PRINCETON – The British government’s recent announcement that a referendum on Britain’s European Union membership will be held on June 23 was quickly followed by a sharp drop in the pound’s value. Exchange rate volatility for the pound is bound to continue until the referendum, and to intensify at moments when a vote for “Brexit” looks more likely. The result may be a self-fulfilling prophecy, in which market and political instability drive British voters to reject the EU – an outcome that would be highly dangerous for them and their European counterparts alike.
The political implications recall the experience of the twentieth century, when the pound’s external value was a national obsession in the UK and currency crises regularly destroyed the credibility of governments and wreaked political havoc. For example, in August 1931 – the middle of the Great Depression – a financial crisis and a run on the pound forced the resignation of the Labour government, led by Prime Minister Ramsay MacDonald; it was replaced by a coalition government, and the Labour Party split apart.
In 1967, another Labour government, led by Harold Wilson, was damaged by a devaluation spurred by a speculative attack; Labour lost the subsequent general election. The party regained power in 1974, but within two years Britain was hit by another currency crisis – this one large enough to require support from the International Monetary Fund. Again, Labour lost the next election and the party split.
Such credibility issues were not exclusive to Labour. It was under Prime Minister John Major’s Conservative government that 1992’s “Black Wednesday” struck, with the pound being forced out of the European Exchange Rate Mechanism, the precursor to the euro. This severely damaged the government’s credibility. Although the Conservatives did manage a narrow victory in the next election, the party’s internal fissure over European integration deepened, and by the end of the 1990s, Labour was back in power (and would remain there for more than a decade).