In the late summer of 1992, British Chancellor Norman Lamont maintained that the United Kingdom would defend the Pound Sterling inside the European Exchange Rate Mechanism (ERM) at all costs. In New York, legendary macro investor George Soros and his chief strategist Stanley Druckenmiller saw a catastrophic sovereign miscalculation.
The ERM Trap and Economic Divergence
The ERM required member nations to keep their exchange rates tied to the German Deutsche Mark. But while post-reunification Germany was raising interest rates to combat inflation, the UK was deep in recession with surging unemployment. Defending the artificially strong pound required the Bank of England to keep interest rates intolerantly high, suffocating the domestic economy.
The $10 Billion Short
Recognizing that the Bank of England’s foreign currency reserves were finite while the capital markets’ supply of pounds was effectively infinite, Soros famously instructed Druckenmiller to ‘go for the jugular,’ ramping their short position to $10 billion.
Black Wednesday: September 16, 1992
Despite emergency interest rate hikes by the Bank of England from 10% to 12% and then 15% in a single day, the flood of selling overwhelmed central bank reserves. By 7:30 PM, Lamont conceded defeat and withdrew Britain from the ERM. The Quantum Fund pocketed an estimated $1 billion in clear profit within 24 hours.