George Soros: The Man Who Broke the Bank of England
George Soros is a Hungarian born American investor famous for ‘breaking the Bank of England.’ Known to be a highly skilled currency trader, his well-timed and outrageously brave bet against the Bank of England in 1992 was what resulted in today’s ‘Black Wednesday’. Due to its failure and inability in defending itself against an attack in the currency markets, Britain's central bank had to incur costs ranging up to £3.3 billion. As a result of the chaos and instability, Soros ended up netting a profit of $1 billion in the end. To better understand the series of events that led to the Black Wednesday, we have to dig deeper into the nitty gritty of European Exchange Rate Mechanism and how it impacted the Britain Sterling.
Before the advent of Europe’s common currency known as the Euro, the European nations decided on coming up with the European Exchange Rate Mechanism (ERM) in March of 1979 to reduce the variations in exchange rates of currencies in European nations and also to stabilize the monetary policies across Europe. To make matters simple, one can simply say that the ERM set both upper and lower margin wherein exchange rates can vary. Britain declined to join the ERM but was later forced to join through a semi-official policy. By October of 1990, Britain finally joined the ERM to prevent its currency from fluctuating by 6% in either directions of both upper and lower margins. To do so, it went about performing several shady countertrades in the currency markets.
As the German currency was the strongest, the rate at the time of Britain’s joining was set to 2.95 Deutsche Marks per Pound Sterling alongside a 6% permissible move in both directions. However, the problem was the fact that Britain suffered from an inflation rate thrice as much as that of Germany’s and interest rates were also at 15%, putting the country in a path of unsustainable economic growth. The crafty currency traders and investors who were well aware of Britain’s faulty moves started borrowing the Pound Sterling and immediately converted it to a foreign currency under the agreement that they shall re-convert them in the future. George Soros too was involved in the aforementioned activity which is also known as ‘short selling’. It was estimated that Soros at a point of time amassed a short position of Pound Sterling worth over $10 billion.
Anticipating the inevitable doom, the government of Britain went ahead and authorized spending billions in Pounds Sterling as an effort to thwart the short selling. Britain further announced stating that it was going to raise the interest rates from 10 to 15 percent. Currency investors weren’t however very trusting of the Britain’s government and kept short selling the Pound Sterling. Ultimately, Britain was forced to withdraw from the ERM so as to let the market valuate the Pound Sterling at the right value. This move allowed several currency investors to pocket a hefty profit; Soros was one amongst several such short selling investors that made a profit of whopping $1 billion.
One of the biggest reasons behind considering Black Wednesday as a devastating event is the fact that it threw Britain into recession. Several Britishers often satirically refer to the ERM as an “Eternal Recession Machine.” While the government ended up losing money, several politicians and economists say that the Black Wednesday played an instrumental role in putting the country into the hands of a more conservative government that ultimately revived the economy. Despite being devastating to the country as a whole, Black Wednesday ended up teaching several important lessons to both the governments and currency traders as well.
Governments learnt that they must not dictate interest rates. For instance, the interest rates for the ERM was primarily set for Germany; instead ERM must have set an interest rate for the whole of Europe by Europe. Moreover, it may also prove futile and counterproductive to pick unnecessary fights against speculators and traders. In an effort to counteract decisive trades, the governments went too far, leading to the humongous loss that Britain had to face. Coming to currency traders, it became apparent that nothing is impossible. As a matter of fact, no one really imagined that the Britain would withdraw from the ERM during such a turbulent time; yet, the UK did pull out from the ERM and suffered the big blow. Secondly, investors must always be ready for extreme measures. Though Black Wednesday’s significance is mostly characterized by a billionaire’s bet against the Bank of England and his subsequent victory, understanding the underlying issues and crises can help central banks from potential pitfalls in the future.