THE postwar instability of sterling has been produced part by the deficits of the independent sterling countries.' Until lately, these countries financed substantial import deficits from their own sterling balances and replenished their reserves without difficulty, mainly from an uninterrupted capital outflow from the United Kingdom and from enlarged export earnings during the post-Korean raw materials boom. Only recently have they faced a shortage of sterling exchange, resulting part from the reintroduction of monetary restraint the United Kingdom late I95I and early I952. The appearance of this shortage of sterling focuses attention upon the strategic role of monetary discipline, both Britain and the independent sterling countries, if the United Kingdom is to achieve for sterling a greater stability than has been attained since I945. Development of the sterling area. Before I9I4, many nations came to use sterling for financing foreign trade because of its universal acceptability. These nations tended to have close monetary and trading ties with Britain, selling much of their exports through British commercial houses; many were dependent upon the London market for capital; and virtually all major commercial banks kept balances and rediscounted bills London. With the end of hostilities I9I8, Britain tried to reestablish the international position of sterling. By I925, the pound had been restored to its prewar gold parity at the risk of internal deflation Britain. Capital lending was also resumed on a large scale, and Britain had a current-account surplus during the I920's. By I930, fact, Britain's total foreign assets were rebuilt almost to the prewar volume. although most of the new outflow had been invested within British Empire countries. Abandonment of the pound's gold parity September I93 I, and the resulting depreciation, altered sterling arrangements. Faced with the choice of following either sterling or gold, the British Commonwealth nations (except South Africa and Canada) decided to maintain stable rates with the pound. The introduction of Imperial Preference I932 strengthened the economic bonds of the Commonwealth. At the same time or shortly thereafter, a number of non-British countries were drawn into a close association with sterling by two practical facts: while prices I93I-32 were comparatively stable sterling, they continued to fall terms of gold; and the volume of Britain's imports was relatively well maintained during the depression. By the time war broke out August I939, however, most of the non-British countries had decided to loosen their ties with a pound that had fallen from $4.68 to $4.03 during the preceding twelve months. During the I930's, the sterling bloc relied upon Britain to maintain exchange stability with the nonsterling currencies. Since sterling remained freely convertible until the war, though the London price of gold was no longer fixed, foreign exchange reserves held as sterling balances could be used to obtain dollar and other currencies at the holder's option. The World War II exchange control machinery, established first Britain September I939 and then other sterling countries, converted the sterling from a loose association of nations into a grouping with a formal structure of administrative regulations as well as some unwritten conventions. Control over foreign currency transactions, introduced for the first time the United Kingdom, provided that no payment could be made in favor of a person who is resident outside the sterling area without Treasury permission.2 *The conclusions of this paper represent the personal opinions of the author and do not reflect the views of the Federal Reserve Board. The writer is indebted to Mr. Arthur B. Hersey for suggestions. 'The important independent sterling countries are Australia, New Zealand, Eire, Pakistan, India, Ceylon, and, for transactions not settled directly with the nonsterling world, the Union of South Africa. IS.R. and 0. 1940, Nos. 1254 and I256, dated July I7, 1940. Under these regulations, the sterling was defined for the first time as an administrative entity as the

M ONTHLY statistics of the sterling area's trade and payments position with Western Europe and North America indicate that a substantial volume of short-term speculation in sterling has taken place since the end of I948 and that inward as well as outward movements of capital have occurred. The pressure against sterling resulting from this speculation has been recognized as a significant factor contributing to the I949 devaluation as well as to the loss of reserves incurred in I95I-52. The short-term flows of funds into and out of sterling, which have been induced principally by the expectation of changes in exchange rates, have been of a disequilibrating character. These transactions have taken the form of leads and lags in sterling payments by merchants in connection with their normal trading operations: hence, this speculation has been effected within the framework of rigorous controls over exchange and foreign trade transactions which have blocked short-term money movements of the pre-i939 character.

N September 30, I950, the Canadian authorities suspended the fixed par value (go9. US cents) of the Canadian dollar.1 During the following twelve months, the Canadian dollar fluctuated between 94 and 96 US cents, but in November I95I it started to move upward at a rapid pace. By February I952 it had attained parity with the United States dollar. It continued to rise, reaching a peak monthly average of US $I .04I7 in September. After declining sharply in early November I952 to below US $I.02, the Canadian dollar recovered to an average of US $I.03 for the month of December. During the period from the middle of I950 to November I95I, capital imports from the United States provided the main source of strength for this currency. Since then, however, an improved trade balance has become the important factor. Had the authorities been prepared to buy United States dollars and gold freely, the appreciation of the Canadian currency might have been moderated and official holdings of foreign currencies augmented. During the recent appreciation, however, the Canadian authorities have pursued a policy of nonintervention in the foreign exchange market. Since this policy was maintained even during the third quarter of I952 when the premium exceeded 4 per cent, it would seem that the Canadian authorities have not altered their thinking about exchange rate policy since September I950. When the fixed par value for the Canadian currency was suspended in I950, the authorities announced that they would intervene only to maintain orderly market conditions. This policy was reaffirmed by Finance Minister Abbott in Parliament on February I9, I953, in these words: As I have stated before, our policy has been to allow the exchange rate to be determined by the normal play of economic forces without official intervention, except to ensure orderly conditions in the foreign exchange market. No attempt is made to reverse persistent trends, but only to smooth out excessive short-run fluctuations.2