The Man That Broke The Bank of England
Back in the 80’s Economies in Europe were not having the best of times, the Germans undergoing the stress of reunification, following the collapse of the Berlin wall; a major setback for the Soviet Union which ultimately to its collapse. England, on the other hand, was having its own battles with its economy and policies as the inflation rates were going up fast.
In a bid to unify the economy of Europe, the British government joined the European Exchange Rate Mechanism (ERM). Although both countries were going through hard times, the Pound has always overshadowed the Mark, even though it was the other way around in theory, because the German Economy was still doing better than the British. On joining the ERM, the market forces would ensure the right rate, but the British set their Pound fixed at above 2.7 Mark (1 Pound = 2.7 Mark), even though the inflation rates were many times that of Germany. This artificial buoyancy of the Pounds created a bubble to which the British Government tried to quickly fill up with solid backing by bringing in foreign investors; increasing the interest rates, rather than devalue its currency and make a profit on the ERM, they preferred a stronger, yet haemorrhaging Pound. This decision led to the Bank of England accruing a loss of over £3 Billion on a single day, September 16, 1992, remembered as Black Wednesday.
There’s a similar situation you might be familiar with; an episode of Billions. In that episode, the Pounds was the Naira. The Nigerian Government floating the Naira at a fixed rate which was not well backed by economic statistics as the inflation rate was high, GDP and revenue were lower, the foreign reserve was lower than previous years. Axelrod was approached with this information and he went on to meet with other fund managers in efforts to raise about $5 Billion in order to Short (bet against) the Naira.
In real life, Axelrod was a man called George Soros. He broke the Bank of England in 1992 by shorting* the Pound with £10 Billion and ended up making £1 Billion profit from the trade. He was a speculator that believed that the artificial floating (bubble) of the fixed rate set by the British Government will definitely crumble (bubble would burst), it did and he pocketed a £1 Billion for his efforts.
A good thing came out of England’s misfortune at the ERM, as they finally devalued the Pound and that lowered inflation, investors moved in and the economy got better and stronger over time. Sometimes it takes a (or more ) hard lesson to make one see that taking the humble pill at times is a more cost-effective solution to progress.
*Shorting: This is a strategy used when an investor/trader believes the price/value of a security will fall in the short term. The trader borrows existing securities from a broker and initiates the Order by selling the security, and closes the Order by buying back the security at a lower price. A practical example: A woman believes First Bank’s share price will drop after its Quarterly report, she approaches her online broker (trading platforms) and borrows 20,000 First Bank shares and sells at NGN 23/share (market value at the time). A few weeks later, First Bank releases their Quarterly Report with the low revenue and way below the projection at the beginning of the quarter, and it affects the share price which drops to NGN 15, and the woman closes her order by buying back the 20,000 shares at NGN 15. She keeps the difference (NGN 8 x 20,000) of NGN 160,000. She shorted First Bank’s stock.
