How George Soros Almost Broke the BOE

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How George Soros Almost Broke the BOE
After the Second World War, European countries
realized that if they had a union of some sort,
they would be less likely to go to war with each
other. Therefore, in 1979, they decided that they
would link their currencies together at a fixed
exchange rate under the Exchange Rate Mechanism
(ERM). Because Germany had the strongest,
countries in the ERM system agreed to fix their
currencies to the Deutschmark within 6 of the
agreed rate. Although this system had benefits,
one major problem was how vulnerable it made
central banks. The central banks had to maintain
the exchange rate by buying or selling their
currencies and using their foreign reserves. The
other option is to alter interest rates, but
this affects the economy as a whole, which makes
it extremely complicated. In 1990, Britain
joined that ERM system at an exchange rate of
2.95 Deutschmark to 1 GBP. The problem was that
at the time Britain joined, they were already in
a recession. Under normal circumstances, the Bank
of England
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(BOE) would cut interest rates to stimulate the
economy. But because the exchange rate was
fixed, the BOE was not free to do that. After a
year and a half of joining the ERM system, GBP
was trading at the lower end of the band.
Traders recognized that this was not sustainable.
The pound was overvalued and the only thing
keeping it from dropping was the promise of the
BOE to keep the rates fixed. George Soros saw an
opportunity in this. He had been building a
short position of GBP worth 1.5B. On
Wednesday, September 16, Soros increased his
short position to 10B. Other hedge funds heard
about his plan and decided that it would be a
good idea to join in. When the markets opened,
the pound was trading dangerously low. The BOE
bought the pound using its foreign reserves, but
that was not enough to contain the price drop.
So, the BOE hiked interest rates by 200 bps on
that same day. Despite all their efforts, they
could not stop the pounds fall. On that same
day, Britain had to withdraw from the ERM system
and let the pound float freely. Soros made around
1B that day, and his firm, Quantum Fund,
increased in value from 15B to 19B. Original
Source How George Soros Almost Broke the BOE