In Britain, Black Wednesday refers to September 16, 1992, which is known as the day that a combination of monetary policy makers and speculators “broke the pound”. They didn't actually break it, but they forced the British government to pull it from the European Exchange Rate Mechanism (ERM), successfully removing itself from the collective “Eurozone” economy.
The European Exchange Rate Mechanism was an act that was created by several European nations in hopes to unify the economies within the Eurozone. ERM was first introduced by the European Community which was created by the Treaty of Rome in 1957.The European nations that first introduced the ERM were Belgium, Denmark, France, West Germany, Greece, Ireland, Italy, Luxemburg Netherlands, Portugal, and Spain. All member countries of the Community (at the time) joined the European Monetary System (EMS); in 1999 all the members of the EMS had adopted the European Currency Unit (ECU), which is considered the precursor to the Euro today. The goal of ERM was to reduce exchange rate fluctuation and achieve monetary stability in Europe ("European Central Bank").
The ERM was a “semi-pegged system” because it uses fixed currency exchange rate margins meaning, exchange rates could vary but had to stay within a set of fluctuation boundaries of the ECU.
The European Currency Unit was a essentially a weighted average of all of the currencies of the European Community member countries, before being replaced by the Euro, this was Europe’s closest unit of account to a centralized currency. As we had stated above the European Exchange Rate Mechanism attempted to minimize fluctuations between member state currencies by way of keeping each currency within a range around the ECU. The ECU was never a true currency though; the ECU was designed to a pure unit of account and the reserve asset at the center of the European Monetary System ("European Central Bank"). It was also used in some large international financial transactions between banks within the Community ("European Central Bank").
At the time, the idea to make currencies “semi-pegged” made sense to many; it would reduce transaction costs dramatically and allow for easier transitions between countries, the amount of headache a local business on the border of Switzerland could potentially be dealing with five separate currencies at once and computing the exchange rates on paper and simple calculator (this was at the dawn of the computer era). Also, from a macroeconomic school of thought, “semi-pegged” currencies would allow relatively small economies to compete against larger economies in the Community, because the ERM would drastically reduce barriers to entry for exporting goods and services within the Community.
To further explain the mechanism of the ERM, we start with the ECU in detail, which is a basket of currencies in the EMS, including the franc, krone, mark, drachma, pound, lira, and guilder would all be compiled together and a...