‘Black Wednesday’ – the day sterling left Europe’s exchange rate mechanism in September 1992 – happened 25 years ago, yet the issues that it raises are still confronting the world today. The documentation of the developments, together with the insights into the thinking on the issues, and the governance process – on the decision-making process and the management of their subsequent implementation – is particularly valuable for our understanding of three important areas concerning the workings of the international financial system.
The first relates to the lessons that can be drawn from the currency arrangements and the evolving dynamics of the foreign exchange market – a market that is prone to disruptions arising from forces that precipitate over adjustments and perpetual disequilibrium conditions which, in turn, have destabilising consequences for our economies.
The second set of lessons which can be drawn are those that relate to the approach to regional financial integration and the pitfalls that need to be avoided if mutually reinforcing benefits are to be gained by the countries that participate in the integration process.
The third relates to the lessons drawn for the management of financial crises.
Asia benefited immensely from the lessons of Black Wednesday, which proved useful when managing the 1997 Asian crisis.
The first important lesson was to allow exchange rates to adjust earlier rather than later. This was particularly significant for Malaysia in July 1997. The decision to allow the exchange rate to adjust avoided futile efforts to defend the currency and subsequent adjustments. It also avoided the depletion of our reserves, which would have resulted in having to adopt an International Monetary Fund programme.
The second lesson relates to the policies implemented at the time as part of the management of the crisis. This included the reliance on interest rates to stabilise the foreign exchange market. Despite the tremendous pressure by the IMF to raise interest rates (in Malaysia’s case by five percentage points), Bank Negara Malaysia resisted on grounds that it would devastate the economy.
The episode in London also provided a greater understanding of the impact of hedge funds and their ability to impact currencies. We learned, too, that policies need to be implemented based on the premise that the worst is yet to come. This was certainly the case for Malaysia, and compelled us to act pre-emptively, reducing the cost to the economy of the crisis.
Perhaps the most important lesson for Asia and, in particular, for the 10 economies that comprise the Association of Southeast Asian Nations, was the manner in which regional financial and economic integration would be realised.
In 2002, 10 years after Black Wednesday, Asean explored the possibility of an exchange rate arrangement, including a single currency. The group’s central banks initiated a comprehensive study, which gave a decisive conclusion; the Asean economies should not pursue a monetary union or single currency. Instead, regional financial integration would be pursued.
Since then, much has been achieved in Asean and greater Asia. Our motivation for pursuing regional financial integration was to facilitate the effective intermediation of funds from the region to be recycled and reinvested in the region. This would contribute towards more stable financial flows, thereby offsetting some of the destabilising flows from other parts of the world.
The intensifying globalisation of finance has prompted the world to come together to address areas of vulnerabilities associated with this trend. The last decade has seen international attention focused on regulatory reforms and financial stability. Equally important, however, is for attention to be accorded to areas associated with the international monetary system.
Changes in frameworks and institutions in the international financial system have not been commensurate with the developments brought by financial globalisation. There has also been insufficient commitment to address the fundamental flaws in the system.
The international monetary system is uneven, unanchored, and unorganised. Uneven, as the dominance of the dollar as the main global reserve currency results in the concentration of risk in the US economy; unanchored, as there is no guidepost and automatic corrective mechanism to facilitate adjustments; unorganised, in terms of the inadequate development of the global response mechanism.
An enhanced approach is needed to respond to the challenges arising from financial globalisation. The slow global response to this challenge has prompted the ‘integrationist agenda’. Yet the issue of whether this will create a more stable world financial system is one of many questions that remain unanswered.
Dr. Zeti Aziz was governor of Bank Negara Malaysia between 2000-16. She is co-chair of the board of governors of the Asia School of Business, Kuala Lumpur, and a member of the board of directors of the OMFIF Foundation, a not-for-profit body domiciled in London. This article is an extract from Dr. Zeti’s address at the launch in London on 15 September of Six Days in September – Black Wednesday, Brexit and the making of Europe, by William Keegan, David Marsh and Richard Roberts, published by OMFIF Press.