In the weeks following Wednesday 16 September 1992, the Pound crashed 25% against the US Dollar. Dubbed ‘Black Wednesday’ or the ‘Sterling Crisis’, the chaotic events of that day would have a lasting impact on Britain’s economy, politics and relationship with Europe. But despite this fact, the causes and effects of the 1992 Sterling Crisis are still not widely understood among the general public today. 

In 1979 the European Economic Community, predecessor to the European Union, adopted the European Exchange Rate Mechanism (ERM). Intended to reduce fluctuations in exchange rates between European currencies, the ERM would simplify trade and prepare the continent for the adoption of a common currency. To do this the ERM instituted a new European Currency Unit (ECU), a unit of account composed of a basket of member-country currencies. Out of this basket Germany’s Deutsche Mark contributed the most to the ECU’s overall value, carrying around one-third of its weight. Each participating country would commit to keeping their currencies within a set exchange rate band against the ECU. Eventually, it was hoped, the various currencies of Europe would settle into fixed ratios, allowing a smooth transition into what would become the Euro. 

Britain initially declined to join the ERM, but by the late 1980s, under Chancellor Nigel Lawson, the UK had adopted an unofficial policy of shadowing the Pound against the Deutsche Mark due to its reliably low inflation. When Lawson was succeeded by the pro-European Chancellor John Major, the cabinet convinced Prime Minister Margaret Thatcher to join the scheme in 1990, to reduce inflation and signal Britain’s commitment to the European integration process.

Immediately, Britain’s involvement in the ERM raised serious economic issues. The UK joined the scheme at the high exchange rate of 2.95 Marks per Pound. Britain’s economy at the time was far less competitive than Germany’s, as it imported more German goods and services than it exported in return. This created a constant net outflow of Pounds to Marks, creating downward pressure on the value of the Pound and upwards pressure on the value of the Mark. To keep Britain within its exchange rate band against the ECU the Bank of England was forced to hike interest rates into the double-digits to encourage people to buy the Pound on international markets. Higher interest rates reduced borrowing and investment, negatively impacting the growth of the British economy. A strong Pound also hurt the UK’s export market as British goods and services became more expensive.

The situation deteriorated further after German reunification in 1990. East Germany’s economy was far less developed than the West’s, after four decades under a totalitarian Communist regime. As such, the German government embarked on a massive public spending campaign to invest in the East and integrate it into the new country. This caused German inflation to rise, with interest rates following suit, ultimately resulting in further upward pressure on the value of the Deutsche Mark. This made it even harder for Britain to keep the Pound in the mandated exchange bracket against the ECU, as further interest rate hikes would cause critical damage to economic growth in the midst of a recession. 

To stay in the ERM the British government had to keep Sterling at an exchange rate above 2.70 Marks per Pound. But even as this became more and more difficult, John Major, who had become Prime Minister in November 1990, was politically unwilling to devalue the Pound and negotiate a lower exchange rate bracket against the ECU. This would have been the obvious solution, allowing interest rates to fall and making British exports more competitive. However, to do so would mean conceding that Britain’s economy was being uncompetitive – a move which carried an immense political and personal stigma for John Major. Back when Britain was part of the Bretton Woods system, with the Pound pegged to the Dollar, Prime Minister Harold Wilson’s decision to devalue in 1967 had contributed to his 1970 electoral defeat. Facing an election of his own in April 1992, Major signed the Maastricht Treaty to facilitate an “ever closer union” of European countries, which marked the transition from the European Economic Community to the European Union. Any talk of devaluation was shut-down by the Prime Minister. 

Speculators on international currency markets soon began to realise that Sterling was overvalued and that Britain’s membership of the ERM was unsustainable. They now began to bet against the Pound by adopting a short position against it. Short-selling is an investment strategy used when it is believed that an asset, such as a currency, will lose value. Speculators began to borrow billions of Pounds from banks, agreeing to pay them back with interest at a set time in the future. They then used the Pounds to buy foreign currencies, such as the Deutsche Mark, which they believed would appreciate in value against the Pound. After the Pound crashed in value, speculators would buy back the Sterling and return them to the lender to close off their position. Their profit would equal the value of the Pounds sold, minus the value of the Pounds bought back and the interest paid to the lender.

The most notable man speculating against the Pound was George Soros, owner of the Quantum Fund, who by mid-September 1992 had adopted a $1.5 billion position against Sterling. All it would take now was a small trigger to set the Pound on a downwards trajectory. After that a positive feedback loop would be created; as more people exchanged Pounds for foreign currencies, the supply of Pounds would increase whilst the supply of other currencies decreased. This would reduce the value of the Pound whilst raising the value of its competitors, only causing more people to sell their Pounds and so on.

The trigger came on Tuesday 15 September 1992. The President of the German Bundesbank, Helmut Schlesinger, was conducting an interview with the Wall Street Journal. In what he thought was an off-the-record moment he remarked that, after the recent devaluation of the Italian Lira, “a more comprehensive realignment” of European currencies would be necessary.  When his comment began to circulate the market interpreted his message loud and clear – the Pound would also have to be devalued.

When the London foreign exchange market opened on the morning of Wednesday 16 September, investors, fearing a decline in value, began to exchange billions of Pounds for foreign currencies. It is important to note that speculators only made up a small fraction of the volume being sold; regular firms also wanted to get rid of their Pounds to guard against losses. Norman Lamont, the Chancellor, and Robin Leigh-Pemberton, the Governor of the Bank of England, spearheaded Britain’s response. They began to use the UK’s foreign currency reserves to buy back Pounds at a rate of 2 billion an hour, hoping to prop up its value – a strategy known as currency intervention or ‘defending’ your currency. But as the day progressed it became clear that investors were selling Pounds at a far higher rate than the Bank of England could ever hope to buy back.

At 10:30 AM the Bank of England raised interest rates from 10% to 12% in a bid to encourage investors to buy the Pound, and to squeeze the short sellers by raising the amount they would have to pay back in interest to their lenders. But speculators believed that Britain could not sustain such high interest rates without severely damaging its economy, especially in the midst of a recession. By now George Soros had expanded his bet to a colossal $10 billion short position. As such the selling continued, despite a second announcement at 2:15 PM to raise the rates again to an eye-watering 15%, effective the next day. After an emergency cabinet meeting the government eventually had to admit defeat. At 7:00 PM Norman Lamont went before the press to announce Britain’s withdrawal from the ERM. The rise to 15% was cancelled, and the Pound would be allowed to float freely on the market.

Over the next few days Sterling fell by 15% against the Deutsche Mark and 25% against the US Dollar as the market was left to itself. In all, the British government had expended roughly £27 billion of foreign exchange reserves in a vain attempt to defend the Pound, experiencing a net loss in the region of £3.3 billion. The speculators, on the other hand, made legendary profits; George Soros is estimated to have earned £1 billion, earning him the title ‘the man who broke the Bank of England’. 

Black Wednesday would have several far-reaching consequences. The Conservative Party’s reputation for economic responsibility was tarnished, contributing to its landslide defeat in the 1997 general election. Ironically, though, the devaluation of the Pound had many positive effects on the economy. The Bank of England was now able to cut interest rates, stimulating Britain’s exports and fuelling economic growth. This brought an end to the UK’s early 1990s recession, and by the time the Conservatives handed over power in 1997 the economy was experiencing strong 4.9% annual GDP growth, primarily export-driven. The crisis also helped drive a rise in Euroscepticism; it seemed that regaining sovereignty of the Pound had reaped far more rewards than continued integration with Europe. 

The Sterling Crisis taught a number of crucial lessons. The first was to show the vulnerability of a fixed-rate system; trying to maintain a fixed rate, especially if there are significant downwards pressures on a currency, will always create the possibility of a speculative attack. The second was to highlight the limitations of central bank intervention and the power of the markets to override government policy; a lesson which the recent Truss ministry would have been prudent to remember.