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In British politics and economics, Black Wednesday refers to the events of 16 September 1992 when the Conservative government was forced to withdraw the Pound Sterling from the European Exchange Rate Mechanism (ERM) after they were unable to keep sterling above its agreed lower limit. The most high profile of the currency market investors, George Soros, made over US$1 billion profit by short selling sterling. In 1997 the UK Treasury estimated the cost of Black Wednesday at £3.4 billion.

The trading losses in August and September were estimated at £800m, but the main loss to taxpayers arose because the devaluation could have made them a profit. The papers show that if the government had maintained $24bn foreign currency reserves and the pound had fallen by the same amount, the UK would have made a £2.4bn profit on sterling’s devaluation. Newspapers also revealed that the Treasury spent £27bn of reserves in propping up the pound.

When the ERM was set up in 1979, Britain declined to join. This was a controversial decision as the Chancellor of the Exchequer Geoffrey Howe, despite his economically dry credentials, was staunchly pro-European. His successor Nigel Lawson was also a believer in a fixed exchange rate, and although he was a mild Eurosceptic he admired the low inflationary record of West Germany, attributing it to the strength of the Deutsche Mark and the management of the Bundesbank. Thus although Britain had not joined the ERM, from early 1987 to March 1988 the Treasury followed a semi-official policy of ’shadowing’ the Deutsche Mark.

Matters came to a head in a clash between Lawson and Margaret Thatcher’s economic advisor Alan Walters, when Walters claimed that the Exchange Rate Mechanism was “half baked”. This led to Lawson resigning as chancellor to be replaced by his old protégé John Major, who, with Douglas Hurd, the then Foreign Secretary, convinced the Cabinet to sign Britain up to the ERM in October 1990, effectively guaranteeing that the British Government would follow an economic and monetary policy that would prevent the exchange rate between the pound and other member currencies from fluctuating by more than 6%. The pound entered the mechanism at DM 2.95 to the pound. Hence, if the exchange rate ever neared the bottom of its permitted range, DM 2.778, the government would be obliged to intervene. With UK inflation at three times the rate of Germany’s, interest rates at 15% and the “Lawson Boom” about to bust, the conditions for joining the ERM were not favourable at that time.

From the beginning of the 1990s, high German interest rates, set by the Bundesbank to counteract inflationary effects related to excess expenditure on German reunification, caused significant stress across the whole of the ERM. The UK and Italy had additional difficulties with their double deficits, while the UK was also hurt by the rapid depreciation of the US Dollar – a currency in which many British exports were priced – that summer. Issues of national prestige and the commitment to a doctrine that the fixing of exchange rates within the ERM was a pathway to a single European currency inhibited the adjustment of exchange rates. In the wake of the rejection of the Maastricht Treaty by the Danish electorate in a referendum in the spring of 1992, and announcement that there would be a referendum in France as well, those ERM currencies that were trading close to the bottom of their ERM bands came under pressure from foreign exchange traders.