The First Financial Crisis of the Twenty-First Century?

Was Suez in 1956 the First Financial Crisis of the Twenty-First Century?

James M. Boughton

The IMF's lending to the four countries directly involved in the 1956 Suez crisis, and particularly to the United Kingdom, raised the institution's profile and established its role in helping member countries cope with international financial crises.

N THE past six years, the IMF has Turkey two years later, the accelerating responded to a series of financial crises demands of the coming century on the IMF around the world by providing and began to look daunting. I coordinating large-scale packages of financial assistance while helping the Background affected countries reform their economic In the midst of a whirl of activity, it is easy to policies. When the first of these crises forget history. Nearly forty years before the erupted in Mexico in December 1994, the pre-Christmas speculative attack on the IMF's then Managing Director, Michel Mexican peso, the IMF was drawn into its Camdessus, called it "the first financial crisis first international crisis, one that had many of the twenty-first century." His point was of the same aspects of speed and speculation that the world had changed. The world's that we recognize today as hallmarks of the capital markets were more fully integrated, globalization of financial markets. In this flows of private capital were much bigger sense, did the twenty-first century really and could move more rapidly, and problems begin in 1956? in one part of the world could now have dra- On July 26 of that year, Egypt nationalized matic effects in distant regions. To deal with the Suez Canal Company and unilaterally this new situation, the IMF would have to assumed control of the canal, displacing the respond more rapidly and more forcibly international consortium that had run it for than ever before. When that "tequila crisis" nearly a century. France, Israel, and the was followed by outbreaks across East Asia in United Kingdom almost immediately began 1997, in Russia and Brazil in 1998, and in planning a joint military action to retake

20 Finance & Development / September 2001 ©International Monetary Fund. Not for Redistribution control while seeking to win international ted itself to provide another $738 million support for a diplomatic solution. When "Up until this in credits on a stand-by basis. For Egypt, diplomacy failed, Israel invaded the Sinai point, the IMF France, and Israel, this lending was con- on October 29, and France and the United ventional balance of payments support. It Kingdom used Egypt's counterattack as an had treated the did not push the IMF into new activities, excuse to attack it by air. One week later, and was of interest primarily because of however, Britain undercut the operation current and the political circumstances that precipi- by accepting a United Nations resolution tated it. None of these three countries had for a cease-fire. On December 3, the capital accounts a convertible currency, and speculative British government announced that it financial pressures were unimportant. But would withdraw its troops over the next as essentially the IMF's lending to the United Kingdom few weeks. France and Israel also soon was cut from new cloth, and it had major withdrew, and Egypt reopened the canal separable." implications for the IMF's later role as an under its own control the following April. international crisis manager. Those impli- That this brief flare-up is universally cations stem primarily from the rescue of regarded as a crisis is primarily because of the pound sterling from a speculative the upheavals it engendered in political attack that created the first major financial relations. The economic consequences were more subtle and crisis of the postwar era. temporary and would not by themselves have constituted an international crisis. For the United Kingdom, however, Suez The threat to sterling was also a financial crisis. Throughout 1956 and 1957, the Despite the surplus in the external current account, the Bank United Kingdom had a current account surplus despite the of England faced widespread speculation, during the 1956 disruptions to its international trade, but the value of its cur- crisis, that it would have to abandon the sterling parity, rency came under speculative pressure. The Bank of England which had been set at $2.80 in 1949. Maintaining that rate was forced to deplete its U.S. dollar reserves to defend the was important for several reasons. The government viewed fixed value of the pound sterling against the dollar. Harold $2.80 as appropriate for trade purposes; it feared the infla- Macmillan (Chancellor of the Exchequer and soon to tionary consequences of having to pay expensive dollars for become Prime Minister) and Cameron Cobbold (Governor oil imports while the canal was closed; and it regarded of the Bank of England) put up a brave front in characteriz- exchange rate stability as essential for preserving both the ing the Bank's ability to stave off an attack, but by December sterling area as a preferential trade zone and sterling's the threat of a forced devaluation or float was very real. broader role as a reserve currency. Although the United These events unfolded at a time when the IMF was almost Kingdom had not yet established full external convertibility totally untested in crisis management. From its first financial (it would do so in 1958), its system of capital controls was operations in 1947 to the onset of the Suez crisis, the IMF fragmented and porous, and the pound was widely held as a had lent to member countries only sporadically and in small reserve and investment medium. Since the late 1940s, the amounts (see chart). The concept of stand-by lending sub- Bank of England had sought to maintain a minimum bal- ject to agreed policy conditions was still being developed and ance of $2 billion in official reserves. If they were to fall had been applied in only a few cases. It was not obvious that below that floor, the Bank assumed, this would be inter- the IMF should play any role at all in the resolution of the preted in financial markets as a signal that devaluation or economic or financial difficulties of the countries involved in even floating would have to be seriously considered. Suez. The United Kingdom's first line of defense to protect the Indeed, the United Kingdom did not obviously qualify for reserve floor was intervention in the form of spot purchases IMF assistance in 1956. The IMF's Articles of Agreement of sterling in the foreign exchange market. A second line of prohibit it from lending to finance a "large and sustained" defense was needed. Despite U.S. opposition to the European outflow of capital, which in essence was what the United effort to force Egypt to return control of the canal, Kingdom faced. That provision was intended to preserve the Macmillan hoped to build on the United Kingdom's and his IMF's limited financial resources for lending to promote own "special relationship" with the United States (his mother international trade in goods and services. Moreover, if the was American) to persuade Washington to help him support speculative outflow from sterling was not both large and sus- sterling. If the Americans would not provide bilateral financ- tained, the Bank of England had enough resources of its own ing, Macmillan expected to be able to count on the apolitical and enough access to credit to fend off the outflow without tradition of the IMF to permit the United Kingdom to draw IMF assistance. the modest amounts to which it was virtually entitled. More Nevertheless, the IMF was called upon to help finance the important, though with less than complete logical consis- external payments imbalances of all four combatants. In nine tency, he expected to be able to build on his country's infor- months, it lent $858 million to these countries and commit- mally accepted special status in the IMF—as one of the two

Finance & Development / September 2001 21 ©International Monetary Fund. Not for Redistribution major founding countries and the second- could cause "a run on the Monetary Fund, largest member—to draw much larger which might be as serious as a run on ster- amounts and to do so to the fullest possible ling." extent. Success would depend almost The United Kingdom faced a firm deadline entirely on U.S. support. for obtaining approval of a financial support package. On December 4, Macmillan would Seeking U.S. support have to announce that a massive loss of In late September, at the Annual Meetings reserves in November had pushed the bal- of the Boards of Governors of the IMF and ance below the $2 billion floor. Without the World Bank in Washington, Macmillan support, the parity would have to be aban- sounded out his U.S. counterpart, Treasury doned. Humphrey was on a short vacation Secretary George Humphrey, on the and would not return to Washington until prospects for U.S. assistance. Although December 3, the same day that Per Humphrey gave Macmillan no promises, the Jacobsson was to arrive for his first day as chancellor returned home confident that he the IMF's Managing Director. If the pound could count on his American friends to help was to be saved, it would have to be saved James M. Boughton, an him maintain "the strength of sterling." on December 3. Assistant Director in the Macmillan took no further action during Left with no alternative, the British cabi- IMF's Policy Development October, as the Bank of England continued net accepted the second half of the UN res- and Review Department, was to sell off its dollar reserves to maintain the olution and set a deadline of December 22 Historian of the IMF from $2.80 exchange rate and the cabinet contin- for a full troop withdrawal. Macmillan's 1992 to 2001. ued to prepare for war. Through this period, emissaries then called on Humphrey to find the Bank of England's reserves were not so out how much financial aid this capitula- much under attack as merely dripping away. Israel's invasion tion had purchased. The extent of bilateral support was still of the Sinai on October 29 and the opening of the Franco- vague but it now could be counted upon and publicly British military offensive two days later solidified U.S. and announced as forthcoming. Of more immediate concern was world opposition to this military intervention and greatly the amount of IMF credits to be put at the United Kingdom's accelerated the drain on U.K. reserves, which increased to a disposal. At the beginning of their meeting on December 3, pace that clearly constituted a speculative attack. On Humphrey continued to insist that his government could not November 2, the United Nations General Assembly over- support a large-scale support operation from the IMF. Then, whelmingly approved a U.S. resolution calling for a cease-fire quite abruptly and to the astonishment of his visitors, he and withdrawal of forces. Four days later, the British cabinet swept aside those worries and proposed that the British bowed to the relentless financial and diplomatic pressure and should draw $561 million immediately and take out a stand- agreed to a cease-fire. As subsequent events demonstrated, by arrangement for another $739 million, a massive total however, the U.S. government was insisting not just on a package of $1.3 billion (100 percent of the U.K. quota in the cease-fire, as Macmillan believed, but also on full compliance IMF). According to one British participant, Humphrey's with the UN resolution—that is, on an immediate with- stated objective "was to demonstrate beyond all doubt to the drawal of all foreign troops from Egypt. world that sterling was supported, and had resources suffi- To get the help he needed, Macmillan was forced into sup- cient to withstand any attack." plication. The U.S. government wanted the British and French troops out of Egypt, and the United Kingdom's need The outcome for financial assistance gave the Americans the perfect lever The crisis was suddenly over. When Macmillan revealed the to force an immediate withdrawal. Macmillan tried unsuc- November reserve losses in the House of Commons the next cessfully to arrange a meeting with Humphrey in late day, he was able simultaneously to announce that the United November, but he also tried to convey to him through emis- Kingdom would be making "an immediate approach" to the saries that a failure to support sterling could have cata- IMF as part of a broad effort to "fortify" reserves, although he strophic political consequences, including a triumph for was still circumspect regarding how much of the U.K. quota international communism. Such threats doubtless seemed might be available. Speculators against sterling still had a one- fanciful to Humphrey, who replied simply that the United way bet, but the odds were now pretty long against it. States would support the United Kingdom when the latter All that remained was for the IMF's Executive Board to ratify was "conforming to rather than defying the United Nations." the arrangements that had been agreed upon by the two great Even then, he warned that a drawing on the IMF of more powers. Success seemed assured, because Jacobsson shared than $561 million (the most it could draw in relation to its Humphrey's view that a $1.3 billion package was needed to quota without having to apply for a stand-by arrangement) stem speculation against the pound. On December 6, as the would be problematic. A larger drawing, Humphrey argued, Board meeting approached, Jacobsson wrote in his diary that

22 Finance & Development / September 2001 ©International Monetary Fund. Not for Redistribution "since the confidence factor played such a great role the amounts ought to be high enough to impress the market." IMF lending, 1948-99 A final roadblock still had to be cleared before the IMF could approve the operation. As noted earlier, the IMF's Articles of Agreement prohibit it from lending to finance a large and sustained capital outflow. On December 5, the U.K. Executive Director, Lord Harcourt, met with Jacobsson to discuss strategy for handling the financing request. He acknowledged that the credits would finance a capital outflow, but Jacobsson suggested (rather stretching the point) that, to the extent that these flows were in the form of "leads and lags" in payments, they were linked directly to the financing of the current account. Harcourt then made a more coherent argument: without this financing, it would be difficult for the United Kingdom to maintain progress Source: Boughtort (2000). toward establishing full convertibility of sterling for current account transactions. Up until this point, the IMF had treated the current and capital accounts as essentially separa- • In both cases, the crisis was precipitated by a clash of ble. Because the United Kingdom's role as an international policy goals between maintaining a stable exchange rate and banker made that separation impossible, this rescue opera- simultaneously establishing open markets for the currency. tion was about to break the mold. • In both cases, a rapid response was essential. The length The staff report that was circulated to the IMF's Executive of time between the onset of the attack and approval of the Directors two days later stated explicitly that financing was financial package was almost the same. needed for the capital account, not the current account. It • In both cases, the key was to post a large enough number also raised the specter of repercussions for the international to impress financial markets, convince speculators that a bet financial system if the IMF failed to act on the British against the currency could not be won, and persuade request. The Executive Board accepted this rationale and investors to keep their money in the country. The required approved the request with one abstention (Egypt). Britain size of the rescue package was determined by market psy- immediately made the drawing of $561 million to replenish chology, not economics. its reserves and announced that it had another $739 million • In neither case could the return of private sector available on stand-by. investors be assured, but in both cases it eventually emerged spontaneously. Conclusions • In both cases, the IMF's involvement was necessitated by The most obvious consequence of the IMF's involvement in the unwillingness of the United States to provide sufficient the Suez crisis is that it put the IMF on the map as an resources bilaterally, despite its acknowledged self-interest in episodic international lender. For the first time, the IMF had a successful resolution of the crisis. A large multilateral pack- played a significant role in helping countries cope with an age would have to be assembled to end the crisis, and the international crisis. Subsequently, it was called upon repeat- IMF was the institution best placed to do so. edly to deal with other shocks to the financial system, Because no one recognized these parallels in 1995, the notably the sterling crises and the gold pool crisis of the Mexican case appeared to be a much more radical departure 1960s, the oil shocks of the 1970s, the developing country from past practice than it actually was. When the IMF made debt crisis of the 1980s, and the financial crises in Mexico, an even more rapid and large-scale commitment to Korea in Russia, and Asia in the 1990s (see chart). Although the IMF the midst of the Asian crisis in 1997, it was building on a also began to lend regularly to help countries cope with the tradition that extended back not two years but more than temporary payments effects of economic imbalances, that forty. B3E ongoing activity was quite small in amount relative to the occasional spurts in lending occasioned by financial crises. This article is based on the author's paper, "Northwest of Suez: The 1956 What has been lost in most discussions of these events is Crisis and the IMF," IMF Working Paper No. 00/192 (Washington: the striking modernity of the 1956 sterling crisis and its sim- International Monetary Fund, 2000). An expanded research article by the ilarity to the Mexican and other crises of the 1990s. author on this topic will appear in IMF Staff Papers in December 2001. • What the United Kingdom faced in 1956 was almost purely a speculative attack on a stable currency against a backdrop of reasonably sound economic policies. As in the 1990s, the most pressing requirement for resolving the crisis was to stem the speculative attack.