This weekend, on Saturday September 16 to be exact, marks the anniversary of Black Wednesday. On that day in 1992, the forex market beat the Bank of England into submission. Back then there was no Euro, but the countries of Europe were preparing for its advent. Part of that preparation was that, in order to create relative stability in the run up to an EU currency, member nations had agreed on trading bands for their currencies, the so-called Exchange Rate Mechanism (ERM).
On Black Wednesday, despite the best efforts of the UK central bank, the sterling (GBP) broke out of its band, resulting in big losses for the Bank of England, but it also marked a change in the way markets saw central bank authority.
I was there, working as an interbank broker on the largest Sterling/Mark (GBP/DEM) desk in the world by volume, back when there was such a thing as a Deutschmark. We were also one of the few companies with a direct line to “the Old Lady,” as the Bank of England was known in London.
It felt on that day and in the days leading up to it as if the whole financial world was going through us, as if the dozen or so guys on that desk were at the center of the universe. That was, I can assure you, not an uncommon feeling for us, and something of which we were all too aware. We were forex brokers, renowned as the most loud and obnoxious market participants in the world, By reputation, we made Gordon Gekko seem like a quiet, unassuming type.
The Changing View of Central Banks
However, the battle with the Old Lady at first didn’t like anything momentous. Central banks were kings at that time in the forex markets, and capricious and cruel kings at that. They intervened frequently, moving the market in chunks whenever they saw fit. They usually didn’t give any hint of their intention to intervene as they believed, rightly, that their sudden involvement would induce panic and have a larger, longer-lasting impact on exchange rates than if their presence was signaled. They were a kind of boogey man, a Keyser Soze for forex traders and brokers, with rumors of their involvement following every big move.
The advent of the ERM, however, changed that to some extent. We didn’t realize it at the time, but giving advance warning of intervention levels changed the game significantly. It took some of the fear away.
What Created the Problem?
All this wouldn’t have mattered had the setting of the bands been handled correctly, but it wasn’t. It was a political process, with things like national pride — something to which the British are particularly prone (and I speak as a Brit myself) — getting in the way of logical economic decisions. That is in part why Sterling was pegged at too high a level. The1980s had seen sky high inflation, and the problem was still evident in 1992. When the ERM was formed, the UK had 15% inflation, three times that of Germany by comparison, and was also mired in a recession. And yet GBP was priced as if it was still a strong currency, a leader in Europe.
That was what made the bottom of the band a target for traders, even though the Old Lady was duty- and honor-bound to protect it. And given that the fear of central banks had gone, that meant that the Bank of England was a target, too.
The Days Before Black Wednesday
GBP/DEM had flirted with the lower level of the band for a while, but by Tuesday September 15, it was stuck at that level. For a while, confident that the Old Lady would be there forever, everyone, including our desk, held onto any sterling they received at the intervention rate and offered it a couple of points above that rate for an easy profit. After a while, though, there were no buyers left at any price above 2.7730, the level at which the Bank of England was buying.
Realizing that they were the only bid left in the market, the Bank let it be known that they wouldn’t accept any more small trades. They initially set a minimum of five million pounds, then quickly raised that to ten, then twenty, then a hundred million. The idea was to make it harder for banks to sell to them, and also to cut down on their brokerage costs as they paid per ticket rather than per million as did everyone else. What happened as a result was a weird situation where for a while, the market was inverted, at 30/29: The offer was lower than the bid, but the difference was size. The offers were in the amounts of five or ten million, but the bid was in the hundreds of millions only.
Eventually, of course, some traders started scooping up the smaller offer at 29, then selling to the Old Lady once they had accumulated a hundred million plus. That resulted in an occasional deal with the Bank of England’s GBP desk, but everything seemed under control. One of my accounts at the time, though, was Goldman Sachs and, as that Wednesday wore on, it became clear from what they and other big players in the market were doing that something had changed. They were hitting the Old Lady’s bid in amounts above 100 million pounds, indicating natural, not accumulated business.
George Soros’ Involvement
Clearly, some people believed that the Bank of England was vulnerable. After the event, George Soros claimed the credit for that. However, as someone who was there and knew all of the traders involved, the notion that he did it singlehandedly is absurd. His Quantum Fund built up a big short position in Sterling, for sure, but so did everyone else. It was a realization by the market as a whole, not one man, that the Old Lady’s position was untenable, and that they could be beaten. What Soros did was brilliant marketing: Nobody had heard of him on September 15, but by the end of the month, everyone knew who he was and how powerful his fund was. Based on my observations from the center of the action, though, he alone did not break the Bank of England; forex traders collectively did that.
The Moment It All Went Crazy
Over a few days, we had become accustomed to the rhythm of the Old Lady’s attempt to protect the 30 level. At the end of each day, they would say that their bid had been passed to the Fed, who would then pass it to the Bank of Australia, and on to the Bank of Japan, before coming back to them in the early morning UK time. That announcement would come out of their squawk box every day at 4 PM and was always the same. On Black Wednesday, however, when 4 PM rolled around, just three words came from that box: “I don’t pay.”
What I remember most is the silence, the pause that followed that simple statement. It seemed like an eternity, but probably took only a second or so for it to register. There was no passing of the order, no continuous bid. We had done it! The market had taken on the Bank of England and won! The euphoria that accompanied that realization, however, quickly turned to panic as the bottom fell out of the market. It took a long time to find another level. Indeed, our desk worked through that night and into the next day, fueled by coffee and food brought to us by colleagues from different desks who stopped by to watch the chaos. It was exhilarating, but scary too. Any mistake in a market that was moving big figures at a time would mean massive losses, but there were massive profits to be made, too.
On a personal level, the immediate aftermath of that day was quickly obvious. My wife and I went to a party that weekend and, when I answered questions about what I did for a living, I saw a response that I had never seen before. Usually, being a city boy garnered some respect, even admiration, even from those who found our reputed arrogance and loutishness obnoxious. That weekend, however, there was universal disgust. Breaking the Bank of England, it seemed, had crossed the line. Polite society saw it as an attack on their country, and thus on themselves. I would have been more popular if I said I was a lawyer or a politician.
On a more general level, though, the events of that day, and of the days surrounding it, changed markets forever. It was the first time that a market took on a government and won. From then on, central banks were seen in the forex market as powerful but not invincible, and politicians realized that if they got involved in markets, the parameters they set had better be based on reality rather than some jingoistic perception. That is why I found the hatred and disgust on a personal level so baffling: For all that it was portrayed as something bad, we knew that what we had been a part of was both inevitable and right, and that it would have massive long-term benefits.
That is how I felt then, and I still believe it to be true, 31 years on. Happy Black Wednesday!
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