Brexit, Black Wednesday and a Thursday letter to Norman Lamont – Part One
By Richard Matthews, London
Live Squawk News, 3 February 2016
While there’s much uncertainty about Britain’s exit from the European Union, it might help to recall that we have been in similar situations many times. In the City and trading, I’ve witnessed the last vote on Europe in 1973 when Harold Wilson was too canny a politician to lose. Then in 1979, when the UK joined the Exchange Rate Mechanism or ERM that aimed for a more stable monetary and exchange rate system and laid the groundwork for the single euro currency. Then, there was the UK’s unseemly exit from the ERM in 1992, which felt anything but stable that day – Black Wednesday.
When Sir Geoffrey Howe, at the time Chancellor of the Exchequer, refused to take Britain into the ERM in 1979, it was considered to be somewhat of a risk since the U.K still had a very weak economy. But the real damage came when the Chancellor, now Nigel Lawson, decided that instead the British pound sterling was to shadow the Deutsche Mark in a futile attempt to replicate Germany’s low inflation and employment. Eventually, John Major (later to be Prime Minister) replaced Lawson and took Britain into the ERM on 8 October 1990. Membership of the ERM guaranteed that the pound would not deviate more than 6% from its entry level of DM 2.95. Little did we realize at the time that this would set the country on course for the perfect currency market storm, which would quickly gather force over the coming months.
By the early 1990’s, the ERM itself was already under significant stresses due to the cost of German reunification after the Berlin Wall came down, while Britain, Italy and France brought their own particular problems to the party. Great Britain’s economy was being savaged by a weak US dollar, and our feelings of national prestige and fear of Europe started to rise over the summer months. Indeed, I remember the feeling of fear that pervaded the country as house prices tumbled and people were forced into negative equity. When Denmark voted against the Maastricht treaty that aimed at further European Integration, the markets started to smell blood as Europe suddenly looked weak.
It is widely claimed that George Soros was the man who broke the Bank of England, but throughout the summer 1992 large short positions of sterling, as well as French francs and Italian lira, were being built as well as significant shorts of the interest rate contracts. Actually, a lot of traders may have been quite happy for Soros to take the publicity, and become the scapegoat. In the afternoon of Tuesday, 15 September 1992, enormous sell orders were being seen across the futures market the size of which were previously unheard of. The phrase brokers loved to hear was: “your amount is my amount.” In other words, unlimited sell orders were being received.
When the market opened on the Wednesday, the 16th, it became obvious that there was only one buyer and that entity didn’t have the resources to take the heat out of the market. So the markets in sterling, including interest rates, were sold — and sold again — until the government started to panic. The Bank of England (BOE) first raised interest rates to 12% from 10%, and then at the close of the day hiked them to 15% in a last-ditch effort to save the pound. Neither the BOE nor the UK Treasury realised that buy orders of £300m were just a drop in the ocean in the brave new world of derivatives. By the close of business, having had the most thrilling day of our lives, my partner and I decided that interest rates of 15% were unsustainable and put on the largest trade we ever did: we bought short sterling. Don’t ask me how much.
At the end of that day, my first reactions were relief and fear — not fear that our trade would go wrong, but that we hadn’t correctly matched all our trades. With days of extreme market volatility and working on the floor where you were literally screaming to be heard, fear was always the overriding emotion. My business partner and I travelled home together in silence, exhausted. As he got out the car, we just looked at each other knowing the no one else would understand what we had gone through that day — or worse what we may now be facing due to an error.
By 7:00 o’clock that evening, the BOE announced that Britain would leave the ERM and cut interest rates to 12%. This was to be followed the next day with another cut back to 10%.
I can’t imagine that we’ll see another day when the currency remains trapped going down a one-way street, the wrong way, during our protracted exit from Europe over the next few years. We are free of the yoke of an exchange rate mechanism and it is hard to pinpoint a particular incident that could lead to a few months or days of concerted movement.
However, the risks remain and a small point that should be taken from the preceding paragraph’s history lesson is the power of the almighty dollar. Look at the movement of sterling against the dollar between 1981 and 1985 when its value effectively halved. Although we collectively blamed all our ills on the ERM, the influence of the dollar stayed strong. Why, one may ask, did this massive prolonged drop occur? Was it to do with UK interest rates below U.S. interest rates for a long period? There is strong evidence to suggest that this was the case, and I’m sure you are aware that is the case again, this time brought on by Brexit fears.
Maybe that was the day that Britain really started its exit from Europe, without an Article 50. Britain prospered and Europe lurched towards the Euro, while the UK could never quite commit to that.
My trading partner and I survived. There is an old maxim: “Don’t bet the farm.” Well, we did, and that day certainly gave me option money – a floor term for I-don’t-care money but said in language I can’t print here. One of my options was to write Chancellor Norman Lamont, thanking him for giving me the finances to buy the beautiful Red Dino Ferrari 246 that was about to appear in my drive. Vintage Ferrari? That was my first ‘options’ trade. There had to be some compensation for constantly being over-worked, still single and hoarse.
This column is the opinion of the author and does not necessarily reflect the opinion of Live Squawk.