George Soros is one of the most successful hedge fund managers ever. While at the helm of the Quantum Fund (founded by Soros and Jim Rogers in the 70s), he generated an average annual return for investors of 30%.
Across this ten-part series, I’m taking a look at Soros’ life, trading career, and political involvements. In the first two parts of this series, which can be found at the links below, I covered the beginnings of Soros’ Quantum Fund and Soros’ trade against the Bank of Thailand. This part covers possibly Soros’ most famous trade against the British pound in 1992. Not only did the trade net the Quantum Fund’s investors over $7 billion in profit it also earned Soros the title ‘the man who broke the Bank of England’.
George Soros Part Three: Breaking The Bank of England
George Soros’ bet on the British pound was in many ways a dress rehearsal for the Thai baht trade his fund placed around a decade later. At its heart, the trade was a simple bet against the Bank of England’s (and British politicians’) aggressive monetary policies, which were put in place so that the country could join the EU.
A precursor to the EU was the European Exchange Rate Mechanism (ERM), which came into existence during 1979. The euro didn’t come into existence until 1999 and up until that point, many countries in the European block weren’t ready to give up their national currencies. Instead, these countries, in an attempt to maintain the sovereignty agreed to fix their exchange rates with each other, and since Germany had the strongest economy in Europe, each country set their currency’s value in Deutschmarks.
Britain’s Prime Minister at the time of the ERM was Margaret Thatcher, arguably one of the UK’s most successful Prime Ministers and a champion of free markets. Thatcher opposed to the ERM, insisting that the price of the pound be set by the markets but by 1990 she lacked the political power to challenge her Chancellor of the Exchequer, John Major (who wanted a united Europe and the ERM) who pulled the UK into the ERM during October 1990. The exchange rate was set at 2.95 Deutschmark for each British pound, and the government was obligated to keep the exchange rate in a trading range of 6% within 2.78 DM to 3.13 DM.
A great idea…in theory
As covered in part two of this series, currency pegs are great ideas in theory when two economies are virtually identical but in practice, there are very few cases where a currency peg has been sustainable for the long-term. Between 1990 and 1992 the UK’s economy, now under the control of John Major as Prime Minister, continued to chug along. Unemployment fell, inflation decreased, and interest rates eased. However, in 1992 a massive global recession saw the UK unemployment rate spike to 12.7% from just 7.7% two years earlier. Traditional economic theory dictates that in such crisis’ policymakers can cut interest rates and increase spending to alleviate financial pressures but with the ERM peg in place, the British government had no room for maneuver.
Still, throughout the summer of 1992 sterling held its position then something astonishing happened. On September 15th, 1992 the Wall Street Journal published an article in which the President of the German Bundesbank, Helmut Schlesinger claimed: “after the realignment and the cut in German interest rates, one or two currencies could come under pressure.” This quote may seem insignificant but with the UK’s economic problems well-known it stoked the fires of speculation. Sterling was widely accepted as being the currency Schlesinger was expecting to come under pressure, and Soros took this as a signal to go all-in on the trade against the currency.
Put it all on sterling
Soros had been building a sterling short since August 1992. It was evident to him that the UK’s economic situation could not last forever. Before the report in the Wall Street Journal was released, Soros’ short against sterling was worth $1.5 billion. According to Sebastian Mallaby’s book More Money Than God, when Soros saw the comments from Schlesinger he told his traders to “go for the jugular.” There was no sense in waiting for the pound to devalue when the catalyst was sitting right in front of him.
The trade against sterling was a no-brainer. The entire financial world could see that sterling was overvalued and the only thing keeping the currency alive was government intervention. Many believed that the risk for speculators was non-existent, and the only way for sterling to go was down. During the morning after the report appeared in the Wall Street Journal, Soros and his traders increased their short position against the pound from $1.5 billion to $10 billion.
“Our total position by Black Wednesday had to be worth almost $10 billion. We planned to sell more than that. In fact, when Norman Lamont [the British finance minister] said just before the devaluation that he would borrow nearly $15 billion to defend sterling, we were amused because that was about how much we wanted to sell.” – George Soros, 1992
With such a huge seller in the market, the whole of Wall Street, the City of London and hedge fund world soon started to follow suit. It didn’t take long for the situation to spiral out of control.
Geroge Soros – Black Wednesday
On the morning of September 16 officials of the Bank of England came into work to find sterling trading dangerously close to its ERM lower bound. To defend the currency, the BoE started buying sterling hand over fist pouring an estimated £27 billion of its reserves into the market yet with everyone else selling; this had almost no effect on the currency’s value. The BoE’s next option was to hike interest rates, which it did at 11 AM from 10% to 12% — this was a disastrous move for a country already in the midst of a recession.
The first rate hike didn’t work so a few hours later the BoE increased rates from 12% to 15%. Soros increased his bet from $10 billion to $15 billion. The pound continued to plummet.
Finally, after the close of business on September 16, the UK announced that it was pulling out of the ERM as the country could no longer afford to defend the peg. With the free market setting the value of sterling, it quickly plummeted by 15% versus the Deutschmark and 25% versus the dollar. The Quantum Fund made a full $7 billion from the trade. Soros and his partners took home at least 20% which is around $1.5 billion. For the BoE September 16, 1992 became known as Black Wednesday.
Without this trade, it’s arguable that Soros would never have been