black wednesday september 16th 1992 bank of england
TRANSCRIPT
29-Sep-10 SIIB, Pune - Batch of 2009-11 1
Lending Risk Management Term Presentation Semester Three
Batch of 2009/11 SIIB, Pune
Submitted to Mr. Sameer Jaiswal
Group 1
BLACK WEDNESDAY (SEPTEMBER 16TH 1992)
The Day the Bank of England Broke
Prologue
It is a story of how one wise man (George Soros)
outwitted Bank of England and made a profit of
$ 1 Billion in a single day (16th September 1992) at its
expense.
This cost Bank of England a whopping £3.4bn
“The man who broke Bank of England”
Agenda…
The story…
UK: 1979-late 80s.. Recession and Lawson’s Boom
UK: 1990…
Germany: 1989-92..
UK: until mid 1992..
The speculators are watching..
US $ vs Brit. Pound..
Speculator’s big idea..
The Game..
Who got what..
The Learning..
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Britain used the fixed exchange rate system
In 1979………
European Community: Hey Great Britain! Care to join the new ERM ?? Its our bid to reduce exchange rate variability and achieve monetary stability in Europe…
Britain: Naah.. I am fine. I am happy with my Fixed Exchange Rate System..
In 1979, UK’s inflation was at its peak- 27% and inefficient
industries and trade unions on rise.
In 1981 : UK govt. brought in deliberate recession to curb
inflation and inefficiencies by:
Increased interest rates
Tightening of Fiscal Policy to reduce the budget deficit.
Sticking to strict Money Supply targets
In 1985 : Unemployment was still over 2.5 million people
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1986-1989… Lawson’s Boom-an inflationary boom..
Lawson’s want for Unofficial Exchange Rate 3 DM to £1 to
prevent increase in interest rate.
Tax Cuts-consumer confidence, Aggregate Demand and
economic growth.
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In
flati
on
(1
0%
)
Late 1980s…
Gro
wth
(5
%)
Stock market crash-1987 (25%)
Housing boom (300%)
In 1990…
Britain decides to join ERM in a bid to
o Keep inflation low
o Provide stability for exporters encouraging trade
Under the powerful political influences of Lawson, ex-
chancellor; John Major, Chancellor and Douglas Hurd,
Foreign Secretary.
The Pound Sterling entered the market at
1 Pound: 2.95 Deutshe Mark
(This rate was despite that British inflation levels that were three times higher than that of Germany)
Consequently, Britain changes to semi-fixed exchange rate system with fluctuation band of ± 6%
Interest rates had to be set at a level consistent with keeping sterling within the agreed ERM bands (limits)
Elsewhere (Germany) Until mid-1992…
Printing more money
Inte
rest
Rate
Inflation
Participatory countries (like UK) in the ERM forced to raise interest rates to maintain the pegged currency exchange rate..
Rate hike led to severe repercussions in the UK
Large Mortgages
Inte
rest
Rate
Unaffordable mortgages
Defa
ult R
ate
In UK until mid 1992…
Economic situation was declining quickly. The UK was sliding
into recession.
High inflation and deteriorating economic activity was making
the Pound less attractive.
Therefore, the Pound kept falling to its lower limit in the
ERM.
With weak economy and high unemployment rate, maintaining high interest rates was not sustainable for U.K.
in the long term.
Hmmm… seems like time to make some quick bucks
!!
Forex speculators naturally picked this up, and anticipated an
eventual devaluation of the British pound against the Deutshe Mark
or exit from ERM
To add to the fortunate/unfortunate events…
In September 1992 the dollar was rapidly depreciating
against the deutschmark.
Tied as it was to the ERM, the pound was hence
appreciating to unsustainable levels against the US
currency.
With a large proportion of British exports priced in
dollars, a pound/dollar correction was well overdue….
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The Big Idea..
Contract debts for the pounds (GBP), and to sell them
for the Deutschemarks (DM), and invest them in the
German assets..
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1st to 16th of Sept 1992…
Speculators intensified the game and sold billions of Pounds hoping to buy them back at
a depreciated rate hence pocket the difference.
George Soros
Bank had only one strategy:
Defend the peg system whenever the rate gets below or hits
lower peg.
Speculators had two strategies :
Strategy 1 : Always attack after bank's defence
Strategy 2 : Attack even if bank has not
defended and exchange rate is above 3DM
September 16th 1992… Day Time.. An desperate attempt….
15 % 12 % 10 % In
tere
st
Rate
The intervention had little or no effect.
Government authorized expenditure of £27 billion to buy back the pounds that were being
frantically sold.
September 16th 1992…Evening… 19:00 Hrs
We hereby exit from ERM and will use free floating Pound sterling.
Interest rates however will remain at 12 %.
George Soros a HAPPY man!!
He made a $1bn profit at Britain's expense.
For UK…. Black Wednesday:: A white Wednesday???
Things turned out better than expected. The pound fell 15% versus the Deutschemark and by 25% versus the US dollar within 5 weeks ,but then rose again. And inflation rather benign.
The ERM helped set a low-inflation foundation for the subsequent decade, however the ERM did prolong the British slump, by preventing UK rates from being cut to the levels justified by the UK economy.
UK became a bit more sceptical about hitching itself to external currency systems.
Pro-and anti-euro campaigners agree the ERM was a mistake
LEARNINGS…..
The traders continued relentlessly shorting the Pound
despite government measures because they knew that at
the end of the day market forces would prevail.
Once these forces push a currency one way it is almost
impossible to intervene via central bank mechanisms,
government directives or otherwise
Black Wednesday reminds us of two things:
The size and power of the Foreign exchange markets
The amounts of money that can be made by well
capitalised, well informed, and pro risk traders.
Risk Associated-Endogenous Risk
Endogenous risk here is with regard to the policy
rule/regime set up by regulatory authorities that end up
causing the instability and risk that they were meant to
avert…
Failed Government Policy
If the UK had joined the ERM at a high level at the start of the boom, the anti inflationary impact would have helped moderate the boom, keep inflation low and prevent a painful readjustment.
But, they joined at the wrong rate at the wrong time.
Trying to keep the Pound artificially high caused a recession, deeper than any of their competitors.
The artificially high exchange rate just attracted financial speculators who saw the British government as a source of easy profit.
“Today, the currency market Forex is far more liquid
than at the beginning of the 90ies. Therefore, no
investor, even having a billion capital, will hardly be
able to influence on the currency rate for a long time.
“Black Wednesday” of September, 1992 is left far
behind, but the historic facts should not be ignored,
because the history has a tendency to recur”
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THANK YOU