Black Wednesday
Encyclopedia
In politics and economics, Black Wednesday refers to the events of 16 September 1992 when the British Conservative
Conservative Party (UK)
The Conservative Party, formally the Conservative and Unionist Party, is a centre-right political party in the United Kingdom that adheres to the philosophies of conservatism and British unionism. It is the largest political party in the UK, and is currently the largest single party in the House...

 government was forced to withdraw the pound sterling
Pound sterling
The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown Dependencies and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence...

 from the European Exchange Rate Mechanism
European Exchange Rate Mechanism
The European Exchange Rate Mechanism, ERM, was a system introduced by the European Community in March 1979, as part of the European Monetary System , to reduce exchange rate variability and achieve monetary stability in Europe, in preparation for Economic and Monetary Union and the introduction of...

 (ERM) after they were unable to keep it above its agreed lower limit. George Soros
George Soros
George Soros is a Hungarian-American business magnate, investor, philosopher, and philanthropist. He is the chairman of Soros Fund Management. Soros supports progressive-liberal causes...

, the most high profile of the currency market investors, made over US$1 billion profit by short selling sterling.

In 1997 the UK Treasury estimated the cost of Black Wednesday at £3.4 billion, with the actual cost being £3.3 billion which was revealed in 2005 under the Freedom of Information Act
Freedom of Information Act 2000
The Freedom of Information Act 2000 is an Act of Parliament of the Parliament of the United Kingdom that creates a public "right of access" to information held by public authorities. It is the implementation of freedom of information legislation in the United Kingdom on a national level...

 (FoI).

The trading losses in August and September were estimated at £800 million, but the main loss to taxpayers arose because the devaluation
Devaluation
Devaluation is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged....

 could have made them a profit. The papers show that if the government had maintained $24 billion foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4 billion profit on sterling's devaluation. Newspapers also revealed that the Treasury spent £27 billion of reserves in propping up the pound.

Prelude

When the ERM was set up in 1979, Britain declined to join. This was a controversial decision, as the Chancellor of the Exchequer
Chancellor of the Exchequer
The Chancellor of the Exchequer is the title held by the British Cabinet minister who is responsible for all economic and financial matters. Often simply called the Chancellor, the office-holder controls HM Treasury and plays a role akin to the posts of Minister of Finance or Secretary of the...

, Geoffrey Howe
Geoffrey Howe
Richard Edward Geoffrey Howe, Baron Howe of Aberavon, CH, QC, PC is a former British Conservative politician. He was Margaret Thatcher's longest-serving Cabinet minister, successively holding the posts of Chancellor of the Exchequer, Foreign Secretary, and finally Leader of the House of Commons...

, was staunchly pro-European. His successor Nigel Lawson
Nigel Lawson
Nigel Lawson, Baron Lawson of Blaby, PC , is a British Conservative politician and journalist. He was a Member of Parliament representing the constituency of Blaby from 1974–92, and served as the Chancellor of the Exchequer in the government of Margaret Thatcher from June 1983 to October 1989...

, a believer in a fixed exchange rate, admired the low inflationary record of West Germany
West Germany
West Germany is the common English, but not official, name for the Federal Republic of Germany or FRG in the period between its creation in May 1949 to German reunification on 3 October 1990....

. He attributed 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.
Matters came to a head in a clash between Lawson and Margaret Thatcher
Margaret Thatcher
Margaret Hilda Thatcher, Baroness Thatcher, was Prime Minister of the United Kingdom from 1979 to 1990...

's economic adviser Alan Walters
Alan Walters
Professor Sir Alan Arthur Walters was a British economist, best known as the former Chief Economic Adviser to Prime Minister Margaret Thatcher from 1981 to 1983 and again in 1989 after his return from the USA.- Early life :...

, 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
John Major
Sir John Major, is a British Conservative politician, who served as Prime Minister of the United Kingdom and Leader of the Conservative Party from 1990–1997...

, who, with Douglas Hurd
Douglas Hurd
Douglas Richard Hurd, Baron Hurd of Westwell, CH, CBE, PC , is a British Conservative politician and novelist, who served in the governments of Margaret Thatcher and John Major between 1979 and his retirement in 1995....

, the then Foreign Secretary, convinced the Cabinet to sign Britain up to the ERM in October 1990, effectively guaranteeing that the British Government would follow an economic and monetary policy
Monetary policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...

 that would prevent the exchange rate
Exchange rate
In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency...

 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
Lawson Boom
"Lawson Boom" is a term used to describe the macroeconomic conditions prevailing in the United Kingdom at the end of the 1980s, which were indelibly associated with the policies of Chancellor of the Exchequer Nigel Lawson....

" about to bust, the conditions for joining the ERM were not favourable at that time.

From the beginning of the 1990s, high German interest rate
Interest rate
An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for...

s, set by the Bundesbank to counteract inflationary effects related to excess expenditure on German reunification
German reunification
German reunification was the process in 1990 in which the German Democratic Republic joined the Federal Republic of Germany , and when Berlin reunited into a single city, as provided by its then Grundgesetz constitution Article 23. The start of this process is commonly referred by Germans as die...

, caused significant stress across the whole of the ERM. The UK and Italy had additional difficulties with their double deficits, while the UK was also hurt by the rapid depreciation of the US Dollar – a currency in which many British exports were priced – that summer. 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
Maastricht Treaty
The Maastricht Treaty was signed on 7 February 1992 by the members of the European Community in Maastricht, Netherlands. On 9–10 December 1991, the same city hosted the European Council which drafted the treaty...

 by the Danish electorate in a referendum in the spring of 1992, and announcement that there would be a referendum in France as well, those ERM currencies that were trading close to the bottom of their ERM bands came under pressure from foreign exchange traders.

Currency traders act

The UK's prime minister and cabinet members tried vehemently to prop up a sinking pound and withdrawal from the monetary system the country had joined two years prior was the last resort. Major raised interest rates to 10 percent 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.
On 16 September the British government announced a rise in the base interest rate from an already high 10 to 12 percent in order to tempt speculators to buy pounds. Despite this and a promise later the same day to raise base rates again to 15 percent, 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 percent (however, on the next day interest rate was back on 10%). It was later revealed that the decision to withdraw had been agreed at an emergency meeting during the day between Norman Lamont, Prime Minister John Major
John Major
Sir John Major, is a British Conservative politician, who served as Prime Minister of the United Kingdom and Leader of the Conservative Party from 1990–1997...

, Foreign Secretary Douglas Hurd
Douglas Hurd
Douglas Richard Hurd, Baron Hurd of Westwell, CH, CBE, PC , is a British Conservative politician and novelist, who served in the governments of Margaret Thatcher and John Major between 1979 and his retirement in 1995....

, President of the Board of Trade Michael Heseltine
Michael Heseltine
Michael Ray Dibdin Heseltine, Baron Heseltine, CH, PC is a British businessman, Conservative politician and patron of the Tory Reform Group. He was a Member of Parliament from 1966 to 2001 and was a prominent figure in the governments of Margaret Thatcher and John Major...

 and Home Secretary Kenneth Clarke
Kenneth Clarke
Kenneth Harry "Ken" Clarke, QC, MP is a British Conservative politician, currently Member of Parliament for Rushcliffe, Lord Chancellor and Secretary of State for Justice. He was first elected to Parliament in 1970; and appointed a minister in Edward Heath's government, in 1972, and is one of...

 (the latter three all being strong pro-Europeans as well as senior Cabinet Ministers), and that the interest rate hike to 15 percent had only been a temporary measure to prevent a rout in the pound that afternoon.

Aftermath

Other ERM countries such as Italy
Italy
Italy , officially the Italian Republic languages]] under the European Charter for Regional or Minority Languages. In each of these, Italy's official name is as follows:;;;;;;;;), is a unitary parliamentary republic in South-Central Europe. To the north it borders France, Switzerland, Austria and...

, 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 high British interest rates, had been arguably to put Britain into recession as large numbers of businesses failed and the housing market crashed. Some commentators, following Norman Tebbit
Norman Tebbit
Norman Beresford Tebbit, Baron Tebbit, CH, PC , is a British politician. A member of the Conservative Party, he served in the Cabinet from 1981 to 1987 as Secretary of State for Employment...

, took to referring to ERM as an "Eternal Recession Mechanism"
after the UK fell into recession during the early 1990s. Whilst many people in the UK recall 'Black Wednesday' as a national disaster, some conservatives claim that the forced ejection from the ERM was a "Golden Wednesday" which paved the way for an economic revival, the Conservatives handing Tony Blair's New Labour a much stronger economy in 1997 than had existed in 1992as the new economic policy swiftly devised in the aftermath of Black Wednesday led to re-establishment of economic growth with falling unemployment and inflation (the latter of which had already been falling before Black Wednesday).

The economic performance after 1992 did little to repair the reputation of the Conservatives
Conservative Party (UK)
The Conservative Party, formally the Conservative and Unionist Party, is a centre-right political party in the United Kingdom that adheres to the philosophies of conservatism and British unionism. It is the largest political party in the UK, and is currently the largest single party in the House...

. Instead, the government's image had been damaged to the extent that the electorate were more inclined to believe opposition arguments of the time – that the economic recovery ought to be credited to external factors, as opposed to good government policies. The Conservatives had recently won the 1992 general election
United Kingdom general election, 1992
The United Kingdom general election of 1992 was held on 9 April 1992, and was the fourth consecutive victory for the Conservative Party. This election result was one of the biggest surprises in 20th Century politics, as polling leading up to the day of the election showed Labour under leader Neil...

, and the Gallup poll for September showed a 2.5% Conservative lead. By the October poll, following Black Wednesday, their share of the intended vote in the poll had plunged from 43% to 29%, while Labour jumped into a lead which they held almost continuously (except for several brief periods such as during the 2000 Fuel Protests
UK fuel protests
The fuel protests in the United Kingdom were a series of campaigns held in the United Kingdom over the cost of petrol and diesel for road vehicle use. There have been three notable campaigns amongst many other protests in the 21st century. The first protest in 2000 was primarily led by lorry...

) for the next 14 years, during which time they won three consecutive general elections under the leadership of Tony Blair
Tony Blair
Anthony Charles Lynton Blair is a former British Labour Party politician who served as the Prime Minister of the United Kingdom from 2 May 1997 to 27 June 2007. He was the Member of Parliament for Sedgefield from 1983 to 2007 and Leader of the Labour Party from 1994 to 2007...

 (who became party leader in 1994 following the death of his predecessor John Smith).

See also

  • Sale of UK gold reserves, 1999-2002
  • Monetary policy of Sweden – 1992
  • Impossible trinity
    Impossible trinity
    The Impossible Trinity is a trilemma in international economics suggesting it is impossible to have all three of the following at the same time:...


External links

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