George Soros: Breaking the Bank of England

Germany was split after the end of World War 2, the eastern part was taken by the Soviet Union and the Western half was under Allied influence headed by the United States. East Germany is a communist state while West Germany is capitalist. The reunification of the two fragmented German states has been a very sensitive political topic; the Soviets were vigilant about a possible reunification because it meant that the communist government would be taken over by the western capitalist half. The wall that separates Berlin was first opened in November 9, 1989. Thousands of people from East Berlin flocked into the capitalist half of Berlin. Once there, East Berliners shopped for goods that were not available in their side of the city this includes pornographic materials. At that time the currency of East Germany lost most of its value, but regardless of this scenario, the government of West Germany allowed a 1 for 1 exchange rate from an East German Mark to the West German Mark. This is clearly a loss for the government but it can be considered as an expensive propaganda that would deliver a good incentive for the reunification of the two states under capitalism.

Across the pond in the UK, its currency the Pound Sterling is a part of the European Exchange Rate Mechanism (ERM) which is supposed to reinforce the unification of the economies of Europe. Under this system, currencies are fixed to a narrow band, they are allowed to fluctuate within the confines of the margin but not over or under. This fixed exchange rate system supported the German Mark at 2.7 to a Pound. However, the market forces of supply and demand pushed the British Pound at a very low interest rate. A low interest rate is supposed to decrease the value of a currency but the ERM is preventing it from fluctuating too much. This dilemma faced by the British government and the upcoming German unification opened a trading opportunity for George Soros. He speculated that the United Kingdom would eventually be forced to leave the ERM because of the pressures from the German Mark which has the potential to rise in value since Germany is reunified and the Deutschemark is rising in value.

George Soros seized this opportunity and bet over $10 billion, a value that was way more than the capital of his Hedge Fund. He then borrowed the UK Pound Sterling and bought the German Marks, in effect he has a short position on the UK Pound and a long position on the German Mark at pre- 16 September levels at 2.95 Deutschmark to a Pound. In September 16, 1992, the British government effectively pulled out from the European Exchange Rate Mechanism. As a result the Pound Sterling was devaluated and German rose significantly in price relative to the drop of the Pound. George Soros then bought the now much cheaper Pound using the German Marks and pocketed approximately $1 billion. George Soros seemed like he broke the Bank of England. But it was really the government that was forced to devalue its currency because it was losing billions to try to keep the value of the Pound artificially high, in effect George Soros only rode the wave created by this activity. However, on a second look, the shorting of the British Pound has put a heavy obligation for the Bank of England to match this massive sell volume. It has to match the same amount just to prevent the currency from sliding. In effect George Soros and his Quantum Fund became the global leading currency speculator.

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