Black Wednesday
September 16, 1992 is widely known as Black Wednesday. On this day, British government withdrew its currency from the European Exchange Rate Mechanism, (ERM). This system tried the value of the pound and other currencies against the German mark. ERM later became a precursor in the adoption of a common currency for the European Union, the Euro. It was estimated the led to massive losses accumulating to £3.14 billion. UK had to withdraw the pound sterling after it failed to maintain the pound above its agreed lower ceiling in the ERM. The day is also associated with George Soros for breaking the Bank of England. Soros reportedly made a $1 billion that Wednesday, stamping his reputation as one of the shrewd forex traders to live ever on the planet.
Background of Black Wednesday
In 1979, during the formation of the ERM, the United Kingdom declined to join the system, a controversial move that many people did not anticipate. Nigel Lawson, a chancellor supported a fixed exchange rate and admired the manner in which Germany was managing its low inflationary numbers, owing to a strong Deutsche Mark and proper management of the Bundesbank. As a result, the Treasury implemented a semi-formal policy, which was to Shadow the Deutsche Mark.
In the years before Black Wednesday, Britain witnessed a range of clashes among leaders as pressure on the currency mounted. This pressure hit sky levels when Alan Walters, Margaret Thatcher’s economic advisor and Lawson clashed. During the showdown, Walters argued that the ERM was half-baked, forcing Lawson to step aside as chancellor. Following his resignation, John Major took over.
High German interest rates
John Major and Douglas Hurd, who was serving as the Foreign Secretary mounted pressure on Thatcher to allow Britain to join ERM in October 1990. This was on the basis that the system would prevent fluctuation of exchange rate between the pound and other currencies. From early1990, soaring German interest rate led to massive economic stress across ERM. There was inhibition of exchange rates ERM was a perceived pathway towards having a single currency. After the rejection of the Maastricht Treaty in the spring of 1992, ERM currencies that oscillated close to the bottom of their bands came under forex pressure, steered by Soros.
After France backed the Maastricht Treaty, pressure concentrated on the pound and the Italian lira. In order to lure speculators into buying the pounds, the government raised base rate from 10% to 12%. However, even with the promise of raising it higher to 15%, dealers sold out pounds. Norman Lamont, then Chancellor announced British exit from ERM to allow rates to go back to 10%. The impact of Black Wednesday was huge as large businesses collapsed and the housing market dived.
Life after Black Wednesday
After UK’s exit from ERM, several things happened, which later shaped the political scene in Britain. More than two decades later, the effects of the momentous decision are still alive. In some analysis, ERM withdrawal made Tony Blair Prime Minister, led to the establishment of a monetary policy and Britain would have been part of a single currency.
Today, from the lessons of 1992, Britain remains cautious against hitching itself on external monetary systems. Supporters and those opposing the Euro agree that ERM was not the best for UK even though they do not have consensus on an appropriate route for Britain. As UK walked out of ERM, other members like Italy returned to the system with wide bands after their currencies breached ERM bands.
Another effect of Black Wednesday was British economic recession of the early 90s. This stemmed from German’s high interest rates against UK’s high interest rates. What followed were collapse of businesses and the plunging of the housing market. While many people in Britain recall the exit as a black day, conservatives saw it as a Golden Wednesday that birthed Britain’s economic revival, consequently guaranteeing a stronger economy for Tony Blair’s New Labor Party. With all its effects, ERM withdrawal was a lesson for politicians against pushing unfeasible economic policies to avoid the influence of financial markets. Major led his camp to dig their graves.
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References:
http://www.fact-index.com/b/bl/black_wednesday.html
http://www.telegraph.co.uk/finance/currency/9533474/Black-Wednesday-The-day-that-Britain-went-over-the-edge.html
http://www.theguardian.com/business/2012/sep/13/black-wednesday-bad-day-conservatives