The history of the Pound Sterling (GBP)

A century and a half later Athelstan, the first King of England, founded a series of mints across his newborn nation, unifying the output in the Statute of Greatley in 928 and founding sterling as a national currency.

Strangely, though, the name “sterling” took a while to appear. The first mention – “sterilensis” in 1078 – is from the days of William the Conqueror, who also introduced the shilling – 20 to the pound – into his new kingdom. The name only became commonplace in the 13th century.

Its origins are lost to time. Stars and starlings both appeared on the minted pennies or “sterlings”, but no one knows if either gave their names to the currency. The easterlings, or early medieval merchants and moneychangers, are another possible source of the name.

Either way, the name stuck, linked to the meaning of “ster” in old German – strong, pure, stable, reliable, or excellent. English silver was held in esteem and that respect was worth keeping.

In 1124, a disgusted Henry I had 94 mint workers castrated for producing bad coins. Nicholas Mayhew wrote in Sterling: the rise and fall of a currency: “It was the earliest, and certainly the bloodiest, of a series of attempts which were to take place over the centuries to restore confidence in sterling.”

Sterling retained importance through the middle ages. Before the foundation of the Bank of England, the Tower of London was the store for spare money. Silver pennies were the only coins right through until the 13th century and silver was the currency standard till the 18th century, when gold became the basis of the pound.

The Bank of England and paper money

In 1694 King William III established the Bank of England to fund his fight with France.

Goldsmiths had issued bank notes – promises to pay set against gold deposits – from the 16th century, but although the Bank of England was the first central bank in history, it has not always had exclusive control over the pound.

Banks in Northern Ireland, Scotland and Wales printed notes, along with satellite banks – but only those more than 65 miles from London. Crime arrived quick on the banknote’s tail.

By 1695 the first fraud happened. The authorities fined one Daniel Perrismore for forging 60 £100 notes – a lot of money in the late 17th century. The the bank introduced a watermark to stop fraud, and the crown introduced the death penalty for counterfeiting.

The Bank provided stability, but the pound still suffered from market ups and downs. The first £10 note was printed in 1759, when the Seven Years War caused severe gold shortages. Inflation fears of war with France led to the first £5 note in 1793.

That same republican threat caused a series of runs on the bank in 1797, ushering in a period of fiscal restriction, which lasted until 1821. About then the Irish playwright Richard Brinselyn Sheriden angrily described the bank as “an elderly lady in the city”.

The name stuck. The Bank became the Old Lady of Threadneedle Street, nicknamed by the cartoonist James Gillray.

Sterling banknotes were originally handwritten, although the notes were part printed from 1725. Cashers still had to sign and make the notes out to someone. The Bank began to print the notes in 1855, no doubt to the relief of their workers.

The Gold Standard and Sterling’s Supremacy

From 1717 the UK defined sterling’s value in terms of gold rather than its original silver, but it was not until the 1870s when Germany adopted gold that the gold standard came about, ushering in an era of grand scale international trade.

The principle of the standard, that a nation must back its banknotes with the equivalent in gold, established exchange rate stability. Sterling’s strength was the basis of the gold standard, and was behind a sustained period of global growth right up until to 1914.

But the 19th century governments’ success rested on the disenfranchisement of the working classes. Modern democracy would not let governments ignore exchange rate pressure and so the gold standard was a unique period in economic history.

While it reduced exchange rate risk, stability based on gold helped British investors and traders. Global finance took off, ushering in an era of ‘gentlemanly capitalism’ when British investors poured money into offshore investments, protected by the immense strength of sterling and the might of the British Empire.

If Britannia ruled the waves, sterling was the global economy’s lifeblood.

But the Gold Standard also had a downside. While prosperity passed rapidly around the world, so did the business cycle and financial panic. The collapse of the American railbuilding boom after the east and west railways met in 1869 caused a bad depression from 1873. The 1890s and 1900s also suffered severe depressions, all at the speed of the telegraph wire.

And the outflow of capital reduced Britain’s productivity in the long run because of its unavailability for British industry, and contributed to a lengthy and slow decline in sterling’s face value.

World War One

The UK suspended the gold standard in 1914 bowing to the necessaries of war. Wartime manufacturing caused inflation and helped enliven trade unions and the Treasury, rather than the Bank of England, printed some banknotes itself during the war years.

After the war Britain sought to return to its former pre-eminence, ignoring the consequences of the war. Winston Churchill returned sterling to the gold standard in 1925 at the pre-war rate of £4.86 to the dollar.

However, the pound was overvalued by 10 per cent. The rate of exchange for sterling had been unchanged since Sir Isaac Newton set it in the 18th century, when he was Master of the Mint. The value was very out of date.

Growing labour militancy after the War made an undemocratic economic goal, an overvalued pound, much harder to justify. Sterling’s expense hurt the British economy.

The End of the Gold Standard

The dollar’s growing dominance began to reduce sterling’s importance as a reserve currency, while sterling remained overvalued.

By the end of 1925 the economics of the coal industry had collapsed, and 1926 brought not stability, but a six-month coal strike, the general strike, and long-drawn-out unemployment.

This economic slide culminated in an irresistible run on sterling in 1931, effectively ending its role stint on the Gold Standard. The standard broke down globally between 1930-1933, under pressure of slump and the huge cutbacks in lending, which led to an era of economic protectionism and limited international trade. The pound remained afloat until 1939 and the outbreak of World War Two.

World War saw a great increase in forgery, as Germany’s Nazi government sought to weaken sterling by spreading counterfeit notes. By 1943 the Germans were producing 500,000 banknotes a month and, although the majority fell to the allied forces as they advanced into Europe and were destroyed, for years afterwards fake pounds were causing major headaches for the Bank of England.

To counter the fraud, the Bank introduced the metal thread during the war to differentiate its issue from Germany’s, and stopped producing some of the higher denomination notes.

Reconstruction at Bretton Woods

The Bretton Woods conference in 1944 heralded the end of sterling’s predominance in international trade, and the triumph of the American dollar.

The agreement defined both the dollar and the pound as reserve currencies, a sop to British pride rather than a reflection of the truth, ignoring the UK’s very large balance of payment deficit caused by the war. That reserve status meant that other nations must accept dollars or pounds to settle debts.

But each country, including Britain, would define the value of its currency in dollars, and the U.S. would tie the value of the dollar to gold.

The world simply did not have enough gold for every currency to hold reserves. In theory there was still a link to gold to impose a discipline on the system.The Americans held their currency stable against their gold reserves in the famous Fort Knox.

But the pound was not a popular reserve currency, although the Commonwealth sterling block helped it retain some importance in currency markets. After the war, rumours swirled that sterling was to devalue, and so many countries converted their pounds to dollars.

At the same time, Britain’s trading partners in the sterling block – mostly her colonies – wanted consumer goods, which the UK could not supply. The UK was still geared for war supply.

These nations turned to the USA and dollars for their consumer necessaries, further weakening the British economy, and by 1949 sterling’s importance as a reserve currency was severely on the wane. Sir Stafford Cripps, then Chancellor of the Exchequer, accepted this uncomfortable fact, although he denied it in public.

The pound was devalued by 30 per cent on September 18 1949. The enormous postwar balance of payments deficit was just too much for the UK. Lend lease and debt due America had taken its toll. Sterling’s weakness and decline then became glaring. National banks wanted dollars not pounds.

Not a penny less: the 1967 Devaluation

Sterling’s role as a pegged reserve currency made the UK’s exports uncompetitive. Its excessive weight reduced exports and led to a manufacturing slowdown, while the US boomed. The constant seepage of reserve from pounds to dollars continued to weaken sterling.

In 1967 the Labour Prime Minister, Harold Wilson, and his Chancellor of the Exchequer, James Callaghan, devalued the currency again, this time by 14.3 per cent.

Harold Wilson made his famous “pound in your pocket” speech, in an attempt to reassure the public about their wages, but his words were cruelly twisted by the Tories and the press to mean devaluation would not entail a rise in prices. After all, life did become more expensive.

And although the 1949 devaluation had helped Britain’s exports, the same was not true in 1967. Domestic inflationary forces arose. To combat these, the government re-introduced charges on NHS prescriptions, abolished free milk in secondary schools and postponed raising the school leaving age to 16.

The welfare state took a step backwards, but long term economic decline and imbalances in the British economy rendered these measures valueless.

Overseas, the sterling currency block creaked towards lesser importance and the pound’s devaluation augured the end of the Bretton Woods system of fixed exchange rates. Dollar were more alluring – and as many thought stable.

But in 1971 President Nixon devalued the dollar – a response to damage done by the Vietnam War – and opened the gates to a new era of floating exchange. The stability of the postwar settlement was over.

War in the Middle East, high oil prices and an international recession, combined with the UK’s slow economic decline struck a hard blow. By 1975, in the face of inflation and a large scale coal miners’ strike, the UK had to apply red faced for a loan from the International Monetary Fund.

The currency snake

Meanwhile the first tentative steps towards a European currency were taking place – 1972 saw the first efforts to fix the pound to other European currencies.

At the start of the year the four major European Economic Community [EEC] currencies – sterling, the deutschemark, the French franc and the Italian lira – formed the so-called ‘snake’. The economic bloc then floated their currencies together on the markets, each country having responsibility for the stability of its currency within parameters.

The experiment failed, though, not long off the ground. Sterling dropped out after only six weeks, weaker than ever, bowing to the dictates of the markets. Currency markets were just too volatile to fix the exchange rates together without damaging the British economy.

Visiting the IMF

1976 saw the pound fall below $2 for the first time. The government approached the International Monetary Fund [IMF] to shore up sterling’s value.

The IMF loan included a ‘letter of intent’, a humiliating agreement to pursue stable economic policies, and the pound gathered some strength. By the end of 1977 the government had abandoned efforts to keep the pound within the trade weighted index.

Sterling was too strong again. Callaghan’s Labour government had to move to control the money supply.

Mrs Thatcher and monetarism

Moves to control monetary supply were in place before Mrs Thatcher came to power in 1979, but her government put much more stall on monetarism.

The dollar’s growing strength overshadowed the pound’s own rise in value in the late 1970s and early 80s. Central banks around the world intervened to prevent the dollar becoming too strong and by 1987 the dollar was at what bankers saw as the ‘correct’ value – so decided at the Louvre Accord.

Nigel Lawson was Mrs Thatcher’s Chancellor at the time. He decided to cap the pound against the deutschemark, inspired by the growing European integration. The pound would not exceed three deutschemarks.

This policy, Lawson believed, would bring Britain’s competitive and inflationary pressures into line with Germany. But Europe at the time was growing slower than the UK, a condition then known as eurosclerosis. The result was massive capital inflow to Britain. Sterling rose as investment flooded in.

Lawson had to remove his cap, but by then it was too late. Inflationary pressures had taken off; consumer spending was at very high levels and the housing market booming. To rein in these pressures interest rates went up, but the property market and consumer spending collapsed.

The UK was in recession by early 1990 and sterling on its way down again.

The Exchange Rate Mechanism and Black Wednesday

Lawson’s successor at 11 Downing Street, John Major, had had to reduce UK interest rates and so encourage the revival of the British economy. He decided to join the Exchange Rate Mechanism [ERM].

Interest rates in Europe were lower than in Britain. Sterling joined at £1 to 2.95 deutschemarks, much the same rate as Lawson’s cap, but Major was hoping for the inflation which Lawson had not wanted.

ERM rules dictated that the pound was to vary by no more than six per cent from its entry rate, three per cent either side. The idea was to reduce UK interest rates by linking them to Germany’s – at eight per cent rather than the UK’s 15 per cent.

But the deutschemark strengthened over the next two years. Germany boomed and the UK slipped further into recession. The fixed strength of sterling, maintained within the ERM’s limits, hit British exports hard, and the Major government’s desperate pleas to the Bundesbank to lower interest rates and so weaken the deutschemark went unheeded.

The Germans were unwilling to shift policy because they were suffering the inflationary consequences of incorporating East Germany. One particularly painful episode took place at the Bath meeting of European financial ministers in 1992. The UK was EU president at the time.

At the summit Norman Lamont, Major’s successor as Chancellor of the Exchequer, berated the Germans over their interest rates, lecturing anyone who would listen about the faults of Germany’s exchange rate policy.

In the meantime, George Soros, the American financier and currency speculator, decided that sterling was overvalued and gambled heavily against the pound, selling sterling for deutschemarks and British securities.

His gamble paid off. Although the Conservative government had vowed again and again that sterling would not leave the ERM, the sale of pounds on the currency market made any effort by the Bank of England to buy sterling back to strength redundant.

By this stage Soros, alongside other speculators, controlled a hedge fund of $10 billion, little less than Mr Lamont had to throw into the currency, and the Bank was running out of reserves. On 17th September 1992, a sombre Mr Lamont announced that the pound was to leave the ERM and devalue.

He shifted exchange rates up from 12 per cent to 15 per cent on that one day, but his attempts to bolster the currency came to nothing. The pound devalued and Mr Soros, rumoured to have made as much as $2 billion in his bet against sterling, was christened “the man who broke the Bank of England” by the Daily Mail.

The day was known as Black Wednesday – or White Wednesday for the UK’s growing contingent of Eurosceptics.

John Major said afterwards: “It was a disaster, a political disaster, there is no doubt about that. It was an embarrassment for the United Kingdom.”

Sterling was back on the free market.

ERM to Today

We are now just over 2 weeks since the recent vote by the British people to leave the European Union. In a vote that shocked the bookies and the financial markets this has caused Sterling to fall by over 20 cents against the US Dollar and 16 cents against the Euro since the vote.

This is great news if you’re selling Euros or US Dollars to buy Sterling but not so positive if you’re sending money to Europe for your living expenses or buying a property in the Eurozone.

The Pound has not been helped by recent comments made by Bank of England governor Mark Carney who suggested that owing to the Brexit the UK may look at cutting interest rates or increasing Quantitative Easing by another £250bn.

Both could weaken the Pound even further and the rumours out there have already caused Sterling to fall.

The Bank of England’s next meeting takes place on Thursday and if we see a monetary policy change you can expect further Sterling weakness. However, if nothing takes place we could see a brief period of Sterling strength against both the Euro and the US Dollar.

Politically the UK is in one of its most uncertain periods of modern history. Prime Minister David Cameron has already announced his resignation due to take place in October and the Tories have still not yet decided whether Teresa May or Andrea Leadsom will replace him.

Once we do know the outcome of the leadership campaign this could provide some certainty and this could help to give strength to the Pound.

However, whether it be May or Leadsom I don’t think Article 50 will be triggered for quite some time if at all.

Clearly the vote was democratic but it still needs parliament to approve the move going forward and with various members of the Leave campaign already resigning it will be difficult to see who will take on the role of leaving the European Union.

Having worked in the industry since 2003 I have never experienced such uncertainty for Sterling exchange rates and that includes the credit crunch, Scottish referendum and various general elections during this time.

Therefore, if you’re thinking about buying or selling Euros in the next few weeks or US Dollars then it may be worth looking at buying a forward contract which allows you to fix an exchange rate for the future for a small deposit.