Throughout the course of history, only a few men have been able to unsettle entire governments through their actions: George Soros stands as one of them.
George Soros was born on August 12, 1930, in Budapest, to a family of Jewish origin. During the Nazi occupation of Hungary, Soros and his family managed to survive by changing their surname from Schwartz to Soros in 1936, due to increasing anti-Semitism. After the end of World War II, in 1947, Soros emigrated to the United Kingdom to avoid the new pro-Soviet regime established in Hungary. In the UK, Soros pursued his education at the LSE (London School of Economics) and earned a Master’s degree in Philosophy. He gained experience working in several commercial banks in London before launching his first hedge fund, Double Eagle, in 1969. The profits from Double Eagle were reinvested the following year in Soros Fund Management, his second hedge fund. Double Eagle, renamed Quantum Fund, became the main company under Soros’s consultancy, going from 12 million dollars in assets under management at its foundation to 25 billion dollars in 2011, most of his total net worth. He is regarded as one of the world’s most successful investors. Soros is also a renowned philanthropist but, despite his vast donations, he remains one of the wealthiest individuals globally: as of October 2023, his net worth stood at $6.7 billion.
He is renowned for his success, especially during the infamous “Black Wednesday” of September 16, 1992, which earned him the moniker “the man who broke the Bank of England and the Bank of Italy”.
To comprehend Soros’s actions, we need to examine the macroeconomic situation in Europe at the time: in 1979 in Europe was established the European Monetary System (EMS) to encourage currency stability through an Exchange Rate Mechanism (ERM) that was envisaged as a precursor to full monetary union. Under this system, the majority of the European Economic Community (EEC) nations tethered their currencies to mitigate significant shifts in relative value. The ERM was created as a fixed but adjustable system in which its member states’ currencies could make small adjustments in permitted bands around their entry rate: if a currency reached its upper or lower limit, the central bank of that country had to intervene in the market to keep it within the band. The ERM was anchored on the Deutschmark, which was considered one of the strongest currencies during that period.
Two main events that ignited the crisis: on the 2nd of June, 1992, Denmark rejected the ratification of the Maastricht Treaty, thereby not entering the EMS. This event immediately put the EMS under pressure, as the markets lost confidence that all European nations would fully commit to the EU construction project and implement the necessary reforms to align macroeconomic parameters. The reunification of Germany is another event identified as a trigger for the crisis: this led to the implementation of more restrictive monetary policies and a rise in German interest rates to counter inflation, at a time when Europe was in dire need of more expansive monetary policies due to high unemployment. German interest rates drew capital from numerous countries, especially from the more vulnerable ones. In addition, the apprehensions about the future of European unification heightened the perceived risk on the continent’s weaker economies, which would have been left completely isolated if unification had not succeeded.
In 1992, both the United Kingdom and Italy were grappling with significant issues: they were burdened with substantial public deficits and had repeatedly devalued their currencies to boost exports, thereby nearing the limits imposed by the ERM.
In the early 1990s in the United Kingdom, Margaret Thatcher had to give up her position as Prime Minister in favor of John Major. Major had persuaded the British people to become part of the EMS. At this time, the pound was already under strain due to an inflation rate hovering around 7/8%, three times higher than Germany’s. The Bank of England (BoE) found itself “trapped”: to stimulate the economy, it needed to reduce interest rates. However, this would have led to capital outflow, further depreciating the pound and thus exceeding the ERM’s devaluation limits. Major, a convinced pro-European, would never have allowed this to happen.
In Italy, on the other hand, inflation had reached rates that were significantly higher than Germany’s, and its public debt had escalated to unmanageable levels. As Italy entered the 1990s, its debt/GDP ratio had soared well above 100%, and efforts to control it seemed futile. The Italian government’s strategy was to continue accruing debt, which required the Bank of Italy to constantly offer Italian government bonds to financial markets for purchase. As long as investors were buying, interest rates remained low, enabling Italy to persist in its borrowing. However, a surge in interest rates could render the situation untenable for the indebted nation, which is forced to give up a large part of its tax revenues for the payment of interest.
At this point, Soros, along with other market players, began to notice the initial indicators of a crisis. They realized that the circumstances in which both countries found themselves were untenable and decided to exploit this situation. Soros had been executing a significant short operation against the pound and the Italian lira for several months. He wagered that, considering their dire positions, the UK and Italy would be incapable of adhering to the exchange rate fluctuation limits. Consequently, they would be compelled to exit the ERM.
Soros initiated his strategy by borrowing pounds from banks, in exchange for a minor interest rate that he had to pay at the conclusion of the transaction. He then sold these borrowed pounds on the market, receiving German marks in return. As the value of the pound decreased, Soros had the opportunity to sell his marks and buy back pounds at a lower cost, enabling him to acquire a larger quantity. He could then return to the banks and repay the initial loan along with the agreed-upon interest using these pounds. The profit from this short operation was the difference between the amount he initially borrowed and what remained after the loan repayment. By August 1992, Soros had amassed a short position exceeding 1.5 billion dollars in value.
He recognized the opportune moment to act when Helmut Schlesinger, the president of the Bundesbank (Germany’s central bank), suggested in a press statement that an adjustment of exchange rates would have been possible, especially for the weaker currencies. Moreover, the BTP auctions went deserted just days before Black Wednesday, leading to a decline in confidence in Italy. During the night of September 15, 1992, Soros reached out to any bank that could provide him with pounds to then sell them in the foreign exchange market. The unique aspect of the foreign exchange market, or Forex, is its 24/7 operation, allowing transactions to occur even in the late hours. By the time the London Stock Exchange opened on the morning of September 16, Soros had sold pounds amounting to 10 billion dollars, resulting in a significant oversupply of the currency.
The UK’s response, however, fell short. On September 16, Finance Minister Lamont authorized the sale of the Bank of England’s foreign currency reserves, amounting to billions of pounds. This move was intended to enable the acquisition of pounds in the market, resulting in the Bank of England successfully procuring 27 billion pounds from foreign exchange markets. Additionally, Lamont persuaded Prime Minister Major to increase interest rates from 10% to 15% to incentivize the market to buy pounds. Despite these efforts, the combined position of Soros and his followers was too substantial. At the end of the trading day, Major announced the suspension of Britain’s participation in the EMS, and consequently, the ERM. The British were able to revert the interest rates to their previous levels, leading to capital outflow and a subsequent 15% devaluation of the pound against the German mark, approximately a seventh less than its original value.
After the downfall of the British currency, Soros swiftly attacked the Italian Lira. The Amato government chose not to devalue the lira. However, with the Bank of Italy nearly depleted of reserves, it sought to repay its creditors by raising taxes, implementing the infamous forced levy. This move involved withdrawing liquidity from Italians’ current accounts and attempting to stabilize the markets by purchasing its own public debt securities. Soros interpreted this as a further indication of Italy’s vulnerability and escalated his attack, bolstering his short position. The situation deteriorated further due to the Bundesbank’s statements, which suggested it would not intervene to support the Italian Lira in the event of currency turmoil. Consequently, Italy was left with no choice but to exit the EMS (and hence the ERM). Italy resorted to printing money to repay creditors, which stabilized its financial situation but resulted in a 20% devaluation of the Lira.
The UK Treasury Department estimated that this speculative attack cost the British approximately 3.14 billion pounds. Meanwhile, Soros’s fund, the Soros Fund, reaped a profit nearing 1 billion dollars solely from the short operation on the pound.
In conclusion, views on George Soros are quite diverse: some hail him as an ingenious visionary, while others criticize him as a merciless speculator who took advantage of systemic weaknesses, causing harm to numerous people. Many perceive Black Wednesday as a blessing in disguise. From then on, both the Bank of England and the Bank of Italy were able to freely manage their respective currencies. Lamont himself asserted that the devaluation had positioned the UK to be more competitive in the coming decades. Indeed, the UK witnessed a rise in its GDP and a decline in unemployment in the years that followed. Similarly, in Italy, the devaluation invigorated the economy, facilitating a steady realignment and subsequent reintegration into the EMS.
Author: Leondardo Zaramella