On September 16, 1992, the British government spent billions defending the pound, raised interest rates twice in a single day, and still lost. This episode explains how the United Kingdom walked into that trap. In October 1990 it joined the European Exchange Rate Mechanism at 2.95 Deutschmarks to the pound, with a hard floor of 2.773, tying a high inflation economy in recession to a disciplined Germany whose Bundesbank was raising rates to pay for reunification.

Currency traders saw the mismatch and built enormous short positions against sterling. Prime Minister John Major’s government, which had staked its reputation on sound money and the European project, refused to devalue. After remarks by Bundesbank president Helmut Schlesinger reached trading desks, the selling became an onslaught. By 7 p.m. Chancellor Norman Lamont announced Britain was leaving the mechanism. The Treasury lost an estimated 3.3 billion pounds, yet the economy that followed led some to call it Golden Wednesday.

• Nigel Lawson’s policy of shadowing the Deutschmark split the government, and Margaret Thatcher’s adviser Alan Walters dismissed the mechanism as half-baked before Lawson resigned.
• At 10:30 that morning the base rate jumped from 10 to 12 percent, and by afternoon the government promised 15 percent, a bluff the market called at once.
• George Soros and his fund made over a billion pounds in profit by shorting sterling.
• Gallup polling showed Conservative support falling from 43 percent to 29 percent in a single month, and the party lost the 1997 election to Tony Blair in a landslide.
• Freed from the peg, Britain switched to inflation targeting, and a cheaper pound helped bring falling unemployment, lower inflation, and a sustained revival.