The Man Who Broke The Bank of England

People in Finance are generally stereotyped as evil masterminds. If there was ever an individual who fully embodied this stereotype, it would have to be the famous English high-profile currency speculator. Meet George Soros, who is notoriously titled “The Man Who Broke The Bank of England“.

 

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(Source: GeorgeSoros)

 

So, how did Soros “break” the Bank of England, the English Central Bank? For this, you need to have a first-hand understanding of how the European Exchange Rate Mechanism (ERM) works. Before the introduction of Euro as a currency, the English Pound traded against several European currencies under the purview of the ERM. The ERM basically promised a fixed rate of the English Pound against several European currencies (To put it in technical terms, The Pound was ‘pegged’ to many European currencues). That is to say, regardless of how bad the economic conditions were at home, the value of the home currency would remain about the same – the Bank of England promised this. And so, every other currency under the ERM had their exchange rates fixed (pegged) against several other ERM currencies. The elaborate and perplexing system of ERM is of little interest to anyone these days.

 

However, many speculators predicted that the Pound being in the ERM was not sustainable and that it would lead to a financial crisis. At the center of this huge outcry was George Soros. Known for his ability to take massive amounts of risk, Soros called a spade a spade. Under his advise, many private fund houses started selling the Pound to ‘anyone who would buy’ and started accumulating other stable currencies – the majority being the U. S. Dollar. If you’re wondering why he would advise this – remember that Soros predicted that the Pound will fall. This meant that a single Dollar note would fetch him more Pounds in the future than today. On top of this, Soros and his accompanying private funds shorted the Pound.

 

John Major, the then Prime Minister of England, did not like this one bit. He did everything in his power to prove Soros and his followers wrong. He asked the Bank of England to raise the policy interest rates to as much as 10 percent. He also authorized an unprecedented accumulation of the English Pound that was being sold by Soros and his private funds. These steps were aimed at maintaining the exchange rate of the Pound vis-a-vis the other European currencies under the ERM system. But soon, the Bank of England noticed that they were running out of Foreign Currency Reserves to purchase the Pound back. Meanwhile, Soros kept on selling and shorting more and more Pounds. Meaning, they stood to make massive amounts of money provided the Pound fell (On the flipside, they also stood to make massive losses if the Pound, in fact, did not fall or worse, rose instead).

 

But soon, the Bank of England gave up. The Pound crashed. The day this happened would later be named the “Black Wesnesday“. The losses estimated would pile up to £3.3 Billion. Soros would personally make £1 Billion out of the deal. Shortly afterwards, the Bank of England pulled the Pound out of the ERM system and promised to stabilize it in phases.

 

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(Source: ForexIllustrated)

 

Later, the Bank of England bitterly blamed George Soros for turning the tide against the market and making individual profits at the cost of massive public losses.George Soros himself felt he did not deserve his infamous title. Says Soros in his book ‘Soros on Soros: Staying Ahead of the Curve‘, “If I had gone against the market, instead of guessing where the market going, my action would not have for example led to the collapse of the pound sterling. Although I believe the man who caused the bankruptcy of the Bank of England was not really me. Market was the one who did it. I guess where the market was going and was an important element of it because I gave him momentum. But I did not cause the bankruptcy of the Bank of England.”

 

Supporters of Soros claim that the Bank of England broke itself – and simply needed a decoy to pin the crisis on. Critics of Soros accuse that the speculator took a position and then manipulated the market participants using his expertise and knowledge, thus manufacturing profits out of thin air. This is now termed in the investment circles as “the Soros effect“.

 

So, is George Soros, and all Finance people in general, inherently evil? George Soros himself provides an interesting answer: “I was a Human Being before I became a Businessman“.

 

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)

The Power of Compounding

There’s a wonderful real-life story (Some say a myth) that puts the power of compounding into perspective.

In 1626, a tribe of Native Indians called the Lenape, who were the inhabitants of a city in the east coast of the U. S. sold their entire land to Dutch immigrants. They took their payment in trinkets and beads amounting to $24 (This is, of course, just a rough representation and often contested by many researchers. The U. S. did not have rules and regulations for Real Estate valuation so far back and the Dutch ones could not be applied to lands in the U. S.). The seemingly low price is justified, seeing as how the Lenape were also looking to form military alliances with the Dutch to combat rival Native Indians.

 

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Sale of Manhattan Island (Source: Wikipedia)

 

But what happened to that piece of land now? That piece of land is now called by the name New York. The sale supposedly took place in the area now known as Inwood Hill Park. Consider the Real Estate prices and approximately evaluate the entire worth of New York city. Did the Lenape get the short end of stick? Well, no.

Let’s look at the historical interest rates in the United States. There is a chart that dates as far back as 1790 and until 2013 (222 Years), but that’s good enough for an approximation of interest rates beyond 1790. The website of the US Department of the Treasury will tell you the highest interest rates achieved between the 2013–2016 period: an average of around 3%.

 

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200+ Years of U.S. Interest Rates (Source: CNBC)

 

Given this information, let us assume that the average interest rate for the 390-year period from 1626 to 2016 is 8%. Remember that the highest interest rate in the US was 20%. So 8% is a reasonable assumption.

Coming back to the Lenape, imagine that their tribe had lived on through the generations and they were somehow able to deposit the $24 for a period of 390 years at 8% average interest rate.

While the amount compounds, let us look at the value of the modern New York City as a whole. The New York City Department of Finance releases the city’s property valuations every year. As per this report, the value of all the properties in the New York City amount to $988 Billion in 2015.

So do you think by 2016, the Lenape would have been able to buy back their land? Behold the power of compounding interest.

$24*(1.08)^390 = $260301027018004 (Approximately). That’s a whooping $26.03 Trillion.

That would have bought the Lenape 26 New Yorks. Or you know, they could have bought the entire United States and more to boot, given that the United States was valued only at $23 Trillion.

No wonder Albert Einstein said, “The strongest force in the universe is Compound Interest.”

 

This article was written by Dinesh Sairam (PGDM, Batch 21, XIME-B)