How George Soros Broke the

Bank of England

How George Soros Broke the Bank of England

George Soros has been a successful investor. He’s one of those that saw early success
in the financial market; having grown his hedge fund, Quantum Fund, to a billion-dollar
fund in the 1980s. In 1992, he made history as the man who broke the bank of England
when he bet against the success of U.K. involvement in the Bundesbank-backed
Exchange Rate Mechanism and won.

German and France initiated the European

Monetary System (EMS) in 1979
German and France in 1979, decided to set up the European Monetary System (EMS)
so as to reduce inflation, maintain stable exchange rates, and prepare Europe for
monetary integration. The Exchange Rate Mechanism (ERM) which was one of the
EMS’s main components allowed every currency in the system a central exchange rate
against a basket of currencies, the European Currency Unit (ECU), led by the
Bundesbank.

In the beginning, the countries involved were: France, Germany, Italy, the Netherlands,
Belgium, Denmark, Ireland, and Luxembourg. They were mandated to keep their
exchange rates no more than a 2.25 percent fluctuation above or below each bilateral
central rate. This system was able to maintain a low-inflationary and stable economy in
Europe under the leadership of German Central Bank, the Bundesbank.

The United Kingdom Joined the Exchange Rate

Mechanism (ERM) in 1990
In order to take part in the stable and low-inflationary economy in Europe, the U.K.
decided to join the Exchange Rate Mechanism (ERM) of the European Monetary
System in 1990. The exchange rate was pegged at 2.95 Deutsche marks to a pound
allowing only +/– 6 percent fluctuation.

This alliance would keep the pound at the mercy of the Deutsche mark as it would
subject the U.K. to the monetary policies enforced by the Bundesbank.

Bundesbank reacted to the inflationary effects of

German reunification
The German reunification in 1989 created a need for massive infrastructural
development. This led to increased government’s spending and inevitably, high inflation.

In mid-1992, the German central bank had to aggressively increase interest rates to
curb the inflation. The interest rate hike expectedly placed upward pressure on the
German mark forcing other central banks to raise theirs to maintain the mandatory
currency exchange rates.
George Soros bet against the success of U.K.
involvement in the ERM
George Soros knew that the United Kingdom could not maintain the pegged exchange
rate mandated by the ERM owing to their high unemployment rate and a weak
economy. He predicted that the pound would depreciate or the United Kingdom would
leave the ERM. So, by the third quarter of 1992 he started shorting the pounds
aggressively.

He established enormous short positions in pounds and long positions in the Deutsche
marks by borrowing pounds to buy marks and also making use of options and futures.
In fact, he leveraged the entire value of his Quantum funds — about $1 billion — to
place a $10 billion position.

Other investors would later follow suit and the pound was under serious pressure. The
Bank of England initially tried to defend the pounds by buying tens of billions of pounds
but was simply overwhelmed by the speculative attacks.

The events of September 16, 1992 — the Black

Wednesday
By September 16, 1992, a day that would be popularly known as Black Wednesday, the
pressure was becoming unbearable for the Bank of England. There was so much
confusion. In an attempt to boost the pound’s appeal, the bank initially announced a 2
percent rise in interest rates — from 10 percent to 12 percent.

A few hours later, it raised the rates again — to 15 percent — but Soros and other
speculators could not be swayed, knowing that the odds are high for U.K. to leave ERM
and devalue the pounds. Speculators continued shorting pounds in huge volumes, and
the Bank of England kept buying them.

Finally, the bank of England caved-in and — at 7:00 p.m. that same day — Chancellor
Norman Lamont announced that Britain would leave the ERM and return the interest
rate to their initial level of 10 percent. As you would imagine, the pound was on a free
fall.
The Quantum Fund made approximately $2 billion
profit in one month
George Soros’s Quantum Funds made about $2 billion profit in the following four weeks
as the pounds depreciated almost 15 percent against the Deutsche mark and about 25
percent against the dollar. He would be known as the man who broke the Bank of
England, for leading the speculative attack on the pounds.

In conclusion, George Soros used his knowledge of the fundamental factors that
determine the value of a nation’s currency to his advantage. Knowing that the odds
were enormously on his side, he was able to go for the kill and ended up $2 billion
richer. In the process, he demonstrated how central banks can be vulnerable to
speculative attacks as well as made history as “the man who broke the Bank of
England”.

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