Why Black Wednesday Still Matters – It Was the Start of Markets Telling Politicians What to Do

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John here. This post tracks some of the recent history of the Bank of England and its relationship with both the government and the EU. By providing this historical context, it shows how the stage was set for Black Wednesday, when traders were able to break the Bank. The resulting reforms determined the current structure of a number of central banks and therefore their responses to the current crisis.

By Alexis Stenfors, a former trader who is now a Reader in Economics and Finance at the University of Portsmouth. Originally published at the Conversation.

I spent Black Wednesday – the day the markets successfully bet against the power of the British government to prop up the pound sterling – on the 28th floor of Dresdner Bank’s headquarters in Frankfurt. I had just been hired as an exchange-student intern in the back office for currency options and interest rate derivatives. Though all days on the trading floor were busy, I had never seen anything like it before.

From one end of the room to the other, men in suits (there were few women) were shouting down phone lines, shouting at each other, or doing both at the same time. There were piles of feather-light trade tickets with numbers scribbled on them: 10, 50 or 100 million Deutschmarks, dollars, francs or pounds.

The excitement was over the exchange rate mechanism (ERM), the framework set up by the European Economic Community in 1979 to keep its members’ currencies in a “trading band” of similar values. If a currency threatened to breach its band, central banks had to intervene. This forerunner to the euro was designed to avoid sharp currency fluctuations and high inflation, and for years did rather well.

Eight countries initially joined: France, West Germany, Belgium, Luxembourg, Ireland, Denmark, Italy and the Netherlands. As a traditionally strong currency in a country of low and stable inflation, the West German deutschmark (DM) acted as the de facto anchor.

France even coined a new phrase for the effect of the ERM on its national currency. “Franc fort” or “strong franc” was not only a homage to the strong anchor but also a cheeky reference to Germany’s financial heartland.

Enter the British

The British famously stayed out of the ERM during the 1980s because Margaret Thatcher didn’t want monetary policy subordinated to Brussels. When she finally agreed to join in October 1990 in the dying days of her premiership, she locked in the pound at £1.00 = DM2.95 plus or minus 6%, meaning it could fluctuate between DM2.77 and DM3.13.

The nation had just entered a recession, however. With high inflation, high interest rates, high government budget deficits, a collapsing housing market and low competitiveness, traders became increasingly doubtful about the Bank of England’s ability to defend the DM2.77 floor.

To rub salt in the wounds, West German premier Helmut Kohl had generously offered a 1:1 conversion rate for East Germans converting East German marks to Deutschmarks following the German reunification in 1990. This spurred inflation in Germany, and the Bundesbank responded by raising interest rates.

The Deutschmark grew stronger as a result, making it harder for the pound and other currencies to stay in their bands. Nonetheless, Thatcher’s successor, John Major, committed to defending the pound at all costs. These were still the days when decisions on interest rates were ultimately taken by the government and not the Bank of England.

After weeks of mounting pressure, on the morning of September 16 1992, the Bank of England was forced to unexpectedly raise interest rates from 10% to 12%. Rates had been at these levels in 1988-91 to counteract a boom, but a raise was the last thing the economy needed during a recession.

Currency traders were unconvinced that raising rates would work and redoubled their bets that the band would not hold. And even when the Bank desperately announced that afternoon that it would raise interest rates to 15%, it did not revive the pound. At 7pm the game was up: Chancellor Norman Lamont announced Britain would leave the ERM.

The pound now returned to “floating”. Or more precisely, it sank like a stone, falling from above US$2 to below US$1.50 in the coming weeks. The whole event dealt a huge credibility blow to the ruling Conservatives. George Soros, a leading currency trader, reportedly made £1 billion betting against sterling.

Central Bank Independence

Black Wednesday can be placed alongside other watersheds in contemporary British-European political history such as opting out of the euro, not signing up to the Schengen area of free movement of people, and, of course, Brexit.

Yet from an economic perspective, its ramifications are arguably unique. The crisis, which also saw the Italian, Swedish and Finnish currencies coming under pressure, led to a consensus that central banks should become independent from their governments and focus on inflation and essentially nothing else.

The Bank of England officially became responsible for targeting inflation in October 1992, before being granted independence in 1997 under Tony Blair’s administration. The European Central Bank (ECB), modelled mainly on the Bundesbank, focused just on targeting inflation from its inception in 1999, and many others have followed suit.

But the true legacy of Black Wednesday is that it was the day the state fought the markets, and the markets won. Financial markets grasped power, and few have dared to challenge them since.

The New Rulers

There are, of course, other events that symbolise the rise of market-oriented thinking: Thatcher’s “big bang” deregulation of the City of London in 1986, the fall of the Berlin Wall in 1989 and arguably even Blair’s election win in 1997. But the timing of Black Wednesday was perfect. The ideological and institutional foundations for free markets had been laid.

Capital had been allowed to flow across borders. Financial innovation had ensured the markets had grown just large enough to be reckoned with. Once they struck the heart of the establishment that September in 1992, it killed off any idea that they could be tamed by democratic means.

They went on to grow ever larger and more powerful, evolving into machines that provide immediate unsentimental verdicts on the history politicians and policymakers are trying to write. It has become hopeless to fight back because the markets are deemed “right”.

Politicians instead compete to please these new rulers. Look no further than former Chancellor Rishi Sunak warning that Liz Truss’s campaign promises would see the markets losing faith in the UK economy. He may not have persuaded voters, but Truss will undoubtedly change tack if there are signs that investors are losing faith in her policies.

It has become, to paraphrase the late philosopher Mark Fisher, easier to imagine an end to the world than an end of the rule of the markets. If I had to pick one day in history to symbolise the supremacy of markets over states and democracies, Black Wednesday would be the one.

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  1. john jones

    To some of us in the UK it was also called White Wednesday – it broke the link between the £/sterling the ERM – in many ways it helped solidify UK views certainly form joining the euro & as acknowledged, likely building up scepticism to the EU as well.

  2. James Cole

    For what it’s worth, British documentarian Adam Curtis puts the moment of conquest of government by banks as 1976’s establishment of the Municipal Assistance Corporation, basically a board composed of bankers, to take over New York City’s finances after NYC defaulted on its debt.

  3. Boatwright

    George Soros has made billions betting against the cult of the “market”. One can look into our past, the middle ages, when Kings were anointed by God and lives were ordered by what seemed to those then living as the only possible world.

    Capitalism requires growth. Every day we hear news about the GDP, happy expansion or fearful recession — but growth above all. A static economy is unthinkable. Trouble is: We cannot grow to infinity and are already seeing the ecological catastrophes that result from way too many of us eating the planet.

    The Black Death, bubonic plague, ended the medieval heavenly ordered world. Melting polar ice and acidifying oceans will end ours.

  4. Revenant

    Is it really the first time the markets won? What about the devaluations of Sterling under the gold exchange standard and then under Bretton Woods? These were also victories for markets, just the market was expressed in terms of official reserves rather than the rate of a free float. The ERM precursor of the Snake for the European currencies was another arrangement that was unsustainable. There were probably various currency board arrangements that blew up earlier – certainly the franc and sterling currency areas retreated throughout the post-war period because the arrangements could not be sustained on the reserves of France or Britain.

    1. eg

      “The markets” don’t always win — there were several incidents when sovereigns didn’t merely default, but executed their moneylenders into the bargain. Sadly it’s been too long since such a felicitous outcome, but one can always hope …

  5. Revenant

    Perhaps the difference is who the market actors were? Was it the first time that currency speculators rather than commercial or multilateral banks told a government the game was up? Even the banks that broke New York had long term skin in the game….

  6. Wukchumni

    Currencies in Europe were kind of like sports teams back in the day before they amalgamated into one super team, with their values corresponding to how their individual economies were doing, but luckily none of that matters anymore to the mouse clique.

  7. Louis Fyne

    to throw out a slightly contrarian view, Black Wednesday was more about John Majors (and Thatcher) being an idiot(s).

    It was Majors (as Exchequers head) who convinced PM Thatcher to join the ERM. It was Majors who continues his pro-ERM policies when he became PM.

    If you read/watch his speeches, Majors had a messianic fervor that ERM would permanently fix the UK’s 1970’s to 1991 economic ailments.

    Fun anecdote as recounted by the people in the room….on Black Wednesday Majors and Norman Lamont didn’t have a TV or radio in the offices for most of the day. They were blissfully unaware of much of the chaos in the markets until after the 2nd rate hike someone suggested that they get a radio to listen to the market reaction

    1. Revenant

      Major (no s) was just continuing Lawson’s policy of shadowing the Dmark which had led to the post 1987 boom. I suspect ERM was Treasury groupthink….

  8. The Heretic

    How is it that England cannot defend the pound, but Hong Kong and Malaysia were able to protect their currencies and stop outflow of capitol during the East Asian crisis of 1998? (Please correct me if I’m wrong !)
    What did they do, why could they do it, especially if one considers they are much weaker economies than England?

    1. Revenant

      Apparently HK defended the currency peg by thinking the unthinkable and abandoning laissez-faire for (clutch pearls!) intervention!



      I think HK was not afraid to show the market a bazooka. The BoE has only had that kind of freedom since the global financial crisis.

    2. eg

      I can’t speak for Hong Kong, but I’m fairly certain that Malaysia exerted its sovereignty via that most reviled (by neoliberals and their plutocratic paymasters) of state authorities — capital controls.

    3. hunkerdown

      It helped that Malaysia refused IMF loans and the odious “structural adjustment” obligations attached to them.

  9. JEHR

    “Financial markets grasped power, and few have dared to challenge them since.”

    It’s difficult for me to see an abstract concept such as “financial markets” grasping anything let alone power. What exactly makes up a financial market? Is it the CEOs of the banks? Is it the billionaires? Is it the lobbyists who buy the politicians? Is it the members of “think tanks”? Maybe it is all of the above.

    Just as the “war on terrorism” is difficult to grasp, so is the grasping of power by financial markets. Maybe the phrase should be “the buying of political power by the rich,” and, if that is so, then there should be a naming of names. It is nice to know the names of politicians and also of those who have “bought” them.

  10. eg

    What the politicians are engaged in here is a form of “play stupid games, win stupid prizes” because they’ve been duped into believing the propaganda that “money grows on rich people” and that the sovereign is somehow supplicant in a topsy-turvy inversion of the actual state of affairs: the currency is a tax credit over which the government exercises a monopoly of issue.

    But with an electorate full of dupes, the silly games proceed apace. So it goes …

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