Black Wednesday September 16th 1992 Bank of England

Group 1
Lending Risk Management

Term Presentation
Semester Three
Batch of 2009/11
SIIB, Pune
Submitted to Mr. Sameer Jaiswal
1 SIIB, Pune - Batch of 2009-11

29-Sep-10
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..
4 SIIB, Pune - Batch of 2009-11 29-Sep-10

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

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.

Late
1980s…
Growth
(5%)
Stock market
crash-1987
(25%)
Inflation
(10%)
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
Interest 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
Unaffordable
mortgages
Default Rate
Interest Rate
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….

The Big Idea..
Contract debts for the pounds (GBP), and to sell them

for the Deutschemarks (DM), and invest them in the
German assets..

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 %
Interest Rate
12 %
10 %
Government authorized expenditure of
£27 billion to buy back the pounds that were being
frantically sold.
The intervention had little or

no effect.
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”

THANK YOU

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Group 1

Lending Risk Management

1 SIIB, Pune - Batch of 2009-11

The Day the Bank of England Broke

It is a story of how one wise man (George Soros)

This cost Bank of England a whopping £3.4bn

“The man who broke Bank of England”

4 SIIB, Pune - Batch of 2009-11 29-Sep-10

European Community: Hey Great Britain! Care to join

Britain: Naah.. I am fine. I am happy with my Fixed

8 SIIB, Pune - Batch of 2009-11 29-Sep-10

Lawson’s want for Unofficial Exchange Rate 3 DM to £1 to

Tax Cuts-consumer confidence, Aggregate Demand and

9 SIIB, Pune - Batch of 2009-11 29-Sep-10

Britain decides to join ERM in a bid to

Under the powerful political influences of Lawson, ex-

(This rate was despite that British inflation levels that

Consequently, Britain changes to semi-fixed exchange

Interest rates had to be set at a level consistent with

 Economic situation was declining quickly. The UK was sliding

 High inflation and deteriorating economic activity was making

 Therefore, the Pound kept falling to its lower limit in the

Forex speculators naturally picked this up, and anticipated an

In September 1992 the dollar was rapidly depreciating

19 SIIB, Pune - Batch of 2009-11 29-Sep-10

Contract debts for the pounds (GBP), and to sell them

20 SIIB, Pune - Batch of 2009-11 29-Sep-10

Speculators intensified the game and sold

Speculators had two strategies :

 Strategy 1 : Always attack after bank's defence

 Strategy 2 : Attack even if bank has not

The intervention had little or

We hereby exit from ERM and will

 The ERM helped set a low-inflation foundation for the subsequent

 UK became a bit more sceptical about hitching itself to external

 Pro-and anti-euro campaigners agree the ERM was a mistake

Once these forces push a currency one way it is almost

The size and power of the Foreign exchange markets

The amounts of money that can be made by well

Endogenous risk here is with regard to the policy

 If the UK had joined the ERM at a high level at the start of

 But, they joined at the wrong rate at the wrong time.

 Trying to keep the Pound artificially high caused a recession,

 The artificially high exchange rate just attracted financial

33 SIIB, Pune - Batch of 2009-11 29-Sep-10

34 SIIB, Pune - Batch of 2009-11 29-Sep-10

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