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A Sterling balance, broadly speaking, is simply a holding of the pound sterling, in either cash or sterling denominated securities (e.g. gilts). These are held either by countries as a part of their Foreign-exchange reserves, or by private bodies that need to use the currency in international trade.

In the context of economic history, the issue of the Sterling Balances or simply the Sterling Balances refers to a specific sitation that arose in the international monetary system between the end of the Second World War and the late 1970s, where the global system of fixed exchange rates, an overvaluation of the pound sterling and the existance of significant balances of sterling held by overseas governments, coupled with the war-induced decline and post-war underperformance of the British economy, made these balances not only a destabilising influence on the British but also on the global economy. The issue was a defining aspect of the final phase of sterling's role as a world currency after the War.

Background to the balances
From 1821 onwards

Pound sterling
In the 19th century, Britain led the world in taking advantage of the industrial revolution, and with France defeated at Waterloo it became the pre-eminent world industrial and imperial power whose currency the pound sterling was adopted as the prime currency for world trade. Although in the 20th century Britain's position was weakened by the economic cost of fighting two world wars, sterling played a significant although steadily decreasing role as a world currency until well after World War 2.

The rise of sterling
After the disruption of the Napoleonic wars, Britain's Great Recoinage of 1816 and then the Bank Charter Act 1844 cemented the pound as a gold standard currency. Sterling was fixed to gold at the pre-decimal equivalent of £4.24 per troy ounce, either through the gold content of the Sovereign coin, or through banknotes fully convertible into gold at the Bank of England in London.

As an island nation, Britain's military expenditure was usually focused on its navy rather than in the maintenance of large standing armies that the continental European powers felt obliged to do. This natural overseas focus and her industrial and technological might gave Brtiain the impetus and also the military power to build the largest empire in the world, an empire founded on trade. This led to the ready availability of sterling in much of the world.

To back up this trade, the City of London developed from being a major port and mercantile centre through which physical goods were traded, into a sophisticated centre of services in support of global trade: deep capital markets plus shipping, insurance and banking services focused on the needs of global merchants, not necessarily requiring them to land goods in London.

As a stable, liquid proxy for gold, sterling had the right foundations; the depth and sophistication of services supporting merchants available in London (and therefore utilising sterling) made it the natural currency for global trade. This caused it to be pre-eminent world currency for many decades.

The decline of sterling
At the outbreak of World War 1 Britain joined many of the other European belligerent countries in suspending convertibility to gold as a war-time measure to protect the national reserves, which was a de facto abandoning of the gold standard. The cost of fighting the war caused Britain to massively expand its money supply and run up large external debts (from being a significant net external creditor before the war). After the war, economic orthodoxy led many of the gold standard countries (Britain amongst them) to attempt to regain the pre-war gold standard. This required significant deflation. The USA, by now the biggest economy in the world, gained in strength during the war from supplying goods and material to the belligerent powers before joining itself in 1917, which led to the start of the rise of the US dollar in world trade at the expense of sterling. The fact that while this was being attempted the Great Depression occurred made this job much harder, as countries were attempting to deflate into a major economic recession. Because of this, Britain was one of the first of the victorious powers to abandon the gold standard in 1931, floating the pound but defending the Empire and Commonwealth economy behind a tariff wall policy of Imperial Preference and instigating the Sterling Area to protect the international position of the pound. This was the position that prevaled up to the outbreak of World War Two