(Source: Bank of England. Bank rate is the interest rate charged to commercial banks that influences the interest rates those banks offer to their customers)
Black Wednesday and Germany’s central bank
Germany’s central bank, Deutsche Bundesbank, played a significant role in Black Wednesday. As stated earlier, those countries with the strongest currencies were supposed to help support the weaker ones to bring stability to all those under the ERM. But instead of selling the Deutsche Mark and buying the pound, the central bank sowed seeds of mischief and shut the vault.
As the former chief dealer of the BoE Jim Trott described, the Bundesbank was the ‘cavalry’ that never arrived. ‘We kept on looking over the hill, but there was no dust and there no hats and no sabres’, he said in the years following the crisis. In the end, not only did the cavalry fail to turn up but they aided the enemy by fuelling reports that the Bundesbank believed the pound needed to be devalued and therefore spending taxpayers’ money on purchasing the pound was pointless.
With little belief behind the UK’s ability to manage monetary policy and the confirmation that no rescue was on its way the markets began to take advantage. The pound kept falling and the BoE’s spending spree meant there was a big buyer to provide liquidity. The BoE ended up buying more sterling on Black Wednesday than it ever has before – up to £2 billion per hour – and the rate was lower with virtually every purchase.
What was George Soros’s role on Black Wednesday?
‘Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected,’ – George Soros.
George Soros, the world-renowned billionaire investor, made his name on Black Wednesday by betting against the pound and making a staggering £1 billion. It was a brave move based on a sharp approach. Soros had actually backed the pound to the tune of £1.2 billion only one month before Black Wednesday, but quickly reversed his position as the sell-off started and the devaluation began.
Through his Quantum Fund, Soros instructed his team to borrow UK gilts and sell them before repurchasing them later on at a lower price. Much like the BoE lost more money with every transaction, Soros and his team were turning a profit with each trade. Reports suggest he eventually built up a short position worth £10 billion on Black Wednesday.
All in all, Soros made £1 billion profit by betting against the pound and the BoE, engraving his name in the history books forever.
What happened to Britain and Europe after Black Wednesday?
The UK’s withdrawal of the pound from the ERM only caused sterling to suffer further and threatened to bring down the entire European project. Europe’s monetary policy committee tried its best to keep the system intact and even sought to capitalise on the UK’s withdrawal by proposing a broader realignment with the possibility that those with weaker currencies, like Spain and Portugal, could be forced out along with the UK.
Initial estimates suggested the BoE had spent anywhere between £13 billion-£27 billion on buying the faltering pound on Black Wednesday, but it was not until 13 years later that the true sum was revealed at just £3.3 billion. This was, according to declassified Treasury papers, because the BoE committed to buying foreign exchange over the following six months so to avoid an immediate hit to country’s reserves.
The ERM eventually unraveled by the end of the decade with nothing to immediately replace it, before being revived under ERM II in 1999, which allowed currencies to trade within a much wider range of 15% within the central rate applied against the euro (for non-euro currencies like the Danish krone). The introduction of the euro, however, slowly eroded the need for a system like ERM.
After Black Wednesday, Major’s government had years to go until it had to call a general election but the event pencilled in a Labour government years beforehand as trust in the government’s ability to manage the economy diminished. A year after Tony Blair swept to success in 1997 his government introduced a crucial policy that gave the BoE the independence that it had long argued for, separating political problems from monetary policy.
Black Wednesday or Bright Wednesday?
The upfront costs of Black Wednesday are evident but the longer-term outcomes are still debated to this day. The pound’s exit from the ERM caused further devaluation as the effect rippled through financial markets around the world.
After the UK markets closed on Black Wednesday the sell-off continued as traders in New York picked up the baton before passing it on to traders in Tokyo who followed their lead to provide sterling with another hammering.
However, there is strong evidence that Black Wednesday brought benefits. Interest rates were gradually cut to 7% and this, combined with the devaluation, helped lower inflation to spur an economic recovery through 1993 and 1994.
According to the Institute of Economic Affairs, the Treasury estimated the output gap in 1993 (the difference between actual and potential output) was around 4% of gross domestic product (GDP) and didn’t close until 1997. Although this helped to bring down inflation, it also held the UK economy back for five years.
Norman Lamont, who took over Major’s role as chancellor when he took the top job, has long held his position that withdrawing from the ERM had achieved the government’s goal: ‘we joined to get inflation down and…succeeded in that’, he said in 2011. Lamont also claimed other members of the ERM had suffered ‘similar losses’. A year later, Major himself claimed there are ‘more myths about Black Wednesday than the Greeks ever created’.
