Options for Europe – Part 51

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).


The Summer of ’92 and Black Wednesday 1992


The 1992-93 crisis demonstrated that the system of fixed exchange rates or even tightly linked exchange rates between economies that were disparate in nature and performance would always fail if capital was mobile. The Bank of England governor Robin Leigh-Pemberton wrote in 1993 that the problem for the UK “arose because the degree of divergence between the domestic policy needs of Germany on the one hand and those of much of the rest of Europe on the other became wholly abnormal, and it was this quite abnormal tension that tested the margin of tolerance built in the ERM to destruction” (Leigh-Pemberton, 1993: 289).

For Britain, the crisis was a chance to distance itself from the EMU forever. Norman Lamont, who was the Chancellor who ‘suspended’ Britain’s ERM membership on Black Wednesday and who subsequently lost that position in the aftermath of the crisis, admitted afterwards that he was “increasingly unhappy” with the decision to join the ERM in the first place “as the recession took its toll” in 1992 (Keegan and Brett, 2007). He also said that once the dust had settled on the calamity, the decision to withdraw “enabled economic policy to be rebuilt ‘out of the ashes'” (Keegan and Brett, 2007). Apparently, he had a habit of singing in the bath each morning and while he refrained on Black Wednesday, his wife heard him singing one morning a few weeks later on a “very beautiful morning” (Keegan and Brett, 2007). At a press conference not long afterwards, Lamont summed up his attitude to leaving the ERM with reference to Edith Piaf: ‘Je ne regrette rien’ (Groom, B. 2008).

Lamont clearly blamed the Germans for the crisis and the President of the Bundesbank, Helmut Schlesinger in particular. The behaviour of the Bundesbank brought back memories of the famous Emminger Letter, written by the then President Otmar Emminger
to Gernman Chancellor Helmut Schmidt on November 16, 1978 (Emminger, 1978). As an aside, the Finance Minister at the time, Hans Matthöfer, a West German trade unionist, described Otmar Emminger as a “miserable know-it-all” (Der Spiegel, 2011). The letter – entitled ‘Stellungnahme des Zentralbankrats zum künftigen EWS’ (‘Statements of the council of the central bank on the future EMS’) – sought to confirm an “agreement” (“eine Einigung”) between the Bank and the Federal Government such that membership of the proposed EMS would provide allow for an “opting out” (“Aussetzung”) of the Bundesbank’s responsibility to support other exchange rates if “internal monetary stability is threatened” (“die innere Geldwertstabilität bedroht wird”). Helmut Schmidt annotated the letter with a lower case ‘r’, shorthand for ‘richtig’ or (correct) to signify agreement. In other words, if the Bundesbank thought that it would be undermining its anti-inflation approach by selling Deutsche Marks in order to purchase weaker currencies as part of its intervention obligations under the EMS this agrement allowed it to simply renege and let the other nation lose reserves and enter crisis.

When Schmidt appeared before the Bundesbank Council on November 30, 1978 to discuss the terms of the letter (that is, to seek the approval of the Bundesbank of Germany’s decision to enter the EMS in 1979) he told the Council in relation to the opt out terms that no formal agreement could be made but a ‘secret’ informal arrangement was understood (Deutsche Bundesbank, 1978, translation via http://www.margaretthatcher.org/document/111554):

… I have quite severe misgivings about a written specification of this sort, a written specification of the possibility of an at least temporary release from the intervention. Let us first of all assume that it appeared tomorrow in a French or Italian newspaper. What accusations would the newspapers then make in editorials against their own Government who got themselves mixed up with such a dodgy promise with the Germans. A Government which promised them to intervene in the framework of certain rules of the game, but internally put in writing its intention to be able to do otherwise if need be. In the matter itself I agree with you, gentlemen, but I deem it out of the question to write that down.

The ‘opt out’ was a feature of the 1992 and forced the Italians out of the ERM in 1992. The resulting forced devaluation then turned the attention of the financial markets towards the Pound and Black Wednesday was the result. It was replayed again when the crisis re-emerged in the Summer of 1993 as the recession became more entrenched and central banks around Europe were signalling a need to lower interest rates, to provide some stimulus support. The constraint they faced was that the Bundesbank would not compromise on its tight monetary policy settings, which were addressing the domestic liquidity consequences of spending associated with reunification. The two positions: high interest rates in Germany and reduced rates elsewhere to fight recession, on the one hand; and maintenance of the agreed exchange rate settings, on the other, were incompatible.

Political pressure on the French government to do something about the rising unemployment became intense as the 1993 summer approached and there were increased calls for France to abandon the EMS. This sort of political instability, especially given the ‘petit oui’ (the narrow affirmative result in the September 1992 French referendum), bred speculative activity. The trading behaviour of the currency market traders suggested they believed the French government would succumb to the domestic pressure to cut rates and devalue the Franc. On July 29, 1993, the Bundesbank confirmed they would not cut German interest rates, and the currency markets went crazy – selling the Franc and other European currencies in huge volumes and making the 2.5 per cent fluctuation bands unsupportable.

The resulting political decision all but ended the EMS. They widened the allowable fluctuation range for all currencies to plus or minus 15 per cent (a 30 per cent overall allowable fluctuation), which made a mockery of the claim that the EMS was maintaining currency stability. The EMS was heading in the same direction as the Bretton Woods system, which collapsed for similar reasons in August 1971. The widening of the bands was called a ‘temporary measure’ by the politicians who accused the Italians and the British of being too lax in their anti-inflation fight or the Germans of being too lax in their spending on reunification. If the ‘fight’ against inflation after the oil price shocks in Italy or the UK was more stringent or the fiscal expansion to allow Germany to absorb the East more quickly had have been more modest, the result would have been even higher unemployment across Europe than was already the case. The political pressures in that regard would have been intolerable and the speculative attacks on the EMS currencies would have occured no doubt. The problem was not ‘laxity’ or excessive fiscal stimulus, but the fact that a ‘fixed’ exchange rate system such as the EMS (and its predecessor the Bretton Woods system) was incommensurate with the economic and political reality. Nations cannot absorb high unemployment for lengthy periods without major consequences such as social instability and increase political extremism. The Germans, above all, should have learned that lesson.

The other reality, beyond the scope of this work, is that a close examination of the Bundesbank behaviour over the life of the EMS reveals that its interventions into foreign exchange markets (buying and selling Marks) were ‘sterilised’ (by simultaneous domestic monetary operations) so that the impact on domestic liquidity (the ‘money supply’) was relatively neutral. It was never in danger of an uncontrollable outbreak of inflation as a result of honouring its EMS obligations (Gros and Thygesen, 1998).

Far from learning from the mistakes, the politicians of the day, claimed that the currency crisis in 1992-93 was evidence of the need to accelerate the move to the single currency. Higgins (1993; 37) illustrated the denial by the politicians at the time with an analogy:

Assume someone embarks upon a trip with only enough gasoline in the car to reach his destination if weather conditions are ideal. If the car were to run out of gas when a strong head wind is encountered, would the driver be justified in blaming bad luck when he has to walk the last few miles? The driver’s misfortune was not inevitable, but it could not be said to be totally unexpected. His plan was faulty in that it allowed no margin of safety.

One might make this point more emphatically. Given the disparities of the economies involved it was always expected that the ‘car would run out of petrol’. The structure of the system was predicated to crisis in the same way as the monetary system that came next – the EMU – has delivered crisis.

While the ‘Emminger Doctrine’ brought the EMS to its knees in 1992-93, it still resonates in the current crisis. Marsh (2013) notes that Jens Weidmann, the current Bundesbank President, “has been known to cite Emminger approvingly in his speeches” and he argues that it was invoked during the March 2013 Cyprus crisis when the ECB delivered an “ultimatum to Cyprus” to agree to the IMF bail-out package or go broke. As we will see, the Cypriots should have ‘gone broke’ and left the Euro and the resulting mess to the politicians in Brussels, while rebuilding their economy ‘out of the ashes’ using the freedom that the British gained when they abandoned their membership of the EMS in 1992.




Additional references

This list will be progressively compiled.

Emminger, O. (1978) ‘Stellungnahme des Zentralbankrats zum künftigen EWS’, 16 November 1978, Deutsche Bundesbank.

Der Spiegel (2011)’ Saving the Euro: Germany’s Central Bank against the World’, November 15, 2011. http://www.spiegel.de/international/europe/saving-the-euro-germany-s-central-bank-against-the-world-a-797666-2.html

Deutsche Bundesbank (1978) ‘Transcript of Meeting of the Bundesbank Council’, 30 November 1978,

Higgins, B. (1993) ‘Was the ERM Crisis Inevitable?’, Economic Review, Fourth Quarter, Federal Reserve Bank of Kansas City.

Keegan, W. and Brett, A. (2007) ‘Mr Lamont’s dark history’, UK Guardian, July 22, 2007. http://www.theguardian.com/business/2007/jul/22/conservativeparty.politics

Groom, B. (2008) ‘Darling – time to sing in the bath’, Financial Times, February 19, 2008.

Leigh-Pemberton, R. (1993) ‘The UK Perspective’, in Temperton, P. (ed.) The European Currency Crisis: What Chance Now for a Single European Currency?, Cambridge, Probus.

Marsh, D. (2013) ‘The Emminger letter reappears’, OMFIF Commentary, April 2, 2013. http://www.omfif.org/intelligence/the-commentary/2013/april/the-emminger-letter-reappears/

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.

This Post Has 4 Comments

  1. Bill, your analysis becomes more impressive by the week. By the way, thanks for including the Keegan reference. I wish my German were up to reading Schmidt’s annotations. I’m sure it would be worthwhile. Ah, well.

  2. Bill, the Emminger letter discussion shown on the OMFIF Commentary web page seems to have “redacted” the author’s name. I know that Marsh researched some of this documentation, but how do you know that he actually wrote this comment? The pdf document link gave a runtime server error when I tried to access it from the given web page. I thought the pdf might be “unedited”.

  3. I’m completely delighted with your blog. I’m Spaniard, and I’ve got a blog. Little heterodox here – not very appreciated, really: in Spain the Euro is nowadays an untouchable Myth.
    But that is not the only reason for enjoying your blog. I like very much your point of view and your explanations.

  4. Dear Miguel,

    If my comments indicated that my appreciation of Bill’s blog is in any way different from your own, let me express my regrets. I wholeheartedly endorse your view of Bill’s blog – I was just being picky. I am sorry to hear that your own heterodox blog is unappreciated in your homeland. I hope it helps to know that you are not alone in this. I am more than a little dismayed to learn that the Euro has reached mythological status in Spain. This is unhelpful to say the least.

    I wish you the best,

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