BLACK WEDNESDAY

George Soros is one of the most influential investors and traders out there. It isn't as easy as it looks to manage trading and investments at the same time. Even though he gives the world, especially India, many reasons to hate him, we should think rationally and have an open mind to absorb his learnings. Out of the many successful trades undertaken by George Soros, this one has the characteristics to stand out. He has famously said that it doesn't matter whether you are right or wrong. What matters is how much you lost when you were wrong and how much you made when you were right. Today, we will talk about one such trade that made people call Mr. Soros a crook and a genius at the same time. For all those historophiles, fasten your seat belts because the amount involved in this trade will surely give you goosebumps.

The event dates back to the 1992 currency crisis that forced the British government to withdraw from the European exchange rate mechanism and devalue its currency, the Pound sterling. In modern history, there have been several instances of currency crises. These are sudden and drastic devaluations in a nation's currency, matched by a volatile market and a lack of faith in the nation's economy. A currency crisis is sometimes predictable, yet it is often sudden.

The European exchange rate mechanism is a set of procedures used to manage a country's currency exchange rate relative to other currencies. It is part of an economy's monetary policy and is put to use by central banks. The most notable exchange rate mechanism occurred in Europe during the late 1970s. The European Economic Community introduced the ERM in 1979 as part of European monetary policy to reduce exchange rate variability and achieve stability before member countries moved to a single currency. The ERM fixed the exchange rates of the participating currencies to the German Mark, which was the strongest and most stable currency in Europe at the time. The ERM allowed for some fluctuations within a certain range, but if the currency reached its upper or lower limit, the central bank of that country had to intervene.

The British initially declined to join the ERM, preferring independent monetary policy. However, under the leadership of Margaret Thatcher, the UK joined the ERM, hoping to take advantage of lower interest rates, lower inflation, and a stronger currency. It wasn't plausible for the Brits to join the ERM because they joined at a high exchange rate of 2.95 German marks per pound, which made their exports less competitive and hurt their economic growth. Second, the British economy was relatively weak, and its inflation rate was higher than Germany's, which meant it had to keep its interest rates high to maintain its exchange rate. Higher interest rates are a must to tame down inflation, but for an economy that was already weak, higher interest rates would have killed the economy. Third, Britain and the Eurozone faced the external shock of Germany's reunification in 1990, which increased Germany's inflation and interest rates and put upward pressure on the mark, devaluing the Pound sterling. The British also faced political uncertainty.

The British entered the ERM with hopes of keeping their currency above DEM 2.70 to GBP 1, but this was practically unfeasible for the reasons described above. The mechanism of the fixed exchange rate has been criticized by many industrialists and politicians.

Enter George Soros. Soros was highly skeptical about the Bank of England's position. Because of this skepticism, he started shorting the Pound quietly at first, accumulating around $1 billion in positions. He soon became outspoken. He knew that Britain's position in the ERM was unsustainable and would eventually have to devalue the Pound, making Soros rich.

He used his hedge fund, Quantum Fund, to borrow billions of pounds from various banks and sell them for other currencies, such as the German mark or the US dollar. This created a huge demand for other currencies, leading to a decrease in the value of the pound. Soros also used derivatives to amplify his bet.

The British government and the Bank of England started raising interest rates and buying back the pound from the markets to stabilize their currency. On September 16, 1992, they announced that they would raise their interest rates from 10% to 12%, eventually halting at 15% to attract investors to buy Pounds. They also used their forex reserves to buy back the pound from speculators like Soros. However, Soros's position was so massive that even after undertaking such economic reforms, they were unable to stabilize their currency. Germany was also trying to help keep the Pound in the ERM. The Germans said that realignment with ERM might be possible in mid-Sept. In response to this comment from Germany, Soros decided to increase the size of his short position from a massive short of $1 billion to $10 billion.

BLACK WEDNESDAY 

After hours of negotiations, the British realized that they couldn't afford to keep buying pounds at the fixed exchange rate. Hence, they decided to withdraw from the ERM and let the pound float freely in the market. Free float means that the value of the currency would be determined by market supply and demand. The Indian Rupee works on the same mechanism.

As a result, the Pound plunged in value by 15% against the mark and 25% against the dollar. Soros made about $1 billion in profits as a result of his successful bet against the pound. Ben Graham, Warren Buffett's idol, once said, "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right". The withdrawal from the ERM was a humiliating defeat for Briain's government and a major blow to its credibility and reputation. It also caused economic turmoil and social unrest in Britain; as a result, interest rates remained high, inflation rose, unemployment increased, and public spending was cut.

George Soros is very wealthy but also infamous for his role on Black Wednesday. He was praised by some as a genius and a visionary and criticized by others as a greedy and ruthless speculator who exploited the weaknesses of the system and caused harm to millions of people, earning the title of "Man who broke the bank of England". Black Wednesday was one of the most dramatic and consequential events in the history of the global financial markets. It showed the power and influence of speculators like Soros, who could challenge and defeat governments and central banks with the size of their bets. I believe that to take such a massive position and to bet against an entire economy, it requires more than just money and knowledge. Soros had the courage to bet against the tide, making him one of the wealthiest speculators in the world.

It is said that it takes 20 years to build a reputation and five minutes to ruin it. Soros did something similar. In order to gain more profits globally, he started funding opposition parties through his non-profit organizations in order to implement favorable policies and profit from them. Sometimes he did make money but lost a lot of reputation. I remember Buffett once saying that if given the opportunity, he would like to write a book titled How to Live on $500 Million, referring to these greedy speculators who would take any measure to earn that extra million. And if you can't live a life on $500 million, God help him.

HAPPY INVESTING.