When Britain crashed out of the ERM 25 years ago it left a toxic trailby Paul Wallace / September 13, 2017 / Leave a comment
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.