[FXG]

Black Wednesday: The Day The Bank of England was Broken.

This is one of the well-known stories in Forex Trading World. Among the largest profiteers was the legendary George Soros, who made an amazing 1 Billion pounds sterling during this episode.

The saga gave him the title of ''The Man Who Broke The Bank of England''.





Here is how he played his moves ………….

Prior to 1990 Britain used the fixed exchange rate system where they pegged the value of the pound sterling. This fixed exchange regime meant below market interest rates and resulted in gradually rising inflation.

In 1990 Britain decided to abandon this practice of fixing its currency and adopted policies of the European Exchange Rate Mechanism. (ERM). The European Exchange Rate Mechanism was a build up to a unified currency (i.e the EURO). The Pound Sterling entered the market at 1 Pound: 2.95 Deutshe Mark. This rate was despite that British inflation levels that were three times higher than that of Germany. Forex speculators naturally picked this up, and anticipated an eventual devaluation of the British pound against the Deutshe Mark.

During the fortnight leading to the 16th of September 1992 speculators sold billions of Pounds hoping to buy them back at a depreciated rate hence pocket the difference. Among them was George Soros.

The British decided to intervene by hiking interests rates to 12 %. Government authorized expenditure of Billions of Pounds to buy back the pounds that were being frantically sold. In effect the government was pumping out massive wealth to speculators. The intervention had little or no effect.

During the evening of September 16, 1992 the British government announced its exit from ERM and reverted back to the pegged Pound sterling. Interest rates however remained at 12 %.


As early as spring 1992, Mr Soros had decided that the pound would have to be devalued because it had been pushed into the ERM at too high a rate. He knew that the Bundesbank favoured a devaluation of both sterling and the Italian lira and believed it would have to happen because of the disastrous impact that high British interest rates were having on asset prices.

Mr Soros spent the next few months building up a position from which he would profit from that devalutaion. He borrowed sterling heavily, reportedly to the tune of £6.5 billion, and converted that into a mixture of Deutschmarks and French francs.

On Black Wednesday, Mr Soros's bet paid off. In the following days, he unwound his positions, paying back his original borrowings and ending with a profit of around £1 billion.

This episode shows that the Free Market Forces that drive exchange rates are indeed ‘Free’. The traders of that time continued relentlessly shorting the Pound depite government measures because they knew that at the end of the day market forces would prevail. Once these forces push a currency one way it is almost impossible to intervene via central bank mechanisms, government directives or otherwise.