Britain’s big bailout, December 15, 1976

Stephen Pickford recalls the day Denis Healey went cap in hand to the IMF

British Prime Minister James Callaghan, left, with Chancellor of the Exchequer Dennis Healey

The most potent symbol of Britain’s 1976 economic crisis was the sight of Chancellor Denis Healey turning back at the airport as the pound plummeted. The next day he announced that Britain would be applying to the IMF for a huge loan. And on December 15, 1976, he signed a Letter of Intent to the IMF, committing to significant public expenditure cuts in return for a $3.9 billion loan.

The value of sterling had fallen from $2 in March 1976 to $1.65 as the Labour Party conference began at the end of September. Jim Callaghan’s government, with a wafer-thin majority of five seats, was struggling with the perennial British post-war weaknesses: a fiscal deficit around 10 per cent of GDP, inflation that peaked at 27 per cent in 1975, and a chronic balance of payments deficit. These were compounded by the ‘sterling balances’ problem and the risk of a run on the pound.

Rising unemployment and criticisms from trades unions and Labour’s left about existing public spending cuts and a voluntary incomes policy – the Social Contract – were leading to disagreements in Cabinet. Healey’s response was to argue for a loan from the IMF to tide Britain over until North Sea oil began to flow.

Britain had already negotiated a $5.3 billion loan from G10 central banks in June but this would expire in December, and markets were becoming increasingly nervous. In fact Healey and the Treasury had already taken steps to get spending under control.

The 1975 budget had promised substantial spending cuts, and the Treasury’s control methods were improving. In retrospect these were more successful than expected, but confidence among investors was still falling. The pound fell another 2 cents in the time it took for Healey to drive from Downing Street to Heathrow.

What followed was six weeks of bitter debate in the Cabinet about the government’s economic strategy. Healey’s plan for what became economic orthodoxy under Margaret Thatcher – controlling fiscal deficits, and directing monetary policy at inflation – had a number of rivals in the Cabinet.

Some favoured import controls, others wanted to call the IMF’s bluff and risk the loan being refused. Tony Benn promoted an ‘Alternative Economic Strategy’ of nationalization and protectionism.

Callaghan’s speech to the Labour Party conference starkly presented the choices – or lack of them. ‘We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending. I tell you in all candour that that option no longer exists.’ That statement spelled the end of the Keynesian approach to demand management which governments had followed since the war.  The episode also represented a final confirmation of the UK’s relative decline in world economic affairs, and the ending of sterling’s status as a reserve currency.

The IMF negotiating team arrived in London on November 1 amid huge press interest. And while their negotiations opened, debate in Cabinet continued.

‘The UK repaid its IMF loan, North Sea oil began to flow and Labour lost the election’

Eventually, Callaghan and Healey’s views prevailed, and Britain offered significant spending cuts. But this was not the end of the negotiation – the IMF (and its major shareholders, the United States and Germany) had to agree. And the IMF was under pressure from emerging markets to be tough on industrialized countries.

In the end Britain largely got what it wanted: the Letter of Intent was agreed, and the IMF’s board signed off the deal. The loan was the largest the fund had advanced.

A further loan from the G10 to deal with sterling balances was also agreed. Sterling recovered quickly, the budget deficit fell more rapidly than expected, the UK repaid its IMF loan early, North Sea oil began to flow in 1978 – and the Labour government lost the next general election.

Britain is now embarking on another momentous negotiation, on exiting the European Union. There are some parallels with 1976 – there are sharp differences of view within Cabinet and Party about the UK’s negotiating position, with some wanting to call the other side’s bluff, and others wanting to ‘take back control’ at all costs.

There are also big differences. The Brexit negotiations will be much more complex, covering all aspects of the UK’s membership, and will go on for at least two years, not six weeks.

On the opposite side of the negotiating table will be the Commission, the 27 members of the European Council, and the European Parliament.

But in some sense the two episodes are just as momentous. Britain was forced to seek a loan from the IMF in 1976 because the government finally agreed that there was no alternative. And in 2016 the referendum has given the government no alternative.

Time alone will tell whether June 2016 also represents a chance to reverse decades of relative economic decline.