Sunday, September 10, 2017
Lessons from the first Brexit for Britain's EU departure
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The Brexit process is proving slower and more difficult than even I expected. Fifteen months after the vote, and with a failed election gamble in between, we have barely got to first base. David Davis, the Brexit secretary told the House of Commons last week that nobody said it would be easy, though he and plenty of other Brexiteers suggested it would be.

The process has made some yearn for what is sometimes called the first Brexit, Britain’s abrupt departure from the European exchange rate mechanism (ERM), 25 years ago this Saturday.

I shall provide a reminder about what the ERM was – and an introduction for younger readers – in a moment. But in that episode, Brexit occurred in a matter of hours, not years. It happened in spite of government policy, which was to stay in, rather than because of it. It marked, if not the start, then the impetus for the longest period of continuous economic growth in Britain’s history, and one of the strongest.

It also, according to a new book from OMFIF (the Official Monetary and Financial Institutions Forum), one in a series of “great British financial disasters”, set Britain on a course of greater Euroscepticism, for which the bigger Brexit we have now embarked upon was a natural consequence.

By the by, it destroyed the Conservative party’s reputation for economic competence, a blow from which the Tories took “nearly 20 years to recover”, according to John Nugee, former manager of reserves at the Bank of England, observes in an introduction.

The book, Six Days In September: Black Wednesday, Brexit and the Making of Europe, by William Keegan, David Marsh and Richard Roberts, has the virtue of having spoken to the main players, either now or at the time, and uses material released from the archives.

Before coming on to what that first Brexit might mean for this Brexit, and for the outlook for sterling and the economy, as promised a brief recap.

The ERM, an attempt to bring currency stability to Europe after the turbulence of the 1970s, was part of the European Monetary System, established in 1979. Member currencies were allowed to fluctuate in either narrow bands (2.25% either side of agreed central rates), or broad ones (6% either side). Exchange rates could and did adjust, in regular realignments, usually to allow the deutschmark to rise.

As was common in EU initiatives, Britain did not join at the outset, leaving it until October 1990, by which time much blood had been spilt in the Tory party. John Major, then chancellor, persuaded a sceptical Margaret Thatcher, not least by pointing to ERM membership as a way to get Britain’s sky-high interest rates, then at a 15% level which were destroying home owners and small businesses.

Entry was messy, as the book recounts. I remember being summoned to the Treasury in the late afternoon of Friday October 5 1990 to be handed a statement, the first line of which was to announce an interest rate cut from 15% to 14%. The much bigger announcement, that Britain would be in the ERM the following Monday, was accorded second place.

It was messy in another way. Britain’s economy had entered recession a few months earlier, as a consequence of those high interest rates, though that was yet to be acknowledged within government. The German economy, meanwhile, was embarking on its post-unification boom. And a booming German economy could, as students of the Federal Republic’s inflation aversion were aware, only mean higher German interest rates. This, Keegan, Marsh and Roberts reveal, was not taken into account by British officials.

Britain struggled in the ERM for 23 months, with the government insisting it could make its attempt to put Britain at the heart of Europe work. Interest rates were brought down to 10%, and inflation fell sharply. But Britain’s weak economy needed rates of well below 10% and that could not be achieved unless Germany’s powerful Bundesbank reduced its interest rates.

Events came to a head in mid-September, as they often do (think of the Lehman Brothers collapse on September 15 2008). On September 15 1992 Helmut Schlesinger, head of the Bundesbank, gave an interview warning of the ERM’s vulnerabilities. It was seized upon by George Soros, the hedge fund titan, and others, to launch a wave of selling of sterling the following day. Interest rates were raised to 12%, with a promise of 15% the following day (which was never enacted) and the Bank expended all its foreign exchange reserves trying to prop up the pound. It was all in vain. Sterling crashed out of the ERM, never to return.

Schlesinger apologises for his part in sterling’s downfall in the book, which is unusual. But the writing was on the wall. Modesty almost prevents me from mentioning a piece I wrote on the Sunday before Black Wednesday, quoted in the book, which said that if the Treasury was waiting for a German interest rate cut to relieve the pressure on the pound it was whistling in the wind.

Are there lessons from that first Brexit for this one? Liberation from the ERM and departure from the EU are very different animals. I used to think that Britain’s post-ERM success was mainly about a rare devaluation that worked. Now, the evidence is that it was mainly that exit provided an opportunity to cut interest rates from an inappropriately high level and to do so very quickly. Rates were cut by four percentage points in four months. No such monetary stimulus is possible now.

Not only that, but it helps hugely to have a successful alternative policy framework. Within weeks of Black Wednesday, and from a standing start, the government had adopted an inflation target and given the Bank the enhanced role that paved the way for independence in 1997. That new framework not only benefited the economy but also pushed up the pound. By the end of the 1990s, and the dawn of the euro, sterling was above the level s against the deutschmark that were regarded as too high in 1990-92. Bank independence transformed international attitudes to UK economic policy. No such game-changer is in sight now.

As noted, that first Brexit proved toxic for the Tories, even as the recovery resulting from it came through. History could repeat itself, particularly with Theresa May once more being pushed by some of her hardline backbenchers towards a no deal, no divorce bill, cliff-edge departure. This would, according to The UK in a Changing Europe, an independent research body, have “widespread, damaging and pervasive” effects. And the Tories would deserve their punishment.