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How George Soros Made a Billion Dollar Betting Against Britain

Black Wednesday: George Soros’s Bet Against Britain

By Arsalan HaroonPublished 2 years ago 10 min read
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Photograph by Daniel Simon / Gamma-Rapho / Getty

On 15 September 1992, George Soros started building a massive short position against the pound. Soros was desperate to increase the size of his position. Soros wanted sterling from anyone who could lend him, So he could sell on the open market to bring down sterling.

When the British woke up, George Soros had already built up a massive 10 billion pound short position against sterling. He was leveraged 10 to 1, meaning he put up a billion and borrowed the rest of 9 billion pounds.

When currency traders and money managers noticed Soros built a massive short position against sterling worth 10 billion pounds.

They started thinking Soros must know something. Otherwise, he wouldn’t bet this much. So other currency spectacular and money managers also joined the ride and started shorting the pound.

On the morning of 16 September, the British government started buying 1 billion pounds so it could not lose its value. But Soros alone had sold nearly 10 billion pounds in the open market.

The UK Government’s buying of 1 billion had no effect, and traders were confident that the sterling had to devalue.

On 16 September, George Soros made 1.1 billion dollars in a single day betting against the pound, and the British government lost 3.3 billion pounds in a single day.

So how did George Soros bet nearly broke the bank of England, which made him 1.1 billion dollars in a single day?

Exchange Rate Mechanism

After the second world war, several European countries believed that the integration and interdependent European economy would lower the likelihood of another world war.

With the treaty of Rome in 1957, the European economic community was born, which today is known as the European Union. The UK joined the EEC in 1972.

Remember, there was no euro at the time because countries were not want to give up their national currencies.

But in 1979, an Exchange rate mechanism or ERM was introduced to stabilize the different European country’s currencies to each other to stabilize the foreign exchange market.

The German economy was the strongest at the time, and its central bank had a reputation as independent from the government. So other European countries pegged their currency to the Deutsche mark.

ERM fixes the exchange rate between currencies. For example, if the ERM rule says that a Swiss franc should stay between 1 to 1.20 per Deutsche mark.

Then when the Swiss franc appreciated more than the 1.20 Deutsche mark, more than the ERM required fixed rates. The Swiss government should sell its Swiss franc to bring its value back to between 1 to 1.20 Deutsche mark.

Similarly, when the swiss franc falls more than 1 Deutsche mark, the erm rules require the swiss government to use its foreign reserves to buy the swiss franc, thereby increasing the demand and artificially influencing exchange rates.

At the time, Margaret Thatcher was the prime minister of the UK. She was a believer in the free market system.

So Margaret thatcher refused to join ERM. She believes that exchange rates should be determined by the market forces rather than intervening in the market.

But what would force the UK government to join ERM? Well, inflation and the struggling economy.

From 1988 to 1990, the average inflation rate in the UK was 8.62%, with high unemployment and low productivity. The UK economy was near a recession.

In 1990, the chancellor of the exchequer at the time, John Major convinced Margaret Thatcher to join ERM. In October 1990, Margaret Thatcher agreed to join ERM.

The reasoning behind joining ERM is that the pound would have fixed exchange rates with the Deutschmark, Which was the pegged currency for ERM member countries. So a fixed exchange rate will stabilize the pound value.

ERM rules state that if the Bundesbank of Germany lowers the interest rates, the UK also has to lower interest rates to bring the exchange rate between agreed fixed rates. It did this by specifying exchange rates between member currencies and using the same monetary policy as the Bundesbank of Germany.

A month after joining ERM, Margaret Thatcher resigned, and John Major became the UK prime minister.

John Major and his then foreign secretary Douglas Hurd convinced the cabinet to sign the ERM in October 1990.

It guaranteed that the UK government would follow economic and monetary policy, preventing the pound and other member currencies from fluctuating by not more than 6%.

The British government was required to keep exchange rates between 2.78 DM to 3.13 DM for each pound. These exchange rates seem to every currency trader way overvalued.

UK Economy on the Brink of Recession

When the UK joined ERM, The UK economy was struggling because of high-interest rates, which caused higher unemployment.

Typically when the economy struggles, the central bank would pursue the policy of expansion by lowering interest rates which would encourage borrowing and investments and make it possible for an economy to recover.

But the UK government can’t cut interest rates because it makes the sterling weaker relative to Deutschmarks, which could force the UK government out of ERM. So the UK could only cut interest rates if the Bundesbank of Germany cut its rates.

But Germany was raising interest rates after the expansionary policy for German unification.

Germany raising interest rates would mean the UK would have to raise its interest rates to keep the exchange rate within the range of ERM fixed exchange rates.

But the UK economy was already struggling with high unemployment. If the UK government raises interest rates further rather than cutting interest rates, Then it could be political suicide for John Major.

Norman Lamont (Chancellor of the Exchequer) requested numerous times to the president of Bundesbank, Helmut Schlesinger to cut interest rates rather than raise them, But he refused.

The UK government had two options, they could cut interest rates to revive the economy, but they would be out of ERM or raise interest rates as Germany did. But it could worsen the economic situation more in the UK, which John Major knew would be a political disaster.

Many currency traders and speculators knew that the devaluation of the sterling was inevitable, and the UK government couldn’t keep the artificial demand for a much longer time.

But the billion-dollar question was when the pound would devalue.

Here comes a man named George Soros, Who was starting to build a 10 billion pounds short position.

He knew that the little pressure from the sellers would force the UK government to devalue the pound.

Everybody knows the set pound exchange rate was way overvalued. But traders and speculators were not convinced enough to take action and short the pound.

Soros knew that if the news came from the high officials about the slightest sign of the devaluation of the sterling, then traders and speculators would join the ride, which would force the pound to devalue.

Luckily for Soros, the push will come when Helmut Schlesinger ( president of the Bundesbank) said in an interview that “he doesn’t rule out some currencies might come under pressure”.

It was a very vague statement, but Soros knew that this statement was enough for currency traders and speculators who knew the currency that may “come under pressure” was a pound.

Big players like Soros were shorted 10 billion pounds on 16 September 1992.

“There is no point in being confident and having a small position.”

– George Soros

After Schlesinger’s comment, speculators were certain that the pound had to devalue, so they also started building a massive short position against the sterling.

But the UK government started to fight back and purchased pounds from the sellers on 16 September 1992, when the massive sell-off happened.

By 9 AM, Norman Lamont (Chancellor of the Exchequer) called prime minister John Major. He said that buying the pound was not increasing the value of the exchange rates due to the massive selling by traders and speculators who believed that the devaluation of the pound was inevitable.

When the UK government realized that buying pounds was not increasing the exchange rate, It started to raise interest rates in the morning from 10 to 12 on 16 September and later raised interest rates to 12 to 15. It increased rates by more than 5 percent in a single day.

When interest rates rise, it typically makes the currency appreciate because more people will convert their savings into the pound because of higher interest rates, thereby increasing the value of the sterling. But this theory didn’t work at the time.

Speculators know that rate hikes were a failed attempt of the UK government to save the pound from falling.

On the night of 16 September 1992, the UK government accepted defeat and withdrew from ERM to make the market decide the exchange rate. This event come to be known as black Wednesday.

The pound falls nearly 10% on Black Wednesday.

Source

The UK government took back its 5% single-day rate hikes and accepted that it was used in a failed attempt to make the pound appreciate.

The problem with ERM

The problem with the exchange rate mechanism was that it required you to follow the same monetary policy as other countries to keep the exchange rate fixed. But the problem was that every country stands at a different stage in the business cycle.

Every country faces a different situation at some point in time. Some economies may need to cut rates to recover, and some may want to take back their expansionary policy and raise rates.

It takes back the control of monetary tools that governments have over their economies to expand or contract their economy.

ERM rule says to countries that they should raise rates only when the pegged country raises rates, so interest rates remain at the range of the fixed exchange rate.

But every economy is different, Some economies may need an expansion policy, and some may want a contractionary policy.

When you raise rates to keep the exchange rate fixed, It would have a significant effect on the nation’s economy.

Conclusion

When the UK government lost 3.3 billion pounds in a single day, George Soros made 1.1 billion dollars in a single day, which made this trade one of the greatest in financial history.

Making a billion dollars in a single day is pretty cool but demolishing the monetary system of Great Britain in a single day is something groundbreaking.

Source

Some people think that Soros is a criminal who made a profit by forcing foreign countries into economic crises. But some people believe that he is a great speculator who predicted the crises of many economies and profited from them.

For some, he is a thief who looted the UK taxpayer's money by bringing the UK monetary system near collapse. But for some people, Soros is a legend who will write down in history as the greatest speculator of all time.

Sources

Originally Published on Medium

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About the Creator

Arsalan Haroon

Writer┃SEO Expert┃Investor

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