David Marsh: Lessons of Black Wednesday-Episode that Paved the Way for Britain's EU Withdrawal

2017-09-12 IMI

This article appeared in The Bulletin September 2017 published by OMFIF. David Marsh, Managing Director of OMFIF. The story of ‘Black Wednesday’ in September 1992, when Britain was forced to withdraw sterling from the exchange rate mechanism of the European Monetary System, has repercussions which have spread over 25 years. It marked the first tremors that led eventually to the upset of last year’s referendum vote for Britain to leave the European Union. Here are 10 sets of conclusions from Six Days in September: Black Wednesday, Brexit and the making of Europe, published by OMFIF Press, explaining the sterling crisis that came to a head on 11-16 September 1992.

What happened with various efforts to join the ERM in the 1980s?

West Germany and France led a drive to create the ERM at the centre of the European Monetary System in 1978 as a ‘zone of monetary stability’ in Europe. Britain rejected ERM membership on the grounds that sterling was likely to be fixed at an uncompetitive rate. Margaret Thatcher, prime minister after 1979, repeatedly displayed strong antagonism, especially as she (correctly) saw the ERM as a forerunner to economic and monetary union in Europe, which she implacably opposed.

Why did Britain join in October 1990?

The Treasury had run out of options to bring down inflation. An economic boom with high inflation unleashed by Nigel Lawson, Thatcher’s second chancellor of the exchequer, who resigned in October 1989, prompted his successor, John Major, to consider raising interest rates beyond 15%. Major persuaded Thatcher that harnessing the power of the Deutsche Bundesbank in the ERM would allow Britain to reduce inflation and interest rates without damaging the economy.

What was the attitude of the Bank of England and Treasury?

Thatcher made entry conditional on a simultaneous cut in interest rates. The Bank of England and Treasury opposed this, but acquiesced as part of the strategy of persuading Thatcher to join. Robin Leigh-Pemberton, BoE governor, warned Thatcher Britain might have to reverse the rate cut. The move was never discussed in Cabinet; Major kept the decision secret from senior ministers. At the Cabinet meeting following the ERM announcement, Major covered up the Bank’s warnings.

Was there widespread disagreement over sterling’s entry rate?

Thatcher wanted sterling pegged at a relatively high exchange rate to bear down on inflation. Karl Otto Pohl, Bundesbank president, told the Bank of England the interest rate cut should be postponed and that the proposed central rate of DM2.95 ‘was a little too high’ Pohl smoothed over protests from other central banks, especially France, that Britain should have discussed entry terms with its European partners. The biggest disagreement was with Jacques Delors, European Commission president.

What was the role of the Bundesbank in Britain’s ERM withdrawal?

Norman Lamont, chancellor of the exchequer after Major took over as prime minister from Thatcher in November 1990, was irked by Bundesbank sniping against sterling. A joint BoE-Treasury mission to the Bundesbank on 14 September was told that sterling was 20% overvalued. ‘Unauthorised’ remarks on 15 September by Helmut Schlesinger, Bundesbank president, about how a realignment focused solely on an Italian lira devaluation should have been wider, triggered massive sterling sales, forcing the UK’s departure.

Why did leaving the ERM on Black Wednesday take such a long time?

A 1985 Treasury paper foresaw that Britain could suspend intervention obligations at a time of crisis. But, anxious to spread political responsibility for the ignominy, Major wasted valuable time on political consultations with ministerial colleagues – contrasting with the secrecy of joining in 1990. Lamont, a sceptic on the ERM, tried to leave earlier in the day on 16 September. He observed later, ‘We were bleeding to death, and all we were doing was talking.’

How much did the UK lose from the ERM debacle?

In the late evening of 16 September the Treasury’s Nigel Wicks related how ‘within a few hours, Britain’s foreign exchange reserves had been transformed from a plus of more than $20bn into a significant negative position.’ On 18 September, Treasury officials were at pains to play down to Lamont the size of the fall, preferring to tell him that the reserves were ‘severely depleted’, rather than ‘negative’. In 1993 the Treasury calculated the accounting loss from the reserves slide at £3.3bn.

How did Black Wednesday affect the economics of the UK and the rest of Europe?

After devaluations by other ERM currencies, and sterling’s and the lira’s withdrawal, the D-mark exchange rate was too high – resulting in a German recession. Outside the ERM, buoyed by a lower exchange rate, able to cut interest rates to levels consistent with British economic needs, and helped by the ERM’s anti-inflationary legacy, the UK boosted economic growth to well above that on the continent and paved the way to the Bank of England’s operational independence in 1997.

What was the political outcome?

As Stephen Wall, a close Major aide, said, ‘Black Wednesday altered the course of UK policies on Europe, and was fundamentally the end of the Major government.’ Britain’s new trajectory of semi-detachment from the European Union culminated 24 years later in the referendum vote to leave the bloc. Major and the Treasury failed to understand how the Bundesbank’s reaction to reunification would prevent extensive falls in UK interest rates, prolong the recession and hamper Britain’s ability to stay in the ERM at a relatively high exchange rate.

What was the effect on monetary union?

Disputes with the Germans in 1992-93 strengthened French determination to forge EMU. The Bundesbank was the apparent Black Wednesday victor, but its anti-EMU resistance weakened. Europe’s failure to make timely post-reunification realignments persuaded Europe’s political leaders to press on with abolishing exchange rates in 1999. Germany’s weakened ability to impose stringent conditions contributed to serious design flaws in EMU that became fully apparent after the 2008 financial crisis.

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David Marsh: Lessons of Black Wednesday-Episode that Paved the Way for Britain's EU Withdrawal

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