Maybe one of the most controversial people in finance can be considered to be the famous trader George Soros.
In this article, we will examine the life of “the man who broke the pound”, George Soros.
George Soros was born in Budapest, Hungary in 1930. Soros and his family, coming of Jewish descent, lived in turbulent times. His father Tivadar even got captured as a prisoner of the Russian army during the first world war. Their initial name was “Schwartz” which would later be changed to “Soros” to camouflage their Jewish descent.
At the age of thirteen, George Soros witnessed the German occupation of Hungary during the second world war.
After four years, at the age of seventeen, George Soros will leave Hungary for Paris, and eventually to England, with the help of a Hungarian government collaborationist whose job was to confiscate Jewish properties, and Soros actually helped him in his job, as he later told in an interview. This man took later Soros as his Christian godson with him and left the country.
In England, Soros would earn his Bachelor’s degree in philosophy, and his Master’s degree in philosophy, both from the London School of Economics.
Soro would be asked later in his life how he transitioned from an immigrant to a financier, to which he would reply “well, I had a variety of jobs and I ended up selling fancy goods on the seaside, souvenir shops, and I thought, that’s really not what I was cut out to do. So, I wrote to every managing director in every merchant bank in London, got just one or two replies, and eventually that’s how I got a job in a merchant bank”.
After working for the merchant bank Singer & Friedlander in London, Soros would move in 1956 to New York City to work as an arbitrage trader for the F. M. Mayer bank, with a specialization in European stocks.
After a while, in 1973 George Soros decided to start his own fund named “Soros Fund Management”, in which people like the legendary investor Stanley Druckenmiller had worked. Soros was also in a managerial position in the “Quantum fund”, a hedge fund he also had also helped to start.
The Alchemy of Finance & the Theory of Reflexivity
Although he has written many books, maybe his most famous book is “the Alchemy of Finance”.
Finance and economics are social sciences, and this means that every asset is valued based on people’s perceptions and not on reality. Through this statement, and from the teachings of his teacher Karl Popper, George Soros has developed his market theory called the “general theory of market reflexivity”.
Starting from financial models and economic indicators, positive feedback loops can influence the expectations of market participants and thus make asset prices deviate from their equilibrium prices.
“The participant’s views, influence the course of events, and the course of events, influences the participant’s views.”— George Soros
The Black Wednesday
The European Exchange Mechanism (ERM I) had been created to reduce change rate variability and promote monetary stability inside the EU. The UK, being a member of the Europen community at that time, joined the ERM in 1990 under Prime minister John Major and after Margaret Thatcher had left office. This mechanism, in theory, would prevent the British pound to fluctuate no more than 6% from the other European currencies.
During the next two years, the British economy would experience a high inflation rate, over three times more than what Germany had at the time, higher interest rates, and a worse overall economic situation.
To follow this route was more and more difficult and costly for the Bank of England, making the British pound more and more overvalued, since the British economy didn’t follow its currency.
At this point, it needs to be noted that the rate of the British pound to the German mark was set unilaterally by the UK government.
“When you are right, and you know something, you really feel it, you can’t have enough… If I have to sum up his investment philosophy in one sentence, [it would be] that it’s not whether you are right or wrong. You just have to have the maximum when you are right.”— Stanley Druckenmiller
In Germany, the west unified with the east after the fall of the Soviet Union. The cost of the unification has been greater than expected, and in order to fight that, the German central bank has to raise its interest rate. This meant that the Bank of England would have to follow, and thus making the British pound even more overvalued.
Two years after the UK joined the ERM mechanism, needed to exit in order to protect the British pound. Market intervention by the bank of England couldn´t stabilize the situation. The solution was to raise its interest rates from 10% to 12%, to 15%, something that signaled to the currency traders that the means of the British central bank to control the situation had come to an end.
“… It indicated to us that we are at the endgame. That this was an act of desperation. So instead of restraining us, it was really an invitation to double up. To try to sell as much more as possible.”— George Soros
On that day, the 16th of September 1992, Norman Lamon announced that the UK was exiting the ERM mechanism, and marked the historical event known as “Black Wednesday”.
In fact, Britain was not the first nor the only victim of this mechanism, Italy started the chain reaction, and eight other countries suffered the same fate after the UK. In fact, on the 15th of September, Helmut Schlesinger, the president of the German central bank said in an interview that gave in the Wall Street Journal that some currencies might come under pressure and might need realignment due to the actions of the German central bank on the German Mark. This statement was the triggering event.
On Black Wednesday, Soros made £1'000'000'000 in a single day, by betting more than his personal fortune at the moment. He was borrowing British pounds, converted them into foreign currencies, mainly the German Mark (DM), and then, when the GBP finally broke downwards, he repaid those loans worth £10'000'000'000 by buying back British pounds at a much lower price and held the difference. He had shorted the British pound.
His fund was so much leveraged, so much so that it borrowed above its entire value. Soros later mentioned in an interview that “in terms of risk, it wasn’t a full exposure. The risk of loss was maybe at 2%. It wouldn’t have killed us.” Stanley Druckenmiller has also stated that this event “was inevitable” to happen.
Soros was planning this trade for many months, but “paid up at this particular moment” as he said. On the day of the British pound crash, the Bank of England lost £6'000'000'000 trying to stabilize the currency.
“I think the most vivid memory I have is just when we put interest rates up from 10 to 12% how it had absolutely zero effect. I remember just looking at the computer and seeing an absolutely straight line, the currency hadn’t moved at all. I felt just like a surgeon looking at a heart graph of a patient and realized the patient was dead.”— Norman Lamont
Soros, as everyone of course, is not always right though. His fund had lost $600 million in 1987 when he was betting on the fall of the Japanese Yen. Instead, the crisis started in the US which fall against the Japanese Yen.
https://dimitriosonline.medium.com/the-man-who-broke-the-bank-of-england-george-soros-and-the-black-wednesday-affe9ce9ccce
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