As war broke out in 1939, the trade surpluses run up by India, Egypt, Brazil and others trading primarily in sterling, were withheld by Britain. Total debt to all such creditors (excluding the US, which obtained British businesses and naval and aircraft bases in return for cash) amounted to £3.48 billion. In addition, two and an half million Indian soldiers fighting in Italy, North Africa, the Middle East and the Far East were paid salaries; when any died, their widows were to be paid pensions by the government of India, which remained uncompensated even as the war ended. All this made India (which included the future state of Pakistan) the largest Allied creditor after the US. Britain owed her £1.335 billion ($5.23 billion, which is about $59 billion today). Britain owed the next largest creditor, Egypt, £450 million. At a conservative estimate, the debt to India amounted to about a fifth of the UK gross national product, or seventeen times the annual government of India revenue at highly depressed prices.
There seemed, at first, to be a way to get such convertible currency. Harry Dexter White, the chief adviser to US treasury secretary Henry Morgenthau, framed a scheme for the purchase of these balances, in stages, by the new fund to be set up after the war, the subsequent injection of liquidity, and re-purchase.
But, as White was aware, if Britain honoured her enormous debts in this way, that might have meant a more rapid disbanding of the British occupation of Aden, Greece, Malaya and many African countries. The Royal Navy would not have had the resources to play a role of any significance, nor would Britain become a nuclear weapons state. India, Egypt, Brazil and others might have fared far better than Britain did. And, as will be become clear, London would not have become the new hub of international finance.
The celebrated economist John Maynard Keynes had been appointed by the UK government to negotiate post-war arrangements with the United States and other countries. He fiercely resisted this White Plan. He set out to make sure that the sterling balances could somehow be conjured away.
Yet after these creditor countries lost out at Bretton Woods, they drew hope from a key provision of the Anglo-American Loan Agreement. Under that treaty, the US provided a credit of $3.75 billion repayable over 50 years at 2% on the specific condition that Britain made the pound sterling convertible into any other currency for current transactions. Accordingly, the pound sterling was made convertible the July 17, 1947.
So as India negotiated the terms of these sterling balances in London over the course of August 1947, her team expected to convert their assets into dollars.
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So, as India’s representative, B.K. Nehru wound up India’s negotiations in London for the transfer of the balances he was mystified by what his British counterpart murmured to him.
“Wilfred Eady ..said to me (August 15, 1947), ‘Watch your dollars’,” Nehru has written. Nehru did not understand.
“Why should he talk about dollars when the pound had become convertible? All the sterling would become available for purchases in the dollar area, so why did he want me to watch my dollars?”
He was to find out when Britain renounced the convertibility of the pound sterling on the current account within five days of signing the agreement with India.
Britain then devalued the pound in 1949, diminishing the value of the claims of the creditor countries by thirty per cent.
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Had Britain not defaulted on convertibility, many countries would have switched to the US dollar in order to finance their imports. Thereafter the central banks of the world would have cut back on their holdings, effectively exiting from the pound sterling.
So default on convertibility was the absolute precondition in order to ensure a gradual drawdown on sterling.
This gave London the time to re-invent itself. Since so many central banks around the world were compelled to hold sterling and therefore trade as much as they could with the UK, Britain survived as an important financial centre.
The UK had found a captive export market for goods that could be exported nowhere else. India’s imports of the Ford Prefect, the Standard Vanguard, the Morris Oxford, the Indian Naval Ships Delhi and Mysore, all date from the golden age of sterling balances.
But as independent India faced acute food shortages, her stock of sterling could buy her none. She had to turn to the World Bank and IMF to make up the convertible currency she needed, and pay for imports of food courtesy the Aid India Consortium, composed of the World Bank and a group of countries that included, ironically, the UK.
