Greetings Traders and welcome back. Chris here as always and today,
I've got something special planned for you all out there,
and that is storytime.
We're going to talk about the time that George Soros attempted
to crash the pound.
This is a particularly interesting story from a trading perspective,
so we're going to dive into all the juicy material
that entails this very intriguing story,
but before we do if you would do me a favor and click that
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Now without further ado,
let's get going into storytime, a new event here that we're
going to be doing quite regularly.
Black Wednesday. Just the sound of that sounds doomsday-ish.
It sounds very scary.
And in reality,
it really was. There were some incredibly profound effects
as a result of Black Wednesday, but let's start off with
the date. September 16th, 1992 is
what is referred to as Black Wednesday.
It's when we saw the pound sterling crash and was one of
the primary reasons itself why the UK was not able to adopt
the Euro. The event ultimately forced Britain out of the
European exchange rate mechanism.
The fall of the pound itself created immense wealth for investors,
like our old pal George Soros, and it's estimated that he
made somewhere around 1 billion dollars on this day.
Black Wednesday also caused tremendous turmoil in the political
landscape of Britain since taxpayer money was spent in a
bid to keep the pound afloat.
So what was Black Wednesday? Well, 300 Traders had built up
powerful short positions on the pound leading up to the depreciation
of the currency itself.
It was a requirement of the European exchange rate mechanism
to keep the currency at a particular value in order to ensure
a stable transition towards a common currency with Europe itself.
Black Wednesday was a major obstacle in this development.
The UK government was forced to resort to a number of measures
in order to prevent the pound from collapsing. The interest
rate in Britain Rose to 10% and foreign currency reserves
were used to purchase pounds in the markets where there was
a huge sell-off. In spite of these measures the UK government
was unable to prevent the pound from falling further since
the pound had depreciated by a significant.
margin, it became difficult for the UK to continue its membership
in the European exchange rate mechanism.
The results of Black Wednesday was disproportionate wealth
being amassed by investors like George Soros at the expense
of the UK treasury. That is the reason Soros is said to have
broken the Bank of England, by taking the short position that
he did. Speculators against the currency built up the short
position and hedges were created to account for the falling
pound. The value of these positions were so high that the
intervention of the UK government was not able to turn the
situation around. It is also believed that the lack of involvement
by Germany's Central Bank was one of the reasons that aggravated
the sell-off. The German Bank could have used Deutsche Marks
to purchase the pounds and that might have bolstered the
efforts by its counterparts in the UK.
However, this did not happen and it was one of the reasons
that encourage speculators to go short on the pound.
The build-up to Black Wednesday started when the UK government followed
a semi-official policy of pegging to the pound. The various
events leading up to The Crisis began in 1987m
when the UK pegs the pound with a tolerance level.
During the late 1980s,
The British currency was following a semi-official policy that
allowed it to fluctuate by plus or minus six percent against
a basket of currencies.
This was done in a bid to shadow the German economy which
saw a low inflationary environment and strong economic conditions.
Then in 1990, the UK committed to the exchange rate mechanism
policy. While the UK was still trying to follow a system of fixed exchange rates,
it was only in 1990 that the country joined the ERM. It now
became mandatory for the UK to ensure that the currency remains
stable. The pound at the time was one of the weakest currencies
in the ERM and joining it was considered to be a major blunder.
Then in 1990 to 1992 the interest rates set forth by Germany
themselves, were extremely high and in an effort to contain
a high inflationary environment,
the US dollar had also depreciated during this time.
This did not fare well
for the UK themselves, the goods exported by the UK became
more expensive in the US market.
It became really difficult for the UK to keep up with the
Germans efforts. Being a Member of the ERM also ensured that
they could not follow a free-floating mechanism that would
have made a price of its exports situation a bit cheaper.
Then we had the situation where we had the depreciation of
the pound itself. The macroeconomic environment in the UK
as well as Europe, paved the way for a weakening of the pound
Traders like Soros look to exploit this condition and decided
to bet against the pound. Positions worth billions of dollars
were taken with speculators adding to the volatility of the
currency and finally intervention by the UK government happened.
The treasury had already started intervening
in the Foreign Exchange market,
thereby depleting its reserves. Without much help from other
members of the ERM, the effort itself proved rather futile.
And there's our old pal George Soros. If you're looking for
something to be on Halloween, he wouldn't be a bad choice.
Black Wednesday saw the fortunes of George Soros rise, and
he earned the reputation of being an expert Forex Trader.
Soros was of the opinion that it was unrealistic for the
pound to maintain its level at the time in the UK when it
joined the ERM.
He believed that the pound would have to be devalued at some
point in time.
This prompted him to take a short position on the currency.
Through his Quantum Fund,
Soros started selling pounds worth almost 10 billion.
The involvement of other traders and speculators also help Soros,
as it piled onto his position and favored the devaluation.
It should be noted that Sorrows did advertise his opinion
and it helped create a panic situation for investors who
had long positions on the currency.
Those investors were made to believe that the pound could
no longer be resilient at the level that it was at. The narrative
did have a basis, since the macroeconomic environment within
the UK did not support the existing existing price level
for the pound sterling.
So this did help with that psychological snowball.
We should also note that Soros had already started building
up a position sometime in August as the evidence of a weak
UK economy began emerging. Soros started taking a leveraged
position therefore amplifying his exposure which was already
large. It was unlikely that such exposure would go undetected
in the hedge fund industry and that others would probably
and did follow suit.
It was certainly a risky position
to take since the pound was backed by the UK government.
However, Soros did back up his analysis and was very confident
of what was going to happen.
He was aware of the lack of Foreign Exchange reserves that
the UK government had and he also predicted that other economies
would not be coming to the rescue.
It is estimated that Soros made profits worth 1 billion pounds in this period.
After the dust settled, being part of the ERM
was difficult for many countries and there were breaches
in the tolerance level set by their group. Currencies like
the Italian lira were also under pressure, but investors focused
mainly on the pound sterling. Rules were relaxed and member
states were allowed to pursue monetary policies of their own.
For the UK, the short-term effects were very profound. Their economy entered
into a recession for the first half of the decade. The housing
market crashed and so did the business environment within the UK.
One of the major fallouts of Black Wednesday was the decline
in popularity of the conservative party or the Tories.
The party lost a number of elections that were held after this
event. Once believed to be party promoting economic reforms
the failure in the financial system changed the perception
of the people towards the party. In 1997,
They suffered a landslide defeat and were not voted into
power for quite some time thereafter. In terms of policy making
the UK could now tackle the economic instability
with a more independent mindset.
It was no longer subjected to the constraint set forth by the ERM.
The dependency on other economies was removed and the
pound was now under a free floating exchange rate regime.
For the first few years
the economy was still in a quagmire, but Black Wednesday
did set the tone for more robust economic reform in the longer run.
policymakers were now in a position to set interest rates based on the inflationary environment
back home and no longer
needed to base its rates on the interest rate regime that
was going on in Germany.
The perception of the masses also changed and the
pro-Euro sentiment instilled by the conservative party were
no longer seen in a good light by the British public.
Depending on how you look at Black Wednesday, there were
definitely effects that could be classified as beneficial.
The new policies set by the government were better tailored
to the economic environment in the UK. Within the next few
years after black Wednesday.
The government was able to tackle inflation. By maintaining
a floating exchange rate system, the economy managed to recover.
The rising unemployment rate was also brought under control
most importantly the UK was able to maintain an independent
status that resulted in a stronger economy.
Black Wednesday also showed the world the demerits of introducing
a fixed rate system of exchange rates across Europe.
It paved the way for more relaxed norms across countries
in the region, and enabled a smoother transition towards a
common currency in the region.
The integration of economies within Europe was made possible
after the reforms introduced in the aftermath of Black Wednesday.
These policies gave more leeway to weaker countries to strengthen
their economies. The rule imposing a cap of six percent fluctuation
in exchange rate was also relaxed, to
enable a fairer movement of currency rates. For UK, many consider
Black Wednesday a blessing in disguise. Since the sovereign
debt crisis hit Europe in the late 2000s, billions of dollars
were pumped in to bail out weaker economies. Without the intervention
of countries, like Germany, the Eurozone would have fragmented.
Meanwhile, Britain managed to keep itself on the sidelines
without almost any economic repercussions. Had the UK adopted the Euro,
It would have had to contribute in order to bail out countries like Greece.
The economy of the UK performed comparatively better during this crisis,
so you could argue that black Wednesday help save the country
from further costs down the road.
As stated, Black Wednesday wasn't all sunshine and rainbows.
The terms of the ERM could have been considered unreasonable
and it was difficult for many countries to keep their currencies fixed.
Black Wednesday damaged the reputation of the Bank of England and the UK.
The amount of the loss incurred by the UK
was estimated to be over three billion pounds, which was
a very substantial amount back in the early 1990s. The semi-fixed
structure also ensured that the pound could not be devalued.
and this hurt the business of exports. Similar problems
were faced by other weak currencies like the Italian lira
and the Spanish peseta.
These currencies were overvalued when they entered the ERM
and their struggle continued even after the UK left the group.
Some of the repercussions of Black Wednesday are visible
still today. The aftermath of the event resulted in a more integrated Europe.
It paved the way for the formation of the Eurozone, although
some of the problems it caused continue to exist.
While there was a common currency
in the region, countries were tied to a single currency
which restricted their ability to act independently.
Exchange rates used to be a tool to control economic policies,
but this was no longer viable with the Euro. For the UK,
the impact was much more short-lived. Their economy went into
a recession and inflation continued to be sticky.
There was a lot of fire fighting that the government had
to do to restore growth in the economy. High interest rates
meant borrowing became expensive and housing markets collapsed.
The newly elected
Conservative party's term went downhill after Black Wednesday.
The event also raised concerns about the ability of governments
to control their economies.
Meanwhile, the reputation of George Soros increased many
times over. It also necessitated the involvement of market
participants in the development of policies.
So to wrap it all up.
Is it possible for a Black Wednesday style event to happen again?
Well, let's see:
Is it possible?
Yes. Is it probable?
No, not so much.
Of course, it can
happen with the right circumstances, but undeniably there
are more checks and balances in place now to help identify
and prevent a type of occurrence like Black Wednesday from
happening again, or at least a limit the impact that it has.
Black Wednesday is arguably one of the greatest events in
recent economic history, showcasing the ability to short a
market and cause some very very crazy outcomes when you get
other people on board with you, but until next time folks,
thank you for joining me for storytime.
It's always a pleasure. Cheers folks, over and out.