrectintheirassessment,the‘eraoffinancialrepression’followingtheSecondWorld

Warcoincidedwiththe‘goldenageofeconomicgrowth’.

Alsoofnoteisthefactthatfrom1945through1980therewasnotasinglemajor

systemicinternationalbankingcrisis.Thisfactstandsinstarkcontrastwithrepeatedbanking

crisesthatoccurredbothbeforeandfollowingthe‘eraoffinancialrepression’.24Onepossible

explanationforthisphenomenonisthat,incontrasttothegrowinginternationaltrade

integrationfollowingtheSecondWorldWar,financialintegrationacrossborderswasprevented

throughanumberofrestrictions.25Asnotedearlier,financialrepressionpoliciessharesome

commonfeatureswithprudentialmeasures,suchasbankreserverequirementsthatmandate

anincreaseingovernmentdebtholdings.Researchhasshownthatbankingcrisesoften

foreshadowsovereigndebtdefaults.26

Arguablyoneofthemostimportantelementsoffinancialrepressionisitsimpacton

publicdebt.Governmentsareoftenforcedtopayahigherrateofdebtinterest,orinextreme

casescanbeentirelyshutoutofdebtmarkets,astheratioofpublicdebt-to-nationalincome

(debt-to-GDP)climbs.Inflation,whichoftenaccompaniesfinancialrepression,iscapturedin

nominalGDPandcanhelpreducethedebt-to-GDPratio.However,significantinflation,or

negativerealinterestrates,neednotaccompanyfinancialrepressiontohaveapositivedebt

sustainabilityeffect;anybelow-marketinterestratereducestheservicingcostofgovernment

23(B.Eichengreen,1996)24(Bordo&Landon-Lane,2010;CarmenM.Reinhart&Rogoff,2009)25(Obstfeld&Taylor,2004)26(C.M.Reinhart&Rogoff,2011)

debt.However,likeinflation,financialrepressionisonlyeffectiveagainstgovernmentdebts

thataredenominatedinthedomesticcurrency.

3Measurementoffinancialrepression

GiovanninianddeMelo(1993)andReinhartandSbrancia(2011)developedmethods

forquantifyingandmeasuringtheimpactoffinancialrepression.Thissectionofcontainsa

discussionofthesemethods,theirresults,andsuggestedalternativeapproaches.

3.1GiovanninianddeMelo

Giovannini’sanddeMeloassembledataforasampleoftwenty-fouremergingmarket

countriesfortheperiodof1972through1987.27GiovanninianddeMelocalculategovernment

revenuefromfinancialrepressionasthedifferencebetweenthegovernment’sforeignand

domesticcostoffunds,multipliedbythepublicdebtofthecentralgovernment:

FR=(if–id)*PD

wheregovernmentrevenuefromfinancialrepression(FR)iscalculatedbysubtractingthe

artificiallylowdomesticinterestrate(id)fromtheforeignmarketinterestrate(if),andthen

multiplyingbygovernmentpublicdebt(PD).

Theirresultsestimatethe'governmentrevenue’fromfinancialrepressionrangedas

highas5.8%ofannualGDPinMexico,or40%oftheMexicangovernment’staxlevies.To

determinetheir‘market’ratetheauthorsutilizedatafromtheWorldBankDebtorReporting

System,whichisbasedonforeign‘commercial’debtinterestfromfinancialinstitutionsthat

havefloatedLIBOR-basedborrowingsoninternationalmarkets,suchasNewYorkandLondon.

27(Giovannini&Demelo,1993,p.957)Somedataismissingforsomeyears,andtheauthorsacknowledgethedebatabledecisionofincludingGreeceandPortugalintheirsample,bothofwhicharegenerallyconsideredas‘advanced’countries.

Oneproblemwiththismethod,whichtheauthorsdonotdiscuss,isthatcommercial

ratesofinterestarenearlyalwayshigherthangovernmentrates,oftenbyasignificantmargin.

Accordingly,commercialratesmaynotberepresentativeofforeignsovereignrates,leadingto

anupwardbiasintheirfinancialrepressioncalculations.Asecondissuewiththeirmethodis

thatratesofinterestcansignificantlyvarybytypeoffinancialinstitution.Manydifferenttypes

offinancialoperatingentitiesbesidesdepositories,suchasinsurancecompanies,investment

banks,specialtyfinancelenders,andautofinancecompanies,canbeclassifiedasa‘financial

institution’.Indefenceoftheauthors,itwasanotuncommonpracticeduringtheperiod

studiedforgovernmentstoown,orexercisesomedegreeofcontrol,overdomesticfinancial

institutions.Itcouldthereforebereasonabletoarguethatfinancialinstitutionsservesarea

reasonableproxyforthemarketinterestratethatforeigninvestorswouldrequiretohold

government'sdebt.However,theauthorsfailtomakethiscase.

Aperhapssignificantconceptualproblemwithrepresentinganinterestratefromthe

periodunderstudyasa‘market’rateisthepervasivenessoffinancialrepressionduringthe

period.28Thelooseningofcapitalcontrolsandfinancialderegulationtookplaceoverthecourse

ofthesampleperiod,notbeforetheperiodofstudy.29Onepossiblewayofaddressingthis

issuewouldbetosegmentandcomparedatabetweendifferentsubperiods.However,suchan

approachwasnotundertakenordiscussedbytheauthors.

Theauthorsexcludedebtheldbythecentralbankintheirfinalcalculation,asthe

interestisreturnedtothegovernment.However,thedebtholdingsofmonetaryauthoritiesare

includedintheireffectivedomesticinterestratecalculations“becausethetreasurynormally

remuneratesthecentralbankforitsholdingsofinterest-bearingtreasurydebt”.30Whilethe

explanationforexcludingcentralbankholdingsinthefirstinstanceseemsreasonable,the

inconsistenttreatmentofcentralbankholdingsisnotsufficientlyjustifiedbytheauthors.

28(C.M.Reinhart&Sbrancia,2011)29(Obstfeld&Taylor,2004;D.Quinn,1997)30(Giovannini&Demelo,1993,pp.956-957)

Last,theauthorsuseoftheterm‘governmentrevenue’todescribetheeffectsof

financialrepressionisproblematic.Thegovernmentdoesnotinfactcollectanytaxrevenue

fromfinancialrepression.Thebenefitsgovernment’srealizefromfinancialrepression,suchas

reducedinterestexpense,areinfactmoreakinto‘savings’thanrevenue.

3.2ReinhartandSbrancia

ReinhartandSbranciareferenceGiovannini'sanddeMelo'smethodsandtakeasimilar

‘bottomline’approachtocalculatethe‘liquidationeffect’,whichtheyalsorefertoas‘financial

repressiontax’,throughanexaminationofrealinterestratesofgovernmentdebt.31They

assembledataforaten-countrysampleofadvancedanddevelopingeconomies,includingthe

UnitedKingdomfor1945-1980.Theirresultsshowthatnegativerealinterestrateshada

significantimpactonreducingtherealcostofpublicdebt.ReinhartandSbranciaacknowledge

thesimilaritybetweentheirsandGiovanninianddeMelo’smethod.Theydonot,however,

considertheGiovanninianddeMelomethodappropriateforthepost-BrettonWoodsera

becausemanycountriesdidnothavemuchifanyexternaldebtdenominatedinaforeign

currency.

ReinhartandSbranciaconstructa‘synthetic’debtportfolioforeachsamplecountryto

determinetheappropriatedomesticinterestrate.Next,theycalculatetherealinterestrate(rt)

foreachcountryasfollows:

Where andiareCPIinflationandnominalinterestrates,respectively.Savingstogovernment

occuranyyearinwhichtherealinterestrate(rt)isnegative.The‘liquidationeffect’,or

31(Sbrancia,2011,p.35)Theauthorsalsostatetheyhavealsochosentoremain“silentabouttheoptimalityordesirabilityofrelyingonthismechanismtoreducedebts”.

t

tttir

ππ

+

−= −

11

π

‘financialrepressiontax’inanygivenyear,issimplycalculatedbymultiplyingthenegativereal

interestrate(rt)bytheoutstandingpublicdebt.

ReinhartandSbranciaalsoproposea“supplementary”methodforcalculatingdebt

liquidationthattakesintoaccountcapitallosses,ordeclinesinbondprices,ongovernment

debt.Thismethodcouldbeimportantforgovernments(orcentralbanks)thatpurchasetheir

country’sdebtinsignificantquantitywhenitisadvantageoustodoso.ReinhartandSbrancia

calculateaholdingperiodreturn(HPR)foreachdebtinstrumentasfollows:

WherePtandPt-1arebondpricesattimetandt-1,respectively,andCtistheyearlyinterest

payment.Similartotheirpreviousmethodpresentedabove,agovernmentdebtliquidation

yearisdeterminedasanyyearinwhichtherealreturnofthedebtportfolioisnegative.The

authorsdonoteseveralproblemswiththissecondapproach,suchashowtofactorinnon-

marketabledebt(forwhichthereisnopricedata),aswellasthegeneraldifficultyofobtaining

historicalbondpricedataforsomecountries.

Withthefirstmethod,Reinhart’sandSbrancia’sfindingsfortheUnitedKingdom

suggestthatnearlyone-halfoftheyearsfrom1945-1980(including1948-1953)weredebt

liquidationyears,withanaveragenegativerealinterestrateof3.8%.32TheirresultsfortheUK

usingthesecondmeasurewereslightlylowerthantheirfirst,withliquidationasapercentage

ofGDPof2.4%versus3.2%,respectively.However,theyonlyutilizebondpricedatafortheUK

fromthe1960onwards.

32Atthetimeofwritingtheirfulldatabasehasnotyetbeenmadeavailableforamoredetailedreviewofmethodsandresults(i.e.,individualyearsorisolatedperiods).

1

1)(

−

− +−=

t

tttt P

CPPHPR

OneofthefirstquestionstoemergefromReinhart’sandSbrancia’sworkiswhythe

years1945-1947werefoundtobenon-debtliquidationyearsfortheUnitedKingdom?As

shownlater,significantinflationcontinuedaftertheendofthewar.Further,whiledebtlevels

peakedin1946,theUK’soveralldebtpositionwasroughlysimilarin1948asitwasin1945,the

firstpost-waryearthatauthorsidentityasadebtliquidationyear.Partoftheexplanationis

thattheirmethodologymaybeoverlyconservative.Theyconsideradebtliquidationyearas

oneinwhichrealinterestratesarenegativeasopposedtowhenrealinterestratesaresimply

belowmarketrates.Theauthorsjustifytheirhigherthresholdduetothedifficultyand

conceptualchallengesassociatedwithdeterminingatrue‘market’rateduringaperiodof

widespreadfinancialrepression.True,negativerealreturnsondepositsandbondswereanear

universalphenomenonduringmuchofthepost-warperiod.Further,eveniftherewereno

restrictionsoninterestratesinarelativelyfreemarketlikeSwitzerland,itisreasonableto

believethatglobalrateshadsomedownwardinfluenceonSwissrates.

Whileitisunclearhowtobesttoadjustfortheeffectof‘worldinterestrates’inanyuse

ofmarketratesincalculatingtheeffectsoffinancialrepression,acknowledgementofthis

problemisinsufficientjustificationforaltogetherdisregardingmarketrates.33Duringandafter

theSecondWorldWarsophisticatedfreemarketsdevelopedinlightlyregulatedvenues.34In

Switzerland,forexample,foreignsecuritiesandcurrenciesweretradedatsignificantdiscounts

totheirofficialrates.35TheBankofEngland“obsessed”withoverseastradingof‘free’sterling,

andapproximately$300millionoffreesterlingwastradedduringoneyearyearinNewYork

alone.36Further,currencyblackmarketsunderminetheefficacyofcapitalcontrols,which

typicallyplayacrucialroleinfinancialrepression.Theexistenceofsizablecurrencyblack

marketscouldconceivablynegatetheeffectivenessoffinancialrepression,particularlyfor

economicactorsthathaveaccesstosuchmarkets.Thesefreemarketsarenotmentionedby

theauthors.

33Forfurtherdiscussionofa‘worldinterestrate’see(Barro&Salaimartin,1990;Blanchard&Summers,1984;Chinn&Frankel,2005;Koedijk,Kool,&Kroes,1994;Lucas,1990;Yi,Blankenau,&Kose,2001)34Seeforexample(Frey&Waldenström,2004)35(TheEconomist,22May,1948)36(Cairncross,1985,pp.258,263)

Asecondwayinwhichtheauthor'scalculationsmayproveconservativerelatestotheir

useofofficialinflationdatasources.37Forexample,theinflationstatisticsreflectedinRichards

(2002)showconsistentlylowerlevelsofinflationthanotherestimatesforthesameperiodthat

areshownlaterinthispaper.Theauthorsdomakenoteofthisissue,butforreasonsthatare

uncleartheydonotutilizearguablymorerealisticinflationfigures.

Thereis,however,aperhapsmorefundamentalissueinReinhart’sandSbrancia’s

secondmethodthatisnotdiscussedbytheauthors.38Itistruethatagovernment,followinga

declineinthepricesofitsbonds,canretiredebtatanadvantageouscosttothegovernment.

However,theinterestexpenseincurredbythatgovernmentonsubsequentdebtissuancemay

increaseasthepriceinvestorsarewillingtopayonanynewlyissueddebtisdeterminedbythe

currentyieldonalreadyissuedbonds.Bondyieldsareinverselyrelatedtobondprices:

𝑐𝑢𝑟𝑟𝑒𝑛𝑡𝑦𝑖𝑒𝑙𝑑 = 𝑎𝑛𝑛𝑢𝑎𝑙𝑐𝑜𝑢𝑝𝑜𝑛𝑚𝑎𝑟𝑘𝑒𝑡𝑝𝑟𝑖𝑐𝑒

Inotherwords,forfixedcoupongovernmentbonds,asbondpricesdeclineyieldsincrease,and

higheryieldsequatetohighernominalinterestexpensebornbytheissuinggovernmentonany

newlyissuedgovernmentdebt.Insum,anyeconomicgainagovernmentrealizesbyretiring

anyofitsbondsthathavedeclinedinvaluemaybeoffsetorexceededbyhigherinterestcosts

associatedwithnewdebtissuance.Asimplehypotheticalillustrationoftheabovepointis

presentedinTable1,whichshowstheimpactofdebtretirementandnewsovereignbond

issuanceonagovernmentbalancesheet.

37(C.M.Reinhart&Sbrancia,2011,p.28)38(C.M.Reinhart&Sbrancia,2011,pp.30-31)

Table1:IllustrationofIntertemporalChangesinPublicDebtInterestExpenseDuetoCapitalGains(Losses)

HypotheticalTreasuryBondIssuanceandTreasuryBalanceSheet

TreasuryBondIssuance 1950 1951 1952 1953 1954Bond(1)principal £100 Couponpayment(fixed) £2.50 £2.50 £2.50 Couponyield(fixed) 2.50% MarketpriceofBond(1) £100 £100 £75.00 CurrentYield 2.50% 2.50% 3.33% Bond(2)-principal £100 Couponpayment(fixed) £3.33 £3.33Couponyield(fixed) 3.33% MarketpriceofBond(2) £100 £100CurrentYield 3.33% 3.33% TreasuryBalanceSheet 1950 1951 1952 1953 1954 BeginningofYearCash £0.00 £100.00 £97.50 £10.00 £10.00 AnnualSurplus/Deficit £0.00 £0.00 -£10.00 -£100.00 £0.00Interestexpense £0.00 £2.50 £2.50 £3.33DebtIssued-Deficit-Interest=Cash £100.00 £97.50 £85.00 £10.00 £6.67 BondRepurchases £75.00 £0.00 £0.00Gain(Loss)onBondRepurchase(onetime) £25.00 Gain(Loss)oninterestrefinancing(reoccurring) -£0.83 Cash-BondRepurchases £100.00 £97.50 £10.00 £10.00 £6.67

Theaboveillustrationdemonstrateshowabeneficialone-timecapitalgainrealizedbya

governmentthroughadeclineinthemarketvalueofitsbondscanbepartially,ifnotwholly,

offsetbymodestlyhigherreoccurringinterestexpensethegovernmentwillincuron

subsequentdebtissuance.Thereasonforthisisthatadeclineinbondpricesresultsinhigher

yieldsonoutstandingdebt,anditistheseexpostyieldsthatguidethepricingofnewlyissued

debt.

Last,theauthorsacknowledgethatinthereductionofpost-SecondWorldWardebts

that“otherfactors,suchasrealgrowth,mayhavebeenrelevantaswell.”39AsnotedinChapter

2,popularnarrativesaswellasacademicanalysisbyBuiter(1985)andothersonhowpost-

SecondWorldWardebtswerereducedthrougheconomicgrowthareincompleteatbest,and

possiblymisleading.However,ReinhartandSbranciadonotattempttocompareorquantify

therelativecontributionofrealgrowthandfinancialrepression.Suchacomparisoncouldbe

helpfulforunderstandingtherelativeimpactofeachonpost-SecondWorldWardebt

reduction.

3.3Alternativesmeasuresoffinancialrepression

Thissectionpresentsanalternativecalculationofgovernmentsavingsfromfinancial

repressionforBritainduringthepost-SecondWorldWarperiod.Thisalternativecalculationcan

becharacterizedasahybridofthepreviouslydescribedmethodsdevelopedbyGiovanniniand

deMeloandReinhartandSbranciaandaddressessomeoftheissuesidentifiedearlier.

Specifically,thealternativecalculationpresentedbelowdoesawaywiththecommercialrateof

interestusedbyGiovanninianddeMeloandinsteadutilizesafreemarketrate.40

Inadditionto‘free’sterling,thereisevidenceofamarketfor‘free’Britishsovereign

debt.InAmerica,NewYork-tradedUKbearerbondswereyielding7%,whichwasmorethan

39(Sbrancia,2011,p.35)40AnothersupplementaryapproachtotheReinhartandSbranciamethodnotperformedherethatcouldbeusefulwouldbetoallowforalowerthresholdofwhatconstitutesadebtliquidationyear,suchaswheneverrealinterestratesarebelowmarketrates.

doubletheapproximately3%yieldthatBritish2.5%couponConsolswerepayinginLondon

duringthistime(Table2).41

Table2:PricesandYieldsofLong-TermBritishGovernmentSecurities,1935-1961

YieldRangeofAllIssues30-yearsor

Longer

Annual MaxCurrentYieldofPremiumIssuesYear Avg. Yield% High Yield Low Yield Low High

1935 86.500 2.89% 94.3750 2.65% 80.000 3.13% 2.88% 3.13% 3.48%1936 85.000 2.94% 87.2400 2.87% 82.250 3.04% 2.96% 3.17% 3.54%1937 76.250 2.28% 84.8125 2.95% 73.125 3.42% 3.37% 3.43% 3.64%1938 74.000 3.38% 79.3750 3.16% 64.000 3.91% 3.56% 3.62% 3.87%1939 67.250 3.72% 71.1250 3.51% 61.000 4.10% 3.65% 3.77% 3.62%1940 73.500 3.40% 77.0000 3.25% 68.125 3.67% 3.25% 3.44% 3.58%1941 79.875 3.13% 82.8750 3.02% 76.750 3.26% 3.03% 3.19% 3.62%1942 82.500 3.03% 83.6250 2.99% 81.000 3.09% 3.03% 3.18% 3.62%1943 80.625 3.10% 83.2500 3.00% 78.250 3.19% 3.14% 3.23% 3.62%1944 79.625 3.14% 82.2500 3.04% 78.688 3.18% 3.07% 3.18% 3.62%1945 85.625 2.92% 92.8125 2.69% 91.563 3.06% 2.74% 2.91% 3.44%1946 96.188 2.60% 99.6250 2.51% 81.125 3.08% 2.53% 2.67% 3.69%1947 90.500 2.76% 99.1250 2.52% 80.000 3.12% 3.00% 3.05% 3.65%1948 77.875 3.21% 83.3750 3.01% 74.500 3.36% 3.13% 3.19% 3.94%1949 75.750 3.30% 81.9375 3.05% 65.128 3.84% 3.56% 3.81% 3.90%1950 70.375 3.55% 74.6875 3.35% 68.125 3.67% 3.53% 3.73% 1951 66.000 3.79% 71.5000 3.50% 60.125 4.16% 4.06% 4.44% 1952 59.125 4.23% 62.0000 4.03% 55.000 4.55% 4.27% 4.61% 1953 61.240 4.08% 65.2500 3.83% 58.375 4.28% 3.89% 4.27% 1954 66.500 3.76% 69.7500 3.58% 58.375 4.28% 3.81% 4.15% 1955 60.000 4.17% 66.5000 3.76% 54.875 4.56% 4.39% 4.50% 1956 52.750 4.74% 56.7500 4.41% 49.875 5.01% 4.90% 5.08% 1957 50.250 4.98% 55.6875 4.49% 45.000 5.56% 5.41% 5.62% 1958 50.250 4.98% 52.8125 4.73% 46.750 5.35% 4.89% 5.20% 1959 51.875 4.82% 53.6250 4.66% 48.625 5.14% 4.99% 5.40% 1960 46.375 5.40% 49.7500 5.02% 43.875 5.71% 5.68% 6.07% 1961 40.375 6.20% 44.0000 5.70% 36.250 6.90% 6.45% 6.85%

41('FreeSterlinginEurope',TheEconomist,22May,1948)Atpresentonlyasinglefreeyielddatapointhasbeenlocated.

Source:Homer(1963)42

TheNewYork‘free’yieldcanbeemployedtocalculategovernmentsavingsfrom

financialrepressionthroughaslightlymodifiedversionofGiovanninianddeMelo’smethod:

(1) FRS=(im–id)*PD

wheregovernmentsavingsfromfinancialrepression(FRS)iscalculatedbysubtractingthe

artificiallylowdomesticinterestrate(id)fromthefreemarketinterestrate(im),andthen

multiplyingbygovernmentpublicdebt(PD).Theresultsofsuchacalculationfortheyears

1945-1951arepresentedinTable3.

42(Homer,1963,p.16)

Table3:UKFinancialRepressionSavingsEstimate,ConstantFreeMarketInterestRate,1946-60

Year

UKNetPublicDebt

(£bs)

Freemarketinterestrate*

Avg.YieldofLong-TermUKDebt

FinancialRepressionSavings(£bs)

FinancialRepressionSavings

%ofGDP1946 23.64 7.00% 2.60% 1.04 10.9%1947 25.63 7.00% 2.76% 1.09 10.1%1948 25.62 7.00% 3.21% 0.97 8.1%1949 25.17 7.00% 3.30% 0.93 7.3%1950 25.80 7.00% 3.55% 0.89 6.7%1951 25.92 7.00% 3.79% 0.83 5.6%1952 25.89 7.00% 4.23% 0.72 4.5%1953 26.05 7.00% 4.08% 0.76 4.4%1954 26.58 7.00% 3.76% 0.86 4.8%1955 26.93 7.00% 4.17% 0.76 3.9%1956 27.04 7.00% 4.74% 0.61 2.9%1957 27.01 7.00% 4.98% 0.55 2.5%1958 27.23 7.00% 4.98% 0.55 2.4%1959 27.38 7.00% 4.82% 0.60 2.5%1960 27.73 7.00% 5.40% 0.44 1.7%

*Note:Atpresentonlyasinglefreeyielddatapointhasbeensourced('FreeSterlinginEurope',TheEconomist22May,1948)Sources:HMTreasury,TheEconomist,Homer(1963),IMF,UKONS

TheresultsindicatethattheeffectsofUKfinancialrepressionwerelikelylargest(asa

percentageofGDP)intheyearsimmediatelyfollowingtheSecondWorldWar,butthensteadily

diminished.In1948,savingsattributabletofinancialrepressionwereover8%ofGDP,or

significantlylargerthanGiovanninianddeMelo’slargestfindingof5.8%ofGDPforMexico.

However,astimeprogressestheaverageyieldoflong-termUKdebtnearlydoubleswhilethe

netpublicdebtonlyincreasesfrom£23.6billionin1946to£27.7billionin1960,orby17%.

However,theaboveestimationassumesnochangeovertimeinthe7%freemarketyieldonUK

debtsourcedfromthe1948TheEconomistarticle.Theresultsfromadjustingthefreemarket

yieldproportionallytotheadjustmentinofficialmarketyieldsarefoundinTable4.

Table4:UKFinancialRepressionSavingsEstimate,AdjustedFreeMarketInterestRate,1946-60

Year

UKNetPublicDebt

(£bs)

Freemarketinterestrate*

Avg.YieldofLong-TermUKDebt

FinancialRepressionSavings(£bs)

FinancialRepressionSavings

%ofGDP1946 23.64 5.50% 2.60% 0.69 7.2%1947 25.63 5.86% 2.76% 0.79 7.4%1948 25.62 7.00% 3.21% 0.97 8.1%1949 25.17 7.20% 3.30% 0.98 7.7%1950 25.80 7.74% 3.55% 1.08 8.1%1951 25.92 8.26% 3.79% 1.16 7.8%1952 25.89 9.22% 4.23% 1.29 8.1%1953 26.05 8.90% 4.08% 1.25 7.3%1954 26.58 8.20% 3.76% 1.18 6.5%1955 26.93 9.09% 4.17% 1.33 6.8%1956 27.04 10.34% 4.74% 1.51 7.2%1957 27.01 10.86% 4.98% 1.59 7.2%1958 27.23 10.86% 4.98% 1.60 6.9%1959 27.38 10.51% 4.82% 1.56 6.4%1960 27.73 11.78% 5.40% 1.77 6.8%

*Note:Adjustedproportionallybasedonchangesintheyieldoflong-termBritishgovernmentdebt.Atpresentonlyasinglefreeyielddatapointhasbeensourced('FreeSterlinginEurope',TheEconomist22May,1948)Sources:HMTreasury,TheEconomist,Homer(1963),IMF,UKONS

Oneuntestedmethodforcalculatingfinancialrepressionsavingsthatisbeyondthe

scopeofthispaperinvolvesthecreationofsyntheticmarketyield.Asnotedearlier,thelackof

amarketinterestratewouldaddressonethemostsignificantissueswiththeGiovanniniandde

Melomethod,whichisthedeterminationofasuitablefreemarketrateofinterest(if)to

comparewiththefinanciallyrepressedrateofinterest(id).‘Free’currencyexchangeratedata

couldbeusedtoconstructasyntheticmarketyieldforbondsbyemployingamodifiedversion

oftheuncoveredinterestrateparityequation:

(2)(1 + 𝑖£) =7898(1 + 𝑖:)

whereFtisthecurrent‘free’exchangerate(whichsubstitutesintheclassicversionofthe

equationfortheexpectedfuturespotexchangerate,giventhatfreecurrencywasoftentrading

atadevaluedfreeratethatanticipatedfutureofficialdevaluations),Stisthecurrentfixed

officialexchangerateattimet,i£istheinterestrateinthethefreecurrencyissuingcountry,

andifisthesyntheticmarketyield.

Furtherstudyisnecessarytodeterminethefeasibilityoftheaboveapproach,but

researchsuggestsastatisticallysignificant,negativelylaggedinfluenceofcurrenciesondebt.43

Further,Flandreau&Oosterlinck(2011)imputedcurrencyvaluesfromgovernmentdebtyields,

anditcouldbeworthexploringwhethersuchatransformationcanbereversedtocalculatea

syntheticmarketyield.44

3.4TheFinancialRepressionIndex

BothGiovanninianddeMeloandReinhartandSbranciausetheresultsfromtheir

quantitativemethodstocomparethedegreeoffinancialrepressionacrossdifferentcountries.

However,withregardstotheReinhartandSbranciamethod,Taylor(2011)notesthatthe

actualreason(s)behindnegativerealyieldsongovernmentdebtarenotalwaysclear.For

example,inMay2012theGermangovernmentsuccessfullyfloatedtwo-yearbondswithazero

coupon,andin2015theSwissgovernmentissuednewdebtwithanegativenominalyield.

TheseeventsoccurredinspiteofthefactthatpositiveinflationexistedinbothGermanyand

Switzerlandatthetimeofdebtissuance,andfutureexpectationsofinflationwerealsopositive.

InvestorsappeartobepayingtheGermanandSwissgovernmentinrealandnominalterms,

respectively,fortheopportunitytolendmoneytothegovernment.IftheReinhartandSbrancia

methodwereemployedinthesecasestheresultswouldsuggestthatbothGermanyand

43(Dreher,Herz,&Karb,2006)44(Flandreau&Oosterlinck,2011)

Switzerlandwereengagedinfinancialrepression.However,thenotionthatfinancialrepression

ineithercountryisresponsiblefortheobservednegativeyieldsisdubious.Instead,aflightto

highercreditqualityinresponsetotheEuropeansovereigndebtcrisesisthelikelyexplanation

behindtheGermanandSwissrates.

Insum,‘bottom’s-up’approachestoidentifyingfinancialrepressioncanproduce

incompleteormisleadingresults.Furtherinsightscanbegainedbycomparingcountriesacross

qualitativemeasuresoffinancialrepressionsuchasacompositeindicator(compositeindex),

whichallowsforcross-countrycomparisonsoffinancialrepressionoveraseriesofstandardized

measuresanddifferenttimeperiods.Samplevariablesthatcouldbeutilizedforthe

constructionofanindextakenfromexistingdatasourcessuchastheIMF,BIS,WorldBank,and

OECDaresummarizedinAppendix1.45

45Unfortunately,forthetimeperiodunderstudyinthisthesismuchofthedatarequiredtocreateafinancialrepressioncompositeindexwaseithernevercollectedorhasnotyetbeenlocated.

4Britishfinancialrepression

Thissectionofthepaperaddressesthedisagreementintheliteratureoverwhatrole

financialrepressionmayhaveplayedinsustainingBritain’srecord-settinglevelsofpublicdebt

followingtheSecondWorldWar.Largelymissingisadetailedhistoricalaccountofthepolicies

andpracticesthatmayormaynothavefacilitatedfinancialrepressionincountriessuchas

Britain.Inotherwords,doesthehistoricalrecordsupportorcontradictReinhartandSbrancia’s

quantitativeargumentoffinancialrepression?Theshortanswertotheabovequestionisthat

yes,Britaindidinfactenactnumerouspoliciesandlegislationthatcanbecharacterizedas

financialrepression.Further,thesepoliciesplayedausefulroleinsustainingBritishsovereign

debt.However,itisfartoosimplistictorefertofinancialrepressionisasimplebinary,yesor

no,fashion.Differentdegreesandtypesoffinancialrepressionexist.

Theremainderofthispaperdescribesthenuanced,multi-facetednatureofBritish

financialrepressionbyfirstexploringtheoriginsofBritishfinancialrepression,thenexamining

thevariousaspectsofBritishfinancialrepression,andconcludeswiththeimpactfinancial

repressionhadonselectareasoftheBritisheconomy.

4.1TheoriginsofBritishfinancialrepression

ThegrowingthreatposedbyanevermoreassertiveNaziGermanyledtheBritishto

rearminthelatter-halfofthe1930s.Whilethisbroughtfullemploymentitalsotriggered

concernsoverinflationandimbalancesinBritain’snationalaccounts.46Itwasduringthistime

thatJohnMaynardKeynes’theoriesonwartimeandpost-warfinance,whichwouldprove

highlyinfluentialtoBritishfinancialrepression,tookshape.InAprilandJuly1939Keyneswrote

severalarticlesintheTimesoutliningadualpolicyoflowinterestratesandcapitalcontrols,

whichwentontobepartiallyadoptedinApril1941.47Keynesalsoadvocatedfordeferred

46(Skidelsky,2000,p.20)47Keynes’ideaswerefirstpublicizedviatwoeditorialsintheTimesonthe14thand15thNovember1939.AbookletversiontitledHowtoPayfortheWarfollowedon27Februaryin1940.However,anearlierlectureonthistopicwasgivenbyKeynesatCambridge’sMarshallSocietyon20October,1939titled‘WarPotentialandWarFinance’

deposits,whichweretobeblockedandhaveanopen-endedreleasedatetobedeterminedat

thediscretionoftheTreasury.48Originallycalled‘compulsorysavings’,theprogramwaslater

rebrandedas‘deferredpay’formarketingpurposes.49Theplancalledforthegovernmenttoset

long-terminterestratesat2.5%,whichrepresenteda17%reductionontheapproximately3%

yieldsoflonger-termBritishdebtinstrumentsatthattime.50

LordKeynesprofessedhimselftobeaproponentofinterestratecapsinhisGeneral

Theory51,andina12January,1937TimeseditorialKeynesstated“wemustavoid[dear

money]…aswewouldhell-fire”.52Thedoctrineof‘permanentlycheapmoney’wouldgoonto

reignoverBritishmonetarypolicyuntil1951.KeynesadvocatedthattheBritishChancellorof

theExchequershouldannouncethathewouldborrowatnomorethan2.5%socreditorshave

zerodoubtthatthesearethebesttermsavailableforlong-datedBritishdebt.Keyneshad‘an

appreciationthatthesocialandpoliticalclimatewouldnotpermitarepeatoftherentier-

friendlypolicyofFirstWorldWar’,althoughKeyneslaterrevisedupwardshissuggested

interestrateto3%.53TobeeffectiveKeynesfelttheChancellor’sstatementwouldneedtobe

buttressedbycontroloverdomesticcapitalissuesandanembargoonforeignlending,meaning

capitalcontrolswouldneedtobeinstituted.54Lowinterestrates,oneofthehallmarksof

financialrepression,werefacilitatedbytheBankofEngland(whereKeyneswasaCourt

member),whichkepttheshort-termTreasurybillrateat1%from1939-1945.

Itisherewiththeselate-1930sproposalsthatweseeKeyneslayingsome,butnotall,of

thetheoreticalandpolicyfoundationsforpost-warBritishfinancialrepression.However,

(Skidelsky,2000,p.43).Coincidentally,theLabourpartyalsopublishedatthistimeanidenticallytitledbookonwarfinance(Durbin,1939).ThereasonKeynes’ideasultimatelywonoutwasbecause,asSkidelskyputit,hehadthe“onlytheoryonofferwhichpromisedbothguns,butterandlowinterestrates”(Skidelsky,2000,p.20).48(Keynes,1940,p.47)49(Skidelsky,2000,p.59)50(Keynes,1940,p.44)51(Keynes,1936,p.351)52(Skidelsky,2000,p.22)53(Kynaston,1999,p.464)54(Skidelsky,2000,pp.24-25)

Keynes’crucialcontributionstoBritishfinancialrepressiongoentirelyunacknowledgedby

Keynes’biographersandothereconomichistorians.55

EvidenceofBritishfinancialrepressionpriortothe1940salsoexists.AfterBritain

abandonedthegoldstandardforasecondandfinaltimein1931,aprohibitiononloansto

overseasborrowerswasimposed.In1933thepurchaseofforeignsecuritieswasalso

prohibited,althoughdirectinvestmentsabroadweretreatedmoreleniently.56Itisunclearwhat

roleifanyKeyneshadonshapingthesepolicies.Onedifferencebetweenthisperiodandwith

thefollowingdecadeappearstobetherelianceoftheBankofEnglandandWhitehallonthe

useofmoralsuasion,asopposedtoregulationsorlaw,toexecute1930spolicychanges.This

approachmayhavealsoplayedatleastsomeroleintherelativelyspeedyreversalofsome

policies,suchastherelaxationofloanrestrictionstoCommonwealthborrowersin1933.These

examplesillustratehowfinancialrepressioncantakebothexplicitandimplicitform.

AsearlyasSeptember1941Britishofficialswerecontemplatingthepost-warfinancial

andeconomicorder.57InDecember1941,ontheothersideoftheAtlantic,TreasurySecretary

MorgenthauaskedHarryDexterWhitetobeginworkonwhatwastobecometheBretton

Woodsagreement.58ItwasduringthistimethatgroundworkwaslaidinbothBritainandthe

U.S.forthepost-warinternationalframeworkthatwouldprovesoconducivetofinancial

repression.Stringentcapitalcontrols,imposedatthebeginningoftheSecondWorldWarin

September1939,providedthenecessaryconditionforthecreationoftheSterlingArea,which

wouldplayasupportingroleinenforcinginternationalfinancialrepression.59Underthenew

rulesallpurchasesofforeignexchangerequiredpriorapprovalofBritishofficials,andcountries

thatdidnotparticipateinthewarceasedtobeapartoftheSterlingBloc(e.g.,Sweden).The

outbreakofwarledBritaintoimposeexchangecontrolonpaymentsoutsidetheSterlingBloc,

whilerelativelyfreemovementofcapital,coordinatedbytheBankofEngland,waspermitted

55(R.F.Harrod,1951;Skidelsky,2000)56(CairncrossandEichengreen,1983,p.22)57(Fforde,1992,p.36)58(Skidelsky,2000,pp.256-263)59(Capie,2010,p.146)

within.60TheregulationsandrulesgoverningtheSterlingAreawerecomplex;varyingdegrees

offreedomexistedonthetransferabilityofcurrency,dependentuponlocationandpurpose.

Importrestrictionsalsoexistedsothat“whiletheremightbefreedomtomakeapayment,

therewasnotalwaysfreedomtomakeapurchase”.61Duringthewara‘DollarPool’was

establishedamongSterlingAreacountriesthatwouldremaininplaceafterhostilitiesended.Its

purposewastoconserveU.S.dollarsamongstSterlingAreamembersbyimposinglicensing

restrictionsondollarimports,andmemberswererequiredtodepositexcessdollarsandgoldat

theBankofEngland.62

Keynes,inadditiontoprovidingtheintellectualfoundationsformuchofBritishfinancial

repression,wouldalsogoontoplayaleadingroleinimplementingfinancialrepressionpolicies

duringandafterthewarfrominsideTreasury.However,itisimportanttonotethatnotall

facetsofpost-warBritishfinancialrepressionwereprescribedbyKeynes.Further,Keyneswas

notaloneinadvocatingforBritishfinancialrepression.Forexample,theBankofEnglandwasat

leastwillingtogoalongwith,ifnotplaytheroleofaccomplice,inthemaintenanceoflow

interestrates.

WhileothereconomichistorianshaveindirectlycoveredvariousaspectsofBritish

financialrepressionwithoutlabellingitassuch,ReinhartandSbrancia(2011)arethefirstto

explicitlymakethecasethatfinancialrepressionwaspracticedinpost-SecondWorldWar

Britainandotheradvancedcountries.Oneofthefirstquestionswhichemergesafterreviewing

Reinhart’sandSbrancia’sresearchthatpromptedTaylor’scritiqueiswhatpoliciesand

outcomesshouldconstitutesufficientevidence,orproof,offinancialrepression?Inother

words,isfinancialrepressionakintotheU.S.SupremeCourt’sdefinitionofpornography,which

basicallyamountsto‘weknowitwhenweseeit’?Orcanthe‘financialrepression’labelbe

assignedinamorerigorous,systematicfashion?Debtliquidationdoesnotrequirefinancial

60(Cairncross&Eichengreen,1983,p.24).61(Capie,2010,p.146;CatherineRuthSchenk,1994)62(Cairncross&Eichengreen,1983,p.25)

repressionasitcanbeduesolelytotheeffectsofinflationinexcessofnominalinterestrates.

Inotherwords,demonstratingthatdebtliquidationoccurredinanygivenyear,oroveran

extendedperiodduetonegativerealinterestrates,isinsufficientproofoffinancial

repression.63

ReinhartandSbranciasupporttheirquantitativeevidencebyidentifyingseveral

financialrepressionmeasuresineachsamplecountry.64FortheUK,theyhighlightthefollowing

threeDomesticFinancialRegulationsmeasures:

1. TheGoldmarketclosedinearlySecondWorldWar,reopenedonlyin1954.65

2. TheBankofEnglandstoppedpublishingtheMinimumLendingRatein1981.

3. In1986,thegovernmentwithdrewitsguidanceonmortgagelending.

ThefollowingtwomeasuresarelistedforCapitalAccount-ExchangeRestrictionsintheUK:

1. AllrestrictionsonoutwardForeignDirectInvestmentabolished,andoutwardportfolio

investmentliberalized.

2. ExchangeControlActof1947suspendedinOctober1979;allremainingbarriersto

inwardandoutwardflowsofcapitalremoved.

Theabovemeasuresareperhapssomeofthemoresignificantfinancialrepression

policiesinBritainfollowingtheSecondWorldWar.However,theauthorsdonotmakeany

referencetotherelativeimportanceofthesepolices,orexplainwhythesewerehighlighted

overotherpoliciesthatcouldconstitutefinancialrepression.Further,theyoverlookanumber

ofotherBritishfinancialrepressionpolicies.Forexample,ChancellorDaltondirected

63Sbrancia(2011)developsaconceptualframeworkutilizinginflationexpectationestimatestodistinguishbetweendebtliquidationrelatedtounanticipatedinflationandfinancialrepression.64(C.M.Reinhart&Sbrancia,2011,p.17)65(BankforInternationalSettlements.,1941)

governmentdepartmentstosupportTreasurydebtauctionsbymakingpurchasesthathelped

financegovernmentdebtatlowratesofinterest.66

Britishfinancialrepressionduringthisperiod,intheformoflegislationand

directives/policies,aresummarizedinTable5andTable6,respectively.Intotal,elevenpieces

oflegislationandsixteenpolices/directivesthatsupportedBritishfinancialrepressionwere

foundeitherinarchivalevidenceortheliterature.Theselegislativeandpolicyactshighlightthe

intricateandcomprehensivenatureofBritishfinancialrepressionduringthisperiod.

66(Cairncross,1985,pp.432-433;Worswick&Ady,1952,pp.196-198).

Table5:UKFinancialRepressionLegislation,1936–1998

Legislation DateEnactedRepealed/Reduced Description

TripartiteAgreement

1936 1973 Beginningwiththe1936TripartiteagreementbetweentheU.K.,FranceandtheU.S.andsubsequentbilateralandmultilateralagreementsthoughSecondWorldWarandthe1944BrettonWoodsagreement,exchangeratesweremanagedsothatforeignexchangecouldonlybelegallyconvertedatofficialexchange

CapitalIssuesCommittee

1936

Late-1950s

Formalgovernmentapplicationprocessforcontrollingcapitalflowstoforeignanddomesticapplicants;only£31millionexportedannuallyfrom1932-3667;alsoreviewedalldomesticissuesover£50,000,andtheBankofEnglandreviewedanythingover£100,00068

DeferredPay

April1941

post-WWII

Originallycalled‘compulsorysavings’,depositsweretobeblockedandhaveanopen-endedreleasedate,tobedeterminedatthewhimoftheTreasury.Aninterestrateofonly2.5%ayear,whichwas17%cutontheroughly3%yieldedbylonger-terminstrumentsatthattime.

CapitalControls

Sept.1939

post-WWII

Permissionfromauthoritiesrequiredpriortomakinganyforexpurchases;restrictionsonforeignexchangeonpaymentsmadeoutsidetheSterlingArea.LimitsonsterlingbanknotestravellerscantakeoutoftheUKof£20and£10,respectively,and“nosterlingcanbesentoutoftheUnitedKingdomwithoutpermission”.69

TreasuryDepositReceipt(TDRs)

WWII

post-WWII

NewsecuritywhichallowedtheTreasurytobypasstheLondonmoneymarketandborrowdirectlyfrombanksthroughtheissuanceofnon-marketableTDRs

ClosureofLondonGoldMarket

WWII 1945 ClosureofLondongoldmarket,tradingandownershipofgold,andrestrictionsonimports/exportsofgold

67(Ingham,1984,pp.195-197;Wilson,1995,p.183)68(Morgan&Thomas,1962,p.210;Wilson,1995,p.189)69C261,LetterfromBankofEnglandtoManageroftheFederalReserveBankofNewYork,NewYorkFederalReserveBankArchive,17October,1946

Legislation DateEnactedRepealed/Reduced Description

BankofEnglandAct

Aug.1946

1998

BankofEnglandnationalizedbytheUKgovernment;clause4(3)gavetheBank,withTreasuryapproval,explicitpowertogoverntheproportionofcommercialbankassets

ExchangeControlAct

1947

Oct.1979

Restrictedsomeexternalloansaswellasinwardcapitalflows;repealin1979ledtotheremovalofallremainingbarriersoninwardandoutwardcapitalflows

MinimumLendingRate

post-WWII 1981 PublishedbytheBankofEngland

TaxIncreaseonDividends

post-WWII

N/A

Increaseinthedividendstaxfrom5%to12.5%madeBritain’ssovereigndebtamoreattractiveinvestmentvis-à-visequities

MortgageLendingGuidance

post-WWII

1986

GovernmentguidanceonUKmortgagelending

Table6:UKFinancialRepressionPoliciesandDirectives,1931–1973

Policy DateEnactedRepealed/Reduced Description

LowInterestRates(‘CheapMoney’)

1931 1951 Exceptforabrieffluctuationatthebeginningofthewar,BankRatewasmaintainedat2%;short-termTreasurybillrateat1%from1939-1945

Foreignloanembargo

1932 1934forSterlingbloc ThebanonforeignloanspartiallyremovedforothercountriesinFeb.1938butthenreinstatedinDec.193870

Withdrawaloflargesterlingnotes

1943 post-WWII Retirementofallnotesof£10anupto“provideanadditionalhandicapforthosewhomaycontemplatebreachesofExchangeControl”71

BankAdvancesRestrictions

1945,1947,1949

post-WWII

RestrictionsonbankadvanceswereissuedthreetimesbytheCapitalIssuesCommittee(CIC)72

IssuingHousesAssociation

1945

post-WWII

Organizationof52Britishmerchantbankswhichfacilitatedthemonitoringandcontroloflending73

BankLendingRestrictions

Mid-1950s

post-WWII

Enactmentofthefirstquantitativelimitsonloansfrombanks.74

SpecialDeposits

Mid-1950s post-WWII “a(relativelysmall)callfor‘specialdeposits’madebyCIC75

70C261,‘BritishandCanadianConversionPolicies.Appendix:BritishTreasuryControloverthePriceofGilt-EdgedSecurities,1932-39’,CorrespondencebetweenL.M.PumphreytoMr.House,NewYorkFederalReserveBankArchive,23October,194171FromC261p.1,‘WithdrawalofLargeBankNotes:TheBritishExperience’,NewYorkFederalReserveBankArchive,4December,1944:“Therealpurposesweretomakemoredifficulttheillegaloperationofnotesmugglersdesirousofevadingexchangecontrolregulations,ofblackmarketoperators,andoftaxevaders—allofwhompredominantlyuselargedenominationnotesinordertocoveruptheirtracks”.BankofEnglandnotesincirculationduringthistimeconsistedof£1,£5,£10,£20,£50,£100,£200,£500and£1000.72(Capie,Collins,&InstituteofEconomicAffairs.,1992,p.68)73(Wilson,1995,p.189)74(Capieetal.,1992,p.68)75(Capieetal.,1992,p.68)

Policy DateEnactedRepealed/Reduced Description

ExportLending 1964 post-SecondWorldWar BankofEnglandestablishedloanprioritieswhichgavepreferencetoexportsanddiscouragedspeculation76

StampDutyonTransfersofFinancialSecurities

post-WWII 1963 Cutsecuritiestransfertaxfrom2%to1%toencourageinternationalfinancialactivityintheCityofLondon77

RestrictionsonLendinginForeignCurrency

post-WWII Oct.1963 Chancellorannouncesthatforeigncurrencyloans‘allowedalmostwithoutrestriction’78

TaxesonBearerSecurities

post-WWII 1963 Reducedfrom6%ofnominalvalueto3%and2%ofthemarketvalueforresidentsandnon-residents,respectively79

RegisteredSecuritiesTax

post-WWII 1963 Ratereducedfrom2%to1%80

DollarPool

WWII

post-WWII

RequiredthatmembersdeposittheirexcessU.S.dollarsandgoldatBankofEngland

Bankadvances-to-governmentdebtratio

WWII

post-WWII

Reductioninbankadvances-to-governmentdebtratiosothatbankscouldholdmoregovernmentdebt

Restrictionsonforwardexchange(forexoptions)

WWII

post-WWII

RestrictionsonUKBanksdealinginforwardexchangeincluded:i)a“genuinecommercialcontractisinexistence”;ii)“itisnotaswap”butan“outrightpurchaseorsaleofexchange”;iii)“thematuritydatemustnotbemorethanfourmonthsahead”.SomeexceptionswereallowedbytheBankofEngland“whensuchapracticeisanormalandnecessaryfacilityofthetradeinquestion”.81

76(Capieetal.,1992,p.68)77(Quennouëlle-Corre&Cassis,2011,p.225)78(Quennouëlle-Corre&Cassis,2011,p.225)79(Quennouëlle-Corre&Cassis,2011,p.226)80(Quennouëlle-Corre&Cassis,2011,p.226)81C260.3p.1,NewYorkFederalReserveBankArchive,9October,1945

Policy DateEnactedRepealed/Reduced Description

FixedExchangeRates

1936

1973

Beginningwiththe1936TripartiteagreementbetweentheU.K.,FranceandtheU.S.andsubsequentbilateralandmultilateralagreementsthoughSecondWorldWarandthe1944BrettonWoodsagreement,exchangeratesweremanagedsothatforeignexchangecouldonlybelegallyconvertedatofficialexchange.

RegardingtheefficacyofthepolicieshighlightedbyReinhartandSbrancia,evenwith

exchangerestrictionsBritainexperiencedsignificantcapitaloutflowstotheSterlingArea,which

callsintoquestionjusthoweffectivecapitalrestrictionswereduringthistime.Dow(1964)

claimsthat20%ofcapitaloutflowswereduetotheloosenessofcontrols.82Therearealso

frequentreportsinarchivaldocumentsofgoldtradeoccurringdespiteofrestrictionsinthe

Londonmarket.Forexample,inaletterdated30January,1947fromMr.WernerKnokeatthe

NewYorkFederalReserveBank(NYFRB)tohiscounterpartandfrequentcorrespondentatthe

BankofEngland,Mr.GeorgeBolton,KnokeinquiresabouttheLondongoldtransactionsthat

are:

“carriedonaverysubstantialscalewearetold,forinstancebySamuelMontagu,whopurchasesthegoldallovertheworld,shippingitdirectlyorviaLondonforsaleinmarketslikeChina,theNearEast,etc.?”83

SamuelMontaguwastheproprietorforSamuelMontagu&Co,whichwasoneofthesix

‘AuthorisedDealers’ingoldotherthantheBankofEngland.84Inareplydated13February,

1947,BoltoninformsKnokethat“beforethewarLondonwasaninternationalcentreforgold

arbitrageandwearethereforeundergreatpressuretoallowLondonfirmstoparticipateinthe

82(Dow&NationalInstituteofEconomicandSocialResearch.,1964,p.24;CatherineR.Schenk,2010)Forfurtherdiscussionontheeffectsandeffectivenessofcapitalcontrolssee(Dulles,1929,pp.226-227;Edwards,1999;B.J.Eichengreen,1998;Montiel&Reinhart,1999)83C261,NewYorkFederalReserveBankArchive,30January,194784TheotherauthorizedLondonbullionbanksatthistimewereJohnsonMatthey&Co.Ltd,Mocatta&Goldsmid,Pixley&Abbell,N.M.Rothschild&Sons,andSharps&Wilkins.C261p.2,NewYorkFederalReserveBankArchive,10February,1947

business”.85HegoesontosaythatthereareexceptionstotheUKrulesagainstgoldownership,

including:

“anypersonnotresidentintheUnitedKingdomorthosepartsoftheSterlingAreawhichprohibittheholdingofgoldbyresidents,mayowngoldintheUnitedKingdom”andclaimthatanytradeinthevarious“freemarkets”ofgoldatpremiumtotheofficial“doesnotnecessarilydamagethemajorcurrencies”.86

WhiletheUKofficiallyposedrestrictionsontheexportofgold,importationwas

encouragedasitservedtoenhanceLondon’sstatusasafinancialcapitalandincreasedthe

likelihoodthatitmaybeofferedforsale(orotherwisemadeavailable)toagold-strappedBank

ofEngland.Boltonalsospeaksofthe“handsomeprofit”thatcanbeearnedinthegold

arbitragetrade,wheregoldispurchasedat$43perounce,claimingthat:

“noirreparableharmresultsfromthesaleoftherelativelysmallgoldproductionofLatinAmericainthevarious‘freemarkets’atasubstantialpremium.Itfeedsahoardingdemandcausesaminorwaveofdisturbanceandmanyconsequentialreactionsbut,whileitunderliestheweaknessofcertainpapercurrencies.”87

However,thistrademayhavealsoincreasedtheopportunityforspeculationandprofiteering

atblackmarketrates.Inamemodated2July,1947,theNYFRBconfrontedtheBankofEngland

abouthow“FranckofSamuelMontaguandGoldsmidofMocatta&Goldsmidseemedthemost

activefactorsinthepremiumgoldmarket”.Bolton,inhisreplytoKnoke,saidhe“wouldtryto

keeptheminline”.88

ThisaboveexchangebetweenBoltonandKnokeonthesubjectoffreemarketgold

tradeisoneofseveralfoundinboththeNYFRBandBankofEnglandarchivalrecordsonthis

subject.Whilethecorrespondencegenerallyimpliesacloserelationshipbetweenofficials,

85C261p.2,NewYorkFederalReserveBankArchive,10February,194786C261p.1,NewYorkFederalReserveBankArchive,10February,194787C261p.2,NewYorkFederalReserveBankArchive,10February,194788C261p.2,PeterLangrecordoftelephoneconversationwithMr.Bolton,BankofEngland,NewYorkFederalReserveBankArchive,2July,1947

differencesofbothopinionandfactsfrequentlyemerge.Forexample,Knoketakesissuewith

Bolton’sclaimthatgoldissellinginNewYorkat$43anounce,stating“wehavenotsunksolow

astohave(black)marketatthiscountryat$43!!!”89PeraNYFRBmemo,aclaimmadebyLord

CattooftheBankofEnglandthatBritain“disapprovesofthesalesofgoldontheblackmarkets

inGreece”isdoubtedinsidetheFederalReserve.NYFRBheadSproulconveystoKnokethat“it

hasalwaysbeenmyunderstandingthatinGreecetheBritishhadbeentheonesanxiousto

makesovereignsavailableforsalethere”.90

Atothertimes,typicallyontheeveofacrisis,apalpabletensionemergesbetweenthe

BankofEnglandandNYFRB.Forexample,on17June,1947,shortlybeforethesterling

convertibilitycrisis,Knokespokewithan“audiblydisturbed”Boltonwhocomplainedthatthe

NYFRBwasbeing“unnecessarilylegalistic”ona“questionconcerningthewholeconstitutional

positionbetweentheBritishTreasuryandBankofEngland”withregardtoarequestbythe

BankofEnglandforanuncollateralizedloan.ThepriorcustomattheNYFRBhadbeentosecure

loanswithgoldonhandinthebasementsafe,andtheBritishgovernmenthadpreviously

informedtheNYFRBthatallgoldonhandwasthepropertyofthegovernment,nottheBankof

England.91

Knokealsoemphasizesthe“seriousmonetaryconsequencesifdealingsingoldat

unofficialandvaryingpricesshouldbecomewidespread”.92Freemarketsingoldandcurrencies

wereaseriousconcernonbothsidesoftheNorthAtlantic,andthereappearstobeaquidpro

quo,whereMr.BoltonoftheBankofEnglandwould“appreciatekeepinghiminformedofany

unusualdevelopmentsinthesterlingmarkethere(NewYork)”,andviceversaontheFederal

Reserve’sinterestinLondonfreegoldactivity.Overall,amplearchivalevidenceindicatesthat

significantgoldtradewasoccurringinLondon,andthatthistradewouldhaveundercutthe

impactofBritishfinancialrepression.Londonplayedacriticalroleinmanagingtheglobalgold

89C261p.2,NewYorkFederalReserveBankArchive,18February,194790C261p.1,LetterfromSproultoKnoke,NewYorkFederalReserveBankArchive,6March,194791C261p.1,NewYorkFederalReserveBankArchive,17June,194792C261p.2,NewYorkFederalReserveBankArchive,18February,1947

market,throughlocally-headquarteredSouthAfricanmininginterests,aswellthroughthe

relationshipwiththeSouthAfricangovernmentthatpurchasedalllocallyminedgoldatparity.93

However,incontrasttoBritain’sfocusonfreesterlingtradeinNewYork,theAmericanswere

theoneswhowereprimarilyconcernedaboutfreetradeingold.TheNYFRBwantedBritain’s

helpto“smashthepremiumbetweenfreemarkettransactionsbetweengoldandthedollar”,

buttheFedalsorecognizedthat“itmightbemuchmoredifficulttosmashthepremiumin

transactionsbetweengoldandthepoundsterling”.94PertheBrettonWoodsagreements,the

U.S.dollarwastheonecurrencytiedatafixedratetothevalueofgold.BoltonandtheBankof

England’spartialassurancesnotwithstanding,anytradeingoldatapremiumover$35per

ounceofficialparitywasclearlyofsignificantconcerntotheU.S.governmentasitsuggested

thattheU.S.dollarwasovervalued,fanningunwantedspeculationofofficialdevaluation.

AsnotedbyCairncross(1985),capitalexportstotheSterlingAreawerenotfullyblocked

until1972.95AsCairncross’analysishighlights,evenwiththeintroductionofthe1947Exchange

ControlActtherewerecapitaloutflowsof£643million,orastaggering8%ofGDP.96Reinhart

andSbranciaaresilentontheactualeffectofsuchcontrols.

Financialrepressioniscomprisedofmanyinterrelatedcomponentsandcannotbefully

appreciatedorunderstoodthroughjustthemeasurementofdebtliquidationandthelistingof

ahandfulofpoliciesofuncertaineffect.Insum,whileReinhartandSbranciaaretheonly

authorstodatetoattempttoquantifytheeffectsondebtofBritishfinancialrepressioninthe

post-SecondWorldWarperiod,theirargumentthatBritainengagedinfinancialrepressionis

nosufficientlysupported.Questionsremainoverwhetherfinancialrepressionwasaconscious

policychoice,andwhatifanyalternativestofinancialrepressiondidcountriessuchasBritain

possess.AndwithrespecttotheroleofBritishbanks,wasmoralsuasionsufficienttoenlist

firmsintoaidinggovernment?Orwiththechangingpoliticalclimateandthedepartureafter

93C261p.4,NewYorkFederalReserveBankArchive,10February,194794C261p.2,LetterfromJ.BurkKnappoftheFedBoardofGovernorstoWernerKnoke,NewYorkFederalReserveBankArchive,4March,194795(Cairncross,1985,p.119)96(Cairncross,1985,pp.153-154)

twenty-fouryearsofthepowerfulcentralbankpersonalityofMontaguNorman,didcorralling

theCitynowrequiretheimpositionofnewformalizededicts?

Theremainderofthepaperisstructuredaroundseveralofthecoreareasofthe

economywhichplayaroleindebtsustainabilityandfinancialrepression,includinginterest

rates,capitalcontrols,andinstitutionssuchastheBankofEnglandandtheBritishbanking

system.

4.2Interestrates

Lownominalandnegativerealinterestratesaregenerallyconsideredtobeahallmark

offinancialrepression.However,thequestionofwhatpreciselyconstitutea‘low’interestrate

isunclear.97Whilethereisconsiderableroomforargumentoverwhatisandisnotanartificially

lowinterestratethereislessdebateonthepoliciesandforcesthatmightcontributetolow

ratesofinterestpaidbygovernmentsonpublicdebt.

Inthe1940stheUKgovernmentsoughtandsecuredwhatitatleastconsideredtobe

lowratesofinterestonpublicdebt.Knownas‘cheapmoney’,lowinterestrateshadbeen

advocatedbyKeynesasearlyas1937andwasadoptedasacornerstoneofwartimecredit

policy.98Britain’sfundingstrategyduringandafterthewarhasbeencharacterizedas‘heavy

governmentborrowingatafixedrateofinterest’.99Exceptforabrieffluctuationatthe

beginningofthewar,theBankofEngland’sBankRatewasmaintainedat2%through1951.100

Thelongendoftheyieldcurvewasmanagedtowardsthegoalofrunning‘a3percentwar’.101

97Foradiscussionofthe‘worldinterestrate’conceptsee(Barro&Salaimartin,1990;Blanchard&Summers,1984;Chinn&Frankel,2005;Koedijketal.,1994;Lucas,1990;Yietal.,2001)98(Skidelsky,2000,pp.22,88)Keynespushedfor“permanentlycheapmoney”,saying“wemustavoid(dearmoney)…aswewouldhell-fire”TheTimes,12January,193799(Cairncross,1985)100(Fforde,1992,p.92;R.S.Sayers,1981)BankRatehadbeenloweredtothe2%levelin1931.101(R.S.Sayers,1956)

TheFirstandSecondWorldWarswerefinancedatfiveandthreepercentratesof

interest,respectively,andtheSecondWorldWar’slowerrate“preventedathreefoldincrease

intheinternalNationalDebt”fromFirstWorldWarlevelswhileleavingtheinterestburdenin

1945comparabletowhatitwasin1919.102WorswickandAdy(1952)explainthislowrateof

interestinfinancialrepressiontermsbystating“solongastheexpenditureoftheprivatesector

waslimitedbyrationingandothercontrols,incomerecipientswouldhavelittleelsetodowith

alargepartoftheirearningsbuttolendittotheGovernment”.103Debtserviceexpense-to-GDP

wasroughly8%and6%followingFirstandSecondWorldWars,respectively.104

Forcesthatcaused“the‘natural’rateofinteresttoberelativelyhigh”inBritainincluded

inflationarypressures,alownaturalsavingsrate,andtheneedforcapitalexpenditures.105

InternaldocumentsfromtheBankofEnglandsupporttheviewofscholarsonthegoaloflow

interestrates.Forexample,aBankofEnglandsurveymarkedconfidentialandtitled

‘DevelopmentsintheControlofCreditintheUnitedKingdom’sharedwiththeNYFRBon25

September,1952describeshow:

“lowandstablelevelsofshort-terminterestrates,withconsequentlyeasycreditconditions,haditsoriginintheneedsofwarfinanceandwascontinued,andevenincreased,inthepost-warperiodwiththedualobjectofkeepingdownthecostofthatnationaldebtandofmaintainingfullemploymentbyfacilitatingborrowingbyindustryandpublicbodiesalike.”(italicsdenoteemphasisadded)106

Post-warChancelloroftheExchequerHughDalton,whohasbeencharacterized

simultaneouslyastheenemyofrentierandthefriendofthespeculator,wasnotcontentwith

thealreadyhistoricallylowratesofinterest.107Daltonsoughtapolicyofevencheapermoney

fromlate-1945through1947,openlystatinghisobjectiveto“bringdownthelong-termrateof

102(Worswick&Ady,1952,pp.191-192)103(Worswick&Ady,1952,pp.191-192)104(Buiter1985,p.17Figure2)105CV61p.2,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948106C261Ap.1,NewYorkFederalReserveBankArchive,25September,1952107(Paish,1947,1950)

interest”.108InJuly1947DaltontoldtheHouseofCommonsthat“cheapmoneyisto

continue”.109OnefinancialinstrumentthatplayedakeyroleinDalton’sefforttodeliverlower

interestrateswastheTreasuryDepositReceipt(TDRs),anewwartimeinventionthatallowed

theTreasurytobypasstheLondonmoneymarketandborrowdirectlyfrombanks.110TDRswere

veryunpopularwithbankersastheywerenon-marketableinstruments,meaningtheycould

notbesoldontheopenmarketbutinsteadonlyexchangedforalosswiththeBankof

England’sdiscountwindow.AsnotedbyWorswickandAdy,"bankerswouldhavewelcomeda

reductioninthevolumeofgovernmentindebtedness,especiallyofTDRs."111

RatesonTDRswereoriginally1-1/8percent,aratethatDaltoninSeptember1945

slasheddownbynearlyinhalftojust5/8ofapercent.112AtthesametimeDaltonalsocutthe

rateonT-Billsbyasimilaramountto1/2apercent.Thesetwochangesreducedthenominal

interestburdenonfloatingdebtbyapproximatelyhalf.Daltonthenmovedtocutlonger-term

ratesthroughanumberofconversionsandthefloatationofseveralissuesatarateof2.5%,

includingtheTreasuryStock1975securities,whichthereaftercametobenon-affectionately

referredtoinbankingcirclesas‘Daltons’.113

TheintellectualinspirationbehindtheDaltons,includingtheoriginalsuggestionofthe

2.5%rate,appearstobeKeynes.InhisGeneralTheoryKeynesstatedthatthatagovernment

couldachieveitsinterestratetargetsifitletthemarketdeterminethetermstructure.114

KeynesoriginallyadvocatedthattheChancellorshouldannouncethatinnocircumstancewill

108C261Dp.2,NYFRBResearchMemorandumtitled‘NotesontheNationalizationoftheBankofEngland’,NewYorkFederalReserveBankArchive,19October,1952109CV61p.6,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948110(Howson,1988;Worswick&Ady,1952,pp.212-213)111WorswickandAdy(1952,p.198,214)112(Worswick&Ady,1952)TheauthorsprovidetwodifferentratesforTDRsonpp.198and214of5/8and7/8,respectively113(Worswick&Ady,1952,p.199)114(Booth,1989,p.157)InTheGeneralTheoryKeynesalsostates“Theremedyfortheboomisnotahigherrateofinterestbutalowerrateofinterest!Forthatmayenabletheso-calledboomtolast.Therightremedyfortheso-calledtradecycleisnottobefoundinabolishingboomsandthuskeepinguspermanentlyinasemi-slump;butinabolishingslumpsandthuskeepingusinapermanentboom.”(Keynes,1936,p.322)

heborrowatmorethan2.5%solendershavezerodoubtsthatthesearethebestterms

availableforlong-datedbonds.SkidelskysummarizesKeynes’positiononhowtoachievethis

interestrateasfollows:

“Inordertoenforcethisratethemarketshouldbegiven‘anincreasedamountofliquidity’topreventthe‘congestionofcredit’,whichKeyneshadwarnedin1938.Tobeeffectivethesetechniqueswouldneedtobebuttressedbythefollowingthreeelements:1)Controlofdomesticcapitalissues,2)Prioritizingtheuseofphysicalresources(rationing),and3)anembargoonforeignlending(capitalcontrols).”115

Keynes,however,laterexpressedthat3%wastheappropriaterateatwhichthegovernment

shouldborrowtoensuredemandandhepersonallyopposedtheissuanceofDaltons.116Asthe

Daltonswerefloatedonthemarketthevalueoflonger-datedgiltissuesbegantosoften.Bythe

timeCrippsreplacedDaltoninNovember1947yieldsonConsolshadclimbedbackupto3%,

andwouldclimbfurtherto3.5%during1949.117Archivaldocumentsstatethatthisclimbin

yieldswas“permitted”bytheUKTreasury,whichhad“rigged”theTreasurybondmarket

throughtheuseofpublicdepartmentstopurchaseUKpublicdebt.118

Theuseofinterestratepolicy,throughchangesintheBankofEngland’sBankRate,was

almostnon-existentduringthetwentyyearsprecedingtheToriesreturntopowerin1951.

Previously,BankRatehadbeenraisedattimeswhenBritain’sreservesweredeclining.Upon

thementioningofthisideaasapossiblemeansofaddressingthe1949devaluationcrisis,

Daltonstated“IsayMontaguNormanwalksagain.Ithoughtwehadburiedallthisstuffabout

BankRate”.119KeynesagreedwithDalton,addingthatthe“socialandpoliticalclimatewould

notpermitarepeatoftherentier-friendlypolicyoftheFirstWorldWar”.120Skidelskydescribes

115(Skidelsky,2000,pp.24-25)116(Booth,1989,p.157)117(Worswick&Ady,1952,p.202)Anincreaseinbondyieldsreflectsadeclinethemarketvalueofthebonds.118CV61p.1,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948119(Cairncross,1985,p.176)DouglasJay,EconomicSecretarytotheTreasury,isalsoquotedtothesameeffect.Daltoncouldn’tseethepointofhigherinterestratesbecausecapitalexpenses“isnotnowdeterminedbywhatpeoplewantbutbywhatthegovernmentpermits”.120(Skidelsky,2000,p.69)

Keynes’“hatredoftherentier”,which“wasproofagainsteconomicarguments,becauseat

bottomitwastheological,notscientific.Thebondholderishismindwasnothingbutthe

medievalusurer,orShylock,someonewhosoughttomakeaprofitoutoflendingmoney.”121

November1951sawthefirstsustainedincreaseintheBankRate,whichwasincreased

from2%to2-1/2%.WhatfollowedwasafairlydramaticincreaseinyieldsacrossUK

governmentdebt,particularlyshort-datedissues,aswellasprivatesectorsecurities(Table7).

TheeffectsoftheincreaseonBankRatewereseenmostdramaticallyontheshort-endofthe

governmentyieldcurve,withyieldsonUKshort-dateddebtmorethandoublingfrom1.70%to

3.48%fromOctober1951toJuly1952.Yieldsonmedium-termandthelonger-termwarloan

didnotseenearlyaslargeajump,increasingby21%and18%,respectively,whichwas

approximatelyin-linewiththeriseseeninprivatesectorsecurities.

121(Skidelsky,2000,p.69)

Table7:AverageYieldofUKSecurities,1950-52

GovernmentDebtSecurities IndustrialSecurities

Shortdated

Mediumdated

3-1/2%WarLoan

Debentures

OrdinaryShares

1950Avg. 2.03% 2.99% 3.77% 4.07% 5.48%1951YTDAvg. 1.84 3.59 3.98 4.28 5.35Oct.1951 1.70 3.66 4.06 4.33 5.26Nov. 1.97 3.78 4.18 4.50 5.76Dec. 2.29 4.08 4.35 4.70 5.90Jan.1952 2.36 4.14 4.37 4.71 6.35Feb. 2.41 4.17 4.42 4.77 6.43Mar. 2.92 4.31 4.54 4.92 6.64April 3.15 4.24 4.50 4.84 6.37May 3.26 4.27 4.56 4.85 6.95June 3.51 4.45 4.75 4.94 7.28July 3.48 4.42 4.78 4.96 6.781952YTDAvg.

3.01% 4.29% 4.56% 4.86% 6.69%

%ΔOct1951toJuly1952

105% 21% 18% 15% 29%

Source:CV261Ap.4,NewYorkFederalReserveBankArchive,25September1952

The‘Daltons’episodeandotherevidenceappearstohavedemonstrated,toatleast

somedegree,theexistenceofa‘marketfloor’.Inotherwords,iftheBritishgovernment

offereddebtatanominalinterestratedeemedtoolowbymarketparticipants,thenthe

marketwasfreetosell-offBritishdebtinsufficientquantitiestocompelauthoritiestooffera

higheryieldonnewbondissues.Forexample,thearchivalrecordsgoontostatethat:

“Soonafterthedeclineofgilt-edgedpricesearlyin1947,themarketbecamethin,nervous,andanemic.Anylargeofferingthatinpreviousyearscouldhavebeeneasilyabsorbedcauseddigestivetroublesandjumpyreactions”.122

122CV61p.4,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948

InOctober1947Daltonremarkedthat“theestablishmentofaneffective3percentgilt-edge

yieldisnomorethanatemporarylapsefromthe2½percentobjective”.However,Dalton

wouldbeprovenwrong.123

Theeffectsofmarketforcesonpublicdebtmarketsalsoexistedinthe1960s.ANYFRB

studyhighlightshow“themarginbetween(UK)TreasuryBillratesandothershort-termratesis

greaterherethanintheUnitedStates”(Table8).Thisfactsuggeststhatiffinancialrepression

wasimpactinginterestratesinbothcountriestheimpactwaslessdramaticintheUKbythe

early1960s.124

Table8:ComparisonofUKandU.S.InterestRates,September1964

Instrument UnitedKingdom UnitedStatesTreasuryBills 5.50% 4.00%LocalAuthorityDeposits(UK)/FinancePaper(U.S.) 6.50% 4.25%FinanceHouseDeposits(UK)/CDs(U.S.) 7.00% 4.38%

Source:CV61Ap.8,NewYorkFederalReserveBankArchive,18October1965

TheNYFRBstudygoesontocommentthatintheUKthe“marketinlocalauthoritytemporary

moneyhasprovidedforeigners,aswellasdomesticholders,withanattractivealternativeto

theTreasurybill”,andthat“thelocalauthoritiesarecompetingforinstitutionalandprivate

fundsnotonlyagainsttheGovernment(withitshighercreditrating),butalsoagainstthe

financehousesandeachother”.125ThoselookingtoputcashtoworkearninginterestinLondon

had“manymoreattractiveoutlets”thanintheU.S.126Bythelate-1950stheLondonEurodollar

marketgenerallyofferedbankstheabilitytoearninterestat4%.127ThefactthatratesintheUK

privatesectorremainedcompetitiveandabovepublicsectorratesofinterestonoffer,andthe

123CV61p.6,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948124CV61Ap.8,NewYorkFederalReserveBankArchive,18October1965125CV61App.11,8.NewYorkFederalReserveBankArchive,18October1965126CV61Ap.16,NewYorkFederalReserveBankArchive,18October1965127CV61Ap.17,NewYorkFederalReserveBankArchive,18October1965

lackofcompressionbetweenthedifferentUKinstrumentscomparedtotheU.S.marketplace,

underminesclaimsthattheUKinterestratesoperatedunderaregimeofstrictfinancial

repression.

Insum,thesefindingsaresomewhatatoddswiththeportrayalofpost-warBritish

financialrepressionasaregimewithabsolutecontroloverinterestrates,oranerawhere

investorshadfewinvestmentoptions.Indeed,therewasasignificantspreadinyieldsacrossa

varietyofdifferentdebtsecuritiesavailableforinvestmentpurposes.Thisevidencehighlights

theimportanceofdistinguishingbetweendifferenttypesanddegreesoffinancialrepression.In

otherwords,whilemoralsuasionandqualitativetechniquesmayhaveencouragedbanksto

holdlonger-termBritishdebt,othereconomicactorsintheUKhadavarietyofinvestment

optionsoutsidelow-yieldinggovernmentsecurities.

4.3Capitalandexchangecontrols

Alongsidelowinterestrates,capitalcontrolsaretypicallyconsideredacornerstoneof

financialrepression.128AsnotedbyinternalarchivaldiscussionsbetweentheBankofEngland

andFederalReserve,“thewarhasdiminishedconfidenceinpapercurrencies”andcontrols

wereseenasonemeansto“avoidtherealdangerofabreakdownorcollapseofsocial

institutionsandpoliticalstructure”.129Thestringentcontrolsimposedatthebeginningof

SecondWorldWarlaidthegroundworkfortheSterlingArea.130

Anexampleofonepolicydesignedtocontrolthemovementofcapitalwasthe

requirementthatpermissionfromauthoritiesbeobtainedpriortomakinganyforex

128See(Aizenman,Gavin,&Hausmann;Alesina,Grilli,&Milesi-Ferrett,1993;Alexander,Enoch,Baliño,&InternationalMonetaryFund.,1995;Wyplosz,1986,2001)Inrecenttimesithasbeensuggestedthatlowinterestratesaretheonlyrequirementoffinancialrepressionasothermechanisms,suchasquantitativeeasing,havereplacedtheneedforstringentcapitalcontrols.129C261p.1,LetterfromSproultoKnoke,NewYorkFederalReserveBankArchive,6March,1947130(Capie,2010,p.146;DeVegh&ScudderStevens&Clark.,1939)ForafurtherdescriptionoftheSterlingAreasee(R.Harrod&PrincetonUniversity.DepartmentofEconomicsandSociology.InternationalFinanceSection.,1952)

purchases.131Keynesarguedagainstclosingdownthestockexchangestatingthat,withforeign

exchangecontrolsandaprohibitiononnewsecuritiesissuance,allsavingswouldbeaccessible

bytheTreasury,thereby“makingcheapborrowingeasy”forthegovernment.132Indeed,in

1913domesticindustryonlycomprised8%ofissuesquotedontheLondonStockExchange.

However,thefigurewouldrisetoandremainover90%fromthelate1940sonwardascapital

exports“remain(ed)inthedoldrums”.133AnotherelementofBritishcapitalcontrolswerethe

restrictionsonforeignexchangeonpaymentsmadeoutsidetheSterlingArea,whichwere

imposedattheoutbreakofwarandmaintainedwellintopeacetime.

FollowingtheconclusionofthewarKeynesfeltthat“nothingismorecertainthanthat

themovementofcapitalfundsmustberegulated”.134TheBankofEnglandinitiallysoughtto

tracehowsomuchsterlinghadwoundupinforeignmarketssuchasNewYork,andcomplex

ruleswereestablishedonhowandbywhomsterlingcouldbeexchangedfordollars.135The

ExchangeControlActwaspassedin1947,whichhadtheeffectofrestrictingsomeexternal

loansaswellasinwardcapitalflows.136ThisactwasnotrepealeduntilOctober1979.137

However,persistentcapitalleakageswereanongoingconcernforpolicymakersinspiteof

controls.ByApril1940Keynesestimatedleakagesof£100Msincethestartofthewar.U.S.

dollars,whichtheTreasurywasseekingtoraise,wereleakingthroughLondon’sallowancefor

non-residentstosellBritishsecuritiesfordollars.ThiscausedKeynesto‘goonthewarpath’to

enforcecapitalcontrols;othersintheTreasurywerenotinfavourofactionduetoconcern

aboutthelossesofforeignbalancesheldinLondon.138

131(Cairncross&Eichengreen,1983,p.24)132(Skidelsky,2000,p.79)133(Wilson,1995,p.188)134(Skidelsky,2000,p.205)TheBankofEnglandalsofavouredcapitalcontrols(p.210)135C261p.1,BankofEnglandlettertoNYFRB’sMr.Knoke,NewYorkFederalReserveBankArchive,7December,1945136(Cairncross&Eichengreen,1983,p.22)137(C.M.Reinhart&Sbrancia,2011,p.17)138(Skidelsky,2000,pp.75-76)

Asnotedearlierinthepaperduringthediscussionofthefreegoldmarket,thereis

somequestionastotheoveralleffectivenessofcapitalcontrols.Further,incertainareasthe

exportofcapitalwasnotprohibitedatall.Forexample,Sophisticatedmarketsfor‘free’sterling

blossomedinNewYorkandSwitzerland.Inaddition,capitalexportswereallowedwithinthe

SterlingAreaupuntil1972atwhichpointexchangecontrolwasapplied.139Dow(1964)

estimatesthat20%ofcapitaloutflowswereduetothe‘looseness’ofcontrols(leakages).140The

regulationsandrulesgoverningtheSterlingAreaandthemovementofcapitalwere,put

simply,complex.Varyingdegreesoftransferabilityofcurrencyanddifferentformsofsterling,

manyofwhichhaduniqueexchangeratesandseparaterulesabouthowthecurrencycouldbe

used,madeforaconfusingregulatoryenvironment.141AsnotedbytheFederalReserveBoard

ofGovernors,sterling’sstatusvariedfromplacetoplace,serving“asahardcurrencyforthe

BelgiansbutasoftcurrencyfortheIndians”.142

TheBritishgoldmarketwasclosedintheearlystagesofSecondWorldWaranddidnot

officiallyreopenuntil1954.143Regulationgovernedtheexportofgold,andBritishcitizens

residingpermanentlyinBritainwereprohibitedfromowninggoldnotmadeintojewellery.

However,Britishcitizensresidingpermanentlyinacountrywhichdoespermitpersonalgold

ownership(e.g.,France)couldowngold.DuringthisperiodseveralLondongolddealers

establishedsubsidiariesinCanada,Beirut,HongKongandSouthAfricawhiletheLondon

marketwasclosed.144Whatisnotentirelyclearfromareviewoftheliteratureandarchival

materialsiswhateffectinpracticetheclosureoftheLondongoldmarketactuallyhadonflows.

Inotherwords,iftheBritishbullionbanks–Rothschild,MocattaandGoldsmid,etal–werestill

largelyabletooperate,astheNYFRBclaimed,didtheclosureoftheLondongoldmarkethelp

139(Cairncross,1985,p.119)140(Dow&NationalInstituteofEconomicandSocialResearch.,1964,p.24)141(Pick,1953)Someofthemanynamesgiventothedifferentversionsofsterlinginclude:cheap,free,overseas,external,blackmarket,Handpayments,etc.142C261p.2,LetterfromJ.BurkKnappoftheFedBoardofGovernorstoWernerKnoke,NewYorkFederalReserveBankArchive,4March,1947143(C.M.Reinhart&Sbrancia,2011)144(Green,1968,p.115)Seealso(Green,1973,1981)

achievetheBritishobjectiveofminimizingthedrainofgoldreserves?Theseandrelated

questionsmaywarrantfurtherresearch.145

Britainwasnotaloneinestablishinggreatercontrolovercapitalandforeignexchange.

FollowingtheSecondWorldWaranelaboratesetoffinancialrestrictions,interestratecaps,

andcapitalcontrolsremainedineffectinadvancedeconomiesuntilthe1970s-1980s,atwhich

pointwidespreadfinancialliberalizationwaspursuedacrossmuchofthenon-communist

world.TheUKhadahigherdegreeofcontrolsinplaceonitscurrentaccountfrom1950-1980

(Figure1).Britain’sdegreeofcapitalaccountopennessfluctuatedbothaboveandbelowthe

sampleaverageduringthistime(Figure2).146

145Unfortunately,awarehousefiredestroyedmuchofthearchivalmaterialthatwasheldbyRothschildabouttheLondongoldmarketduringthisperiod,soitisnotclearwhatarchivalmaterialsmayexist.146(Obstfeld&Taylor,2004,pp.160-171;D.Quinn,1997;D.P.Quinn&Toyoda,2008)

Figure1:Current-accountopenness,1950-2004

(100=moreopen)

Figure2:Capital-accountopenness,1950-2004

(100=moreopen)

Note:samplecountriesincludes:Australia,Austria,Belgium,Denmark,Ireland,Italy,Finland,Germany,Greece,France,Japan,NewZealand,Netherlands,Portugal,Spain,Sweden,andSwitzerland.Sources:Quinn(1997),QuinnandToyoda(2008)

0

20

40

60

80

100

120

Sample UK

0

20

40

60

80

100

120

Sample UK

4.4Bankingsystem

“Thecommercialbankingsystemistobefitted,asanintegralpart,intowhatpromisestobeagreaterdegreeofcentralorganizationoftheBritisheconomythanhaseverexistedinthepast”.

-Anonymous,NewYorkFederalReserveBankArchive147

BeforeexploringtheparticularsoftheroleplayedbyBritishbankinginpost-Second

WorldWarfinancialrepressionitusefultodiscussthehistoryandstructureoftheBritish

financialsystem.Onthewhole,theBritishbankingandfinancialsystemhasproven

comparativelystable.148Whilenotimmunefromproblems(e.g.,the1890Baring’scrisis)the

buoyancyofBritishbankscomparesfavourablywithothercountriesduringperiodsof

economicdistress.Forexamples,inthe1930sU.S.banksfailedenmasse(thousands)whilefar

fewerBritishbanksfailed(bothinabsolutetotalnumberandasapercentageofthenumberof

banksinexistenceatthetime).149

SincetheBaringscrisis,theBankofEnglandhadacceptedfinancialresponsibilityforthe

principalmerchantbanks.TheBankwaswillingtobuymerchantbankacceptancesinthe

marketwithoutformallimit.PrincipalmerchantbanksheldaccountsattheBankandwere

membersoftheAcceptingHousesCommittee(AHC),formedin1914.AllAHCmemberswerea

liabilityoftheBankofEngland,whichassistedmerchantbanksin1939(asin1931and1914)

whenstandstillsoccurred.OnefurtherreasonfortherelativestabilityofBritishbanksduring

thisperiodwasduetothestructureoftheBritishfinancialsystem,particularlytheclearlinesof

demarcationbetweeninstitutionsthatcouldengageindifferentfinancialfunctions.

Restrictionskeptdiscount,merchantandclearingbanksoutofeachother’slinesofbusiness.150

Ittookthe1933U.S.Glass-SteagallAct,whichrequiredthatseparatecompaniesperformthe

147CV61Ap.3,NewYorkFederalReserveBankArchive,1946148(Fforde,1992,p.749)149(Bemanke&James,1991,pp.51-55;Grossman,1994;Wicker,2001)150(Capie&CityUniversity.CentreforBankingandInternationalFinance.CentrefortheStudyofMonetaryHistory.,1987;D.T.Llewellyn,1985;DavidT.Llewellyn,1985,p.10)Seealso(Fforde1992,p.758)

functionofmanagingdeposits,investmentbanking,andinsurance,tocreatewhatalready

informallyexistedinBritain.

DidthegreaterrelativefinancialstabilityenjoyedbytheBritishbankingsystemgohand-

in-handwithhavinganoligopolisticbankingindustry?TheBritishbanking‘cartel’,asithasbeen

sometimesreferred,formedinthelate19thcenturyandhasfurtherconsolidatedthroughthe

presentday.151WhiletheBankofEnglandsteppedintoarrangemergers(e.g.,Governor

Norman’scoordinationofthemergerbetweentheRoyalBankofScotlandandWilliams

DeaconsBank),mergersandfurtherindustryconsolidationbyLondon’sBigFivecleaningbanks

waseschewedbytheBankofEnglandgiventheoligopolisticnatureofBritishbanking.152The

BankofEnglandcertainlytooktheviewthatlowcompetition,whilereducingefficiency,ledto

higherstability.

TheBankofEnglandalsofounditeasiertodealwitharelativelysmallnumberofbanks,

whichmayhaveplayedanimportantroleinthestate’sabilitytoinfluencethecompositionof

bankbalancesheets.Indeed,anarchivaldocumentfromanNYFRBstudyshowshowamuch

greatershareofUKTreasuryBillsareheldbytheUKbankingsystemascomparedtotheUnited

Statesbankingsystem.153ThestudygoesontodiscusshowbythistimeUKTreasurybills“now

fulfilthefunctiononceperformedbycommercialbills”asameansforBritishbankstoconvert

liquidassetsintocash,underscoringtheimportanceintheshiftfromprivateinstrumentsof

credittopubliccreditinbankoperationsandtheLondonbillmarket.However,therewas

arguablyatrade-offbetweenstabilityandlowerefficiency,whichcanbeseenintherelatively

highcash/depositandliquidityratiosof8%and28-30%,respectively.154

151(Strange&RoyalInstituteofInternationalAffairs.,1971,p.162)152(Capie,2010,p.327)TheBigFiveLondonClearingbanksduringthistimewere:Midlands,Barclays,Lloyds,NationalProvincialandWestminster.153ThiswastrueinspiteofthefactthattheUKandU.S.Treasurybills“fundamentallyalike”instructureCV61Ap.1,18October1965,NewYorkFederalReserveBankArchive154(Capieetal.,1992,p.69)

The‘specialrelationship’betweentheBankofEnglandandLondon’sclearingbanks

allowedtheirprofitsandlossestobekeptfromthepublic(aswellastheBankofEngland).155As

notedbyFforde(1992):

“Thespecialrelationshipwiththebankwasfarmorethanthatofsupervisorandsupervised.Itisunlikelythatthosewordswereeverused.Itwasmorelikearelationshipbetweenpartners,eachpossessingsomedegreeofcontrolovertheother.Itwasallveryinformal.”156

Britishbanksweregivenaspecialdegreeoflatitudebytheirregulator,theBankofEngland,in

theformofpracticessuchasthemaintenanceofhiddenreserves.157Thehiddenreservesof

Britishbankscloudthequestionofwhatpreciselywerebankprofitsduringthisperiod,and

somequestionableclaimsarefoundintheliteratureregardingBritishbankprofitability.For

example,WorswickandAdy(1952)describebonddealingsforbanksas“highlyprofitable”.158

However,theydonotprovidesufficientdetailsonhowtheeffectsofinflationmayhaveeroded

therealvaluethebondsheldbyBritishbanks.

Flexiblearrangementsondisclosureandliquidity,alongwithrestrictionsoncompetition

andsomewhatguaranteedmarketshare,couldhelpexplainwhybanksacquiescedtothe

substantialreductionseeninthevalueoftheirpublicdebtholdings.Forexample,inthepost-

warperiodthedepositreserveratioforUKbankswasrelaxedfrom10%ofdepositsrequiredto

bekeptinnotesandcoininreservetojust8%.159Britishbanksdidnotcloselyadheretothe

definedminimumrequirementthat30%ofBritishbankliabilitiesbeheldin‘liquid’assetssuch

asTreasurybills,commercialbills,andTreasurydepositreceipts.160Furtherexaminationofrates

ondepositsatBritishbankscouldbeuseful.AsnotedbyReinhartandReinhart(1999),“banks

passthereserverequirementscomponentofthefinancialrepressiontaxontodepositorsvia

155(R.S.Sayers,1976,pp.552-560)156(Fforde1992)157(Capie,2010,pp.445,591;Capieetal.,1992,pp.68-69)158(Worswick&Ady,1952,p.215)159C261Ap.1,NewYorkFederalReserveBankArchive,25September,1952160C261Ap.1,NewYorkFederalReserveBankArchive,25September,1952

lowerdepositratesand/ornon-governmentborrowersviahigherlendingrates.Thismix

betweenthetwodependsuponwhichhasaccesstomorealternatives”.161

SignificantchangecametotheBankofEnglandinthemid-1940s.First,in1944,after

servingfor24years,GovernorMontaguNormansteppeddownatage72.TheninAugust1946,

theeraofbankregulationreferredtoasthe"theworldofthe'Governor'seyebrows”,cameto

anendwhenthe‘OldLadyofThreadneedleStreet’wasnationalizedundertheBankofEngland

Act.162AsnotedbyFforde(1992),theBank’s:

“relationswithWhitehallandtheCitywereclearenoughinbroadoutline,butofteninformal,unmodified,anduncertainonthemargins.MaintenanceoftheauthorityoftheBank,togetherwithcontroloverthedirectioninwhichitmoved,thereforedependedunusuallyonthesupremacyoftheGovernor.”163

Thisinformalarrangementchangedwhencontroversialclauses4(3)and4(4)ofthe

nationalizationactwereadopted,whichformalizedtheBank’srelationshipwithTreasury.

WherepreviouslytheBankhademployedmoralsuasion,clause4(3)gavetheBank,withthe

approvaloftheTreasury,explicitpowertogoverntheproportionofcommercialbankassets.164

TheformalizationofthispowerandtheadditionoftheTreasuryinthedecisionmaking

frameworkonthemixofassetsbankswouldholdcanbeviewedasasignificantadvancement

offinancialrepression.Oneofthecoreelementsoffinancialrepressionistheabilityfor

governmenttomandatethecompositionoffirmbalancesheetstoensurethegovernmentdebt

isheld,andclause4(3)and4(4)formalizedthegovernment’sauthorityinthisregard.These

sectionsallowedtheTreasuryto:

161(C.Reinhart&Reinhart,1999)162(Capie,2010,p.590)163(Fforde,1992)164(Fforde,1992,p.7)

“requestinformationfromandmakerecommendationstobankers,andmay,ifsoauthorizedbytheTreasury,issuedirectionstoanybankerforthepurposeofsecuringthateffectisgiventoanysuchrequestorrecommendation.”165

Indeed,statementsfromboththeMidlandsandWestminsterbankchairmencondemnedthe

adoptionofclause4(3)andrepresentoneoftheonlyinstancesfoundintheliteratureofan

objectiontoBritishfinancialrepressionpoliciesbybankers.166However,itwasstatedthat

“certainsafeguardstobankersandcustomersareprovidedfor”,suchasthe“rightofbankers

tomakepriorrepresentationswiththeBankofEnglandandtheTreasurybeforethe‘directions’

areissuedtothem”.167AnoteintheNewYorkFederalReservearchivesrecordsaquote

summarizingDalton’sviewonthenewpowerhierarchybetweenBritishbanksandthe

government:“inthelastresort…asamatterofprinciple,iftherebeaseriouscaseofconflictor

challenge,theBankofEnglandmustbemasterandtheleaderoftheclearingbanks”.168As

notedbyWorswickandAdy,“thusthebankingsystemwasausefulinstrumentinthehandsof

adeterminedChancellor.”169

WhatultimatelywastheimpactofthenewBankofEnglandcontrolclausesand

nationalization?Therearereferencestothegovernment’sshareoftheoverallbusiness

handledbybanksincreasingsignificantlyfollowingthewar.170Itisunclearhowmuchthe

establishmentofthisclauseimpactedbankassets.171Theliteratureonlyaddressestheprocess

whichledtotheAct’spassage,andWorwisckandAdystate“noinstanceofitsusehasbeen

publicized”.172Incontrast,archivalevidencepointstosignificantinfluencebytheUKTreasury

onbankbalancesheets.Forexample,thepreviouslycited1952BankofEnglandstudyoncredit

controlstatesthatthebanks:

165C261Dpp.19,NYFRBResearchMemorandumtitled‘NotesontheNationalizationoftheBankofEngland’,NewYorkFederalReserveBankArchive,19October,1952166(Fforde,1992,p.7)167C261Dpp.19,NYFRBResearchMemorandumtitled‘NotesontheNationalizationoftheBankofEngland’,NewYorkFederalReserveBankArchive,19October,1952168CV61Ap.3,NewYorkFederalReserveBankArchive,1946169(Worswick&Ady,1952,p.217)170(InstituteofBankers.,1949)171(Fforde,1992)SeeCh.1(pp.1-30)172(Worswick&Ady,1952,p.218)

“madeeveryefforttocomplywiththerequestsofsuccessiveChancellorsoftheExchequerthatcreditshould,asinwar-time,begrantedonlyforessentialpurposes,whichinthepost-warperiod,weretobejudgedinthelightofthecriterialaiddownfromtimetotimefortheguidanceoftheCapitalIssuesCommittee.Thus,thoughtheweaponsofquantitativecontrolofbankcreditcouldnotbeused,abroadqualitativecontrolwasmaintained.”173

Thisqualitativecontrolonbanklendingwassupplementedwiththereintroductionof

quantitativemeasuresinNovember1951,namelythefirstsustainedincreaseinBankRatein

nearly20years(from2%to2-1/2%).174Thereturntoquantitativemeasureswasinpartdriven

bythefactthatthe“efficacy”ofqualitativemeansofcontrollingbankbalancesheets“was

limited,inspiteofthecooperativeattitudesofthebanks”.175

Fromtheliteraturethereisalsoadiscussionofpressureonbankstosupport

governmentbonds.Forexample,newdiscounthousesappeartohavebeenforcedtotakeona

newroleofholdinggovernmentdebt.176TheaforementionedTreasuryDepositReceipts(TDRs)

werealsounpopularamongbankers.177UKbankswererequiredtomaintainacertainratioof

liquidassetsthatincludedTreasurybills,whichcontrastedwithU.S.banksthatonlyhadto

keepcashanddeposits(butnotgovernmentdebt)withtheFederalReserve.178

Howmuchofthisrepresentedachangefromthepastisnotentirelyclear.Forsome

timepriortonationalizationtheBankofEnglandwasdescribedbysomeas“littlemorethana

handmaidenoftheTreasury”.179DuringtheSecondWorldWarBritishbankstookonall

173C261Ap.2,NewYorkFederalReserveBankArchive,25September,1952174C261Ap.2,NewYorkFederalReserveBankArchive,25September,1952175C261Ap.2,NewYorkFederalReserveBankArchive,25September,1952.Thememorandumgoesontonotethat“thegenerouscompensationtobegiventoprivateownersofpresent(BankofEngland)stock,havealsodonemuchtodampenoppositionoftheBill”.176(Worswick&Ady,1952,p.215)"Itwasmadeclearthataslongastheywerepreparedtoactasgenuinejobbers-thatis,tobuytocapacityonfallingmarkets-theauthoritieswouldsupporttheirliquidity."177(R.S.Sayers,1953)178Source:CV61Ap.20,NewYorkFederalReserveBankArchive,18October1965179Source:CV61p.1,ResearchMemorandumonthe‘ProsandConsofBankofEnglandNationalization’,NewYorkFederalReserveBankArchive,22December1945

governmentdebtnotpurchasedbythepublic.Britishbanks’advanceratio(the%ofassets

allottedtoloansandoverdrafts)droppedfromthepeacetimelevelof50%to15%,indicatinga

largeshiftawayfromprivatesectorloansinfavourofgovernmentdebt.Theadvanceratiodid

notreturntothepeacetimelevelasquicklyasithadafterFirstWorldWar,takinguntilthe

1960sfortheratiotoreturnto40%.180Ashiftbybanksawayfromprivatesectorloansin

favourofgovernmentdebtisacommonfeaturefinancialrepressionpolicy.Thebankscould

discounttheirT-billswiththeBankofEnglandforanycashthatwasneeded,andbywar’send

Britain’smoneysupplyhaddoubled.181

AfterthewarBritishbankswereswimminginliquiditywithlargedepositbasesand

liquidassets,andthecomparativelyhighlevelofliquiditypossessedbythebankspersistedwell

intothe1950s.182TheDaltonpolicyof‘cheapmoney’initiallyledtoariseinthevalueofstocks

andgilts.183However,bondpricesdiddeclinelaterbyasignificantmarginfollowingthe

introductionofthe2.5%‘Daltons’.Theclearingbanksinparticularwererequiredtokeepon

theirbalancesheetsalargepercentageofgovernmentsecuritiesduetothe“subjugationof

bankbehaviourtotheperceivedgreaterneedsofgovernmentfinance”.184Afterthewar,banks

weretryingtorebuildtheiradvances-governmentdebtratio.Atthesametimeauthoritieswere

tryingtosellmoredebtandcapandorslowgrowthinbankadvances.185Forexample,archival

documentsdescribeaUKgovernment“fundingoperation”inNovember1951,supportedby

thebanksand“importantoverseasholdersofTreasuryBills”,whereby£1billioninUKTreasury

Billswereexchangedfor1-3/4%SerialFundingStockmaturingin1952,1953,and1954.186The

effectofthisfundingoperationwasto“sharply”reducetheliquidassetsoftheclearingbanks

sothat“shouldtheneedarise”thebanksclearingbanks“wouldberelativelysusceptibleto

pressure”bytheBankofEnglandonthecompositionoftheirbalancesheet.

180(Capieetal.,1992,p.64)Ratioofadvancestototalassetsatcommercialbanksinthelate19thcenturywere60%,50%intheinterwarperiod,and16%in1944.181(Fforde,1992,p.7)182(Capieetal.,1992,p.64)183(Worswick&Ady,1952,p.194)184(Capieetal.,1992,pp.67-68)185(Capie,2010,pp.80-81)186C261Ap.5,NewYorkFederalReserveBankArchive,25September,1952

ThereisalargeacademicliteratureonLondon’sbanks.However,thereisverylittleto

nodiscussionofthepoliciesorsentimentsoftenassociatedwithfinancialrepressioninthe

bankingliteraturecoveringthisperiod.Forexample,Burk’s(1989)historyofMorganGrenfell,a

leadingAnglo-Americanmerchantbank,focusesonpersonalitiesandtransactions,butdoesnot

referencefinancialrepression.187ThesameistrueofSayers’(1968)studyofGillets,which

includestheyears1945-51.188Whilethisabsenceoffinancialrepressionfromtheliteraturemay

inpartbeduetothefactthatmanyofthehistoriesonBritishbankswere‘official’,theprivate

diariesofBritishmerchantbankerSiegmundWarburgalsodonotmentionfinancial

repression.189OnenotableexceptiontothesilencefrombankersoccurredinJanuary1947,

whenthechairmenoftheBigFiveclearingbanksurgedintheirannuallettersanendto

Dalton’spolicyof‘cheapmoney’.190However,thegeneralabsenceofdiscordraisesquestions.

BritishbankswouldholdlargequantitiesofBritishbondswellintothepost-warperiod(Table

9),andintheUK“amuchhigherproportionofthetotaloutstanding[Treasurybills]isinthe

handsofthebankingsystem(includingdiscounthouses)thanitisintheUnitedStates”.191

Table9:InstitutionalComparisonofUKandU.S.TreasuryBillHoldings,30September1964

Sector UnitedKingdom UnitedStatesCommercialbanksanddiscounthouses 50% 27%Foreignholders 42% 19%Otherholders 8% 54%

Total 100% 100%

Source:CV61Ap.10,NewYorkFederalReserveBankArchive,18October1965

187(Burk,1989)188(R.S.Sayers,1968)189(Ferguson,2010)190(Worswick&Ady,1952,p.201)AnotherexampleofprotestwastheearliernotedcommentsbythechairmenofMidlandsandWestminstercondemningclause4(3)intheBankofEnglandAct(Fforde,1992,p.27).191CV61Ap.10,NewYorkFederalReserveBankArchive,18October1965

Asnotedearlier,therealvalueofBritishbondsexperiencedasteadyandsubstantial

declinefollowingSecondWorldWar.Onewouldexpectthatthepost-SecondWorldWar

liquidationofthevalueofBritishdebtofperhapsunprecedentedproportionstogenerateat

leastamentioninpassingfrombankers,whichinturnwouldbepickedupinthehistorical

literature.Howcanthisapparentparadoxbeexplained?ItishardtoimaginethatBritishbanks

werenotawareofthefactthattherealvalueoftheirBritishdebtholdingswasbeingeroded.

Thereareatleastfourpossibilitiesthatcouldexplaintheparadoxbehindtheexistence

ofBritishfinancialrepressionandtheabsenceofmentionintheliteratureandandby

financiers:a)historicalresearchtodatehassimplyoverlookedthisaspectofBritishfinancial

history;b)Britishbanksfoundawaytomitigatetheeffectsoffinancialrepression;c)afinancial

repressionbargain,sotospeak,existedbetweenthebanksandtheauthorities;d)financial

repression’seffectsweresmallenough,andstretchedoutoversufficienttime,toescape

protest.Itistemptingtospeculatethatthelattertwoexplanationsarecorrectbasedwhatlater

happenedtoBritishbanking.Themerchantbankswereconsideredtobethecrèmedelacrème

oftheLondonbanks.However,onceLondon’sfinancialderegulatory‘BigBang’occurredmost

ofLondon’smerchantbanksceasedtoexistasindependentgoingconcernsoverthenext

severalyears.OftheoriginalmerchantsbanksonlyRothschildhasremainedanindependent

entity.192Merchantbankshadbeenshelteredandsimplyfoundtheywerenolonger

competitiveinaglobalizedfinancialmarket.

4.5Directedlending

Directedlendingisacommonfeatureoffinancialrepression,andBritishgovernment

departmentssuchastheNationalDebtCommissionersandthePostOfficeSavingsBankwere

directedtosupportTreasurybondauctionsandtheoverallgovernmentbondmarket.Other

agenciesthatsupportedgovernmentdebtmarketsincludedthetrusteesavingsbanks,the

192KleinwortwasboughtbyDresdner.S.G.WarburgwaspurchasedbySwissBankCorp.(nowCreditSuisse).MorganGrenfellwasboughtbyDeutscheBank.Schroeder'swaspurchasedbyCitibank.HambroswassoldtoSociétéGénéralein1998.Baringsfailedin1995.

socialinsurancefunds,theExchangeEqualizationAccountandtheIssuesDepartmentofthe

BankofEngland.193Thesedepartmentswereoftenusedtosupportconversionsthrough

advancebuyingofthesecuritytobeconverted,therebyhelpingtoensureasuccessful

conversion.

Daltonorchestrateddirectedlendingoperationswiththegoalofmanaginginterest

rates.Lowinterestrateswereeffectedbyswappinghigherinterestratelong-termtermdebt

withlowerinterestrateshort-termdebt,aswellbyunderwritingnewlower-interestrate

issues.194BothWorswickandAdy(1952)andCairncross(1985)brieflydiscusstheseoperations.

However,Cairncrossdescribedthemas“rumour”,whileWorswickandAdyrefertothe

departmentsasthe“Treasury’screatures”thatwere“takinguptheslackonthoseissueswhich

thepublicwouldnottake”.195Whiletheseoperationswereoriginallyconcealedfromthepublic

archivaldocumentsrevealtheextentoftheseoperations.196ANewYorkFederalReservereport

citesanotherreportbyaMr.Bloomfieldtitled“InterestRatePolicyinGreatBritain-1945-48”

thatdescribestheeffectsofBritishdirectedlendingasfollows:

“2½percentConsolsundertheimpactofvigorousbuyingbythepublicdepartmentshadrisenbyNovember1946towithinapointofparity,thehighestlevelin44years,andthemarkethadbeensufficiently‘rigged’topermittheissueatpartofa2½percentTreasurystockredeemableafter1975attheTreasury’sdiscretion”(the‘Daltons’).197

Comparingnon-bankprivatesectorinstitutionsintheU.S.andUK,weseethatin1963thatU.S.non-bankprivatesectorinstitutionsheldamuchlargerportionoftheirshort-termassetsinTreasuryBillsthanintheUK(

193(Worswick&Ady,1952,p.197)194(Worswick&Ady,1952,p.197)195(Cairncross,1985,pp.432-433;Worswick&Ady,1952,pp.196-198,215)196(Worswick&Ady,1952,pp.197,202)WorswickandAdyalsostatedthatitispossibletomakeaback-doorcalculationbymonitoringcreditcreation,particularlytheincreaseofdeposits.TheyalsonotethattheactivitiesofthedepartmentsdeclinedundertheCrippsChancellorship.197CV61p.1,Mr.KlopstocktoMr.Sproul,‘TheCheaper–MoneyPolicyinBritain–ALessonfortheUnitedStates”’,NewYorkFederalReserveBankArchive,7September,1948

Table10).

Table10:PrivateSectorInstitutionalComparisonofUKandU.S.TreasuryBillHoldings,%ofTotalShort-termAssetsheldinTreasuryBills,1963

Sector UnitedKingdom UnitedStatesInsurancecompanies 2% 10%Corporatepensionfunds 1% 40%Mutualbanks 0% 18%Savingsbanks 0% 12%

Source:CV61Ap.8,NewYorkFederalReserveBankArchive,18October1965

U.S.companiesweregenerallyconsideredtobemuchmore‘liquid’thantheirUKcounterparts,

withcurrentassetsof40%and22%,respectively.UKprivatesectorsinsurancecompanies,

whenaskedbytheRadcliffeCommitteetoexplainthispreferenceforlonger-termsecurities,

stated:

“Wedonotwanttohavesecuritiesthatturnovertoorapidlyortoofrequently,suchasbillsorshort-datedinvestments;wewouldratherhavesomethingwhichisgoingtobethereforareasonableperiodoftime,forpurelyadministrativereasons”.198

HowshouldweinterpretthepreferenceonthepartofBritishinsuranceandpension

organizationsfornotholdingUKTreasurybills,eventhoughastheNYFRBstudyputsit“itmight

havepaidthemtodoso”?TheNYFRBascribesapartialexplanationto“habit”onthepartof

Britishinsuranceandpensionschemes.Perhapsthisandthepreviousexplanationevidencedin

theabovequotefromtheinsurancesectordoexplaininpartthepeculiarpreferencefor

preferringtoearnaloweryield.However,giventheactiveroleofgovernmentinthe

managementofUKeconomicaffairsinthepost-warperiod,questionsaboundoverwhether

somedegreeofmoralsuasiononthepartoftheauthoritiescouldplayaroleinthese

preferences.

198CommitteeontheWorkingoftheMonetarySystem(RadcliffeCommittee),Question7092.UKNationalArchives,1957-59

OthersignificantdifferencescanbeseenbetweentheUKandU.S.Treasurybillholdings

inothersectorsoftheeconomy(Table11andTable12).UKnon-financialcorporationsheld

just8%oftheUKTreasurybillmarketcomparedtothe18%heldbyequivalentU.S.firms.

However,UKlocalauthoritiesheldjust0.1%oftheUKTreasurybillmarketandsowouldnot

appear,atleastasof1964,tohavebeenapartytodirectedlendingschemes.

Table11:UK%ofTotalTreasuryBillMarketHeldbySector,30September1964

Sector £smillions %ofT-billmarketLocalauthorities £3 0.1%Insurance 3 -Trusteesavings 2 -Privatesectorpensionfunds - 0.1%Othernon-bankfinancialinstitutions 3 0.2%Non-corporatebodies(PublicTrustee) 5 0.1%Non-financialcorporations 4 7.7%

Total £229 8.3%Source:CV61Ap.12,NewYorkFederalReserveBankArchive,18October1965Table12:U.S.%ofTotalTreasuryBillMarketHeldbySector,30September1964

Sector £smillions %ofT-billmarketStateandlocalgovernments £1,940 12%Insurance 200 1%Mutualsavingsbanks 120 1%Savings&loans 240 1%Corporatepensiontrustfunds 290 2%Non-financialcorporations 2,830 18%Misc.(includingnon-banksecuritydealers) 3,017 19%

Total £229 54%Source:CV61Ap.12,NewYorkFederalReserveBankArchive,18October1965

The1964NYFRBstudyremarksonhowtheinstitutionalholdingsofUK(andU.S.)Treasurybills

hasremainedconsistent“overthelastfouryears,eventhoughtherehasbeenanincreasein

alternativeoutlets(forearninginterest)outsidethepublicsector”,particularlythetime

certificateofdeposit.199

4.6Inflation

Financialrepressioncanbeeffectivewithoutinflationbysimplyreducingthelevelof

nominalinterestexpenseonpublicdebt.200However,inflationoftenaccompaniesfinancial

repression,anditneednotbesignificanttohaveamaterialimpactondebtsustainabilityover

anextendedperiodoftime.Further,smalldifferencesintherateofinflationcanhavea

significantimpactovertimeonthevalueofpublicdebt,aswellasdeterminingthenumberof

yearsorperiodswhichcanbelabelledasperiodsof‘debtliquidation’.

OtherthantheWorldWarsandtheirimmediateaftermath,thefirsthalfofthe20th

centuryinBritainwasmarkedbyverylittleinflation.201AstheSecondWorldWarcommenced

Keynesarguedagainstwhathecalledthe‘old-fashionedlaissez-fairesolutionofinflation’asa

meansofpayingforthewar.202InasectionofHowtoPayfortheWarcoveringinflationduring

theperiodsurroundingfirstgreatconflictofthe20thcentury,Keyneswrote:

“Butwhataridiculoussystemwithwagesandpriceschasingoneanotherupwardsinthismanner!Noonebenefitedexcepttheprofiteer.Theseedsofmuchsubsequenttroubleweresown.AndweendedupwithaNationalDebtvastlygreaterintermsofmoneythanwasnecessaryandveryilldistributedthroughthecommunity.”203

MuchofKeynes’pre-andearly-warpolicyeffortswerespentadvocatingagainstthe

government’suseofinflationasameansoffinancingthewar.204WhetherornotKeynes

199CV61Ap.17,NewYorkFederalReserveBankArchive,18October1965200(C.M.Reinhart&Sbrancia,2011)201(Capieetal.,1992,p.63)Infactmuchoftheinterwarperiodwasmarkedbydeflation.202(Keynes,1940,p.70;Skidelsky,2000,p.63)Keynes:“Anindividualbysavingmorecannotprotecthimselffromtheconsequencesofinflationifothersdonotfollowhisexample.”203(Keynes,1940,p.73)Also,inthechaptertitled‘CantheRichPayfortheWar?’,Keynesarguesthattherichwouldbetherelativebeneficiariesofinflation.(p.21)204(Skidelsky,2000,p.55)

intendedtoremainstaunchlyanti-inflationaryafterthewarisunclearashewasoftencriticized

duringthisperiodfor‘makinguptheoryonthehoof’.205

Somewhatsurprisingly,deflationwasreportedbysometobeasgreataconcernas

inflationbothduringthewarandthepost-warperiod.206However,aswithmanyotherwars

inflationclimbedduringtheSecondWorldWar,withretailpricesincreasingonaverageby6.3%

annually.207Thereissomedisputeintheliteratureonthelevelofinflationduringthewar(and

afterward)withCairncross’estimating50%inflationduringtheSecondWorldWar.208Inflation

intheSecondWorldWarwasapproximatelyhalfthatoftheFirst,withWoodward(1991)

claimingthatthis“relativesuccess”wasachievedthrough“muchlessdependenceon

borrowingandmoreconcertedefforttoreduceconsumptionthroughincreasedtaxation”.209

Rationingwasdeemedcrucialtomakingpricecontrolseffective.210Avarietyofmeasureswere

employedtomanagedemand,prices,costs,andoverallinflationpressure,includingprice

controls,subsidies,standardizationschemes,andqualitycontrols.Suchmeasurescould

perhapsbeconsideredaselementsthatsupportedfinancialrepression,buttheygenerallyfall

outsideofthedefinitionoffinancialrepression.

Anotherhallmarkoffinancialrepressionisarelativelyhighsavingsrateinspiteoflow

interestratesandorinflationduetofew(ifany)investmentorspendingalternatives.211

Averageweeklywagesfrom1940-1945increasedbyarateof5%peryear,laggingslightly

behindpriceincreases.Woodward(1991)speculatesthattradeunions,whichhadastrong

wagebargainingpositionduetolowunemployment,exercisedwagerestraintduetoboth

sympathiesforthewareffortandtheirinclusioninwaradministration.Paradoxically,the

205(Skidelsky,2000,p.23)206(Dow&NationalInstituteofEconomicandSocialResearch.,1964,p.10)TheWhitePaperonEmploymentPolicy(Cmd.6527,1944)warnedofdeflation.207(Cairncross,1985;Crafts,Woodward,&Duckham,1991,p.189;Mitchell,1975)Wholesalepricesduringthisperiodroseby8.8%annually.208(Cairncross,1985,pp.14-15)209(Craftsetal.,1991,p.190)210(Capie,Pradhan,Wood,&CityUniversity.CentrefortheStudyofMonetary,1986;Capie&Wood,2002)211(McKinnon,1973;Shaw,1973)

savingsratealsogrewduringthisinflationaryperiodofdecliningrealwagesto15%.212

However,thisisrevealedtobelesssurprisinggivenrationingandotherrestrictionson

purchasesbothduringandafterthewar.213

Woodward(1991)claimsthatpost-SecondWorldWar(1945-1950)inflationaveraged

4.3%peryear,rangingbetween3-7%annually.214Realwageswereunchangedthrough1951

butrealearningsincreasedby10%.215In1948,30%ofconsumptionwasrationed;by1950only

11%.In194783%ofUKrawmaterialswereundersomedegreeofofficialcontrol;by1950the

figurehaddeclinedto47%.216Woodwardalsostatesthatforthisperiod“atnotimewastherea

returntotheexcessof1919-20”,whenannualinflationranat21.5%and24.8%,respectively.217

However,otherresearchsuggeststhatactualpost-warinflationwassignificantlyhigherthan

nationallyreportedfiguresusedbyWoodwardandRichard(2002),particularlyifoneaddsthe

early1950sintotheanalysiswheninflationapproachedpost-FirstWorldWarlevels.218

Cairncross(1985)notesthattheofficialCost-of-Livingindex,basedonpre-FirstWorld

Warestimates,was“farfrombeingatruemeasureofthechangeinthevalueofmoney”.219

Woodwardalsostated“intheearlypost-waryearscontrolsweredeliberatelyusedtocontain

demandpressuresandtopreventthepricesofanumberofkeycommoditiesfromrising

rapidly.However,from1947onwardsthecontrolsweregraduallyrelaxed,andhadmoreorless

disappearedwiththechangeingovernmentin1951”.220Whileitistruethatpriceanddemand

controlswerelargelyremovedbytheearly1950s,Woodwardsaysnothingoffinancialcontrols,

suchasthoseonforeignexchangeconversionandotherrestrictions,whichmayhaveplayeda

212(Cairncross,1985,pp.13-14)213(Zweiniger-Bargielowska,2000)214Thesefiguresarein-linewithRichards(2002)morerecentnumbers.215(Cairncross,1985,p.18)216(Cairncross,1985,p.23)217(Richards,2002,p.15)218(Díaz,Lüders,&Wagner,2003;Feinstein,1972;Friedman&Schwartz,1982;Price,1988;Wiles,1952)219(Cairncross,1985,p.39)220(Craftsetal.,1991,p.191)

significantroleinsuppressinginflationduringthistime.221ThegrowingconflictontheKorean

peninsulain1950-51islargelycreditedwiththespikeininflationduringthisperiod.Thecostof

rubbertripled,woolandcottondoubled,andnumerousothercommoditieswentupinpriceby

50%.222ThevariousinflationseriesfoundintheliteraturearepresentedinFigure10andTable

21.

Figure3:UKInflation(RetailPrices),AnnualPercentageChange,1941-1960

Sources:Diaz,LudersandWagner(2005)Richards(2002),FriedmanandSchwartz(1982),PriceandBain(1988)

Thesmallestandlargestvarianceintherangeofvaluesforanygivenyearduringthis

periodare1.6%and10.5%fortheyears1946and1949,respectively.Overall,giventhewide

variationininflationestimatesforthisperioditmaybemoreaccuratetoutilizearangeof

inflationestimatesforcalculatingdebtliquidation.

221(Craftsetal.,1991,p.191)WoodwardarguesthepostwarLabourGovernmentuseditcloserelationshipwiththetradeunionmovementtoexercisewagerestraint;1948wastheyearofthefirstvoluntaryincomepolicy,whichinsuredwageincreaseswerekeptwellbelowinflation.222(Dow&NationalInstituteofEconomicandSocialResearch.,1964,p.55)

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

1941 1943 1945 1947 1949 1951 1953 1955 1957 1959

Richards Diaz,etal Bain&Price Friedman&Schwartz SampleAverage

Table13:UKInflation(RetailPrices),AnnualPercentageChange,1945-1951

Year Richards DiazBain&Price

Friedman&Schwartz

SampleAverage

RangeHigh-Low*

1945 3.2% 3.0% 5.1% 0.5% 2.9% 4.6%1946 3.5% 3.6% 5.1% 3.8% 4.0% 1.6%1947 7.4% 9.1% 8.2% 8.5% 8.3% 1.7%1948 6.6% 7.8% 10.8% 12.3% 9.4% 5.7%1949 2.6% 13.1% 5.1% 5.2% 6.5% 10.5%1950 2.8% 0.3% 5.6% 1.7% 2.6% 5.3%1951 9.5% 15.9% 16.6% 12.9% 13.7% 7.1%

AnnualAverage 5.1% 7.5% 8.1% 6.4% 6.8% 5.2%

*Note:thedifferencebetweenthehighestandlowestestimateeachyear.Sources:Diaz,LudersandWagner(2005)Richards(2002),FriedmanandSchwartz(1982),PriceandBain(1988)

5Conclusion

Thispaperhasshownthatopportunitiesexistforimprovingbothourquantitativeand

qualitativeunderstandingoffinancialrepressionthroughanin-depthexaminationofBritish

mid-20thcenturyfinancialrepression.Furtherresearchisnecessaryonwhowerethewinners

andlosersoflowinterestrates.WorswickandAdy(1952)statethatlowinterestratesintheUK

mayhavecauseda"redistributionfromthesmallertothelargerrentier”.223However,littleto

noquantitativeevidenceispresentedtosupportthisclaim.Thereisalsothequestionofthe

knock-oneffectsoflowinterestratesontheBritisheconomyandfinancialsystem.Duringthe

post-waryears“anundulylargeproportionofworldtradehadcometobefinancedinLondon

inordertotakeadvantageofthelowinterestrates”.224Buthowmuchdidthisinflowoffunds

fortradefinancefurtherdestabilizethefragilebalanceinBritain,withitshigh-debtand

overvaluedcurrency?

Furtherresearchisalsonecessarytounderstandthetrade-offsbetweenthenegative

consequencesoffinancialrepression,suchasitsimpactoneconomicgrowth,anditspotentially

positivefeatures,suchasbuttressingthefinancialsystem.Inadditiontopromotingfinancial

stability,financialrepressioncanhelpachievedebtsustainability.Contrarytowhatitsname

implies,financialrepressionmayonoccasionbeanappropriatepolicy.Itmaythereforebe

appropriatetodetermineamoreneutralnameforfinancialrepression,whichisoftenusedas

pejorativeforscoringrhetoricalpointsinpolicydebates.

223(Worswick&Ady,1952,pp.204-205)224C261Ap.5,NewYorkFederalReserveBankArchive,25September,1952

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