Jupiter Merlin Weekly: ‘Black Wednesday’, or ‘Liberation Day’?
Jupiter Merlin Weekly: ‘Black Wednesday’, or ‘Liberation Day’?
The Jupiter Merlin team look back at ‘Black Wednesday’ 30 years on, and ask whether it represents an economic calamity or a fortuitous dodging of an economic bullet.
Investment Manager, Jupiter Independent Funds/Merlin
Investment Manager & ESG Investment Director, Independent Funds/Merlin
Amid all the great events of the last 10 days, as the Monarchy seamlessly passes from the much lamented late Queen to our new King, and significantly in Ukraine President Zelensky’s cobbled-together but defiant defence forces convincingly begin to turn Putin’s flank in the Donbas, a small but important anniversary has slipped by largely unnoticed.
September 16th, 1992: “Black Wednesday”
Last week marked the 30th anniversary of Black Wednesday in 1992, the culmination of a tumultuous week in currency markets the conclusion of which was the UK being ejected from the European Exchange Rate Mechanism (ERM). The shambles had to be seen to be believed as the Bank of England, under instructions from the Chancellor, ramped up interest rates on 16 September from 10% to 12% and raised the prospect of immediately going to 15% in a Canute-like effort to support sterling and keep it above the prescribed lower limits laid down by Brussels to remain a participant. The UK’s ejection from the ERM came before 15% was implemented, policymakers realising that while the lower limit of sterling was theoretically fixed, with the markets smelling blood, no amount of government intervention was going to stop short-selling speculators dumping pounds faster than the Bank had a capacity to buy them: the game was up. Adding to the embarrassment, the UK at the time held the revolving presidency of the European Economic Community (EEC).
Following the unexpected 1992 election victory in April, only five months later the images of hapless Prime Minister John Major and his beleaguered Chancellor Norman Lamont both looking utterly drained and defeated outside No 10, and the media headlines of “Black Wednesday!” and accusing the government of incompetence, were the defining turning point in Major’s and the Conservatives’ fortunes, presaging a long and painful descent to their landslide defeat in 1997 and the following 13 years spent in the political wilderness.
For all Margaret Thatcher’s natural Euroscepticism, nevertheless in the late 1980s it seemed to be the UK’s inevitable destiny that our future was inextricably bound to Europe. The established view (or more accurately the strongly pro-European Establishment’s view) was that Britain was a fast-fading economic and geopolitical power, that the then EEC (of which we were already member, though not of the ERM) could only become more powerful. Alone, it was thought, we would become merely a marginal island in the Atlantic of increasingly little relevance. Eventually, full integration with the EEC and its successor the EU was widely perceived as inexorable. It was merely a question of when and how, not if.
Following the unexpected 1992 election victory in April, only five months later the images of hapless Prime Minister John Major and his beleaguered Chancellor Norman Lamont both looking utterly drained and defeated outside No 10, and the media headlines of “Black Wednesday!” and accusing the government of incompetence, were the defining turning point in Major’s and the Conservatives’ fortunes, presaging a long and painful descent to their landslide defeat in 1997 and the following 13 years spent in the political wilderness.
For all Margaret Thatcher’s natural Euroscepticism, nevertheless in the late 1980s it seemed to be the UK’s inevitable destiny that our future was inextricably bound to Europe. The established view (or more accurately the strongly pro-European Establishment’s view) was that Britain was a fast-fading economic and geopolitical power, that the then EEC (of which we were already member, though not of the ERM) could only become more powerful. Alone, it was thought, we would become merely a marginal island in the Atlantic of increasingly little relevance. Eventually, full integration with the EEC and its successor the EU was widely perceived as inexorable. It was merely a question of when and how, not if.
Embarrassing certainly, but “Black”? Liberation more like!
Regardless of the market chaos and the deep political humiliation, the reality is that it was far from a disaster. At the time, our own Alastair Irvine was an equity analyst at brokers Smith New Court where the Chief UK economist was Paul Turnbull, a wise man in the mould of Alan Walters with strong monetarist convictions. That, like Walters, he was also a strong Eurosceptic was incidental.
As markets went “fast”, seemingly out of control along with sterling, his calm but very firm words to the gathered assembly of shocked analysts and brokers were memorable: “listen” he said in his flat midland tones, trademark cigarette in one hand, Biro and spiral-bound pad in the other, “ignore all the rubbish you’re reading about an economic disaster. It’s just the opposite. It’s economic Liberation Day. We’ve just endured a two-year recession massively and unnecessarily exacerbated by sterling being in a ridiculous straight- jacket. The pound can now find its own level. It might take a day or two to settle down. But get this, the UK economy will take off from here and by this time next year, we’ll be wondering what all the fuss was about”. The political mud would stick to Major, determined still to bind the UK into Europe. Having lost the motion initially, his railroading his party into voting in favour of the Maastricht Treaty by turning it into a confidence vote was a pivotal moment on the road to Brexit. But economically, how right and visionary Turnbull was.
The ERM, the precursor to the creation of the euro, was designed gradually to harmonise the exchange rates of all member states. National central banks were forced to use interest rates to keep their currencies within strict upper and lower limits, the shadow median of which was essentially the EEC’s centre of economic gravity, the German Deutschemark (it was Chancellor Nigel Lawson, seduced by Germany’s relative lack of inflation, who had decided to shadow the Deutschemark before Major, as Lawson’s successor, led us in to the ERM in 1990). To use a 1920s flying circus analogy, it was like barnstorming in tight formation when each aircraft was tied to its neighbour by a length of ribbon: pilots would be constantly juggling their throttles and expending much fuel in the process while being so utterly pre-occupied with the proximity of their neighbour to prevent a collision but nobody wanting to be responsible for breaking the line; you needed 100% faith that the leader knew what he was doing and where he was going; a bit like the ERM, it didn’t always work!
As markets went “fast”, seemingly out of control along with sterling, his calm but very firm words to the gathered assembly of shocked analysts and brokers were memorable: “listen” he said in his flat midland tones, trademark cigarette in one hand, Biro and spiral-bound pad in the other, “ignore all the rubbish you’re reading about an economic disaster. It’s just the opposite. It’s economic Liberation Day. We’ve just endured a two-year recession massively and unnecessarily exacerbated by sterling being in a ridiculous straight- jacket. The pound can now find its own level. It might take a day or two to settle down. But get this, the UK economy will take off from here and by this time next year, we’ll be wondering what all the fuss was about”. The political mud would stick to Major, determined still to bind the UK into Europe. Having lost the motion initially, his railroading his party into voting in favour of the Maastricht Treaty by turning it into a confidence vote was a pivotal moment on the road to Brexit. But economically, how right and visionary Turnbull was.
The ERM, the precursor to the creation of the euro, was designed gradually to harmonise the exchange rates of all member states. National central banks were forced to use interest rates to keep their currencies within strict upper and lower limits, the shadow median of which was essentially the EEC’s centre of economic gravity, the German Deutschemark (it was Chancellor Nigel Lawson, seduced by Germany’s relative lack of inflation, who had decided to shadow the Deutschemark before Major, as Lawson’s successor, led us in to the ERM in 1990). To use a 1920s flying circus analogy, it was like barnstorming in tight formation when each aircraft was tied to its neighbour by a length of ribbon: pilots would be constantly juggling their throttles and expending much fuel in the process while being so utterly pre-occupied with the proximity of their neighbour to prevent a collision but nobody wanting to be responsible for breaking the line; you needed 100% faith that the leader knew what he was doing and where he was going; a bit like the ERM, it didn’t always work!
The euro: expertly managed, fundamentally flawed
The creation of the euro itself on 1st January 1999, overnight irreversibly fixing 19 countries’ national currencies and introducing a unitary currency controlled by the ECB with a one-size-fits-all interest and exchange rate (for its first three years the euro was a virtual currency, euro notes and coins only physically replaced sovereign currencies on 1st January 2002), while minutely and completely successfully managed, was fundamentally and profoundly flawed at the outset.
The moment national exchange rates were irreversibly fixed, individual countries’ economic fortunes were automatically locked, for good or ill. Reflecting the amalgam of 19 economies with disparate economic and social structures but a unitary monetary policy and without the homogeneity of complementary fiscal union, the subsequent level of the euro against major currencies such as the dollar, the yen and sterling has bedevilled European economic performance ever since. The most notable tensions have been the two biggest industrialised and exporting members, Germany and Italy. The euro has traded at a weaker level than the Deutschemark would, giving Germany a big competitive advantage with its exports. Italy on the other hand suffered the opposite: the euro has been stronger in value than the Lira would have seen, putting Italy at a notable disadvantage and leading to more than two decades’ worth of economic stagnation and significant relative decline and all the political instability resulting from that. Greece, failing all the economic tests for admission, was allowed in for purely political reasons ultimately creating the euro crisis of 2012 when the Greek economy was all but bust and had to be bailed out, resulting in a near-death experience for the euro. At the other end of the scale, Ireland’s national bank rate automatically fell from 5.75% to the ECB’s new 3.3%; together with a flood of EU support financing, the Irish economy took off in an almost uncontrolled, debt-crazed boom (it was known as the Celtic Tiger), which ended in tears in the Global Financial Crisis (GFC).
The moment national exchange rates were irreversibly fixed, individual countries’ economic fortunes were automatically locked, for good or ill. Reflecting the amalgam of 19 economies with disparate economic and social structures but a unitary monetary policy and without the homogeneity of complementary fiscal union, the subsequent level of the euro against major currencies such as the dollar, the yen and sterling has bedevilled European economic performance ever since. The most notable tensions have been the two biggest industrialised and exporting members, Germany and Italy. The euro has traded at a weaker level than the Deutschemark would, giving Germany a big competitive advantage with its exports. Italy on the other hand suffered the opposite: the euro has been stronger in value than the Lira would have seen, putting Italy at a notable disadvantage and leading to more than two decades’ worth of economic stagnation and significant relative decline and all the political instability resulting from that. Greece, failing all the economic tests for admission, was allowed in for purely political reasons ultimately creating the euro crisis of 2012 when the Greek economy was all but bust and had to be bailed out, resulting in a near-death experience for the euro. At the other end of the scale, Ireland’s national bank rate automatically fell from 5.75% to the ECB’s new 3.3%; together with a flood of EU support financing, the Irish economy took off in an almost uncontrolled, debt-crazed boom (it was known as the Celtic Tiger), which ended in tears in the Global Financial Crisis (GFC).
The system’s shortcomings still persist and define EU policy today
Why rake over old history? Is it relevant to today? Absolutely. Three decades ago, Thatcher’s chief economic adviser Alan Walters called economic monetary union “half baked”. Fast forward to now, through the GFC, the various Greek crises, Brexit, and the European Central Bank having to come up with ever more creative ways of preventing the Italian banking system falling over, absolutely nothing has changed. The EU, and the inner circle of the 19-state eurozone, remains a substantially unfinished political project and a veritable dog’s breakfast. If anything, the exogenous shocks of the pandemic and a major war in Europe (which the EU was designed to prevent) and all the knock-on economic effects of spiralling inflation and the risk of economic recession looming as Putin turns off the gas taps, have caused regression.
Until July, the EU was comprised of 27 members, 19 of which are in the eurozone bound together by monetary union; the remaining 8 countries on the path to full membership all retain their own currencies and monetary policies. There is still no fiscal union (the pre-requisite of which is political union). Now however, since July, even the notion of monetary union in the eurozone has been blown apart. As inflation becomes endemic, the economic tensions between the fiscally conservative members of the eurozone (Germany, Holland, Finland, Austria etc) and those which are habitually incontinent (irreverently known as the ‘Garlic Belt’ countries, but principally Italy and Greece) have grown significantly. As the economic risks to financially over-stretched economies rise, reflected in Italian (4.06%) and Greek (4.26%) national 10-year bond yields and their premium or spread over Germany’s 1.78%, the ECB saw the only solution to be the introduction of a two-tier policy within the eurozone. It has raised the interest rate universally and continues to do so; however, to contain the spreads (by a process known in the trade as ‘yield curve management’), it has stopped the programme dating back to 2015 of buying the national bonds of the conservative governments while still buying them from those which are shaky. If raising interest rates at the same time as still buying government debt is not economically literate (the equivalent of putting one foot on the brake and the other on the accelerator simultaneously—best left only to expert rally drivers), Germany remains concerned that the ECB’s policy is quite possibly illegal.
Until July, the EU was comprised of 27 members, 19 of which are in the eurozone bound together by monetary union; the remaining 8 countries on the path to full membership all retain their own currencies and monetary policies. There is still no fiscal union (the pre-requisite of which is political union). Now however, since July, even the notion of monetary union in the eurozone has been blown apart. As inflation becomes endemic, the economic tensions between the fiscally conservative members of the eurozone (Germany, Holland, Finland, Austria etc) and those which are habitually incontinent (irreverently known as the ‘Garlic Belt’ countries, but principally Italy and Greece) have grown significantly. As the economic risks to financially over-stretched economies rise, reflected in Italian (4.06%) and Greek (4.26%) national 10-year bond yields and their premium or spread over Germany’s 1.78%, the ECB saw the only solution to be the introduction of a two-tier policy within the eurozone. It has raised the interest rate universally and continues to do so; however, to contain the spreads (by a process known in the trade as ‘yield curve management’), it has stopped the programme dating back to 2015 of buying the national bonds of the conservative governments while still buying them from those which are shaky. If raising interest rates at the same time as still buying government debt is not economically literate (the equivalent of putting one foot on the brake and the other on the accelerator simultaneously—best left only to expert rally drivers), Germany remains concerned that the ECB’s policy is quite possibly illegal.
Union? What Union?
We talk of the European Union. That concept of Union considerably stretches the imagination. There is seldom unanimity; factionalism is rife; decision making is sclerotic; policies are inevitably arrived at by endless compromise and fudge, usually after a row. Leaving aside what we have described above economically, there are palpable political divisions too perpetually simmering away, often boiling over.
The cost-of-living crisis claimed the scalp of the Italian government last month. It was the 69th government since the end of the War. If the polls are accurate (always to be taken with a pinch of salt), the 70th government in Rome is likely to lurch sharply to the right under the prospective leadership of Georgia Meloni of the Brothers of Italy party as a mooted prime minister, in cahoots with Matteo Salvini of the League as her #2. Both are adamant that with Italy vulnerable to Russia cutting off gas supplies, western sanctions are hurting Italy considerably more than they are affecting Russia; breaking the EU’s and NATO’s public party line, they insist a deal with Putin must be done. Hungary is 100% reliant on Russia for its gas supplies; Prime Minister Orban, if not a lackey of Putin’s then certainly a chum of his, last month went rogue and signed a new gas supply agreement with the Kremlin; Hungary is both a member of the EU and NATO.
But nowhere divides opinion in the EU more than Poland. Warsaw, or more accurately the right-wing PiS government, is a permanent occupant of the EU’s ‘naughty step’. It is regularly threatened with Article 7, the suspension of voting rights, as it persistently transgresses EU rules and values regarding freedom of the media and the independence of the judiciary. Never quite having had the nerve to ‘go nuclear’ and suspend Warsaw, Brussels has instead imposed severe financial penalties on Poland, fining it €1m per day of non-compliance and €100m for subsequent failure to pay (in aggregate €230m by mid-July), and withholding €36bn of central aid due to Poland from the EU’s €750bn Covid Recovery plan. Poland’s plight is unenviable. It has just reported its economy shrinking by 2.1% in the second quarter of this year against the first quarter; inflation is 16.1%; interest rates are 6.75%; there are still an estimated 1.5-2.0 million Ukrainian refugees in Poland, putting strain on resources and the economy. America says that Poland needs economic aid. Brussels determines nothing but economic punishment. No wonder Poles sometimes wonder why they bother with Europe. They might have been a significant net beneficiary of EU largesse, but Poland is due soon to be a net contributor to the EU budget.
The cost-of-living crisis claimed the scalp of the Italian government last month. It was the 69th government since the end of the War. If the polls are accurate (always to be taken with a pinch of salt), the 70th government in Rome is likely to lurch sharply to the right under the prospective leadership of Georgia Meloni of the Brothers of Italy party as a mooted prime minister, in cahoots with Matteo Salvini of the League as her #2. Both are adamant that with Italy vulnerable to Russia cutting off gas supplies, western sanctions are hurting Italy considerably more than they are affecting Russia; breaking the EU’s and NATO’s public party line, they insist a deal with Putin must be done. Hungary is 100% reliant on Russia for its gas supplies; Prime Minister Orban, if not a lackey of Putin’s then certainly a chum of his, last month went rogue and signed a new gas supply agreement with the Kremlin; Hungary is both a member of the EU and NATO.
But nowhere divides opinion in the EU more than Poland. Warsaw, or more accurately the right-wing PiS government, is a permanent occupant of the EU’s ‘naughty step’. It is regularly threatened with Article 7, the suspension of voting rights, as it persistently transgresses EU rules and values regarding freedom of the media and the independence of the judiciary. Never quite having had the nerve to ‘go nuclear’ and suspend Warsaw, Brussels has instead imposed severe financial penalties on Poland, fining it €1m per day of non-compliance and €100m for subsequent failure to pay (in aggregate €230m by mid-July), and withholding €36bn of central aid due to Poland from the EU’s €750bn Covid Recovery plan. Poland’s plight is unenviable. It has just reported its economy shrinking by 2.1% in the second quarter of this year against the first quarter; inflation is 16.1%; interest rates are 6.75%; there are still an estimated 1.5-2.0 million Ukrainian refugees in Poland, putting strain on resources and the economy. America says that Poland needs economic aid. Brussels determines nothing but economic punishment. No wonder Poles sometimes wonder why they bother with Europe. They might have been a significant net beneficiary of EU largesse, but Poland is due soon to be a net contributor to the EU budget.
A success? You judge
The EU is in a jam. Politically it is incapable of progressing. The last 20 years since the creation of the euro demonstrate that. The logical step is full union. But the means by which it gets there require political will which is lacking. Then it needs full-scale reforms of the voting process and its governance as a pre-requisite to political and fiscal union, in that order (voting reform to address the significant democratic deficit: you cannot have a stable and enduring political system in a democracy in which taxation is imposed without representation). Until all that happens, Europe will remain expending much energy merely holding itself together, rather than moving forwards. Perhaps the most damning indictment of the failure to complete the project is that in 30 years, the EU has conceded ten percentage points’ share of global GDP since 1990, falling from 25% to 15% today.
As for the UK? Since September 16th, 1992, and Turnbull’s Liberation Day? We remain a relatively small economy, 6th in the world and around 4% of global GDP. But while the EU has demonstrably gone backwards in relative terms, our fortunes at least have remained relatively near-constant. While it is far from a ringing endorsement, it is far better than what might have been!
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
As for the UK? Since September 16th, 1992, and Turnbull’s Liberation Day? We remain a relatively small economy, 6th in the world and around 4% of global GDP. But while the EU has demonstrably gone backwards in relative terms, our fortunes at least have remained relatively near-constant. While it is far from a ringing endorsement, it is far better than what might have been!
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
The value of active minds – independent thinking
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Fund specific risks
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Important information
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