Black Wednesday was a “day of disaster” from which then Prime Minister John Major’s government would not recover.
September 16 marks the 30th anniversary of Black Wednesday, the day the pound sterling was ignominiously ejected from the European Exchange Rate Mechanism (ERM). Not all birthdays are cause for celebration, and that’s especially true for this one.
Black Wednesday was a “day of disaster” from which then Prime Minister John Major’s government would not recover. It was the latter who brought Britain into the ERM in 1990, when he was finance minister, despite the objections of Margaret Thatcher, the stubborn prime minister at that time.
Major believed that pegging the pound to the Deutschmark would solve Britain’s economic problems. It was supposed to “somehow import the credibility of German monetary policy and curb Britain’s chronic inflation. The adoption of the continent’s most efficient economic model was to boost growth.
This was obviously wishful thinking and did not magically bring Britain the investment it expected, the skilled operators or German export prowess. Moreover, as soon as the pound pegged to the Deutschemark, Germany had to face its own economic difficulties, the Federal Republic endeavoring to absorb the former East Germany.
One of these difficulties was inflation. The Bundesbank tried to bring it under control by raising interest rates, as it used to. The Bank of England (BOE, Bank of England) had no choice but to follow suit. As part of the single market program, European countries have removed the remaining capital controls. As a result, interest rates had to evolve together, because nothing prevented investors from directing their capital towards countries with high interest rates. If a country hesitated to match foreign rates, it risked capital flight and a deluge of currency sales.
Black Wednesday also marked the proximity of the referendum which was to be held immediately afterwards in France on the Treaty of Maastricht, the founding document of the euro.
The Major government had reason to hesitate. The British economy had gone into recession in 1991, and rising interest rates made the situation even worse. The weak economy has led to a weak real estate market, with prices already falling. In a country where mortgages are variable rate, the BOE rate hike has led to higher mortgage payments and further weakening of the property market. An essential part of the conservative electorate, the owners living in the well-to-do suburbs, paid the price. So you didn’t have to be a big politician to realize that there were limits to what Major could do to keep the pound indexed.
The tide turned against the British currency in September, when Major’s finance minister, Norman Lamont, and Bundesbank president, Helmut Schlesinger, clashed verbally. Finally, on September 15, Schlesinger made some remarks to the press – one could call it “revenge” – about the possibility of devaluation of currencies, including the pound. The next morning, there was a tidal wave of selling of the pound sterling.
Massive currency purchases by the BOE failed to stem the tide. The Major government raised interest rates twice, but didn’t want to go any further. That same evening, he canceled the second rate hike and Lamont announced that he was suspending the pound’s participation in the ERM. The BOE’s failure to defend the pound cost it more than £3bn ($3.5bn) – and removed the cornerstone of Major’s economic agenda.
The consequences were colossal. For Britain, it was the final abandonment of the fixed exchange rate regime to which it had been committed and recommitted since 1717. The BOE had to develop another monetary policy. In October, adopting the strategy pioneered by the Central Bank of New Zealand, it decided to target a given rate of inflation – something it has continued to do ever since, for better or for worse.
Leaving the ERM, the United Kingdom could not join the euro zone. In view of their recent and painful experience of an imported monetary policy, British officials considered this to be a positive consequence of their policy. Britain thus found itself with one foot in Europe and one foot outside. This reinforced the country’s ambivalence towards the European project – an ambivalence that would tip into rejection with the Brexit referendum in 2016.
For the other European countries, this episode highlighted the urgency of completing the construction of the euro zone. He showed that the indexation of exchange rates was fragile, and that left to itself, the Bundesbank would not adapt its policy to European needs.
Black Wednesday also marked the proximity of the referendum which was to be held immediately afterwards in France on the Treaty of Maastricht, the founding document of the euro. According to the polls, the No was to win – leading to the fall of the euro. But four days later, having seen what the alternative led to, the French voted in favor of it.
In a sense, had Major not made the ill-advised decision to introduce the pound into the ERM, the euro would not exist. As for the UK, Prime Minister Lizz Truss no doubt hopes that the 30th anniversary of Black Wednesday will not be celebrated by its repetition.
Translated from English by Patrice Horovitz
Copyright: Project Syndicate, 2022.
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