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Chapter 19 George Soros: story of one trader

George Soros: story of one trader

Like in every sphere of life, there are outstanding persons on Forex, whose names went down in history. On the currency market George Soros is one of the most successful traders in history. His career began from the establishment of the Quantum Fund in 1969 on Curacao (Netherlands Antilles in West India). During the time of its existence, the Quantum Fund conducted a lot of profitable speculative operations on Forex market. For example, on the spot market in 1996 only, the fund received the profit equaling to that of the annual income of McDonald’s Corporation. However, the most money-making deal of George Soros is the British pound sterling trade held in 1992, due to which he gained a net profit of $2 billion within one month. Thanks to such success and the facts, by which it was caused, George Soros got the reputation of "the man who broke the Bank of England".

George Soros owes such triumphant deal to the situation in the world in the 90s. In 1979 Germany and France initiated establishment of the European Monetary System (EMS). The EMS was created to maintain the stability of the national currency rates of the countries-members of the system and to prepare for the currency integration. The initial members of the EMS were Germany, France, Italy, the Netherlands, Belgium, Denmark, Ireland, and Luxemburg. The mechanism of regulating the currency rates (the European Exchange Rate Mechanism (ERM)), the core of the EMS, was based on the introduction of the European Currency Unit, ECU, which was a prototype of the today’s Euro (EUR). The central rate versus the ECU and the currency rate limits (a corridor), within which the change in the currency exchange rate was allowed, was set for every EMS member. The members of the EMS were obliged to maintain the rate of their national currency by any means under conditions of the agreement or leave the system. Under the terms of the treaty, the central rates of the countries-members of the EMS could be changed, and it had happened 9 times from 1979 to 1987.

In 1990, Great Britain joined the EMS and the rate of the pound (GBP) was fixed at 2,95 (DEM) with a permissible currency corridor ± 6%. By the middle of 1992, thanks to the ERM, the inflation tempo in the European countries-members of the EMS significantly decreased. Nevertheless, the artificial maintenance of the currency rates in the limits of the currency corridor arose doubts among the investors. The situation got worse after the reunion of West and East Germany in 1989. The weakness of West Germany’s economy brought to the incensement of the national outlay, which forced Bundesbank to issue more money. This policy led to inflation, and Bundesbank reacted to this by uprising the interest rate. The high interest rates attracted foreign investors, this, in its turn, caused an excess demand on the Deutschemark and resulted in the growth of its rates. Great Britain, being bound by the EMS agreement, had to maintain its national currency rates within the fixed limits of the currency corridor versus the Deutschemark. The British economy at that time was destabilized; the unemployment rate of the country was high. The uprise of the interest rate after Germany in such conditions could only make the situation worse. But there were no other possibilities to strengthen the domestic currency rate in the near term. At that time George Soros and many other investors considered that GB would not be able to maintain the domestic currency rate at the needed level and it would have either to announce its devaluation or refrain from the ERM.

George Soros took a decision to borrow the pounds (GBP), sell them for the Deutschemarks (DEM) and invest in the German assets. As a result, almost GBP 10 billion was sold. George Soros was not alone thinking in this direction, and many investors followed his actions.

As a consequence of such speculations, the unstable economical situation in Britain became even worse. The Bank of England in the attempt to set the situation right and increase the currency rate repurchased for its reserves around GBP 15 billion. But it did not bring the desired result. Then on September 16, 1992, which would further be called the “Black Wednesday”, the Bank of England declared that it raised the interest rate from 10% to 12%. It wanted to neutralize the boom, but the expectations of the English politicians were not satisfied.

The investors, who had sold the pounds, were sure that they would gain an enormous profit after the further downfall of its rate. A few hours later the Bank of England claimed to increase the interest rate to 15%, but traders kept selling pounds. This continued till 19:00 of that very day, later on the Chief Secretary to the Treasury Norman Lamont announced that Great Britain left the European Exchange Rate Mechanism (ERM) and lowered the interest rate to 10%. From that day on, the pound rate started falling. It plunged by 15% versus the Deutschemark and by 25% versus the US dollar within 5 weeks. This brought a giant profit to the Quantum Fund – within only one month George Soros gained around 2 billion US dollars buying the significantly cheaper pounds for the German assets. As it can be noticed, only in September 1992 the pound fell by almost 3,000 ticks!

Thus, George Soros, "the man who broke the Bank of England" showed to what extent the central banks can be vulnerable to currency speculations of large investors in the conditions of the artificially maintained currency rates. Use of the borrowed funds allowed George Soros to gather wealth within just a few weeks, which set the beginning of his charity work. As we have seen it, in order to prevent the negative influence of the currency speculations on the economy of the country, central banks create reserves in the form of foreign assets. But as the practice has shown, such reserves can be ineffective if they are opposed to the large capitals of the investors, who have the same goal.

Today Forex is far more liquid than at the beginning of the 90s. Therefore, no investor, even having a billion capital, will be able to influence the currency rate for a long time. “Black Wednesday” of September 1992 is left far behind, but the historic facts should not be ignored, because the history has a tendency to recur.