Wikipedia

Black Wednesday

"White Wednesday" redirects here. For the online movement, seeWhite Wednesday (movement).For the shopping event, seeWhite Wednesday (shopping).For other uses, seeBlack Wednesday (disambiguation).

Black Wednesday,or the1992 sterling crisis,was a financial crisis that occurred on 16 September 1992 when theUK Governmentwas forced to withdrawsterlingfrom the (first)European Exchange Rate Mechanism (ERMI),following a failed attempt to keep itsexchange rateabove the lower limit required for ERM participation. At that time, the United Kingdom held thePresidency of the Council of the European Union.

The number of Deutschmarks which £1 could purchase from August 1992 to January 1993; Black Wednesday is marked by a solid red vertical line

The crisis damaged the credibility of thesecond Major ministryin handling of economic matters. The rulingConservative Partysuffered a landslide defeat five years later at the1997 general electionand did not return to power until2010.The rebounding of the UK economy in the years following Black Wednesday has been attributed to thedepreciationof sterling and the replacement of itscurrency trackingpolicy with aninflation targetingmonetary stability policy.[1][2]

Prelude

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Further information:Monetarism

When the ERM was set up in 1979, the United Kingdom declined to join. This was a controversial decision, as theChancellor of the Exchequer,Geoffrey Howe,was staunchly pro-European. His successor,Nigel Lawson,whilst not at all advocating afixed exchange rate system,nevertheless so admired the low inflationary record ofWest Germanyas to become, by the mid-eighties, a self-styled "exchange-rate monetarist", one viewing the sterling–Deutschmark exchange rate as at least as reliable a guide to domestic inflation – and hence to the setting of interest rates – as any of the variousM0-M3 measuresbeloved of those he labelled as "Simon Pure"monetarists. He justified this by pointing to the dependable strength of theDeutsche Markand the reliably anti-inflationary management of the Mark by theBundesbank,both of which he explained by citing the lasting impact in Germany of the disastrous hyperinflation of the inter-warWeimar Republic.Thus, although the UK had not joined the ERM, at Lawson's direction (and with Prime MinisterMargaret Thatcher's reluctant acquiescence), from early 1987 to March 1988 the Treasury followed a semi-official policy of "shadowing" the Deutsche Mark.[3]Matters came to a head in a clash between Lawson and Thatcher's economic adviserAlan Walters,when Walters claimed that the Exchange Rate Mechanism was "half baked".[4]

This led to Lawson's resignation as Chancellor; he was replaced by former Treasury Chief SecretaryJohn Majorwho, withForeign SecretaryDouglas Hurd,convinced the Cabinet to sign Britain up to the ERM in October 1990, effectively guaranteeing that the UK Government would follow an economic andmonetary policypreventing theexchange ratebetween the pound and other member currencies from fluctuating by more than 6%. On 8 October 1990, Thatcher entered the pound into the ERM atDM2.95 to £1. Hence, if the exchange rate ever neared the bottom of its permitted range, DM2.773 (€1.4178 at the DM/Euro conversion rate), the government would be obliged to intervene. In 1989, the UK had inflation three times the rate of Germany, higher interest rates at 15%, and much lower labour productivity than France and Germany, which indicated the UK's different economic state in comparison to other ERM countries.[5]

From the beginning of the 1990s, high German interest rates, set by the Bundesbank to counteract inflationary effects related to excess expenditure onGerman reunification,caused significant stress across the whole of the ERM. The UK and Italy had additional difficulties with theirdouble deficits,while the UK was also hurt by the rapid depreciation of the United States dollar – a currency in which many British exports were priced – that summer. Issues of national prestige and the commitment to a doctrine that the fi xing of exchange rates within the ERM was a pathway to a single European currency inhibited the adjustment of exchange rates. In the wake of the rejection of theMaastricht Treatyby the Danish electorate ina referendumin the spring of 1992, and an announcement that there would bea referendum in Franceas well, those ERM currencies that were trading close to the bottom of their ERM bands came under pressure from foreign exchange traders.[6]

In the months leading up to Black Wednesday, among many other currency traders,George Soroshad been building a hugeshort positionin sterling that would become immensely profitable if the currency fell below the lower band of the ERM. Soros believed the rate at which the United Kingdom was brought into the Exchange Rate Mechanism was too high, inflation was too high (triple the German rate), and British interest rates were hurting their asset prices.[7]

The currency traders act

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The UK government attempted to prop up the depreciating pound to avoid withdrawal from the monetary system the country had joined only two years earlier.John Majorauthorised the spending of billions of pounds worth of foreign currency reserves to buy up sterling being sold on the currency markets. These measures failed to prevent the pound falling below its minimum level in the ERM. The Treasury took the decision to defend sterling's position, believing that todevaluewould promote inflation.[8]

Remarks byBundesbankPresidentHelmut Schlesingertriggered the attack on the pound.[9]An interview of Schlesinger by theWall Street Journalwas reported by the German financial paperHandelsblatt.[10]Schlesinger told the journalist that "a more comprehensive realignment" of currencies would be needed, following a recent devaluation of the Italian lira.[11]On the evening of Tuesday, 15 September 1992, the headline was already circulating. Schlesinger said he thought he was speaking off the record. He later wrote that he stated a fact and this could not have triggered the crisis.[12]This remark hugely increased pressure on the pound leading to large sterling sales.[9][13]

Currency traders began a massive sell-off of pounds on Wednesday, 16 September 1992. The Exchange Rate Mechanism required theBank of Englandto accept any offers to sell pounds. However, the Bank of England only accepted orders during the trading day. When the markets opened in London the next morning, the Bank of England began their attempt to prop up their currency, as decided byNorman Lamont,thechancellor of the exchequer,andRobin Leigh-Pemberton,governor of the Bank of England.They began accepting orders of £300 million twice before 8:30 am, but to little effect.[14]The Bank of England's intervention was ineffective because traders were dumping pounds far faster. The Bank of England continued to buy, and traders continued to sell, until Lamont told Prime MinisterJohn Majorthat their pound purchasing was failing to produce results.[15]

At 10:30 am on 16 September, the British government announced an increase in thebase interest rate,from an already high 10%, to 12% to tempt speculators to buy pounds. Despite this and a promise later the same day to raise base rates again to 15%, dealers kept selling pounds, convinced that the government would not keep its promise. By 7:00 pm that evening, Lamont announced Britain would leave the ERM and rates would remain at the new level of 12%; however, on the next day the interest rate was back to 10%.[15]

It was later revealed that the decision to withdraw had been agreed at an emergency meeting during the day between Lamont, Major, foreign secretaryDouglas Hurd,president of the Board of TradeMichael Heseltine,and home secretaryKenneth Clarke(the latter three all being staunchpro-Europeansas well as senior Cabinet ministers),[16]and that the interest rate hike to 15% had only been a temporary measure to prevent a rout in the pound that afternoon.[17]

Aftermath

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Other ERM countries such as Italy, whose currencies had breached their bands during the day, returned to the system with broadened bands or with adjusted central parities.[18]

Some commentators, followingNorman Tebbit,took to referring to ERM as an "Eternal Recession Mechanism"[19]after the UK fell into recession during the early 1990s. While many people in the UK recall Black Wednesday as a national disaster that permanently affected the country's international prestige, some Conservatives claim that the forced ejection from the ERM was a "Golden Wednesday"[20]or "White Wednesday",[21]the day that paved the way for an economic revival, with the Conservatives handingTony Blair'sNew Laboura much stronger economy in 1997 than had existed in 1992[21]as the new economic policy swiftly devised in the aftermath of Black Wednesday led to re-establishment of economic growth with falling unemployment and inflation.[22]Monetary policyswitched toinflation targeting.[23][24]

TheConservative Party government's reputation for economic excellence had been damaged to the extent that the electorate was more inclined to support a claim of the opposition of the time – that the economic recovery ought to be credited to external factors, as opposed to government policies implemented by the Conservatives. The Conservatives had recently won the1992 general election,and theGallup pollfor September showed a small lead of 2.5% for the Conservative Party. By the October poll, following Black Wednesday, their share of the intended vote in the poll had plunged from 43% to 29%.[25]The Conservative government then suffered a string of by-election defeats which saw its 21-seat majority eroded by December 1996. The party's performances in local government elections were similarly dismal during this time, while Labour made huge gains.

Black Wednesday was a major factor in the Conservatives losing the 1997 general election to Labour,[citation needed]who won by a landslide under the leadership ofTony Blair.The Conservatives failed to gain significant ground at the 2001 general election under the leadership ofWilliam Hague,with Labour winning another landslide majority. The Conservatives did not take Government again untilDavid Cameronled them to victory in the 2010 general election, 13 years later. Five years later in 2015, the party won its first overall majority 23 years after its last in 1992, five months before the crisis.

George Sorosmade over £1 billion in profit byshort sellingsterling.[26]

The cost of Black Wednesday

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In 1997, theUK Treasuryestimated the cost of Black Wednesday at £3.14 billion,[27]which was revised to £3.3 billion in 2005, following documents released under theFreedom of Information Act(earlier estimates placed losses at a much higher range of £13–27 billion).[28]Trading losses in August and September made up a minority of the losses (estimated at £800 million) and the majority of the loss to the central bank arose from non-realised profits of a potentialdevaluation.Treasury papers suggested that, had the government maintained $24 billion foreign currency reserves and the pound had fallen by the same amount, the UK might have made a £2.4 billion profit on sterling's devaluation.[29][30]

See also

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Footnotes

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  1. ^McRae, Hamish (10 February 2005).How the ERM disaster turned into a triumph.The Independent.Retrieved 21 October 2019.
  2. ^Moore, Charles (3 November 2018).Bring on the next Black Wednesday.The Spectator.Retrieved 21 October 2019.
  3. ^"Not while I'm alive, he ain't – Part 4 Thatcher and Lawson".The Westminster Hour.BBC Radio 4. 15 May 2003.
  4. ^"Sir Alan Walters".The Daily Telegraph(obituary). 5 January 2009.Retrieved21 October2019.
  5. ^Bonefeld, Werner; Burnham, Peter (13 January 2006)."1990–1992: Britain and the politics of the European exchange rate mechanism".Libcom.Retrieved17 January2024.
  6. ^Aykens, Peter (April 2002)."Conflicting Authorities: States, Currency Markets and the ERM Crisis of 1992–93".Review of International Studies.28(2). Cambridge University Press:359–380.doi:10.1017/S0260210502003595.JSTOR20097797.Retrieved21 October2019.
  7. ^Mallaby, Sebastian (10 June 2010).More Money Than God: Hedge Funds and the Making of a New Elite.Penguin Press HC.ISBN9781594202551.
  8. ^Bootle, Roger (28 April 2008)."Pound fall is UK's get-out-of-jail-free card".The Daily Telegraph.London, UK. Archived fromthe originalon 1 May 2008.
  9. ^abAlain Naef (30 September 2022)."A small remark with big consequences: what sparked Black Wednesday?".Economic History Society.Retrieved26 May2024.
  10. ^James, Harold (2020).Making a Modern Central Bank: The Bank of England 1979–2003.Studies in Macroeconomic History. Cambridge: Cambridge University Press. p. 229.ISBN978-1-108-83501-5.
  11. ^Eichengreen, Barry; Naef, Alain (1 September 2022)."Imported or home grown? The 1992–3 EMS crisis".Journal of International Economics.138:103654.doi:10.1016/j.jinteco.2022.103654.ISSN0022-1996.
  12. ^Marsh, David; Keegan, William; Roberts, Richard (15 September 2017).Six Days in September: Black Wednesday, Brexit and the making of Europe.OMFIF Press.ISBN9780995563636.
  13. ^Naef, Alain (2022).An Exchange Rate History of the United Kingdom: 1945–1992.Studies in Macroeconomic History. Cambridge: Cambridge University Press.ISBN978-1-108-83999-0.
  14. ^Litterick, David (13 September 2002)."Billionaire who broke the Bank of England".The Telegraph.Retrieved16 May2014.
  15. ^abInman, Phillip (13 September 2012)."Black Wednesday 20 years on: how the day unfolded".The Guardian.Retrieved21 October2019.
  16. ^"Major's dither cost UK billions, says Lamont".The Independent.27 September 1999.Retrieved21 October2019.
  17. ^Johnston, Philip (10 September 2012)."Black Wednesday: The day that Britain went over the edge".The Daily Telegraph.Retrieved21 October2019.
  18. ^Sevilla, Christina R.Explaining the September 1992 ERM Crisis: The Maastricht Bargain and Domestic Politics in Germany, France, and Britain.Harvard University. Retrieved 21 October 2019.
  19. ^Tebbit, Norman (10 February 2005)."An electoral curse yet to be lifted".The Guardian.London, UK.Retrieved30 December2008.
  20. ^Roger Bootle(15 May 2009)."A strong-arm policy is needed to hold the pound down on the rebound".The Daily Telegraph.London, UK.Archivedfrom the original on 12 January 2022.
  21. ^abKaletsky, Anatole (9 June 2005)."The reason that Europe is having a breakdown...it's the Euro, stupid".The Times.Archived fromthe originalon 29 May 2010.Retrieved30 December2008.(subscription required)
  22. ^[1]Archived16 October 2011 at theWayback Machine
  23. ^"Inflation Targeting Has Been A Successful Monetary Policy Strategy".NBER.Retrieved31 October2016.
  24. ^"Targeting Inflation: The United Kingdom in Retrospect"(PDF).IMF.Retrieved31 October2016.
  25. ^"Gallup spreadsheet".Archived fromthe originalon 13 October 2009.Retrieved28 July2014.
  26. ^Litterick, David (13 September 2002)."Billionaire who broke the Bank of England".The Daily Telegraph.London, UK.Retrieved24 February2013.
  27. ^Dury, Hélène."Black_Wednesday"(PDF).Retrieved24 February2016.
  28. ^Tempest, Matthew (9 February 2005)."Treasury papers reveal cost of Black Wednesday".The Guardian.London, UK.Retrieved26 April2010.
  29. ^Freeman, Harold."The Cost of Black Wednesday Reconsidered"(PDF).HM Treasury.p. 4. Archived fromthe original(PDF)on 3 April 2013.Retrieved9 October2018.
  30. ^"Guide to the papers and full list of documents".HM Treasury.Archived fromthe originalon 3 April 2013.Retrieved9 October2018.

Further reading

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  • Budd, Alan. "Black Wednesday-A Re-examination of Britain's Experience in the Exchange Rate Mechanism."IEA Occasional Paper 135(2005).online
  • Bustos, Sebastian, and Martin Rotemberg. "Elasticity Pessimism: Economic Consequences of Black Wednesday." (2017).online
  • Gottschalk, Sylvia. "From black Wednesday to Brexit: Macroeconomic shocks and correlations of equity returns in France, Germany, Italy, Spain, and the United Kingdom."International Journal of Finance & Economics28.3 (2023): 2843-2873.online
  • Roberts, Richard Whitfield, William Keegan, and David Marsh.Six days in September: Black Wednesday, Brexit and the Making of Europe(OMFIF Press, 2017). ISBN 9780995563636
  • Truman, Edwin M.Economic Policy and Exchange Rate Regimes: What Have We Learned in the Ten Years since Black Wednesday?(LSE Financial Markets Group, 2002).online
  • Ward, David. "Black Wednesday 30 years on." (2022).online
  • Williams, Ben. "Black Wednesday: thirty years on." Political Insight 13.3 (2022): 22-25.online
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