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Ancient Greek tragedies all have the key element of the fall into disaster by their heroic protagonist. It is in that fall that the essence of tragedy lies. Black Wednesday was no different, and this all but forgotten crisis can give us perspective on how to approach incoming economic difficulties through two key lessons: consensus and reality.
Before describing what happened on that fateful September day in 1992, it’s important to set the scene. Maastricht was not yet in force, the reunification of Germany was underway, challenging as it was, and the Soviet Union was in its final days. It was almost a completely different world from the one we occupy today. And the euro was only an idea, still in swaddling clothes.
But before the euro, there was the original European Exchange Rate Mechanism (ERM), not to be confused by the present-day ERM II. Its basic principle was to bring about German-style prosperity through the stability of interest rates. National currencies such as the British pound and the Italian lira agreed to be pegged to the German deutschemark and to stay within tight margins of the Bundesbank’s interest rates.
In 1990 the British Chancellor of the Exchequer, and soon to be Prime Minister John Major, persuaded Margaret Thatcher to join the ERM at a considerably high exchange rate. There the crisis started its course towards disaster. 16th of September 1992, was the day when the British pound fell to its knees at the mercy of currency speculators, remembered in history as “Black Wednesday”.
In 1992, finance ministers were shocked to see that German inflation was rising under the immense cost of reunification. As German inflation rose, the Bundesbank decided to start to raise interest rates in the summer of 1992. Under the ERM, this meant that members’ Central Banks had to follow suit and raise their interest rates too, within tight margins set by the mechanism. But not all economies are built the same. If the UK matched the increased interest rates, that would mean calamity for its housing market.
Helmut Schlesinger, Bundesbank President from 1991-93 was adamant. There would be no reduction in interest rates, saying of the UK Chancellor of the Exchequer, Norman Lamont: “he is not my master, I must bring this exercise to an end”. Schlesinger had essentially put forward an ultimatum: either devalue the pound or increase interest rates. Both of which were, for their own reasons, unfeasible for the UK at the time. Then Schlesinger proposed the unacceptable – Germany would decrease interest rates if Italy, the UK, and others devalue their currencies in turn, and in retrospect would have made the crisis much worse had the ERM followed through. Rumours nonetheless spread that pound sterling would devalue.
Then, on Black Wednesday, the UK Government raised interest rates twice, first at 12 and then at 15 percent, desperately trying to stop the massive attack on the pound’s value by speculators such as George Soros. By the afternoon though, an ashamed Norman Lamont stood in front of the Treasury Building in London and delivered a short statement. Britain decided to leave the ERM.
The economic damage of this run on Sterling was substantial. Thirteen years after the crisis, the UK Treasury released its updated estimates on the economic damage of that fateful day to be upwards of £3.3 billion.
Almost 30 years later, this crisis has faded away into obscurity. It is a footnote of economic history compared to the sovereign debt crisis that enveloped the EU in the 2010s. Although new risks lie in the creation of the Digital Euro announced by the ECB, any currency crisis there would be unprecedented in this new age of digital transactions.
Black Wednesday brings home two key lessons for Europe now. First, that European solidarity and consensus is key to economic stability. And second, that “before you can have a strong currency you need a strong economy” as rightfully put by John Smith, the Labour Leader, the day after Black Wednesday in the House of Commons.
I fear that the first lesson was not heeded after 1992, and ignorance of it made the 2010s hellish for southern nations. Perhaps we have learnt this now though, with financial relief measures put in place to protect economies from the pandemic showing a strong EU solidarity. Although, there are rumblings inside the German Finance Ministry that a revision of the EU’s Stability and Growth Pact should still impose strict margins for national debt to GDP ratios.
As for the second lesson, if Britain’s housing market had been stronger it would have been more flexible to Germany’s changing interest rates. At the base of any currency crisis is the strength of the real economy. That is precisely why EU governments should stop wasting time giving massive subsidies to pollsters as an ashamed Sebastian Kurz did or directly subsidizing friendly newspapers and websites under, at the least, dubious pretexts as the Greek government did.
We face many concerns in the EU nowadays: the frighteningly close possibility of war with Russia and its implications for 40% of our natural gas supply, staggering inflation and rises in the cost of living, and an incoming debt crisis. Now is the precious time for policymakers to reflect on history and remember mistakes made in crises gone by. Don’t concede that autumn day in 1992 to the vague past; Black Wednesday has still much to teach us.
Sources:
https://www.theguardian.com/business/2012/sep/13/black-wednesday-20-years-pound-erm
https://www.ft.com/content/e9c65160-8c3b-11e8-b18d-0181731a0340
https://www.ft.com/content/42672fe6-9706-11e7-8c5c-c8d8fa6961bb
Kettell, Steven A Complete Disaster or a Relative Success? Reconsidering Britain's Membership of the ERM, 1990-1992 https://warwick.ac.uk/fac/soc/pais/people/kettell/research/erm.pdf
Quotes: BBC documentary ‘Black Wednesday (1997)’ - Black Wednesday (BBC 1997) - YouTube
Written by Odysseas Digbassanis in collaboration with Res Publica Politics.
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