Canberra, 20 November 1967
Secret
Sterling Devaluation: Policy Implications for Australia
On Sunday morning the United Kingdom Government announced that the £ sterling had been devalued from $US2.80 to $US2.40, a devaluation of 14.3 per cent.
2. Associated measures announced were:–
- an increase of 1.5 per cent to 8 per cent in the bank rate;
- a reduction in government expenditure in the next year of £400 million sterling, including a £100 million sterling reduction in defence spending;
- a tightening of consumer credit;
- abolition of export rebate;
- a request to the International Monetary fund for a standby credit of $1.4 billion.
3. Secret messages received by the Prime Minister and myself on Saturday afternoon from Messrs. Wilson and Callaghan advised us of these moves and also indicated that taxation increases in the next Budget were contemplated.
4. These United Kingdom measures followed persistent and increasing pressure on sterling in recent weeks. The United Kingdom, despite a variety of measures in the past year or so, has been unable to prevent a serious weakening in its balance of payments on current account; the Middle East crisis and the closure of the Suez Canal earlier this year added further to the strains being felt. The purpose of the devaluation and of the associated steps is to provide a decisive and once-and-for-all correction to the fundamental balance of payments disequilibrium into which the United Kingdom has drifted in recent years.
5. The devaluation of 14.3 per cent is a moderate one. It is obvious that a major aim in choosing a move of this size was to forestall the possibility of an extensive chain reaction of competitive devaluations by other countries. We have been informed that none of the major countries—such as the United States, the European Common Market countries, Canada and Japan will devalue. A number of small trading nations will doubtless devalue. It has already been stated that Ireland, Finland, Denmark and Israel will devalue; on the other hand, countries such as Sweden, India, South Africa, Malaysia and Singapore are not proposing any change; New Zealand seems likely to devalue. The Situation is plainly very different from that in 1948–491 when countries accounting for about 65 per cent of world trade devalued.
6. The United States and the United Kingdom are particularly anxious to see devaluations confined to the United Kingdom and a few small trading countries. (Indeed the United Statues is hoping that even New Zealand will not devalue.) The United States Secretary of the Treasury and the Chancellor of the Exchequer have telephoned me to say that the United States would like Australia to stay put and not devalue. This view is undoubtedly shared by other major countries. Their desire is to ‘isolate’ as far as possible the United Kingdom action to ensure that it does not trigger off a run of major devaluations and the chaos that could ensue.
7. The position then is that we are not seen as one of those countries which might be expected, in the normal course of events, to follow the United Kingdom. Our reserves position is strong. Our holdings of gold and foreign-exchange amount to $1170 million and our drawing rights with the Fund stand at $630 million—a total of $1800 million. Our export prospects, at least in the medium and longer-term, are highly promising. This is partly a reflection of our burgeoning mineral prospects but, drought problems apart, the longer-term outlook for rural production also holds much promise. Although imports have begun to increase fairly strongly, partly as a result of increased imports for defence purposes, this has not created major worries with respect to the balance of payments.
8. Nonetheless, we do run a very substantial current account deficit—estimated at about $950 million in 1967–68—and reserves have been declining. The odds are that they will continue to decline through 1967–68. Whether or not the decline would continue into 1968–69 is impossible to say; predictions in this field are notoriously prone to go awry.
9. The United Kingdom devaluation will not, of course, leave our balance of payments prospects quite unaffected. If we did not devalue, those of our exports competitive with United Kingdom exports—e.g. manufactured exports to New Zealand—would encounter stronger price competition. Within the United Kingdom market, which now absorbs only 13 per cent of our exports, the sterling price of some of our exports (e.g. on dairy products, canned and fresh fruits) would probably remain much the same, at least in the shorter term, with consequential reduced receipts in terms of Australian dollars for exporters here; in certain cases, some rise in the sterling price could be expected but not to the full extent of the devaluation (e.g. meat, wheat). In other cases, in which the United Kingdom pays world prices, the sterling price should rise more or less to the full extent of the devaluation (e.g. wood, metals). It will take a little time for the exact consequences to become clear. There are, too, some existing export contracts expressed in sterling. The value of these is not yet known; however, in such cases and where there is no exchange guarantee the United Kingdom devaluation effectively reduces the value of the receipts involved.
10. The United Kingdom devaluation will also affect the pattern and perhaps the volume of our imports. United Kingdom imports, which represents about 24 per cent of our total imports, will become more competitive in relation to imports from other countries and in relation to Australian production. There would be some substitution of British imports for other imports; there could also be some increase in total imports. Against this, we could obtain plant, machinery and other imports from Britain at a lower cost.
11. The effects on our balance of payments would, in short, be particular rather than general; there will be marked effects on some sectors but, overall, the balance of effects will not be very great. In short, the effects on our balance of payments could scarcely be regarded as significant enough in themselves to provide a case for devaluation. The International Monetary Fund must approve any devaluation and before giving such approval, the formal requirement is that the International Monetary Fund has to be satisfied that Australia is faced with a ‘fundamental disequilibrium’. To support a claim that we were in such a state, we would need to point to a chronic external imbalance which showed no reasonable prospects of being corrected by a better export performance or by curbing import demand or rising costs by tolerable domestic measures.
12. It would be difficult to argue such a case. Whatever one might think about the short-term outlook, we should be able—given reasonable good fortune—to handle it by drawing on reserves; meanwhile, it is at the very least possible that the balance of payments will strengthen as increasing mineral exports come on stream—and, indeed, as import-replacing developments, such as domestic oil production, continue.
13. Australia, is of course, in a creditor position in the International Monetary Fund—there have been net drawings of Australian currency. Indeed, Australia is being asked to put up $45 million in the current operation in support of sterling. Our creditor status would not enhance our chances of persuading the Fund that we are in a state of ‘fundamental disequilibrium’. As already mentioned, major countries would in any case be anxious to confine devaluation to as small a number of countries as possible. These countries have a preponderance of voting power in the International Monetary Fund and would not welcome an approach from a country of Australia’s stature and strength.
14. The first ground on which a case could be built has already been mentioned; the United Kingdom devaluation directly affects our balance of payments outlook, perhaps more than that of most other countries. However, something of the same case could be made by various countries which will not devalue; we need something a good deal more persuasive.
15. The firmest ground on which to build a case would seem to be in terms of the position of our rural industries. Export prices have been falling; meanwhile costs, although not rising fast by the standards of most International Monetary Fund member countries, have been on an inexorable upgrade. Import prices too have been rising. The consequence has been a sharp deterioration in the past year in the terms of trade. There is the distinct risk that unless this trend is checked the incentives to expand rural output will weaken, with deleterious effects on our export potential. Devaluation would, at least for a time, increase the incomes of primary producers in terms of Australian currency. It should be noted, however, that in terms of foreign exchange devaluation would not raise export prices and therefore would not automatically boost export income in terms of foreign currency. In time, moreover, cost increases attributable, directly or indirectly to devaluation, could erode the gain initially derived by rural producers from devaluation.
16. Leaving the question of International Monetary Fund approval aside what is the case for a devaluation of the Australian dollar?
17. The only serious argument in favour of devaluation is that cited above; it would increase the gross income of the primary producers and others engaged in the export trade. There is little doubt that, for a time at least, this group in the economy would benefit significantly. However, this benefit would not originate overseas—it would essentially involve a redistribution of income within Australia from other sectors to the export sector.
18. The other effects of devaluation are unfavourable. Devaluation would almost certainly impart an upward thrust to costs—the cost of imports, other than from the United Kingdom and other countries devaluing, would tend to rise in much the same way as if there were an equivalent across-the-board rise in tariffs. To some extent the existence of the exceptions cited would enforce some price-cutting on the part of other importers—however, there can be no doubt that the general trend in import prices would be upwards. Meanwhile, with costs rising, demand would tend to rise too as the groups benefiting from higher incomes adapted their spending patterns accordingly. Wage-earners would, of course, seek energetically to regain some or all of the proportion of national income shifted away from them and they would have some good talking points to sustain a case that the primary producers were getting a bonus from devaluation. Their effective power to force wages increases would be enhanced by the inevitable ‘bidding-up’ which would result as secondary industries attempted to take advantage of the weaker competitive position of most imports.
19. In the event, we as a Government would have to move to stop these sorts of developments getting out of hand. Both fiscal and monetary measures would have to be called into play to curb pressures on available supplies in the economy. However, we cannot be confident about carrying through such measures without bringing on disadvantageous effects and without creating a great deal of dissension among the numerically large groups who would bear the brunt of the increase of costs and prices.
20. On the other hand, it can be argued that if we were not to devalue in present circumstances, fears—no matter how unfounded—about our balance of payments prospects in the new and disturbed international situation could lead to speculation against the Australian dollar. The argument can go on to predict the loss of substantial reserves through withdrawals of capital from Australia and a falling off in capital inflow.
21. How large such a risk may be is difficult to say. Withdrawal of capital on a large scale may not be easily accomplished and may itself produce losses for the investor withdrawing—for example, portfolio investors cannot readily disengage from Australia without forcing down the prices of the securities they wish to sell. Australia’s basic attractiveness in the eyes of investors for [sic] overseas would remain—indeed, if we stood with the strong rather than the weak nations on this issue of devaluation, it would be enhanced. This latter point, I think is of great importance.
22. In general, and making full allowance for risks, the purely balance of payments case for a devaluation is not at all strong. The case essentially must rest on improving the relative position of the primary producer vis-a-vis the rest of the Australian community.
23. Were a decision taken to seek approval from the I.M.F. for a devaluation, it is clear from the foregoing that it would have to be small. It would, of course, need to be publicly presented as a final devaluation. It would best be presented both to the Fund and to the public as a strictly limited and once-for-all measure to mitigate the effect of the U.K. devaluation on the rural export industries.
24. There would remain two issues, one immediate, the other longer-term. The immediate issue would concern the economic policies to be followed to limit the rise in demand and costs which would inevitably be generated. l cannot canvass the policies which would be required here; however we would need to act firmly in various fields, especially in respect of credit and interest rate policy. Without such action, the improved position of the primary producer would be eroded very quickly. Some erosion is, of course, inevitable especially as we cannot do much about the increase in costs resulting from the lift in most import prices which must follow devaluation.
25. The longer-term issue would concern the future measures especially designed to alleviate the position of the primary producer and industries in competition with imports. The new context would mean that such measures—e.g. tariff protection, subsidies and other assistance to industries, export incentives, preferential interest rates for primary producers—would not necessarily be appropriate or wholly appropriate any longer; it would mean that new proposals with regard to such measures would also have to be considered in the light of the new situation in which a shift in the distribution of the community’s income had already occurred towards the groups the measures would benefit.
26. The conclusion I come to then is this. On strictly economic ground I think the weight of the case is definitively on the side of staying put and not devaluing with the United Kingdom. While there would be some repercussions of so doing we could, I am sure, certainly live with the situation without great risk or difficulty, either domestically or externally and we could find other means to deal with particular effects.
27. There are, of course, other aspects of the situation before us, not all of them purely economic. A decision not to devalue at all would probably pose difficulties for some groups in the community, especially primary producers, and if we do not devalue at all, other means might have to be found to see that they did not bear the brunt of the effect of the U.K. devaluation on the Australian economy.
28. As I have indicated above, it cannot be taken for granted that the I.M.F Board would approve an Australian devaluation. If we sought approval, we would on present appearances be the only major trading country to be seeking to devalue in the wake of the United Kingdom move. That is a bridge we would have to cross.
1 In 1948 the Attlee Government devalued the pound against the US dollar. The Chiftey Government in Australia quickly followed suit, as the overwhelming bulk of Australia’s trade was with the Sterling Area at that time. One Australian pound was devalued from US$2.80 to US$2.24.
[NAA: A5842 VOLUME 18]