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.
In the past six years, the IMF has responded to a series of financial crises around the world by providing and coordinating large-scale packages of financial assistance while helping the affected countries reform their economic policies. When the first of these crises erupted in Mexico in December 1994, the IMF’s then Managing Director, Michel Camdessus, called it “the first financial crisis of the twenty-first century.” His point was that the world had changed. The world’s capital markets were more fully integrated, flows of private capital were much bigger and could move more rapidly, and problems in one part of the world could now have dramatic effects in distant regions. To deal with this new situation, the IMF would have to respond more rapidly and more forcibly than ever before. When that “tequila crisis” was followed by outbreaks across East Asia in 1997, in Russia and Brazil in 1998, and in Turkey two years later, the accelerating demands of the coming century on the IMF began to look daunting.
In the midst of a whirl of activity, it is easy to forget history. Nearly forty years before the pre-Christmas speculative attack on the Mexican peso, the IMF was drawn into its first international crisis, one that had many of the same aspects of speed and speculation that we recognize today as hallmarks of the globalization of financial markets. In this sense, did the twenty-first century really begin in 1956?
On July 26 of that year, Egypt nationalized the Suez Canal Company and unilaterally assumed control of the canal, displacing the international consortium that had run it for nearly a century. France, Israel, and the United Kingdom almost immediately began planning a joint military action to retake control while seeking to win international support for a diplomatic solution. When diplomacy failed, Israel invaded the Sinai on October 29, and France and the United Kingdom used Egypt’s counterattack as an excuse to attack it by air. One week later, however, Britain undercut the operation by accepting a United Nations resolution for a cease-fire. On December 3, the British government announced that it would withdraw its troops over the next few weeks. France and Israel also soon withdrew, and Egypt reopened the canal under its own control the following April.
“Up until this point, the IMF had treated the current and capital accounts as essentially separable.”
That this brief flare-up is universally regarded as a crisis is primarily because of the upheavals it engendered in political relations. The economic consequences were more subtle and temporary and would not by themselves have constituted an international crisis. For the United Kingdom, however, Suez was also a financial crisis. Throughout 1956 and 1957, the United Kingdom had a current account surplus despite the disruptions to its international trade, but the value of its currency came under speculative pressure. The Bank of England was forced to deplete its U.S. dollar reserves to defend the fixed value of the pound sterling against the dollar. Harold Macmillan (Chancellor of the Exchequer and soon to become Prime Minister) and Cameron Cobbold (Governor of the Bank of England) put up a brave front in characterizing the Bank’s ability to stave off an attack, but by December the threat of a forced devaluation or float was very real.
These events unfolded at a time when the IMF was almost totally untested in crisis management. From its first financial operations in 1947 to the onset of the Suez crisis, the IMF had lent to member countries only sporadically and in small amounts (see chart). The concept of stand-by lending subject to agreed policy conditions was still being developed and had been applied in only a few cases. It was not obvious that the IMF should play any role at all in the resolution of the economic or financial difficulties of the countries involved in Suez.
Indeed, the United Kingdom did not obviously qualify for IMF assistance in 1956. The IMF’s Articles of Agreement prohibit it from lending to finance a “large and sustained” outflow of capital, which in essence was what the United Kingdom faced. That provision was intended to preserve the IMF’s limited financial resources for lending to promote international trade in goods and services. Moreover, if the speculative outflow from sterling was not both large and sustained, the Bank of England had enough resources of its own and enough access to credit to fend off the outflow without IMF assistance.
Nevertheless, the IMF was called upon to help finance the external payments imbalances of all four combatants. In nine months, it lent $858 million to these countries and committed itself to provide another $738 million in credits on a stand-by basis. For Egypt, France, and Israel, this lending was conventional balance of payments support. It did not push the IMF into new activities, and was of interest primarily because of the political circumstances that precipitated it. None of these three countries had a convertible currency, and speculative financial pressures were unimportant. But the IMF’s lending to the United Kingdom was cut from new cloth, and it had major implications for the IMF’s later role as an international crisis manager. Those implications stem primarily from the rescue of the pound sterling from a speculative attack that created the first major financial crisis of the postwar era.
The threat to sterling
Despite the surplus in the external current account, the Bank of England faced widespread speculation, during the 1956 crisis, that it would have to abandon the sterling parity, which had been set at $2.80 in 1949. Maintaining that rate was important for several reasons. The government viewed $2.80 as appropriate for trade purposes; it feared the inflationary consequences of having to pay expensive dollars for oil imports while the canal was closed; and it regarded exchange rate stability as essential for preserving both the sterling area as a preferential trade zone and sterling’s broader role as a reserve currency. Although the United Kingdom had not yet established full external convertibility (it would do so in 1958), its system of capital controls was fragmented and porous, and the pound was widely held as a reserve and investment medium. Since the late 1940s, the Bank of England had sought to maintain a minimum balance of $2 billion in official reserves. If they were to fall below that floor, the Bank assumed, this would be interpreted in financial markets as a signal that devaluation or even floating would have to be seriously considered.
The United Kingdom’s first line of defense to protect the reserve floor was intervention in the form of spot purchases of sterling in the foreign exchange market. A second line of defense was needed. Despite U.S. opposition to the European effort to force Egypt to return control of the canal, Macmillan hoped to build on the United Kingdom’s and his own “special relationship” with the United States (his mother was American) to persuade Washington to help him support sterling. If the Americans would not provide bilateral financing, Macmillan expected to be able to count on the apolitical tradition of the IMF to permit the United Kingdom to draw the modest amounts to which it was virtually entitled. More important, though with less than complete logical consistency, he expected to be able to build on his country’s informally accepted special status in the IMF—as one of the two major founding countries and the second-largest member—to draw much larger amounts and to do so to the fullest possible extent. Success would depend almost entirely on U.S. support.
Seeking U.S. support
In late September, at the Annual Meetings of the Boards of Governors of the IMF and the World Bank in Washington, Macmillan sounded out his U.S. counterpart, Treasury Secretary George Humphrey, on the prospects for U.S. assistance. Although Humphrey gave Macmillan no promises, the chancellor returned home confident that he could count on his American friends to help him maintain “the strength of sterling.”
Macmillan took no further action during October, as the Bank of England continued to sell off its dollar reserves to maintain the $2.80 exchange rate and the cabinet continued to prepare for war. Through this period, the Bank of England’s reserves were not so much under attack as merely dripping away. Israel’s invasion of the Sinai on October 29 and the opening of the Franco-British military offensive two days later solidified U.S. and world opposition to this military intervention and greatly accelerated the drain on U.K. reserves, which increased to a pace that clearly constituted a speculative attack. On November 2, the United Nations General Assembly overwhelmingly approved a U.S. resolution calling for a cease-fire and withdrawal of forces. Four days later, the British cabinet bowed to the relentless financial and diplomatic pressure and agreed to a cease-fire. As subsequent events demonstrated, however, the U.S. government was insisting not just on a cease-fire, as Macmillan believed, but also on full compliance with the UN resolution—that is, on an immediate withdrawal of all foreign troops from Egypt.
To get the help he needed, Macmillan was forced into supplication. The U.S. government wanted the British and French troops out of Egypt, and the United Kingdom’s need for financial assistance gave the Americans the perfect lever to force an immediate withdrawal. Macmillan tried unsuccessfully to arrange a meeting with Humphrey in late November, but he also tried to convey to him through emissaries that a failure to support sterling could have catastrophic political consequences, including a triumph for international communism. Such threats doubtless seemed fanciful to Humphrey, who replied simply that the United States would support the United Kingdom when the latter was “conforming to rather than defying the United Nations.” Even then, he warned that a drawing on the IMF of more than $561 million (the most it could draw in relation to its quota without having to apply for a stand-by arrangement) would be problematic. A larger drawing, Humphrey argued, could cause “a run on the Monetary Fund, which might be as serious as a run on sterling.”
James M. Boughton, an Assistant Director in the IMF’s Policy Development and Review Department, was Historian of the IMF from 1992 to 2001.
The United Kingdom faced a firm deadline for obtaining approval of a financial support package. On December 4, Macmillan would have to announce that a massive loss of reserves in November had pushed the balance below the $2 billion floor. Without support, the parity would have to be abandoned. Humphrey was on a short vacation and would not return to Washington until December 3, the same day that Per Jacobsson was to arrive for his first day as the IMF’s Managing Director. If the pound was to be saved, it would have to be saved on December 3.
Left with no alternative, the British cabinet accepted the second half of the UN resolution and set a deadline of December 22 for a full troop withdrawal. Macmillan’s emissaries then called on Humphrey to find out how much financial aid this capitulation had purchased. The extent of bilateral support was still vague but it now could be counted upon and publicly announced as forthcoming. Of more immediate concern was the amount of IMF credits to be put at the United Kingdom’s disposal. At the beginning of their meeting on December 3, Humphrey continued to insist that his government could not support a large-scale support operation from the IMF. Then, quite abruptly and to the astonishment of his visitors, he swept aside those worries and proposed that the British should draw $561 million immediately and take out a standby arrangement for another $739 million, a massive total package of $1.3 billion (100 percent of the U.K. quota in the IMF). According to one British participant, Humphrey’s stated objective “was to demonstrate beyond all doubt to the world that sterling was supported, and had resources sufficient to withstand any attack.”
The crisis was suddenly over. When Macmillan revealed the November reserve losses in the House of Commons the next day, he was able simultaneously to announce that the United Kingdom would be making “an immediate approach” to the IMF as part of a broad effort to “fortify” reserves, although he was still circumspect regarding how much of the U.K. quota might be available. Speculators against sterling still had a oneway bet, but the odds were now pretty long against it.
All that remained was for the IMF’s Executive Board to ratify the arrangements that had been agreed upon by the two great powers. Success seemed assured, because Jacobsson shared Humphrey’s view that a $1.3 billion package was needed to stem speculation against the pound. On December 6, as the Board meeting approached, Jacobsson wrote in his diary that “since the confidence factor played such a great role the amounts ought to be high enough to impress the market.”
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 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 separable. Because the United Kingdom’s role as an international banker made that separation impossible, this rescue operation was about to break the mold.
The staff report that was circulated to the IMF’s Executive Directors two days later stated explicitly that financing was needed for the capital account, not the current account. It also raised the specter of repercussions for the international financial system if the IMF failed to act on the British request. The Executive Board accepted this rationale and approved the request with one abstention (Egypt). Britain immediately made the drawing of $561 million to replenish its reserves and announced that it had another $739 million available on stand-by.
The most obvious consequence of the IMF’s involvement in the Suez crisis is that it put the IMF on the map as an episodic international lender. For the first time, the IMF had played a significant role in helping countries cope with an international crisis. Subsequently, it was called upon repeatedly to deal with other shocks to the financial system, notably the sterling crises and the gold pool crisis of the 1960s, the oil shocks of the 1970s, the developing country debt crisis of the 1980s, and the financial crises in Mexico, Russia, and Asia in the 1990s (see chart). Although the IMF also began to lend regularly to help countries cope with the temporary payments effects of economic imbalances, that ongoing activity was quite small in amount relative to the occasional spurts in lending occasioned by financial crises.
What has been lost in most discussions of these events is the striking modernity of the 1956 sterling crisis and its similarity to the Mexican and other crises of the 1990s.
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.
In both cases, the crisis was precipitated by a clash of policy goals between maintaining a stable exchange rate and simultaneously establishing open markets for the currency.
In both cases, a rapid response was essential. The length of time between the onset of the attack and approval of the financial package was almost the same.
In both cases, the key was to post a large enough number to impress financial markets, convince speculators that a bet against the currency could not be won, and persuade investors to keep their money in the country. The required size of the rescue package was determined by market psychology, not economics.
In neither case could the return of private sector investors be assured, but in both cases it eventually emerged spontaneously.
In both cases, the IMF’s involvement was necessitated by the unwillingness of the United States to provide sufficient resources bilaterally, despite its acknowledged self-interest in a successful resolution of the crisis. A large multilateral package would have to be assembled to end the crisis, and the IMF was the institution best placed to do so.
IMF lending, 1948–99
Source: Boughton (2000).
Because no one recognized these parallels in 1995, the Mexican case appeared to be a much more radical departure from past practice than it actually was. When the IMF made an even more rapid and large-scale commitment to Korea in the midst of the Asian crisis in 1997, it was building on a tradition that extended back not two years but more than forty.
This article is based on the author’s paper, “Northwest of Suez: The 1956 Crisis and the IMF,” IMF Working Paper No. 00/192 (Washington: International Monetary Fund, 2000). An expanded research article by the author on this topic will appear in IMF Staff Papers in December 2001.