Before the EU, Europe had the ERM to fix their exchange rates with the Deutschmark within 6% of the agreed upon rate.
Keeping the exchange rate fixed requires governments to nudge the rate, e.g.
- Use reserves of foreign currency to buy up their own currency
- Set high interest rates to entice lenders to buy their currency
Margaret Thatcher (PM) opposed the fixed exchange rates but lost the vote to Major, an ERM proponent.
1992: England feels global recession, rising unemployment. But due to the ERM, the pound must not fall.
Would England stay indefinitely committed to buying pounds? The President of the Bundesbank remarked that one/two currencies might come under pressure. The market lost its faith in England.
Soros' Quantum Fund had a $1.5b bet against the pound. Soros increased it to $10b. Other funds caught on. England didn’t have enough buying power to fight them all.
The Handbook of Hedge Funds: …Even if the devaluation did not occur, the chances of seeing the pound strengthen were small – it was more likely to stay at the bottom of its fluctuation band. The only downside for speculators was transaction costs…
Increasing interest rates in a recession is political suicide. 11AM: 10% -> 12%, nothing. 12% -> 15%, nothing. 7:30PM: Britain announces exit from ERM.
Soros and the speculators won. Soros and his partners made at least 20% of that $7b upside.