This week sees Britain celebrating.
No, not the end of a phenomenal summer of sport.
No, not the Queen’s Diamond Jubilee again.
And no, not the 200 year anniversary of the start of the end of Napoleon after his fatal march to Moscow, although how we missed celebrating that one
I don’t know.
No, it’s none of those, although it does have a relationship
with that last one as yes, it’s the celebration of 20 years since leaving the
European Monetary Union (EMU).
Twenty years ago, the headlines were all about a currency in
The currency was the pound sterling, and billions of pounds
were being bet by George Soros on the one hand and Norman Lamont on the other.
It culminated in Black Wednesday – Wednesday, 16th
September 1992 – with the economy in chaos, the Chancellor announcing two interest
rate rises in one day, and then the pound reverting back to a free float after
having to eject Britain from the Exchange Rate Mechanism (ERM) meant to enable
euro integration and harmonisation.
Britain was not the only one affected – the Italian Lira was
also forced out – but it left an irrecoverable scar on Britain’s view of the EU
and the euro, such that we have never felt it conducive to return.
In fact, eleven years later Gordon Brown, the then
Chancellor, set out the criteria for the UK joining the euro, a criteria that has now been shelved and gathers dust in the corridors of
So, to spend a little bit of time reminiscing and thinking
about current climate, here’s a few choice snippets about the euro and
Britain’s background in the ERM that you might find interesting.
From the New York Times, Thursday 17th September 1992:
With the Bundesbank
staying largely out of the ferment in European financial markets Wednesday,
speculation spread that the turmoil might be just what the Bundesbank secretly
By doing little
further to relieve the pressures building within Europe's currency system, the
Bundesbank appeared to be prodding Germany's neighbors to accept that economic
imbalances required a further realignment of exchange rates. The hard-line
stance reasserted the German central bank's position as the continent's
monetary muscleman, analysts said.
that with this piece about Mario Draghi’s announcement of buying bonds to prop up Eurozone countries
in turmoil last week:
Stock markets soared
on both sides of the Atlantic on Thursday afterMario Draghi, the president of
the European Central Bank, unveiled a plan to save the euro by buying up the
bonds of distressed eurozone countries such as Spain and Italy in unlimited
agreement for the scheme, known as "outright monetary transactions"
(OMT), against fierce objections from the Bundesbank, in a rare defeat for
Germany in eurozone policymaking.
The Bundesbank issued
a statement condemning the proposal as "tantamount to financing
governments by printing banknotes". Draghi admitted there had been one
dissenter at Thursday's meeting of the ECB's governing council, widely thought
to be the Bundesbank's Jens Weidmann.
How times change and it reminds us that the Eurozone has
never really been without crisis, but it’s all about how you face up to the
crisis that counts.
For example, when Britain crashed out of ERM on that Black Wednesday,
the media attacked out political leaders from all sides. Here’s how the Guardian reported it:
The Chancellor, Norman
Lamont, announced that the Government could no longer hold the line at the end
of a day of desperate and futile attempts at propping up sterling, which
included spending what the City estimated as £10 billion from Britain's
reserves and a two-stage rise in interest rates to 15 per cent.
Sure, the government may have spent billions propping up the
pound, but what was the true cost?
In a look back at the events that occurred in 1992, treasury official Harold Freeman published a paper in August 1997 that stated the government
faced a loss of £800 million on reserve operations in August and September
1992, with a total loss of around £3.3 billion.
Wooo… scary numbers, but nowhere near as scary as the QE and
crisis numbers we talk about today.
Mind you, Britain’s brush with ERM twenty years ago was
preceded by a similar brush with Euro co-ordination twenty years before, and it might be that we’re just not suited to this sort of central system
pegging of economies.
That’s certainly the conclusion of Mathias Zurlinden, an
economist with the Swiss National Bank, writing an analysis of the whole farce for the Federal Reserve
Bank of St Louis in September 1993:
Proponents of pegged
exchange rates have argued for years that exchange rate pegging provides a way
to import the reputation of the Bundesbank and get a credible anchor for
monetary policy. For obvious reasons,
this approach had a special appeal to countries lacking a credible monetary
policy. Yet the argument is less convincing if speculative attacks are
self-fulfilling and the credibility of a country’s exchange rate commitment can
vanish as quickly and unexpectedly as it did in September 1992.
A necessary condition
for such an attack to occur is that the markets expect the central bank to
shift policy as a result of the attack. If the markets have reasons to believe
that a country will relax monetary policy once a speculative attack has
exhausted the central bank’s reserves, an attack is more likely.
In the case of
Britain, a persistent recession prepared the way for such beliefs.
Uncertainties about the prospects for EMU and the reluctance of British authorities
to allow short-term interest rates to rise in defense of the pound subsequently
accelerated the attack and reinforced a realignment of the pound. In short, the
United Kingdom could not convince the markets of its commitment to a fixed
exchange rate. This credibility is an essential factor in maintaining an
effective exchange regime.
In reviewing the whole debacle, Martin Wolf maybe sums it up
best in the Financial Times, when he says: ‘we went into the ERM in despair and left in disgrace”.
Maybe, or maybe it did us a favour ever as, if we had joined
the euro in the 1990s then today, we would be another Greece.
For example, take that statement about ERM having special appeal to countries lacking a
credible monetary policy, that certainly
seems to be the case on reflection of how Greece joined the euro.
In a February report for the BBC’s Newsnight,
Nick Dunbar showed how Greece managed to join the euro by hiding its debt.
In 2001, the Greek government was wondering how to meet the
conditions of Euro membership.
One of the key requirements for membership is that member
states show ‘directionality’ in their public debt.
This meant that the country’s debt ratio needed to be going
down year on year: ‘The national debt should not exceed 60% of GDP, but a
country with a higher level of debt can still adopt the euro provided its debt
levels are falling steadily’.
That was a problem for Greece.
Whilst national debt was increasing generally, they had the
additional challenge of the Olympics looming in the future and requirements for
major infrastructure investments.
What to do?
The solution they came up with was not to cut spending or
raise taxes, but to hide their debt.
Easily done when Goldman Sachs created
a plan to strike a financial deal called a ‘swap’ with the Greek
Government. Through this instrument, the
government legitimately removed €2.8 billion from the country’s balance sheet.
I guess we could have done that
back in 1992 … glad we didn’t.