Black Wednesday
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In British politics and economics, Black Wednesday refers to 16 September 1992 when the Conservative government was forced to withdraw the pound from currency fix, the European Exchange Rate Mechanism (ERM) after they were unable to keep Sterling above its agreed lower limit when currency markets believed the policy was unsustainable. The most high profile of the currency market investors, George Soros, made over US$1 billion profit. In 1997 the UK Treasury estimated the cost of Black Wednesday at £3.4 billion.
The trading losses in August and September were estimated at £800m, but the main loss to taxpayers arose because the devaluation could have made them a profit. The papers show that if the government had maintained $24bn foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4bn profit on sterling's devaluation (Financial Times, 10 February 2005). The papers also show that the Treasury spent £27bn of reserves in propping up the pound; the Treasury calculates the ultimate loss was only £3.4bn.
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[edit] The prelude
When the ERM was set up in 1979, Britain declined to join. This was a controversial decision as the Chancellor of the Exchequer Geoffrey Howe, despite his economically dry credentials, was a convinced pro-European. His successor Nigel Lawson was also a believer in a fixed exchange rate, and although he was a mild Eurosceptic he admired the low inflationary record of West Germany, attributing it to the strength of the Deutsche Mark and the management of the Bundesbank. Thus although Britain had not joined the ERM, from early 1987 to March 1988 the Treasury followed a semi-official policy of 'shadowing' the Deutsche Mark. [1]
UK fiscal policy at the time was lax {references needed} [2]. Yet interest rates were set at relatively low rates and the risk of future inflation only appeared to be a secondary consideration in retrospect.
Matters came to a head in a clash between Margaret Thatcher's economic advisor, Alan Walters, and Lawson, when Walters claimed that the Exchange Rate Mechanism was "half baked". This led to Lawson resigning as chancellor to be replaced by his old protégé John Major, who, with Douglas Hurd, the then Foreign Secretary, pressured Margaret Thatcher to sign Britain up to the ERM in October 1990, effectively guaranteeing that the British Government would follow an economic[3] and monetary policy that would prevent the exchange rate between the pound and other member currencies from fluctuating by more than 6%. The pound entered the mechanism at DM 2.95 to the pound. Hence, if the exchange rate ever neared the bottom of its permitted range, DM 2.778, the government would be obliged to intervene. With UK inflation at three times the rate of Germany's, interest rates at 15% and the "Lawson Boom" about to bust, the conditions for joining the ERM were not favourable at that time.
From the beginning of the 1990s, high German interest rates, set by the Bundesbank to counteract inflationary effects related to excess expenditure on German reunification, caused significant stress across the whole of the ERM. The UK and Italy had additional difficulties with their double deficits. Issues of national prestige and the commitment to a doctrine that the fixing 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 the Maastricht Treaty by the Danish electorate in a referendum in the spring of 1992, those ERM currencies that were trading close to the bottom of their ERM bands came under pressure from foreign exchange traders.
[edit] The currency traders act
The UK's prime minister and chancellor tried all day to prop up a failing pound and withdrawal from the monetary system the country had joined two years prior was the last resort. Chancellor Norman Lamont raised interest rates from 10% to 12%, then to 15%, and authorised the spending of billions of pounds to buy up the sterling being frantically sold on the currency markets.
But the measures failed to prevent the pound falling lower than its minimum level in the ERM.
The Treasury took the decision to defend Sterling's position, believing that to devalue would be to promote inflation. [4] On 16 September the British government announced a rise in the base interest rate from an already high 10% to 12% in order 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 stick with its promise. By 19:00 that evening, Norman Lamont, then Chancellor, announced Britain would leave the ERM and rates would remain at the new level of 12%.
[edit] The aftermath
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. Even in this relaxed form, ERM-I proved vulnerable, and ten months later the rules were relaxed further to the point of imposing very little constraint on the domestic monetary policies of member states.
The effect of the high German interest rates, and so the high British interest rates, had been arguably to put Britain into recession as large numbers of businesses failed and the housing market crashed. In his memoirs, John Major claimed that ERM membership had had the beneficial effect of wringing inflation out of Britain's system.
The shadow chancellor, Gordon Brown, said colossal errors of judgement by the prime minister and chancellor had betrayed the British people. Liberal Democrat leader Paddy Ashdown said the government's policy had failed.
Indeed the performance of the UK economy subsequent to the events of Black Wednesday has been significantly stronger than that of the Eurozone and, despite the damage caused to the economy in the short term, many economists now use the term 'White Wednesday' to describe the day (a term originally coined by Euro-sceptics happy at the stalling of further European integration).
However, the reputation of the Conservatives for competent handling of the economy was shattered. The Conservatives had recently won the 1992 General Election, and the Gallup poll for September showed a 2.5% Conservative lead. By the October poll, following Black Wednesday, they had plunged from 43% voting intention to 29%,[5] while Labour jumped into a lead which they held more-or-less unbroken (except for several brief periods such as during the 2000 Fuel Protests) until David Cameron became leader of the Conservative Party. It took 15 years for the Conservatives to regain the 42%+ popularity that is considered the minimum necessary for a Conservative general election victory. [6] [7] Many commentators believe that the event was a key reason for the party's long-term relative unpopularity, although it is arguable that Black Wednesday would still have occurred had Labour been in power at the time.
EU economists' analysis of this event concluded that stable exchange rates are the result, not the cause, of a common approach to economic management, resulting in the Stability and Growth Pact that underpins ERM II and subsequently the euro single currency.
[edit] Footnotes
- ^ "Not while I'm alive, he ain't - Part 4 Thatcher and Lawson", The Westminster Hour, BBC Radio 4, 15 May 2003.
- ^ This is a matter of some debate. Former Prime Minister Edward Heath referred to this as a "one club golf" policy. Interest rates are a blunt instrument that affects all aspects of the economy equally. They should be supplemented by selective fiscal policies. However, to do so was contrary to the prevailing monetarist views at the time.
- ^ Contemporary comment accused John Major and Norman Lamont of repeated delay in taking the fiscal and monetary steps that were needed until after the latest of the many by-elections, thus accelerating the decline. At the time, the Bank of England was not independent and interest rates were set by the Chancellor of the Exchequer.
- ^ Bootle, Roger. "Pound fall is UK's get-out-of-jail-free card", The Daily Telegraph, 28 April 2008.
- ^ Gallup spreadsheet
- ^ Sunday Telegraph 14 October 2007: ICM poll puts Conservatives on 43%
- ^ Ipsos MORI: Voting intentions (Westminster) - all companies' polls
[edit] See also
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