Toscafund Discussion Paper- 1992 It will be deja-vu all over again

TOSCAFUND Economics June 2016 1992 – It will be déjà vu all over again

One of the most remarkable experiences of recent days is having discussions with

‘market participants’ who were not working in capital markets in 1992 and many had not even

been born then. I do not pick this year randomly but because it was the year the UK made its

EXIT from the ERM. In the wake of this the pound fell, GDP recovered strongly (see Chart 2

and 4) and the FTSE ultimately surged. Well, it should really be déjà vu all over again. And the

reason it hasn’t been thus far, is because so many participants in capital markets were not

participating then. Well I can say that most of the Partners at Toscafund were very much

working in finance in 1992 and we know what comes next.

Yes, the pound has weakened. But no, it has not done so by a percentage which has not

been experienced before; experienced before and, I hasten to add, enjoyed the

competitiveness enhancing consequences of before (see Chart 1). Yes, the UK equity market

recently moved lower, but not by a percentage outside of our experiences. And whilst equity

prices edged downwards, Gilt prices went higher, for me a reassuring and more than justified

move given the UK economy’s sound fundamentals.

Back in the wake of our EXIT from the ERM interest rates were cut as the currency fell.

The former lifted what had been appallingly weak domestic demand whilst the latter lifted

trade.

This time around the domestic economy is actually in far stronger shape and the

employment level today stands at 34.3 million compared to 27.6 million in 1992 (see Chart 3).

Moreover, the domestic economy is far more service orientated today than in 1992; the index

of services currently stands at 110. It had not been created back in 1992, beginning in 1997 at

65. Since then it has compounded at annual real growth rate of 2.7%. Services will continue to

be a long-term driver for UK economic growth. Back in 1992 our hotels were characterised by

Fawlty Towers, now they tower in every corner. Back in 1992 our University capacity was

scaled to cater for a privileged few, now our Universities are on an industrial scale.

Back in 1992 there was no China on the global stage. Now it is a growth behemoth

whose strength many across the emerging world feed off. And few nations in the developed

world have greater connectivity with it than we do across the UK. Back in 1992 Central and

Eastern Europe were still outside the EU and struggling to see clearly in post communist

daylight. This time the likes of Poland et al would prove our loudest EU supporters to avoid

the UK being rusticated from it.

That was before the Single Labour Market. Now watch as EU nationals from France, Italy

et al flock here, fearing that if they delay they might be “gated out”. Watch too as our

Universities are overwhelmed by applicants from beyond the EU looking to capitalise on the

cuts to our tuition fees brought about by sterling weakness. Watch also as tourists exploit a

weak pound and as we opt for a ‘staycation’. Also, listen out for the container ships filled with

UK made cars heading for customers across mainland Europe and beyond it taking advantage

of our improved competitiveness. Watch and listen as our economy strengthens rather than

struggles as so many youthful and inexperienced commentators claim. Keep an eye out too

for inflation which did not surge post our EXIT from the ERM and neither will it surge now. In

our reasoned and seasoned expectation consumer price inflation will settle nicely within the

range 1-3% which the Bank of England is mandated to achieve. And as for George Osborne’s

threatened tax rises in ‘Autumn’, these will fail to materialise just as his emergency Budget.

Toscafund’s forecast for UK GDP growth in 2017 is a range of 1.8%-2.2%. More

importantly the medium term outlook ultimately benefits from the exit.

Author: Dr Savvas Savouri

Contact information Toscafund Asset Management LLP 90 Long Acre London WC2E 9RA England

t: +44 (0) 20 7845 6100 f: +44 (0) 20 7845 6101

e: [email protected] w: www.toscafund.com


Chart 1: Leaving the ERM: £ down but inflation stable Chart 2: Leaving the ERM lifted GDP

Source: Bank of England, ONS, Bloomberg, Toscafund

Chart 3: Leaving the ERM lifted employment Chart 4: Leaving the ERM lifted the FTSE

Source: ONS, Toscafund

Chart 5: Leaving the ERM lifted tourism Chart 6: Leaving the ERM lifted house prices


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We must reconcile ourselves to the momentous events of last week. We need to reconcile with the fact it has happened, and

this needs to include reconciliation with each other; a tolerance between those who voted differently, and a peace between

the UK and the 27 nations of the EU. It serves no interests for bitterness and recrimination to pervade coming days, weeks

and months. We do not need ill chosen words, either those spoken in English or those which might be controversially

translated or repeated out of context.

Let me be clear, whilst I argued for this outcome I did not expect it. I was shocked by it because I was shocked by the extent

to which the economic arguments against it had become so hyperbolic as to present a dystopian UK future were we not a

member state of the EU. Well, we can now test the veracity of what we had to contend with. And what we have seen thus far

has been reassuring.

Yes, the pound has weakened. But no, it has not done so by a percentage which we have not experienced before;

experienced before and, I hasten to add, enjoyed the competitiveness enhancing consequences of before. Yes, the UK equity

market moved lower, but not by a percentage outside of our experiences. And whilst equity prices edged downwards, Gilt

prices went higher, for me a reassuring and more than justified move given the UK economy’s sound fundamentals. As for

the emergency Budget which the Chancellor threatened us with, this has been exposed as an idle threat. For his part the

Governor of the Bank of England has joined George Osborne in offering words of reassurance, a far cry from their

forebodings ahead of the referendum. Most refreshingly of all Mark Carney’s predecessor Lord King has spoken positively

concerning London’s financial services in the years ahead outside the EU.

There has been much talk of the referendum outcome triggering a technical recession in the UK economy – two sequential

quarters of declining real GDP. Not only do I dismiss such alarms out of turn, I challenge those who make them to explain the

precise transmission mechanism for the shock result to shock the economy. A weak currency is hardly consistent. Nor too are

sound demographics, a UK which looks in parts as if it were an emerging economy by its youthfulness. Those who tell us that

fixed capital formation and other such investment will be paralysed have to be reminded that UK construction activity has

grown comparatively modestly over recent years, to the frustration of those who seek more homes and offices, but to the

benefit of those who actually hold such assets. As to what real GDP growth will be across the UK over coming years my

answer is quite simply, the highest across the EU, mostly centred on Middle England.

My arguments for the UK separating itself from the EU were made in a series of discussion papers written ahead of June 23rd,

and these will no doubt be what I and other leavers will be tested on in the interesting times ahead. I made clear that our

leaving would not be a trigger for unfavourable economic and political developments across Europe; rather my contention

was that as these were unfolding anyway, we were better off distancing ourselves from them and their costly consequences.

I emphasised that the euro-zone’s economic problems were such that its worse was not behind it. In part this is the result of

the ECB acting too late in confronting the euro-zone’s deflationary challenges. Also contributing too has been stubbornness

from certain EU quarters – centred on Germany – to use a spending-based solution to the challenges confronting large parts

of the single market, most notably the Mediterranean facing members. I made particular reference to the one euro-zone

nation which filled me with most concern: France. My contention was and remains that for all the pressures which Greece,

Cyprus, Portugal and other Mediterranean nations have placed on the EU and the euro-zone within it, these were already

largely recognised, whilst the deep rooted problems of France are not. When these finally became clear, and they will soon,

one can only wonder at the unpleasant shocks this realisation delivers to mainland European capital markets.

Since the Single Market was so much lauded by ‘remainers’ I spent a great deal of time writing down my thoughts on it, and

these were far from flattering. I argued those seeing an attractive expansive single EU market which the UK was enjoying

increasing export demand from were suffering from dysmorphia. For whilst recognising its comparatively high percentage

share as a destination for our visible exports, I could plainly see this ratio trending lower over recent years, with our trade

deficit with the EU widening as a result. Indeed I argued that whilst the EU’s appetite for our goods was in decline, our

demand for products made across the EU was increasing. Far from reflecting poorly on the quality of UK made products,

these trade trends are in fact testament to the growth in our economy and the lacklustre nature of continental markets; we

have after all been enjoying the highest export value ever for British made cars, demand for them strongest beyond the EU.


I argued, in short, that against the backdrop of poor continental labour markets, Europeans were not particularly good

customers to rely upon. I argued it was far better to focus ones trade attentions elsewhere around the world to nations with

a growing appetite for all things ‘Made in Britain’; from cars and whiskey to legal and insurance services to educat ion and

tourism. And far from seeing a weak pound as a concern we need to view it for the competitive benefits it delivers. My

reasoning was leaving the EU was not so much “Auf Wiedersehen, Pet” as “Huanying, Pet” and “Svaagat he, Pet”. After all by

sheer size the single markets of China and India dwarf the EU’s. And as for abandoning the EU I made it clear a vote to leave

it would show leadership for others to reconsider their own futures within it. I also made clear that in exporting ever more

Minis, Bentleys and Rolls Royces’ beyond the EU the earnings from these sales would provide welcome remittances into a

Germany beginning to struggle economically. Germany would also benefit financially from the investments EoN and RWE

have made across the UK power sector, Deutche Bahn across our transport sector. The reality is that the interests of a great

many German corporates - and through them the German Finance Minister - are cemented and aligned with those of the UK

economy.

Chart 7: UK population growth compared Chart 8: Birth rates compared

Chart 9: UK Labour market: made of sterner stuff Chart 10: UK Regional unemployment rates compared

Source: UN population division (medium estimates), ONS – UK mid-year statistics, ONS, Toscafund

When Dick Clement and Ian La Frenais scripted “Auf Wiedersehen, Pet” back in 1983 the world economy was far, far

different, and so too the UK economy within it. Then we were entertained watching Britons at work in Germany and then

Spain. This was, of course, bitter sweet because the plots were based on lack of work within the UK for our craftsmen in the

building trade. How very different today. Then the UK was undergoing the painful process of almost root and branch supply-

side reform and industrial restructuring. Now the UK is the prototypical high value added economy; adding considerable

value to goods and services demanded internationally from law and insurance to education and aero engines. Then China

was closed, whilst now it is very much open for international business. Then we exported our labour, now we have seen

more than a decade of mainland Europeans coming to the UK to work. I mention this not to criticise the Single Labour

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Market, which I have never wavered in supporting, but to criticise the economic management of the euro-zone and its

proxies across the EU. I also have never been able to fathom the UK’s stated immigration strategy since 2010.

If I have a frustration with immigration it is not the single labour market but the coexistence of this with a target on net

immigration; set by Teresa May and endorsed by David Cameron. The consequence of this ridiculous combination is the UK

denying entry to those from beyond the EU who would wish to work or study here. We have been telling affluent Indians we

do not want to educate their young adults and refusing the lucrative fees and living expenses which accepting them would

bring. We are telling Australians and we are telling New Zealanders and we are telling Canadians that despite our deep-

rooted historic commonwealth they do not have the same privileges to enter the UK for work, as EU nationals. This is not to

say that Bulgaria or Latvia, Estonia or Slovakia or any of the other twenty three EU nations have a comparatively inferior

workforce. Rather it is to say there is nothing particularly superior about it. How could it be when compared against

Singaporeans, Canadians, Australians or the educated and skilled masses across Asia writ large. And in leaving the EU we can

now correct this prejudice for the UK’s economic good.

Chart 11: Net migration, by main reason, EU Chart 12: Net migration, by main reason, Non-EU

Chart 13: Non-UK Students in UK Universities Chart 14: Tourism to the UK, with Brexit forecasts

Source: HESA, ONS, Toscafund

Let me address myself for a moment to those who dispute that the referendum result actually produced ‘a conclusive’

outcome. Some of these have argued that those who voted Leave were poorly informed as to what it actually meant, and

indeed many now regret doing so. Others have pointed to the detail that the referendum is advisory and so should be taken

in that context and the population’s advice be ignored by Parliamentarians. I am as distant from being a constitutional expert

as I am an expert in the oboe. What I do know is that to deny popular sentiment when it goes against the Establishment is to

court challenges; figuratively and literally. I want to focus instead on a recent referendum whose outcome was indeed

ignored. Back in April 64% of Dutch voters rejected the Deep & Extensive Free Trade Agreement which the EU had signed

with Ukraine back in January. As I have said their wishes were not realised and the agreement stands. What makes this story

so instructive to me is that the same EU which has claimed that a Free Trade agreement with the UK would take considerable

time is the very EU which took literally no time signing one with Ukraine. Surely the simple solution is to take Ukraine’s

agreement and ignore the ‘Raine’.

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It has been fascinating watching how our referendum vote has been interpreted by journalists in a global context. If I can coin

a phrase there has been a frenzy of ‘Brexitification’; attributing every development across the world’s capital markets to

Brexit. Such partial analysis is the default option for the press. That the yen was rising uncomfortably for Japan well ahead of

June 23rd and the Nikkei struggling would be clear to anyone choosing to look. The reality is that Japan’s economic problems

have nothing to do with the UK’s EU status. They are instead due to purely domestic policy errors performed over thirty or so

years. As for China and its currency; the moves we have been seeing were ongoing long before June 23rd and far from being a

cause for concern underscore how committed Beijing is to maintaining China’s economic growth through active monetary

and fiscal management. Where we do need global context in the aftermath of our referendum is monetary policy. What the

MPC does in the time ahead must be viewed as much alongside how other central banks behave, as how UK inflation moves.

True the pound’s weakness presents the prospect of inflation. No less true the transmission mechanism from a currency

decline to an incline in inflation has changed dramatically. Do I believe UK inflation will accelerate? Of course. Am I concerned

this will trigger the MPC to raise the base rate? No. After all we are currently “in breach” of the 1% lower target for the CPI

and so any forces that lift above this target should be welcomed. What of a rate cut? At 0.5% we have always had room for

more easing were it ever needed; a privilege the FOMC, ECB, Banks of Japan, Switzerland and Sweden et al. do not have. This

is not to say I expect a rate cut anytime soon, just that I see it as more a possibility than a rate rise.

Chart 15: Exchange rates: moving all the time

Chart 16: Gilts, bunds, treasuries yields (10 year)

Source: Bloomberg, Toscafund

Whilst I will begin to close here what I currently have to say on matters, this is far from where I will end matters. In

subsequent pieces I will reflect on what Scotland’s uncertain future within the UK might mean for the economies of the

‘home nations’. I will do so bearing in mind the momentum for devolving considerable fiscal powers not only to Holyrood but

to the Senedd in Cardiff and to new unitary assemblies across England, was in train regardless of our EU status.

Having cleared its final Parliamentary hurdles back in late March the Scotland Act 2016 received Royal Assent. This bill

provides the most far reaching devolution of economic powers back to Edinburgh for over three hundred years. I would

recommend to the SNP that they reflect on how being in a UK outside the EU allows even more decentralisation of powers to

the Scottish Parliament. By contrast becoming a sovereign state within the EU is to be part of a union which holds

harmonisation as a stubborn doctrine. Rather than champion a second Referendum on independence I would argue it might

be wiser for the SNP to demand that the Scotland Act 2016 be followed by a Scotland Act 2017 or 2018 providing Holyrood

with all the powers which a unified UK outside of the EU would allow it.

I will not reflect here on what the political fall-out from events in Westminster might mean for the UK economy, if it will

mean anything of course; party leaders come and they go after all. I will confine myself in all future writings by reflecting on

what matters for the UK economy and its markets; property most importantly. I will say here that I have few concerns that

we face a property crisis because I see developments in both residential and commercial property markets as no “bubble”

because I have plainly seen strength underpinned by fundamentals; strong demand and rather constrained supply in general.

Indeed were we to see construction being delayed because of Brexit fears one could easily see markets tighten rather than

loosen. I will reflect on all this as the data becomes available.

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Chart 17: FTSE 250 index

Chart 18: FTSE 250, daily percentage change

Source: Bloomberg, Toscafund

One cannot, of course, touch upon the events since Thursday without dealing with the 7.2% decline recorded in the FTSE250

on Friday June 24th, amongst the most marked daily falls ever recorded in that index (the worst since October 1987). That it

continued this fall into Monday 27th only increased the attention upon it. Since this index is considered the equity market

benchmark most closely associated with the fortunes of the internal UK economy, is its decline forewarning of a recession?

My answer is that the decline has been significantly exaggerated. Exaggerated because it has failed to reflect the

competitiveness boosting decline in the pound; boosting the fortunes of those ranging from the hotel and leisure sectors

across to trade natured and overseas earnings businesses. Exaggerated too because it assumes that the UK economy, which

has grown impressively into and through a series of uncertain events, will fail to continue its momentum. Exaggerated

moreover because for all the talk concerning future migration flows the UK has one of Europe’s most youthful populations

largely because of the arrival in considerable numbers of prime-age migrants over recent years. These have not simply

stopped the median age from rising as it has been elsewhere across the Continent but lifted the UK’s birth rate promising an

economy not simply larger than Germany’s by headcount before 2060 but also larger by GDP. Talk that certain construction

projects and recruitment plans are being suspended has, of course, acted to weigh on FTSE250 constituents. My response to

such anecdotal information is that we are in a permanent phase of hiring and firing and the UK labour market is emerging

from the Referendum result at its strongest level ever in terms of employment and vacancies with an unemployment rate the

envy of most of the EU. That construction activity is being delayed or indeed abandoned should be put in the context that

this sector has been a general laggard in the GDP growth of recent years and in supply constraining real estate has

contributed to lifting property prices and rents. If anything further construction restraint will only fuel these inflationary

forces which should in such a low yield world and competition for capital growth and income swiftly see construction

‘strikers’ quickly break ranks and return to work. Services will continue to be a long term driver for UK economic growth.

Chart 19: UK Service sector, strength through uncertainty

Chart 20: No. of British cars produced & exported, record highs


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The recent reversals of the FTSE250 need also to be placed in the context of its stellar moves higher over recent years. The

context of moving from a high of 12,000 just before the crisis which began to show itself from late 2007, to reclaiming this

level in late 2011. And in the context of a more recent high of 18,000. The context moreover of the decline it suffered having

reclaimed 12,000 only for it to power higher once this interruption had passed (chart 17).

Since financials – essentially banks and insurance firms – account for a sizeable share of equity markets no discussion of

moves in one can go without a view on the other. Rather than consider how UK financials have performed in the context of

Brexit we need to reflect on their relative moves with their peers across Europe and elsewhere. The reality is that deflation

and negative interest rates do not serve the interest of financial facing firms. And the reality is that the decline in sterling has

done the UK the service of making sure we do not suffer deflation and the negative interest rates which it inevitably brings.

Let me touch upon concerns that the vote to ‘Leave’ the EU exposes the City of London to the risk that business is wrenched

from it. I have no doubt effort will indeed be made to this effect. I am sanguine, all the same, because in markets such as

insurance underwriting London’s excellence is peerless across Europe and demands to participate in that market are growing

strongly beyond Europe from emergent nations whose insurance markets are, in effect, in their infancy and set to grow

impressively for the foreseeable future. Moreover Europe is in no place to provide China et al with a reason NOT to be in

London, since Beijing and other business centres across the Emerging World – and I include Sydney and Singapore in this list

as well as Kuala Lumpor, Jakarta, Toronto, Wellington etc - has no interest in London for its “passporting” rights but because

of its right time zone, language, labour force and regulatory regime.

In short, Brexit will quite simply not stop the UK as it heads towards becoming the largest nation by population and economy

across Europe within most lifetimes.

To do all this reflecting will require seeing how events unfold and how long it takes for the bitterness some now taste from

the result to clear. To be clear, it requires reconciliation.


I have taken the liberty of reprising text from the first of the three Toscafund Discussion Paper’s written concerning the

referendum in the run up to it. The paragraphs below first appeared February:

Even if I am right and we are encouraged by the leaders of all political parties (bar UKIP of course) to vote to stay ‘In’, I have

to accept that ‘Out’ is still possible with a probability which will confuse rather than be clarified by opinion polls. This will

ensure that uncertainty will hang over the outcome; made more unsettling because of the confusion over the economic

implications of an ‘Out’ vote. And there can be no denying such uncertainties will have ever more noticeable consequences

to our economy in the period ahead of the referendum. The uncertainty will influence household and business decisions

over whether and where to invest, and decisions over when, what and how much to consume. These will be impacted of

course by how much capital markets choose to buffer sterling in the face of having to deal with contingent outcomes, with

uncertain consequences. And the more uncertain the outcome the more insecurity there will be in the UK’s economic

outlook and, of course, the price of assets, goods and services will be affected. There will, moreover, not only be the

uncertainty of those within the UK but those outside looking in. All this said, I would recommend not falling into the trap of

exaggerating the actual ‘harm’ uncertainly does to our economy. After all, the UK economy performed remarkably well,

considering it was clouded in uncertainty over the outcome of the 2015 General Election. The UK economy also performed

perfectly well when there was the question over Scotland’s potential to break from the Union.

Some will no doubt claim we will never know how ‘good’ the economy might have performed were it to have been free of

election and referendum uncertainties. My reply is that we are surrounded by uncertainties and continue by and large to

behave calmly. Indeed, what we do know for certain is that during both 2014 (which the Scottish Referendum was held in)

and 2015 (the middle of which we had the General Election) the UK recorded one of the European Union’s strongest rates

of GDP growth, indeed the best across the G8, as well as an impressive improvement in job creation and strong real estate

markets.

Chart 21: England vs Scotland; Employment levels Chart 22: England vs Scotland; Unemployment rates

We can see from charts 21 to 22 that the UK labour market performed generally well through the ‘uncertain’ periods ahead

of Scotland’s Independence Referendum on September 18th 2014 and the General Election on May 7th the following year.

The charts which follow reveal how capital markets ‘priced’ in the outcomes of these uncertain events. On the one side we

see how the pound was treated on foreign exchange markets – chart 23 - and on the other, how Gilts performed in money

markets. Whilst one cannot say how events would have unfolded ceteris paribus had there been neither a closely fought

Referendum, nor a, no less contentious, General Election, the graphics hardly strike one as capital markets taking fright and

fleeing the UK. Some will no doubt claim that Brexit, or rather its possibility, involves a wholly different set of uncertainties

for both employers and investors. My reply is that if the UK’s labour market were to soften it would do so from an

impressive level of strength. And if capital markets do sell down sterling, this itself will hardly prove unwelcome to those

across the economy, from manufacturers across to the leisure and indeed property sectors, who will be able to exploit a

more competitive and affordable pound.

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Chart 23: Sterling’s performance against the $ & € Chart 24: 5 year Government bonds

If we consider the yield performance of 5 year Gilts during the uncertainty surrounding Scotland’s Referendum on

Independence and the General Election we see little discernible difference from how United States Treasuries performed

through the same periods. As for ‘underperforming’ comparable German Bunds one should notice the ECB’s rate cut as the

explanation, not some increased risk-aversion towards UK Government debt (chart 25).

I am not suggesting that uncertainty ahead of the referendum will not influence economic activity within the United

Kingdom; I have already written earlier that, of course, it will. What I am simply asking is that ahead of the referendum we

please keep our heads when it seems that all about us there are those losing theirs. Let me try to explain why the pricing in

of risk will actually provide its own rewards within the UK economy.

Consider the plight of the pound whose rate of exchange against the dollar and euro has been slipping of late; against the

euro down from buying 1.42 to 1.3 in the space of six weeks. Now, if we assume sterling weakness continues because of

Brexit uncertainty this will come as a welcome development for those across the UK who will benefit from a more

competitive currency, particularly in relation to neighbourly rivals across the euro-zone (from exporters of goods to those

competing for leisure and tourist custom). Of course each dip in sterling will have inflation implications. Well, at a time

when the greatest fear is being mired in deflation this is hardly a bad thing. A weaker pound also raises the intriguing

prospect of UK assets becoming more affordable for those with an eye on them from overseas, and either, convinced that

the probability of Brexit is being exaggerated and/or its unfavourable economic consequences to the UK overstated. Those

with this mindset could only welcome any downwards re-pricing of UK real estate and sterling assets more widely since this

would provide them with an ever more affordable acquisition. As for the Monetary Policy Committee (MPC), I refuse to

accept it will vote for a base rate rise until the Brexit question has been answered. I am reminded at this point of two

fateful events for the UK in 1992 (I had become chief UK economist at the stockbrokers Hoare Govett from November

1991).

Firstly, there was the ‘surprise’ General Election win for John Major over Neil Kinnock. Such was the expectation of a Labour

victory back in 1992 that sectors, notably the privatised utilities, were ‘sold-off’ since they were seen as targets of a new

Government whose Chancellor would be the very much ‘old Labour’ John Smith. As it was, we woke on April 10th to find

opinion polls had got it wrong (plus ça change). When markets closed for the day on the 10th those sectors and particular

stocks which had been sold-off ahead of the General Election recorded spectacular revivals. In fact the 5.59% rise in the

FTSE 100 on that day remains one of its best ever percentage improvements.

This brings me to the second memorable event of 1992. When the London markets closed on September 16th we went

home expecting to wake to a base rate of 15%. As it was, in the early evening Norman Lamont stood in front of the

Treasury to announce the pound’s membership of the Exchange Rate Mechanism (ERM) had been ‘suspended’, and so too

the second (300 basis point) rate rise which he had earlier announced in the Government’s efforts to forestall just such an

exit (not to forget the tens of billions of our foreign reserves squandered to that purpose). Now what makes this eventful

day so very memorable is that having at first been branded ‘Black Wednesday’, it instead quickly came to be remembered

as ‘White’. This was because on September 16th the UK escaped from the constraints imposed on it by the Economic and

0.0

0.5

1.0

1.5

2.0

2.5

2003 2005 2007 2009 2011 2013 2015 2017US dollars per Sterling Euro per Sterling

-0.5

0

0.5

1

1.5

2

2.5

3

3.5

4

2011 2012 2013 2014 2015 2016 2017

%

UK Germany US ECB Rate


Monetary Union (EMU – for the record the FTSE 100 rose 4.44% on September 17th, high up in the table of best ever

percentage moves). It is true that almost all ERM pegs were re-set in the weeks which followed September 16th, but only

the pound escaped entirely from the ‘mechanism’ which would go on to forge the euro (how the likes of Spain, Greece and

others in need of currency freedom now wish they had escaped with the UK). The UK’s ERM exit meant a more competitive

pound as well as a progressive and much needed cut to the base rate, or as we knew it then, the minimum lending rate. We

saw this reduced to 9% on September 22nd with further cuts thereafter, all of which contributed to reviving a UK economy,

which had been wallowing for four years, not least because the monetary stimulus it so needed could not be administered.

Quite frankly, not only had the UK lost self-determination over monetary policy because of the constraints imposed by

membership of the ERM, but this mechanism was made all the more inflexible and insensitive not only to the needs of the

UK but others within it, because it was stubbornly serving the interests of a recently re-unified Germany (for the record

within a handful of years the ‘flexible’ pound would buy more than the 2.95 Deutschmarks which the ERM had ‘dictated’

should be its central rate, chart 25).

Chart 25: Pounds per Deutschmark before & after ERM EXIT

Chart 26: Real GDP, UK versus Germany and France

There are, in my mind, three clear lessons from September 1992. One is that in a period of political-economic uncertainty

markets naturally factor in the perceived ‘worst’ outcome; and in so doing they hit the currency and other asset prices.

However, if/when this worst-case outcome is not realised the affected asset prices rebound in an impressive relief rally,

resulting in a ‘hockey-stick’ move. Another lesson is that flexibility to act is a sovereign economy’s most powerful weapon.

The third lesson is that clearly signed ‘EXITS’ exist in enclosed spaces for a very good reason; they help you escape when it is

necessary to do so. And as we are always being instructed, if we do need to evacuate it should be done in as orderly a way as

possible; or put simply, please “Don’t panic”.

0

2

4

6

8

10

12

14

16

2

2.2

2.4

2.6

2.8

3

3.2

1991 1992 1993 1994 1995 1996 1997 1998

Ba

se r

ate

(blu

e li

ne

)

+6

Central rate-6%

-8

-6

-4

-2

0

2

4

6

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

% ch

ange

, yr-

on-y

r

United Kingdom Germany France


Toscafund Asset Management LLP

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Documents

Toscafund Discussion Paper- 1992 It will be deja-vu all over again