Today is the 20th anniversary of the day popularly known as Black Wednesday. It was the day when some folks made billions of dollars out of short selling while the economy of UK screamed in agony. Many of you may have a brief idea about what happened on that day. Yes! A guy by the name George Soros turned into a billionaire and is now trying to decriminalize marijuana in California but that’s just the fancy part of it. The crisis UK went through during that time was the real deal. It was sad, in fact devastating but it‘s got so much to learn from. There is a lot to learn from this one incident. If economy is something that interests you then fasten your seat belts because I am going to show you the real game.
Black Wednesday wasn’t a result of some cosmic powers (As Deepak Chopra might call it :p) but in fact a series of wrong decisions and bad timing. It all started in 1990 when UK agreed to join the Exchange Rate Management (ERM). ERM was a system introduced by the European countries that aimed at having a relatively fixed and common exchange rate mechanism for every country in Europe so as to achieve stability in the exchange rates and progress towards a stable economy like Germany at that time. The thought was completely legit as a strong currency would promote better trade relations between the participating countries and also attract foreign investors. Also, during this time UK was going through terrible recession and country really needed low interest rates to promote trade activities and bring the economy back to its original state.
Now once UK became a part of ERM, devaluing the currency was not a possibility solely because that was reason why ERM was formed in the first place. Also, interest rates in Germany were high at that time because it was going through a reunification that required the government of Germany to spend a lot on the same and hence higher interest rates would reduce public expenditure keeping inflation under control. As I mentioned earlier, UK had a high rate of interest too and was going through a recession at the same time. Getting out of recession would require UK to reduce its interest rates but reducing interest rates would mean depreciating the value of pound. This is fundamentally because lower interest rates would reduce the foreign capital in the country leading to lower exchange rates. Depreciating the pound wasn’t possible as UK was now a part of the ERM. Hence UK continued with higher interest rates.
It was now 1992, marking almost 2 years of UK’s struggle to keep up with the ERM and the German standards. Morale within the people in UK was low as there was no incentive being given to promote business activities. People now knew that UK couldn’t possibly continue with the ERM as the economy would completely crash otherwise. Hence short selling of the pound now started. Short selling is where a speculator sells a security, which does not belong to him, at a higher current price and later buys it back at a lower price to return it back. Hence mass selling of the UK pounds started to happen. You may wonder who exactly was buying these pounds if everyone was keen on just selling them off. It was the Bank of England. The Bank of England kept on buying the pounds to show that the same pounds still have a demand in the market and hence keep rate of these pounds within the band prescribed by the ERM. It was a trade off between an economy crash and keeping up with the ERM. Surprising how UK chose ERM.
It was now the 16th of September 1992. UK could no longer bear the pressure and the time had come when it had to pull itself out of the ERM. It in fact did and as a result the value of pound fell and all those who sold the pounds earlier were now rich, really rich. The economy of UK cried on the other hand.
What you read above can be called a very simplified version of the whole event. It was a complete chaos. People were going crazy over selling pounds while John Major (then Prime Minister) was considering yet another increase in the interest rates. The damages were so extreme that the country hasn’t really recovered from it till today! Damn, I wish I could see that mayhem.
- Black Wednesday: The day that Britain went over the edge (telegraph.co.uk)
- Black Wednesday: Britain was free, but we Tories were done for (telegraph.co.uk)
- Black Wednesday, 20 years on: a bad day for the Tories but not for Britain (guardian.co.uk)