When I talk about foreign exchange (FX) markets, what do you think of? I’m sure you have some memory of being at the airport in a foreign country, standing at a little stall as screens flash a constant stream of numbers telling you how much your AUD is worth in a whole range of currencies you might not have ever even heard of. If this is likely one of the only interactions you will ever have with the FX market, I’m sorry to say your contribution means virtually nothing. Supply and demand are fundamentals in all markets, but the currency quotes you get are passed down a ladder with hundreds of rungs, and it’s only right at the top that these prices are determined. Yet who actually determines these prices? Only the very biggest fish in the financial world: investment banks, large multinationals, government treasuries, and any other massive financial institutions, operating in a mysterious sea known as the “interbank” market. But in the September of 1992, one man, George Soros, pulled off one of the most audacious currency trades of all time, simultaneously making himself around GBP 1 billion, and breaking the Bank of England.
In 1990, Britain joined the European Exchange Rate Mechanism (ERM), which had been established in 1979 as a way of stabilising exchange rates and inflation between countries. This essentially involved pegging member currencies within a certain band of the European currency unit (ECU), a weighted basket of member currencies. Upon entry in 1990, the Deutsche Mark (DM) came to be the dominant currency in the ECU, due to the strong growth and low inflation levels of post-reunification Germany, and many countries tied their monetary decisions to that of the German central bank’s. When Britain entered the ERM at DM 2.95 to the Pound, German inflation was much lower, and growth much higher, than that of Britain. This only furthered the issues with the British economy, as inflation got out of control, forcing the Bank of England (BoE) to raise interest rates to 10%, putting increased strain on growth and asset prices. This dire economic situation led to mass speculation on the Pound. Chief among these speculators was George Soros, chairman of the hedge fund Quantum Fund, who believed that Britain’s inflation and interest rates were too high, and that it had entered the ERM at too high a rate to the Deutsche Mark. Soros knew that a massive speculative attack upon the Pound would leave the British Government with no choice but to withdraw from the ERM and devalue the Pound. These beliefs caused Soros to build up a monumental short position of around £10 billion, convincing other large speculators to do the same, so that when the Pound fell below the lower band of the ERM, Soros would profit enormously. And profit he did.
The British Government, however, was bullish on remaining in the ERM, and instructed the BoE to adopt a policy of buying Pounds in order to keep the currency above the lower bound. They believed that by allowing the Pound to devalue, they would only worsen inflation and send the economy into an even worse state. Then, on Tuesday September 15, 1992, the sell-off began. Under the rules of the ERM, the BoE had to accept any sell offers for the Pound, and they gladly did so as they saw it as the only way to maintain its value. As the day went on, it became apparent that the speculators were selling faster than the BoE could buy back, and the spending was failing to have the desired results. By market close, the BoE’s foreign currency stocks were beginning to run low, and there was uncertainty as to whether this strategy could be maintained. The next day however, Wednesday, September 16, 1992, would be one of the most catastrophic days in Britain’s recent history: Black Wednesday.
At market open, the British government launched a desperate bid to place upward pressure on the Pound, announcing an interest rate hike from 10% to 12%, and later in the day to 15%. Yet the speculators did not bite and continued to sell, not believing the government’s promises. This desperation got to a point where the BoE was buying around £2 billion every hour, but it was not enough. By the end of the day, an emergency meeting was held between senior government officials, and at 7 PM, British Chancellor of the Exchequer, Norman Lamont, announced that Britain would leave the ERM. This led to a massive devaluation of the Pound, of around 15%, allowing Soros and other speculators who had shorted the Pound to pay off their loans at far lower prices. By the day’s end, the BoE had lost £3.3 billion Pounds, and George Soros had made over £1 billion.
The aftermath of Black Wednesday was profound, both for Britain and for Europe as a whole. The ERM was eventually abandoned in favour of the Euro and a more relaxed ERM II. The Conservative government of the day would end up losing the 1997 election in a landslide to Tony Blair’s Labour Party, and the failures of Black Wednesday ensured Britain never entered the Eurozone, as well as allowing for the persistence of Euroscepticism, eventually culminating in Brexit. Despite this, Black Wednesday is often believed to have helped bring down inflation and led to the BoE being finally granted their much-desired political independence. Meanwhile, Soros became one of the most revered currency speculators in the world, as well as the poster boy of right-wing conspiracies regarding the political nature of his trading.
Nevertheless, in one audacious trade, Soros had helped bring down an entire country’s economy, and put a serious dent in Europe’s dreams of integration.
BabyPips.com. (n.d.). Forex Market Structure. Forex Market Structure – BabyPips.com
Investopedia. (29/9/2008). What Was Black Wednesday? What Was Black Wednesday? (investopedia.com)
IG. (17/12/2018). Black Wednesday Explained. Black Wednesday explained | IG EN
Corporate Finance Institute. (3/11/2020). European Monetary System (EMS)- Overview, History, Mechanism. European Monetary System (EMS) – Overview, History, Mechanism (corporatefinanceinstitute.com)
History of Yesterday. (10/8/2021). The Day George Soros Broke the Bank of England To Make $1.1B. The Day George Soros Broke the Bank of England To Make $1.1B | by Sylvain Saurel | History of Yesterday
Investopedia. (27/8/2021). European Monetary System (EMS). European Monetary System (EMS) Definition (investopedia.com)
The Balance. (21/1/2022). Black Wednesday: George Soros’s Bet Against Britain. Black Wednesday: George Soros’s Bet Against Britain (thebalance.com)