When currency traders circled the pound like sharks...

Black Wednesday: Breaking the Bank

May 15 by Angelika Dehmel

Question: How do you pull off a bank heist without breaking any laws?

Answer: Ask George Soros.

It’s an achievement worth bragging about on your LinkedIn profile: “Outwitted and ‘broke’ the Bank of England.” That’s Soros’ claim to fame, which helped him to pocket a cool billion dollars in a single day.

What the heck happened?

To tell this story, we have to travel back to 1979. To the year when Donna Summer’s “Hot Stuff” dominated airwaves and the European Economic Community established a monetary system. The idea behind the European Monetary System (EMS) was to link European currencies to keep exchange rates stable.

So if you think of the EMS as ground rules set by parents to control unruly teenagers, then the exchange rate mechanism (ERM) was like a curfew. Remember when your parents once limited your freedom by saying, “You can go out with your friends – but only until 9pm.” In the same way, ERM allowed exchange rates to fluctuate but only within a specified band.

The British didn’t join the ERM until 1990. The trouble was the pound had been ‘shadowing’ the German mark for some time in a bid to keep up with the Kardashians Joneses. It didn’t actually make sense since its inflation was actually three times the rate of Germany’s. So it struggled to stay within its ERM band.

Many currency speculators, like Soros, could see the sterling was actually overvalued compared to the German mark. But they had to wait for the perfect time to pounce…

 

The right moment for the attack

 

If Soros was waiting for a sign, he got it from the then-chief of the German central bank. In an interview, he implied that some currencies *cough pound cough* would have no choice but to be devalued.

Soros and his hedge fund, Quantum, had made a huge bet against the pound (known as short-selling). Now they went for broke, along with currency speculators the world over. This put pressure on the pound and the Bank of England frantically tried to prop up its currency by buying it back at a frenzied pace. They spent billions of their foreign currency reserves to load up on sterling. But they couldn’t buy as fast as Soros’ crew was dumping.

This basically sums up the Bank of England’s futile efforts to keep the pound up

This brought the bank to its knees, forcing Britain to withdraw from the ERM. The pound was allowed to float again – to a lower rate (where it rightfully belonged in the first place). This took place on Wednesday, September 16, which entered the annals of financial history as Black Wednesday. The long-suffering British taxpayers would later refer to ERM as the “Eternal Recession Machine,” god bless ‘em.

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