What Is Black Wednesday?
Black Wednesday refers to 16 September 1992, the day the U.K. government had to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM). While the nation entered the ERM in October 1990, it had to exit the system because the pound's value failed to stay within a specific, required range.
Under the ERM, the currencies of member nations were required to fluctuate within a specific range relative to each other. To maintain this situation, member nations with strong currencies were supposed to sell them and also purchase weaker currencies in order to help maintain suitable exchange rates.
The pound was one of the weaker currencies in the ERM and struggled to remain within the aforementioned range. British government officials took action to place upward pressure on the pound, hiking interest rates from 10% to 12% and then later to 15% in the space of one day.
However, this move was ineffective and failed to appease the concerns of market participants who were skeptical of the British government's ability to stabilise the pound, and they continued selling the currency.
Another factor that contributed to the pound's worsening situation was the failure of Germany's central bank, Deutsche Bundesbank, to support the currency relative to its own. In September 1992 the deutschmark was the strongest ERM currency and the pound was the weakest.
In spite of this situation, Germany's central bank refused to purchase the pound and did not sell many deutschmarks. When traders caught wind of that, the head of the Bundesbank wanted the pound to ease relative to other currencies, they pounced on the situation.
Role Of Speculators
Speculators, led by billionaire investor George Soros and his Quantum Fund, sought to turn a profit by borrowing U.K. gilts and selling them, before buying them back at lower prices later on. Reportedly, the speculators repeated this process every couple of minutes, turning a profit with each instance.
While Soros had originally backed the pound—he purchased at least US$1.5 billion (£1.2 billion) of the currency—he changed his approach when the devaluation crisis began.
While the Bank of England spent an estimated 40% of its foreign exchange reserves on propping up the pound, these efforts ended up being futile. On the evening of 16 September, the Chancellor of the Exchequer, Norman Lamont, announced that the U.K. was suspending its membership from the ERM.
The cost of Black Wednesday was originally estimated at being between £13 billion and £27 billion, but documents released in February 2005 under the Freedom of Information Act indicate that the cost of the event may have been far less, at £3.3 billion.
Some market observers portrayed Black Wednesday in a fairly positive light, going so far as to describe the event as Golden Wednesday. Interest rates were quite high during the U.K.'s tenure in the ERM, a development that led to business closures and surging mortgage expenses.
Once the U.K. left the ERM, the nation's economic conditions improved markedly. Interest rates dropped, and inflation subsided. The value of the pound plummeted following this exit, which helped support the nation's economic recovery by making its goods and services cheaper for buyers using foreign currencies.
Although the U.K. entered the ERM in late 1990, it was unable to remain a part of this system for long. Within two years, the nation had to leave the ERM after the British pound fell outside the required range relative to the currencies of other member nations. While the financial cost to British taxpayers was significant, Black Wednesday did bolster the economy by helping create low inflation.
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