The Afternoon a Hedge Fund Beat the Bank of England

Britain entered Europe's Exchange Rate Mechanism in 1990 on a commitment: the pound would trade against the Deutsche Mark inside a narrow band, and the UK government would intervene to keep it there. By 1992, with German rates climbing after reunification and the UK in recession, traders had started to doubt the promise was sustainable.

By August, Stanley Druckenmiller — chief portfolio manager at George Soros's Quantum Fund — had built a $1.5 billion short on the pound. On the evening of September 15, Bundesbank president Helmut Schlesinger let slip to reporters that "one or two currencies" might still come under pressure even after recent realignments. The market read it as a coded warning about sterling.

Druckenmiller went to Soros and proposed adding to the position. Soros's reply, repeated in every later account, was: "Go for the jugular." Overnight, the fund pushed the short up to about $10 billion.

At 10:30 a.m. on September 16, the British Treasury raised base rates from 10% to 12%. Within hours it promised a further hike to 15%. The Bank of England burned through an estimated £27 billion of foreign reserves trying to absorb the selling. The pound kept falling. At 7 p.m. Chancellor Norman Lamont stood outside the Treasury and announced that Britain was suspending its ERM membership. The 15% hike was quietly dropped.

The Treasury later put its net loss at £3.3 billion. Soros's fund made over £1 billion. In Britain it was the moment a Conservative government's reputation for economic competence broke. In markets it was the moment everyone learned that no central bank's reserves are infinite if a fund decides to test them.