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Chapter 19 George Soros: success story of legendary investor

George Soros: success story of legendary investor

Like in every sphere of life, there are outstanding persons on Forex, whose names went down in history. George Soros is one of the most successful traders in the forex history. His career began from the establishment of the Quantum Fund in 1969 on Curacao (Netherlands Antilles in
 the Caribbean Sea). In the course of its existence, the Quantum Fund conducted a lot of lucrative speculative operations on Forex. For example, in the spot market in 1996 only, the fund made the profit equaling the annual income of McDonald’s Corporation. However, the best-known deal of George Soros is the pound sterling trade held in 1992. As a result, he gained a net profit of $2 billion within one month. Because of this roaring success and its background, George Soros earned the reputation of "the man who broke the Bank of England".

George Soros owes such a staggering profit 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 participating in the system and to prepare for the currency integration. Originally, the EMS consisted of 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 contemporary Euro (EUR). The centralized rate versus the ECU established. Besides, the currency rate limits (a corridor), within which fluctuations in a currency exchange rate were allowed, were set for every EMS member. The participants were obliged to maintain the rate of their national currency by any means under the agreement terms or leave the system. According to the charter, the centralized rates of the EMS participants could be changed. This happened 9 times from 1979 to 1987.

In 1990, Great Britain joined the EMS and the exchange rate of the British pound (GBP) was set at 2.95
Deutsche Mark (DEM) with a tolerated corridor ± 6%. By the middle of 1992, thanks to the ERM, inflation rates in the European countries participating in the EMS significantly decreased. Nevertheless, the artificial maintenance of the currency rates within the currency corridor aroused doubts among investors. The situation got worse after the reunion of West and East Germany in 1989. The weakness of East Germany’s economy brought to huge expansion of the government spending that forced Bundesbank to issue more money. This policy led to high inflation, and Bundesbank responded to this by lifting the key interest rate. High interest rates attracted foreign investors. This, in its turn, caused robust demand for the Deutsche Mark that inflated its value. 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 Deutsche Mark. The British economy at that time was in dire straits. Unemployment rates in the UK were soaring. The Bank of England did not dare to raise interest rates following suit of Germany’s Bundesbank as this move could only make the situation worse under such conditions. 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 the UK would not be able to maintain the domestic currency rate at the required level and it would have either to announce its devaluation or withdraw from the ERM.

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

As a result of such speculations, the unstable economic situation in the UK became even worse. In the attempt to set the situation right and increase the currency rate, the Bank of England repurchased around GBP 15 billion for its reserves. But it did not achieve the expected goal. 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%. The regulator wanted to calm down turbulence, but the expectations of the central bank officials were not satisfied.

Those investors, who had sold the pounds, were sure that they would gain an enormous profit after a further nosedive of its value. A few hours later, the Bank of England claimed its intention to increase the interest rate to 15%, but traders kept selling pounds. This continued till 19:00 of that very day. Later on, 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 went into a tailspin. 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. Remarkably, in September 1992, the pound slumped by almost 3,000 pips!

Thus, George Soros, "the man who broke the Bank of England" showed to what extent central banks can be vulnerable to currency speculations of large investors under conditions of artificially maintained currency rates. The borrowed funds allowed George Soros to gather wealth within just a few weeks, which opened the door for his charity work. To prevent the negative influence of currency speculations on the economy of the country, central banks create reserves in 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 any currency rate for a long time. “Black Wednesday” of September 1992 is left far behind, but the historic facts should not be neglected, because the history has a tendency to repeat itself.


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