What is ‘black Wednesday’? How George Soros toppled the Bank of England?

Black Wednesday refers to the day when the British government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM). It took place on 16 September 1992 which is remembered as a dark day in British economic history (Tarzi, 1999).

Setting the Stage for Black Wednesday

In March 1979, the European Exchange Rate Mechanism (ERM) was set up in order to reduce exchange rate variability and achieve financial stability across Europe. Under the ERM system, the member nations were required to fluctuate their currencies within a specific range relative to each other.

Britain initially declined to join ERM when it was first introduced, but later adopted a semi-official policy which shadowed the Deutsche Mark (a German currency). Having said that, Britain decided to join the ERM in October of 1990, after a shake-up in leadership. When the country entered the ERM the pound’s value failed to stay within a specific rage. The country prevented its currency from fluctuating more than 6 percent in both upper and lower margin direction by intervening in the currency markets with countertrades.

Black Wednesday’s Underlying Causes

After joining the ERM, Britain set their currency at a rate of 2.95 Deutsche Marks per British pound with a 6 percent permissible move in either direction. At that time, the status of pound sterling currency was so weak in the ERM and struggled to remain within the aforementioned range. British government official placed upward pressure in order to make its currency strong by hiking its interest rates from 10% to 15% in the space of one day. However, this move failed to conciliate the concerns of market participants who were doubtful of the British government’s ability to stabilize the pound.

Currency traders took note of these problems and they began shot selling the pound sterling. In that time, they borrowed and immediately converted British currency into a foreign currency with the agreement to re-convert them in the future. George Soros was one of these bearish cash dealers, accumulating a short position of more than $10 billion worth of British currency.

ROLE OF SPECULATORS

George Soros is a businessman and one of the most famous currency traders in the world. He is an intensely intellectual man who spends much of his time in Eastern Europe as educational and political philanthropist (Kaletsky, 1992). He is known as the “Man Who Broke the Bank of England” as of going short against the Bank of England. A billionaire investor George Soros sought to turn a profit by borrowing U.K. gilts and selling them, before buying them back at lower prices later on. Reportedly, he repeated this process which made him a profit every couple of minutes.

References

Kaletsky, A. (1992, Oct 26). How Mr Soros made a billion by betting against the pound;George Soros. The Times .

Tarzi, S. M. (1999). Financial globalization and national Macroeconomic policies: Managerial challenges to the nation-state. The Journal of Social, Political, and Economic Studies, 24 (2).

Guell (2015), in their book Issues in Economics Today, in politics and economics, Black Wednesday refers to 16 September 1992, when the British Conservative government was forced to withdraw the pound sterling from the European Exchange Rate Mechanism (ERM) after it was unable to keep the pound above its agreed lower limit in the ERM. ERM was an exchange rate policy of European countries majorly formulated to unify European economies especially by reducing exchange variability and stabilize the monetary transaction between the European nations. Thus, in that course, England pegged its currency with the currency of Germany to make the trading activities more flexible and efficient.

However, this exchange rate system was not working in Great Britain as their currency was getting weaker and weaker against the currency of the Deutsche Mark. The British officials and Bank of England were unable to keep their currency value with Germany’s Deutsche Mark which as result their economy was getting adversely affected. This situation majorly prevailed due to differed inflation rate between these countries. In Germany, there was a low inflation rate, whereas England was standing from high inflation rate. Therefore, due to this UK’s currency was further getting depreciated. Thus, the currency trader and speculators began to sell the pound sterling and bought Deutsche Mark. This further created an immense trouble for the UK as the demand for Pound sterling was decreasing and supply of currency was imminent (Budd, 2005).

The opportunity that was made from the situation was seized by George Soros. He noted that the British regime was under great pressure and presumed that Great Britain was either going to massively devalue its own currency or that it was proceeding to allow the EMS. In concert with other investors, Soros capitalized big amounts of money to deteriorate the British pound. He did so by swapping pounds for other European currencies such as the Deutschmark or the French franc. When the bank was fluctuating its interest rate, after few hours bank announces 15% interest rate, but Soros and his investor’s do not respond and did not get the lure. They merely waited and at & p.m. the same day, British Treasury announced that Britain was leaving the European Monetary System and the intense devaluation of the British pound earned Soros a billion bucks.

To sum up, Britain should have joined ERM at the start before economic boom. From the black Wednesday incident the lesson is learned that a country should have proper government policy in order to fight economic downturn. Also understanding the issue, bank can avoid the future crisis.

References

Budd, A. (2005). Black Wednesday-A Re-examination of Britain’s Experience in the Exchange Rate Mechanism.

Guell, Robert C. (2015). Issues in Economics Today , 7th edition- 2015 ISBN: 978-0078021817