Black Wednesday and the Bundesbank
by Helmut Schelsinger
Tue 12 Sep 2017
Britain's departure from the exchange rate mechanism of the European Monetary System on Wednesday 16 September 1992 had important consequences. Some might see this as beginning the UK's separation from European Union membership.
Many countries in the ERM system of fixed exchange rates with relatively narrow bands underestimated the system's weaknesses, particularly its vulnerability to speculative attacks. A speculator acting on the expectation of a member country's devaluation could expect high profits from a devaluation, but practically no risk if it didn't arise. During her visit to Germany shortly after 'Black Wednesday', Queen Elizabeth asked me, 'Is the speculation really so strong?' My modest answer, was: 'In this system (the EMS) the possibilities of profit are very high and the risks are negligible.'
A sizeable number of experts considered that the pound entered the ERM 1990 at too high a rate. Yet a thorough, open discussion about this among the partner countries did not take place. One form of defence against currency depreciation, often with only a limited impact, consists of changing interest rate differentials between the 'weak' and the 'strong' currency. Inevitably there were loud calls in 1992 for the Bundesbank to cut rates. But the politically justified, rapid unification of the two differently structured parts of Germany in 1990 had led to strong monetary tensions, in particular, accelerating inflation. The Bundesbank had to fight this with high interest rates, even though the economic situation in some EMS countries demanded lower rates.
To resolve such tensions, the rules of the monetary system provided for the possibility of exchange rate adjustments. Under the fixed rate Bretton Woods system up to 1973, Germany had learned the difficulties of carrying out such parity changes. In the days leading up to Black Wednesday, with the Bundesbank forced into obligatory intervention to support individual currencies, especially the lira, the Bundesbank asked the German government to pave the way for an ERM realignment. According to the ERM rules, this should have led to a meeting of the European Monetary Committee, but only bilateral telephone conversations took place. Later information showed Britain did not know of the German initiative. So, initially, nothing happened apart from the devaluation of the Italian lira.
Later in September 1992, speculation escalated towards more devaluations. For the pound, the tension was defused only with the UK government's decision to leave the ERM. I regret to this day – without being really able to assess the effect – that a general remark by myself, not focused especially on the pound, should have played a role in aggravating sterling's position. George Soros, the most powerful speculator at the time, had already geared himself to the pound's depreciation.
The ERM currency system with narrow bands failed as a result of its over-ambitious construction. This became clear when the French franc came under pressure in summer 1993. it was decided to widen the bands, to plus/minus 15%. This eliminated the incentive for risk-free speculation on parity changes. The ERM functioned without tensions until the introduction of the single currency in 1999.
Political clashes over exchange rates change are nothing new. In the case of the UK, the decision to reject the devaluation foreseen under ERM rules and leave the EMS reversed the loss of Britain's national autonomy associated with ERM membership. The long-standing member countries of the European Community, on the other hand, had already gained years of experience of co-operation, involving self-imposed constraints on their freedom of action. Since the creation of economic and monetary union in 1999, these limitations have become still more pronounced.
The single currency by no means ended economic tensions. After the outbreak of the global financial crisis in 2007-08, divergences increased again. As exchange rate changes were no longer available, financial and monetary policy instruments were used to promote internal adjustment. This generated some severe domestic political tensions in the countries concerned, as well as sporadic turbulence in relationships between member states.
Despite this, these countries and ultimately their citizens now appear to be in an advanced state of integration. And the practical difficulties now facing Britain's EU exit offer other member states little encouragement to follow the same path.
Helmut Schlesinger was Bundesbank president in 1991-93. This article is an edited version of Schlesinger's foreword to Six Days in September: Black Wednesday, Brexit and the making of Europe, by William Keegan, David Marsh and Richard Roberts, published on 15 September by OMFIF Press. On 15 September 1992 Schlesinger gave an interview to Handelsblatt and the Wall Street Journal. An 'unauthorised' version of Schlesinger's comments, sent by Handelsblatt to news agencies on the evening of 15 September, stated that an ERM realignment on 13 September had not gone far enough – leading to pressure on the pound that precipitated Britain's ERM withdrawal on 16 September.
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