This is one of the well-known stories involving Forex Trading. Among the largest profiteers was the legendary George Soros, who made an amazing 1 Billion pounds sterling during this episode.
The saga gave him the title of ”The man who broke the Bank of England”.
Here is how things played out………….
Prior to 1990 Britain used the fixed exchange rate system where they pegged the value of the pound sterling. This fixed exchange regime meant below market interest rates and resulted in gradually rising inflation.
In 1990 Britain decided to abandon this practice of fixing its currency and adopted policies of the European Exchange Rate Mechanism. (ERM). The European Exchange Rate Mechanism was a build up to a unified currency (i.e the EURO). 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. Forex speculators naturally picked this up, and anticipated an eventual devaluation of the British pound against the Deutshe Mark.
During the fortnight leading to the 16th of September 1992 speculators sold billions of Pounds hoping to buy them back at a depreciated rate hence pocket the difference. Among them was George Soros.
The British decided to intervene by hiking interests rates to 12 %. Government authorized expenditure of Billions of Pounds to buy back the pounds that were being frantically sold. In effect the government was pumping out massive wealth to speculators. The intervention had little or no effect.
During the evening of September 16, 1992 the British government announced its exit from ERM and reverted back to the pegged Pound sterling. Interest rates however remained at 12 %.
This episode shows that the Free Market Forces that drive exchange rates are indeed ‘Free’. The traders of that time continued relentlessly shorting the Pound depite 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