George Soros: a man shrouded in political controversy and yet one of the most successful
investors of all time.
While many today are familiar with his political endeavors, there is a much more interesting
story that has in comparison avoided the public spotlight.
In this video, we’re going back to the decade before the euro, where the wild west of European
currencies allowed George Soros to almost break the Bank of England and to make a billion
dollars in the process.
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In the aftermath of the Second World War, the nations of Europe decided that the only
way to prevent the same sort of destruction from ever happening again was by banding together
and forming a closely integrated union.
The idea was that if the European economies all depended on each other they’d be unlikely
to start another war.
The ultimate expression of this integration is, of course, the Euro, but before the single
currency was introduced in 1999, Europe had another system to manage its currencies.
Back in 1979, the countries of the European Community weren’t ready to give up their
national currencies just yet, but they did agree to link them all together at a fixed
rate, effectively removing the exchange rate fluctuations you usually have to consider
when doing business across borders.
This new system, known as the Exchange Rate Mechanism or ERM, sounded good on paper and
did make things easier for a lot of people, but it also made the national banks of these
countries very vulnerable.
You see, people buy currencies every day in vast volumes to fund imports or exports and
these transactions have a significant effect on the actual exchange rate you can get from
the market.
So once a country became a part of the ERM, it had to constantly monitor the markets and
intervene if their exchange rate started to deviate too much.
If too many people were buying, the national bank would start to sell and if everyone was
selling, it would go in to buy.
Without going into too much detail, the ERM was flawed because every country is unique:
it has to constantly balance interest rates, inflation and economic growth, which it cannot
do if its currency is artificially chained to others.
Margaret Thatcher, the Prime Minister of the UK at the time, understood this very well,
which is why she opposed it and why Britain wasn’t a part of the ERM when it first began.
However, as the British economy worsened towards the end of the 1980s, Thatcher’s eurosceptics
lost ground to the more pro-European members of the Conservative Party.
By October 1990 Thatcher’s power had diminished so much that Britain joined the ERM despite
her opposition, thanks to the political power of John Major, the Chancellor of the Exchequer
at the time.
Less than a month later, Thatcher had resigned and Major was selected as prime minister,
hailing the ERM as his victory.
All my adult live I’ve seen British governments driven off their virtuous pursuit of low inflation
by market problems or political problems.
I was under no illusions when I took Britain into the Exchange Rate Mechanism.
I said at the time that membership was no soft option.
The soft option, the devaluous option, the inflationary option, in my judgement that
would be a betrayal of our future at this moment and I tell you categorically: that
is not your government’s policy.
But while November 1990 might have been the start of a very successful political career
for John Major, it was just the beginning of Britain’s economic problems.
You see, when the UK joined the ERM, it was already in a recession.
Now, when an economy is in a recession the central bank, in this case the Bank of England
wants to cut interest rates to prop things up, but because of the ERM it could no longer
do that.
The British pound was already a very weak currency, with the UK’s inflation rate being
three times higher than Germany’s.
If the Bank of England cut rates, it would help the British economy, but it would devalue
the pound so much that Britain would have to leave the ERM, which of course John Major
would never allow.
And so between 1990 and 1992 the British economy suffered.
Of course, just keeping interest rates high wasn’t enough to maintain the pound’s
value and so throughout these two years the Bank of England would frequently go to the
market and start buying up pounds by the millions, using up its foreign exchange reserves in
the process.
Even that didn’t really help though, since the pound continuously weakened during this
time, just barely within the limits of the ERM.
Pretty much every currency speculator understood that eventually the British pound would have
to devalue, but the billion-dollar question was, when would that happen and the man with
the answer was George Soros.
He had been running his hedge fund since the 1970s and his specialty was predicting and
sometimes forcing the catalysts to big market events.
He knew that almost everyone was ready to bet against the British pound if only there
was some sort of bad news that could trigger a stampede big enough to overwhelm the Bank
of England.
Starting in August 1992, Soros and his fund began building a position against the pound
and here’s how he did it.
He’d go to a big bank or another hedge fund and he’d borrow pounds from them, with the
promise of repaying them with some interest on top.
Then, he’d go to the foreign exchange market and he’d sell those borrowed pounds to buy
G You can expect my next video two weeks from
now, and until then: stay smart.erman marks instead, the idea being that when the exchange
rate drops he’d be able to buy back those pounds cheaper, earning the difference as
profit.
By the end of August Soros had slowly built up a position equivalent to $1.5 billion dollars
against the pound, but the exchange rate had barely moved.
He needed some sort of news to really start increasing his position and luckily for him,
on September 16th the President of the Bundesbank held a seemingly innocent interview that Soros
could nevertheless use.
The Bundesbank President said that he “doesn’t rule out that some currencies might come under
pressure,” which in and of itself is a very vague and unconvincing statement, but Soros
decided that it was good enough for him.
That same night, while Europe was fast asleep, Soros called up any international bank or
company or really anyone that had British pounds and he tried to borrow them with great
success.
By the time the British woke up, Soros had sold the equivalent of $10 billion worth of
pounds on the open market.
Unsurprisingly, the Bank of England was in complete chaos.
After an emergency meeting with John Major, the Chancellor of the Exchequer began a desperate
fight.
At 8:40 AM on September 17th, he authorized the purchase of one billion pounds from the
market to no effect.
By 9 AM he had purchased another two billion pounds, at which point he dialed John Major
again to request permission to increase the interest rate, which of course because Britain
was in a recession would be devastating to the economy.
Initially, John Major refused because he thought it would be political suicide, but as Soros
and the global currency market continued selling pounds, by 11 AM Major conceded and Britain
made a surprise announcement that it was increasing its interest rates by two percent, which is
a very big increase.
By the end of the day, Britain had purchased 27 billion pounds and had increased its interest
rate a second time to 15%, but just Soros alone had sold about half as many pounds and
by that point the entire world was following suit.
At 7:30 PM the British government accepted defeat with the following news conference.
A unique day in London’s financial markets ended with the Chancellor announcing that
the pound was being suspended from the ERM and that the second of two dramatic interest
rate rises during the day was after all cancelled.
Today has been an extremely difficult and turbulent day.
Massive speculative flows continued to disrupt the functioning of the Exchange Rate Mechanism.
As chairman of the Council of European Finance Ministers I have called a meeting of the Monetary
Committee in Brussels urgently tonight to consider how stability can be restored to
the foreign exchange markets.
In the meantime, the government has concluded that Britain’s best interests are served
by suspending our membership of the Exchange Rate Mechanism.
Over the next few days, as the foreign exchange markets were left to their own devices, the
British pound fell by 15% against the German mark and by 25% against the US dollar.
Soros and his fund pocketed a nice $1 billion from their trade, while the estimated cost
to the British taxpayer was over 3 billion pounds.
Here’s the funny thing though: in the aftermath of Black Wednesday, as they called it, the
Bank of England was once again free to control the British pound, which it did and over the
next few years it steadily cut interest rates and actually restored the British economy
to high levels of growth.
By 1997 the British pound was actually more valuable than it had been during the ERM and
the UK was on its way to 16 consecutive years of economic expansion, so much so, that some
people actually call that day White Wednesday.
So in the end, Soros might’ve actually done the British a favor, even though he pocketed
about $15 for every man, woman and child in Great Britain.
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