In October 1990, the United Kingdom joins the European Exchange Rate Mechanism, the system paving the way for a single currency. Sterling is pegged to the German mark around a central rate, with an allowed band of fluctuation. If it nears the floor, the Bank of England must defend it, whatever it costs.
On paper, it is a guarantee of stability. In practice, it is a promise the whole market can test.
A promise that couldn't hold
In the early 1990s, the British economy is in poor shape. Unemployment is rising and growth is slowing. Supporting the economy would call for lower rates. But defending the pound means keeping them high, because a reunified Germany is itself holding rates very high.
The UK is stuck between two incompatible goals. Several investors see it. One of them, George Soros's Quantum Fund, run day to day by Stanley Druckenmiller, builds a massive short position against sterling, in the order of ten billion dollars.
16 September 1992
In the morning, the pound comes under attack from all sides. The Bank of England buys its own currency in bulk, then raises its base rate from 10% to 12%. Nothing works. In the afternoon, it announces a move to 15%.
That evening, Chancellor of the Exchequer Norman Lamont announces that the UK is suspending its membership of the mechanism. The rise to 15% never takes effect. The pound falls away.
Who won, who lost
The Quantum Fund is reported to have made around a billion dollars on the trade. George Soros earns a nickname: "the man who broke the Bank of England".
The cost to the British Treasury was later estimated, in papers released years afterwards, at more than three billion pounds. Some economists nonetheless call it "White Wednesday": freed from the currency constraint, the country could cut rates, and growth picked up in the years that followed.
The lesson for traders
People remember the spectacular profit. They forget what made it possible: the bet wasn't on a chart, it was on an inconsistency. A central bank could not defend forever an exchange rate at odds with the state of its own economy.
Big moves rarely start with an indicator. They start with a promise someone can no longer keep.
And the essential reminder: for every winning bet told in the history books, there are many others, just as convinced, that lost. Conviction is not risk management.
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