In the 1950s the sterling area (35 countries and colonies pegged to sterling and holding primarily sterling reserves) accounted for half of world trade and sterling accounted for over half of world foreign exchange reserves. In the early post-war years, this share was even higher – the IMF estimated that official sterling reserves, excluding those held by colonies, were four times the value of official USD reserves and that by 1947 sterling accounted for about 87% of global foreign exchange reserves.2 It took ten years after the end of the war (and a 30% devaluation of the pound) before the share of USD reserves exceeded that of sterling. This rather contradicts Chinn and Frankel’s assertion that ‘by 1945 the dethroning [of sterling] was complete’. Figure 1 shows the changing composition of foreign exchange reserves from 1950 to 1982.
How do we explain the gradual nature of the decline of sterling, what Paul Krugman refers to as a ‘surprising persistence’? Was this due to British government efforts to prolong sterling’s role because it increased the capacity to borrow, because it enhanced Britain’s international prestige, or because it supported London as a centre for lucrative international finance? These are the traditional explanations in the literature, but archival evidence shows that from the 1950s many British ministers and officials believed that the burdens of sterling’s role in terms of cost of borrowing and confidence in the exchange rate outweighed the benefits of issuing an international currency (greater demand for national debt).
You can download the paper here.