Black Wednesday for Britain!
“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.” - George Soros.
You must be familiar with “Black Friday,” the busiest shopping day in the United States. But here we will talk about black Wednesday, a big day for Britain and investors in forex market. A hedge fund manager named George Soros played a key role in making that Wednesday black.
Who is George Soros and what did he do?
He is a hedge fund manager with worth of $8 billion and known for donating more than $30 billion for health, education, democracy, human rights etc.
He anticipated that the British pound is overvalued against the German currency in European currency market and made $1 billion in a single day (17 September 1992).
But why did he anticipated that the British pound is overvalued and will go down in near future?
Well to know this, we have to go back to the times after the World War second ended. After the end of the World war II, the European countries decided to come together and get depended on each other in order to avoid any war among them in future. They formulated European money system, European exchange rate mechanism and signed many other treaties. The European exchange rate mechanism, with an aim to promote stability of exchange rate, used to fix the lower and upper limits that an exchange rate could deviate between. If violated, the country could face suspension of the membership from the mechanism.
When Britain joined the mechanism, its economy was already in recession. Generally, in order to cope up with recession, the central Bank of the country lower the interest rates to combat high interest rates and to bring more liquidity in the economy. The bank of England also wanted to lower the interest rates but could not due to the fear of devaluation of pound resulting in higher deviation in exchange rates than the set limit under ERM. At that point of time, George Soros could smell how over valued the pound was relative to the German currency.
What did he do then?
He reached out to various hedge fund managers and banks to borrow the pounds with an obligation to pay back with interest? He borrowed $10 billion worth British pounds. He planned to sell the pounds at that point of time and buy the pounds back at cheaper rates. In short, he planned short selling.
On 16 September 1992, the president of a German bank gave a statement regarding possibility of a currency coming under pressure. On the same night, George sold all the British pounds and the price of pounds fell drastically over the night when other investors also followed him and started short selling. And he started buying at cheaper price in the next morning.
The impact of this trade
The Bank of England stepped in and bought pounds worth $27 billion but that wasn't enough. The chancellor of Exchequer (finance minister of the country) recommended the bank to increase the interest rates to attract the investors for either holding or buying the pound.
But the British Prime minister refused to do so since it would have further fuelled the recession.
When the Britain could not see any other solutions, it announced increase in interest rate by 2% and then further increase to 15%. This didn't help either. So, at 7:00 PM on 17th of September the chancellor of exchequer announced the suspension of Britain from the ERM. By that time George had already gained $1 billion and almost broke the Bank of England.
That trade is still recognised as the greatest currency trade of all time. You must be tempted to know “how you can invest in a foreign exchange?”. Just like a stock market, we have Forex markets. In India, the forex trading is offered by national Stock Exchange and Bombay Stock Exchange. The only prerequisite of forex trade is making a “forex trading account”.