In Britain, Black Wednesday, which occurred on September 16, 1992, is now known as the day when speculators "broke the pound," which is an euphemism used to describe the moment in time where market forces coalesced to force the British government to exit the European Exchange Rate Mechanism (ERM) by removing its currency from that agreement. Joining the ERM was part of Britain's effort to help the unification of the European economies. However, it soon became clear that Britain could not adhere to the agreed upon terms which led to the removal of its currency, the Great British pound (GBP), from the agreement.

Key Takeaways

  • September 16, 1992, known as Black Wednesday, was the day speculators forced the British government to pull the pound from the European Exchange Rate Mechanism (ERM). 
  • Britain joined the ERM in a concentrated effort to stimulate the unification of the European economies—an effort that unfortunately failed.
  • Leading up to the 1990s, the British pound had shadowed the German Deutschmark, which had the deleterious effect of spiking inflation in Britain.

Although it stood apart from European currencies, the British pound had shadowed the German Deutschmark (DEM) in the period leading up to the 1990s, which left Britain with low interest rates and high inflation. Britain entered the ERM with hopes of keeping its currency above 2.7 DEM to GBP. This was fundamentally unsound, mainly due to the fact that Britain's inflation rate was many times that of Germany's.

The underlying problems inherent in the pound's inclusion into the ERM was compounded by significant economic strain resulting from Germany's reunification. This, in turn, put pressure on the Deutschmark as the core currency for the ERM. The drive for European unification also hit bumps along the road during the passage of the Maastricht Treaty, which was meant to bring about the euro. Speculators began scrutinizing the ERM, causing them to start wondering how long fixed exchange rates could fight natural market forces.

The Maastricht Treaty was created as a follow up to earlier treaties establishing the European Communities (EC), which were the EU's first pillar.

Spotting the writing on the wall, Britain upped its interest rates to the teens in an effort to attract more people to the pound. However, speculators such as George Soros began to heavily short the currency. Consequently, the British government gave in and withdrew from the ERM, once it became clear that it was losing billions of pounds in its attempt to artificially buoy its currency to higher levels.

While this was a difficult decision to undertake, the pound came back stronger as the British economy strengthened once inflation levels were controlled and high interest rates were reduced. Soros, for his part in "enforcing" market dynamics, pocketed $1 billion on the deal and cemented his reputation as the premier currency speculator in the world. (For more on Soros' feat against the British pound, check out The Greatest Currency Trades Ever Made.)