The night of 23rd June 2016 when Britain learned that it had decided to leave the European Union was one that few will forget, not least frantic currency traders as the pound plummeted.
But this was not the first time that the British had exited a European club and sterling had slumped. On September 16th 1992 the pound was forced out of Europe’s currency grid after a tumultuous day in which interest rates were yanked up from 10 per cent to 12 and then again to 15 per cent (though this second rise was cancelled) and the Bank of England flung billions of pounds at the currency markets in a vain attempt to defend the exchange rate against overwhelming selling pressures. For many, “Black Wednesday” also remains etched in their memories, as in the early evening an ashen-faced Norman Lamont announced this latest financial Dunkirk in the long post-war retreat of sterling. Also present outside the Treasury was David Cameron, then a special adviser to the chancellor of the exchequer, whose decision as prime minister to hold an unnecessary referendum on British membership of the EU was to bring about Britain’s second inglorious exit.
As well as a common character in Cameron—though he bore no responsibility for the ERM debacle—the two episodes share high drama and a tumbling pound. But otherwise they appear quite distinct. The pound’s exit from the European “exchange-rate mechanism” (ERM), which in effect pegged sterling and other European currencies to the deutsche mark, was a financial and political convulsion but it did not jeopardise Britain’s membership of the EU. It occurred immediately whereas the Brexit vote to leave the EU will not take effect until March 2019 and even then is likely to be softened by a subsequent transition period lasting perhaps three years. Britain spent only two years inside the ERM whereas it has been almost 45 years in the EU and its predecessor, the European Economic Community.
The economic impact of the two exits also looks set to be very different. Britain’s departure from the ERM turned out to be good for the economy, which had been mired in recession between 1990 and 1992. The falling pound worked the way that currency depreciations are supposed to work: exports surged and Britain moved into a trade surplus. More important, the government was able to bring down interest rates which had been kept high in order to defend the pound within the ERM. A long economic boom got under way, helped by the creation of a single market in the EU, in large measure at the behest of Margaret Thatcher’s government of the 1980s. This swept away non-tariff barriers such as customs checks for goods and regulatory hindrances to the export of services.
“Britain’s departure from the ERM turned out to be good for the economy—the falling pound worked the way that currency depreciations are supposed to work”Since the vote to leave the EU was held little more than a year ago only a provisional verdict on its economic impact is possible, but already it is decidedly negative. Although GDP growth held up in the second half of last year, it has since faltered. In 2016 Britain was the second fastest-growing among the G7 economies (just behind Germany); in the first half of 2017 it was the slowest. The big decline in sterling has done nothing to improve trade even though the euro area is now expanding much more strongly, creating extra demand for British exports. What the weaker pound has done is to push up inflation—now almost 3 per cent—hurting living standards and holding back consumer spending.
The failure of sterling’s depreciation to stimulate trade over the past year or so makes unfortunate sense. Brexit has created corrosive uncertainty about what Britain’s future trading arrangements with the EU will be. Even if a satisfactory deal can be reached in negotiations, which is far from assured since they are already fraught, it will be worse than the current set-up under which firms in Britain—including those from outside the EU such as Japanese carmakers and Swiss banks—can trade without impediments within the single European market. In these circumstances exporters have little incentive to invest in order to boost their sales in the EU, which are worth nearly half of total British exports.
Yet there are telling similarities as well as differences between the two exits. For one thing both had shattering political effects. In the immediate wake of the Brexit vote, Mark Rutte, the Dutch prime minister, said that Britain had “collapsed—politically, monetarily, constitutionally and economically.” That judgement appeared rash when Theresa May swiftly replaced Cameron as prime minister and as the economy kept going. But it now looks worryingly pertinent following the June general election that cut May down to size—and as the sheer scale of the task of unravelling Britain’s intricate relationship with the EU is laid bare.
“The failure of sterling’s depreciation to stimulate trade over the past year or so makes unfortunate sense”Unlike Cameron in 2016, John Major did not have to resign in 1992 over Black Wednesday—though he came close to doing so. But Britain’s ignominious exit from the ERM undermined his authority since he had staked so much on maintaining the pound within it. Even more important was the effect in souring the Conservative Party’s stance towards Europe. Less than two years earlier Thatcher had been ousted because of her increasingly anti-European stance, giving Major his opportunity to become prime minister. Major had won plaudits for securing Britain’s opt-out from the European plan to create a single currency at the European summit in Maastricht in December 1991. Yet as Kenneth Clarke, who became increasingly isolated in the Conservative Party because of his unswervingly strong European commitment, recalls in his memoir “Kind of Blue,” Black Wednesday “opened the eurosceptic floodgates” and “marked the beginning of a fierce Conservative civil war over Europe.”
The spectre of Black Wednesday also hung over Tony Blair’s more pro-European government, frustrating his hopes to take Britain into the single currency that had come into being in 1999. As chancellor, Gordon Brown mobilised the Treasury to assess the economic arguments for and against adopting the euro. The answer in 2003 was never in doubt with or without the nineteen volumes of analysis that thudded down to add weight to the chancellor’s verdict against British entry. Yet even if the economic case for joining had been stronger the political obstacles of convincing the public to support such an entanglement following the experience of the early 1990s appeared insurmountable.
There were many reasons for the Brexit vote, ranging from the long-term effects of the financial crisis a decade ago in undermining the authority of elites and sapping living standards to worries about the scale of immigration. Cameron’s decision to hold the referendum in order to placate Tory eurosceptics and to fend off Ukip was itself a reckless gamble. But the difficulty that the remain camp had in persuading voters to stay in the EU was rooted in the fact that he and other leading British politicians had done too little in the preceding two decades to make the case for Europe. Therein lay the toxic trail between Black Wednesday and Brexit.
