The European Exchange Rate Mechanism (ERM) was set up in 1979 to reduce fluctuations in the values of European currencies prior to the introduction of the common currency eventually known as the euro. The ERM also helped harmonize member countries’ monetary policies: their central banks’ attempts to control the supply of money in the economy and thereby achieve certain growth and inflation targets 🤓

The UK joined the ERM in 1990. As part of the deal, Britain agreed to prevent its currency from moving more than 6% in either direction versus the Deutsche mark. Only problem was, inflation in Britain was much higher than in Germany. An economic boom in the country had tipped over into unsustainable growth, setting the scene for an economic bust. These factors meant investors were putting downward pressure on the British pound – but the British government and the Bank of England (at that time less independent than it is today) were compelled to step in should the currency’s value risk falling below its lower agreed band against the Deutsche mark.

In a classic case of global macro investing in action, Stanley Druckenmiller, Soros’s long-term investment partner at Quantum, took the view that the pound was overvalued. He began shorting the pound – that is, betting it would fall further – in the summer of 1992, and Quantum was soon joined by other currency speculators who saw the pound’s peg to the Deutsche mark as unsustainable. Their actions forced Britain to intervene to defend the currency’s value, both by buying it on the open market and raising interest rates in an attempt to make shorting more expensive. But these actions were hugely expensive for the government 😟

By 1992, the Quantum Fund had shorted around $1.5 billion worth of pounds. Realizing that the British government was having trouble keeping the currency propped up, Soros now increased that bet to a whopping $10 billion. On Wednesday September 16th, the inevitable happened. Realizing it could no longer afford to defend the pound, the UK announced its withdrawal from the ERM and return to a freely floating currency. The pound promptly fell 15% versus the Deutsche mark – delivering Soros’s Quantum Fund over $1.8 billion in investment profit 🤑