FOR those of us of a certain age, Black Wednesday, September 16, 1992, was a defining moment. There had been devaluations before, and there had been more serious crises, notably the IMF (International Monetary Fund) crisis of 1976, immortalised in one subsequent account as “Goodbye, Great Britain”.
The 1992 fiasco was somehow more shocking because of its suddenness. The combination of a misguided and inappropriate policy, brazenly unhelpful comments from Helmut Schlesinger, then head of Germany’s Bundesbank, and the forces of currency speculation led by George Soros (but including some blue-chip British financial institutions), wrecked UK economic policy in a few hours.
I had thought there was not much else to say on this episode. But papers released by the Treasury (www.hm-treasury.gov.uk) under the freedom of information act shed new light on it. They also raise questions that are still relevant today.
Did we need this brush with economic disaster to reap the success that followed it, as claimed by John Major, Norman Lamont and some Treasury officials of the time, such as Sir Alan Budd? In other words, was it needed to break inflation once and for all? And if all participants, including the Treasury, the Bank of England and Gordon Brown (who supported the policy), could get things so badly wrong, to what extent is the current success a fluke? To recap briefly, Black Wednesday was the sudden collapse of a policy the Tory government had put in place two years earlier. In October 1990, seemingly having tried every other monetary policy option, and with inflation rising and interest rates high (15%), Major, who was chancellor then, persuaded Margaret Thatcher to let sterling join the European exchange-rate mechanism (ERM), Europe’s fixed-rate currency system, at DM2.95 to the pound.
On September 16, 1992, the policy fell apart, sterling being forced out of the ERM despite successive announcements that interest rates would rise from 10% to 12% and later to 15%, and the exhaustion of Britain’s currency reserves in a vain attempt to prop up the pound.
The Treasury came out poorly. Even when outsiders, including this newspaper, were warning that the economy was tumbling headlong into recession in 1990, it continued to produce optimistic forecasts that, the documents now concede, were “spectacularly wrong”. So convinced was the Treasury that entry was a political decision that virtually no preparatory work was done on the economics of it. The Treasury, according to one very frank internal assessment, was “blinkered” in its attitude.
German unification, an event that meant higher ERM interest rates (the Bundesbank effectively set rates for the whole system), appeared to have passed the Treasury by. Entry itself was bungled, being accompanied by a one- percentage-point interest-rate cut that Thatcher had insisted on. A paper by Sir Nigel Wicks, then a senior official, records that many in the Treasury were “extremely unhappy” with that cut, which sent the message that membership was just a route to cutting rates, not controlling inflation. The documents do not record whether such unhappiness was passed on to the chancellor.
Not everybody in the Treasury comes out badly. Chris Riley, a senior official, was writing a paper arguing the case for devaluation when Black Wednesday occurred. Without it, he argued, Britain was likely to be condemned to years of slow growth. The paper, circulated the day after sterling’s expulsion from the system, said presciently that it could be a “blessing in disguise”. Sir Andrew Turnbull, now the cabinet secretary, wrote a strong paper arguing against any early return to the system. Even Norman Lamont, chancellor at the time and the biggest political loser, had argued quietly within the government for a devaluation.
Lamont was made to look foolish by the Treasury, not just by those bad forecasts but by a speech he gave in July 1992, publicly warning of the disastrous consequences of leaving the ERM. But he and Major point out, correctly, that the cost of the failed attempt to support the pound was a net £3.3 billion, not the tens of billions often bandied about.
Nor was Lamont helped by the Bank, whose actions the Treasury believes (in bits of the documents it did not want released) were “sub- optimal”. The Bank did not point out that the only real way to prop up the pound was to announce a pre-emptive interest-rate hike. Its intervention tactics, echoing a Bundesbank criticism of the time that the Bank of England did not act “until the ball was on the goal-line”, are also criticised.
What was the lasting legacy? The Major-Lamont-Budd argument is that we are still enjoying the benefits of the fact that ERM membership destroyed inflation. The policy framework put in place after the exit in the autumn of 1992, including the adoption for the first time of an inflation target, paved the way for eventual Bank of England independence, and brilliantly created triumph out of disaster.
Not everybody in the Treasury, however, had confidence that it would last. A January 1994 assessment by Paul Gray, another senior official, described the period after Black Wednesday as “a purple patch, which we’ll look back to in the future with nostalgia and longing”. He was wrong, and the purple patch has lasted. To insiders, however, it looked like touch and go.
But this was, of course, not how it was meant to be at all. Had Major and Lamont followed their policy and seen off the speculators, sterling would have stayed in the ERM. Growth would have limped along, perhaps nearer to Germany’s 1% average than the 2.7% achieved over the past decade. Unemployment would have stayed high and taxes would have risen even further.
Labour might have won in 1997, although it would not have had much to offer as an alternative economic vision. Bank independence would not have been remotely on the agenda. Brown, then much more of an enthusiast for the single currency, might have held out the prospect of euro entry in the first wave in 1999.
We had a fortunate escape. The economy has turned out very well. The Treasury will never again allow such an important decision to be taken with so little preparation. It is, in addition, now so institutionally opposed to the euro that entry looks impossible any time soon. Things have turned out fine. We should never forget, however, that it was all the result of a lucky accident.
PS: Figures can appear to make a fool of you. Last week’s piece saying that house prices would not crash was followed by Land Registry data showing they fell 2.7% in the final three months of last year. Was this the beginning of the great slide? No. The trouble with the Land Registry figures is that they are crude averages, making no attempt to adjust for size and type of property, and that they are not seasonally adjusted. House prices tend to weaken in winter and this is what the Land Registry was reporting.
Thus, in 1998, prices fell by 2.6% in the final three months of the year, in 2001 they were down 4.1%, and in 2002 they dropped by 1%.
On the other hand, non-seasonally-adjusted house prices always rise in the spring. The right way to treat such data is to compare them with a year earlier. On that basis the Land Registry has prices rising by 11.8%.
Plenty of readers have asked about buy-to-let landlords. If they withdraw from the market, will not a crash be inevitable? The evidence is that buy-to-let investors are in it for the long term, with at least a 15-year investment horizon, and are not busily trading between housing and equities, partly because of high transaction costs. Buy-to-let investors have displaced some first-time buyers, who cannot raise deposits for house purchase. Instead, the properties are bought by these new landlords, who rent them to frustrated first-timers. A neat circle.
