The ‘first Brexit’ was, plausibly, Britain’s ‘Black Wednesday’ withdrawal from Europe’s exchange rate mechanism – the forerunner of economic and monetary union – on 16 September 1992. There had been antecedents. Some might date the first schism with Europe to the departure of Roman legions in 400AD or Henry VIII’s 1530s break with the Church of Rome. There may be parallels, too, with the retreat of the British Expeditionary Force from Dunkirk in 1940. Yet, through whatever lens it is viewed, the chronicle of Britain’s entanglement with the ERM represents a major landmark in the UK’s European history.
Having advanced separately alongside the creation of European institutions and the march of economic integration in the 1950s and 1960s, Britain, by entering the European Community in 1973, established significant convergence with the continent. However, sterling and the British economy thereafter developed on a semi-detached path. By joining the ERM in October 1990 Britain had, seemingly, become a full European participant. Then came the traumatic exit – a reversion to the UK’s traditional distance from Europe. The experience of 16 September contributed to the discredit and later electoral defeat of Prime Minister John Major and to the Labour government’s reluctance to join the euro when Tony Blair took power in 1997. A logical next step was the June 2016 referendum rejection of EU membership, marking a return to the separation of the 1950s and 1960s.
In 1990 Britain signed up to a central element of western European unity just at the time when it was changing force and character in a way that no one – certainly not the British with their island ways – could recognise. With the fall of the Berlin wall and the dissolution of the Soviet empire, the circumstances that had drawn western Europe together after 1945 began to lose traction. Europe’s political leaders (principally Germany’s Helmut Kohl and France’s François Mitterrand) believed transforming the Bundesbank-dominated ERM into EMU was an essential instrument both to complete European integration and to guard against German hegemony. The UK, however, joined in a bid to stabilise the economy because of the abject failure of the Thatcher government’s flagship counter-inflation policy, namely monetarism. So the ignominy of joining the mechanism and its subsequently mishandling fell to the Conservative party.
Intermingled with these developments were three tragic British miscalculations. The first was to underestimate how the EMU goal of a permanent currency merger was already a powerful influence over the ERM’s operation. In the decisive months of July-September 1992, Britain was unable to use the flexibility in running the ERM that the UK government had believed was one of its prime tenets.
Second, Britain failed to appreciate how Germany’s reunification-induced economic overheating and the Bundesbank’s associated desire to raise German interest rates would necessarily counter Britain’s overriding objective of easing the credit squeeze in line with success in defeating inflation. The result of this conflict could only be an increased threat of a political and economic upheaval.
Third, Major wholly overestimated his ability to influence German monetary policies. Even set against past standards of other inept British attempts at European diplomacy over the decades, Major’s three fruitless letters on interest rates to Kohl in July-August 1992, a bid to apply pressure on the Bundesbank via the German chancellor, stand out as prime examples of haplessness.
France, Britain and Italy would have had a better chance of prevailing against the Bundesbank had they possessed the strategic insight to join forces in 1991, soon after reunification, in seeking a German revaluation. This would have pre-empted the exchange rate pressures that erupted in 1992. As it is, the build-up of European pleas for German interest rate cuts came when the issue of a possible currency realignment had already become hopelessly intermingled with France’s September 1992 Maastricht referendum. These late, desperate efforts to break through the monetary impasse were doomed to failure.
David Marsh is Managing Director of OMFIF.