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What I would like to see is what led to the pound being so badly mispriced in the first place. Did they just price it at whatever was the prevailing price? And

by ummonk 7y ago

What I would like to see is what led to the pound being so badly mispriced in the first place. Did they just price it at whatever was the prevailing price? And was that why the Bank of England ended up with such small reserves? Presumably they could have priced it lower and bought up Deutschmarks to bring down the price of pounds and build up reserves to start with when they decided to fix it. There is also the question of how much Germany was contributing to the problem by keeping its currency overly strong, making it harder for other countries to stay in sync. Presumably if the Germans had raised interest rates somewhat and / or bought more reserves from other countries they could have helped relieve the pressure.

LatteLazy 7y ago
It was a political choice. The idea was to avoid inflation and keep prices low for consumers. Of course the same action strangled exporters but they don't vote much...
- H8crilA 7y ago
  Indeed, and that's also why the trade was so good. The pound couldn't possibly get much higher, but it could break and go far far lower. That's why Soros bet 200% of his fund on this position, huge upside with very small, tolerable downside.
- sgt101 7y ago
  Also it meant that the owners of UK assets had the best possible valuation of those assets. Those asset owners were significant in the calculations of the tory party, for some reason.
nostrademons 7y ago
Market prices for currencies reflect what you can buy with them. If a country's economy is strong, they're exporting a lot of things that the world wants to buy from them, and the world wants to invest in a bunch in a number of securities denominated in their currency, the currency will be strong. If the country's economy weakens (relative to other countries in the global economy), the currency will weaken. There could be a lot of potential causes for that. A generation of lazy people who don't work hard. Poor corporate leadership that has people building products that nobody wants to buy. Corruption and misincentives that encourage people to shift value around rather than producing value. The rest of the world suddenly building out their technology and capital stock and catching up to your economy. Britain was the pre-eminent world power up through WW2, so there was a lot of historical inertia propping up the value of the pound. They recovered slowly from WW2, though, lost their position as world leader to America, and had a very rough 70s and 80s. The historical strength of the pound actually hurts in that regard: it makes their exports less competitive, which leads to industry moving away from Britain and a generation that has difficulty finding work. Through their 80s they still had much of their reputation as a world power (the Falklands war was fought over it); by the 90s it was becoming apparent that reality did not match reputation.
- ClumsyPilot 7y ago
  > "A generation of lazy people who don't work hard" I am sorry for derailing, but how does that happen, did they come out like a faulty batch from a factory? The mantra of "It's important to work hard" needs to die. Today we have fewer friends than ever, population is unhealthy and the biggest killer of young men is suicide. Please don't perpetuate this nonsense. It should be: "Work smart, and look after yourself/ your family"
  - nostrademons 7y ago
    It's one of many mutually reinforcing factors. I'm not trying to assign blame here (of which there is plenty to go around), but observing a dynamic. That dynamic is essentially that success begets success. If you have a population that has the experience, from an early of age, of teams where everybody works hard at an uncertain goal and accomplishes their objective, it builds more than just the objective. It also builds trust among the team and the population in general; it builds a number of ancillary skills that were necessary to accomplish the objective; and it builds courage, and the belief that even if obstacles look hard, they can be surmounted. If you set out to build & market a computer game by yourself and fail, you've accomplished a lot more than failure. You've also taught yourself to program; taught yourself game design; taught yourself graphic design; taught yourself marketing and differentiation; taught yourself how to listen to early users and make decisions; and taught yourself perseverance. And conversely, if you have a society where corporate leaders habitually throw young employees into the meat grinder, burn them out on busywork, and pay them little, there will be very little incentive for these employees to do anything other than put in the bare minimum amount of work and spend the remainder of their workday on Facebook or HN. They build no ancillary skills; they learn distrust rather than trust; they learn that perseverance is a waste of time; and they learn nothing about how to break down big goals and make them achievable. Say that a nation full of the former has to compete (either economically or militarily) with a nation full of the latter. Who do you think is going to win? There's nothing wrong with "Work smart, and look after yourself & your family" from the perspective of an individual. There is something gravely wrong with it from the perspective of a nation, which has effectively disintegrated at that point. We're talking about national currencies, which are an abstraction of the national economy as a whole. If there is no national economy, but a bunch of independent producers who search for whatever personal advantages they can get for themselves, that national currency is not going to be worth much.
AnimalMuppet 7y ago
It was probably based on the price at the time the UK joined the Exchange Rate Mechanism.
makomk 7y ago
It was priced based on the prevailing price, whereas the actual value fluctuated depending on the economic state and interest rates in the various countries. The UK wasn't the only country which had this problem; the allowed margin of variation had to be massively expanded shortly afterwards to keep a bunch of other European states in the ERM. Also, the fact that the ERM was structured in a way that effectively benefited Germany over the other members was probably a major contributing factor. Remember, this was right after the fall of the Berlin Wall and German reunification which had huge economic consequences - East German industry was basicsllly wiped out and a huge amount of money was spent on rebuilding its infrastructure to West German standards. Germany got to set its interest rates in a way that minimised the impacts to them, and everyone else was dragged along.
- dageshi 7y ago
  I think there was a danger that France would've had to leave due to similar pressures the UK faced, Germany bent for France in a way they wouldn't for the UK. I am thankful though, the UK leaving the ERM meant the euro was dead in the UK.
tomatocracy 7y ago
The UK entered at what was the floating exchange rate at the time, although it had unofficially shadowed the DM for several years during the 80s. Ultimately the problem was that the correct price for the GBP/DM rate in 1989 wasn't the same as the correct price in 1992 - the divergence was largely because rates of inflation differed markedly between the UK and Germany and didn't converge. Also on your point re what the Germans could have done - they would have needed to cut rates to alleviate pressure. Instead they raised rates to head off inflation in Germany (this was in the context of German reunification which had led to a dramatic increase in government spending in Germany which has inflationary effects).

by ummonk 7y ago

LatteLazy 7y ago

It was a political choice. The idea was to avoid inflation and keep prices low for consumers. Of course the same action strangled exporters but they don't vote much...

H8crilA 7y ago
Indeed, and that's also why the trade was so good. The pound couldn't possibly get much higher, but it could break and go far far lower. That's why Soros bet 200% of his fund on this position, huge upside with very small, tolerable downside.
sgt101 7y ago
Also it meant that the owners of UK assets had the best possible valuation of those assets. Those asset owners were significant in the calculations of the tory party, for some reason.

nostrademons 7y ago

Market prices for currencies reflect what you can buy with them. If a country's economy is strong, they're exporting a lot of things that the world wants to buy from them, and the world wants to invest in a bunch in a number of securities denominated in their currency, the currency will be strong. If the country's economy weakens (relative to other countries in the global economy), the currency will weaken. There could be a lot of potential causes for that. A generation of lazy people who don't work hard. Poor corporate leadership that has people building products that nobody wants to buy. Corruption and misincentives that encourage people to shift value around rather than producing value. The rest of the world suddenly building out their technology and capital stock and catching up to your economy. Britain was the pre-eminent world power up through WW2, so there was a lot of historical inertia propping up the value of the pound. They recovered slowly from WW2, though, lost their position as world leader to America, and had a very rough 70s and 80s. The historical strength of the pound actually hurts in that regard: it makes their exports less competitive, which leads to industry moving away from Britain and a generation that has difficulty finding work. Through their 80s they still had much of their reputation as a world power (the Falklands war was fought over it); by the 90s it was becoming apparent that reality did not match reputation.

ClumsyPilot 7y ago
> "A generation of lazy people who don't work hard" I am sorry for derailing, but how does that happen, did they come out like a faulty batch from a factory? The mantra of "It's important to work hard" needs to die. Today we have fewer friends than ever, population is unhealthy and the biggest killer of young men is suicide. Please don't perpetuate this nonsense. It should be: "Work smart, and look after yourself/ your family"
- nostrademons 7y ago
  It's one of many mutually reinforcing factors. I'm not trying to assign blame here (of which there is plenty to go around), but observing a dynamic. That dynamic is essentially that success begets success. If you have a population that has the experience, from an early of age, of teams where everybody works hard at an uncertain goal and accomplishes their objective, it builds more than just the objective. It also builds trust among the team and the population in general; it builds a number of ancillary skills that were necessary to accomplish the objective; and it builds courage, and the belief that even if obstacles look hard, they can be surmounted. If you set out to build & market a computer game by yourself and fail, you've accomplished a lot more than failure. You've also taught yourself to program; taught yourself game design; taught yourself graphic design; taught yourself marketing and differentiation; taught yourself how to listen to early users and make decisions; and taught yourself perseverance. And conversely, if you have a society where corporate leaders habitually throw young employees into the meat grinder, burn them out on busywork, and pay them little, there will be very little incentive for these employees to do anything other than put in the bare minimum amount of work and spend the remainder of their workday on Facebook or HN. They build no ancillary skills; they learn distrust rather than trust; they learn that perseverance is a waste of time; and they learn nothing about how to break down big goals and make them achievable. Say that a nation full of the former has to compete (either economically or militarily) with a nation full of the latter. Who do you think is going to win? There's nothing wrong with "Work smart, and look after yourself & your family" from the perspective of an individual. There is something gravely wrong with it from the perspective of a nation, which has effectively disintegrated at that point. We're talking about national currencies, which are an abstraction of the national economy as a whole. If there is no national economy, but a bunch of independent producers who search for whatever personal advantages they can get for themselves, that national currency is not going to be worth much.

AnimalMuppet 7y ago

It was probably based on the price at the time the UK joined the Exchange Rate Mechanism.

makomk 7y ago

It was priced based on the prevailing price, whereas the actual value fluctuated depending on the economic state and interest rates in the various countries. The UK wasn't the only country which had this problem; the allowed margin of variation had to be massively expanded shortly afterwards to keep a bunch of other European states in the ERM. Also, the fact that the ERM was structured in a way that effectively benefited Germany over the other members was probably a major contributing factor. Remember, this was right after the fall of the Berlin Wall and German reunification which had huge economic consequences - East German industry was basicsllly wiped out and a huge amount of money was spent on rebuilding its infrastructure to West German standards. Germany got to set its interest rates in a way that minimised the impacts to them, and everyone else was dragged along.

dageshi 7y ago
I think there was a danger that France would've had to leave due to similar pressures the UK faced, Germany bent for France in a way they wouldn't for the UK. I am thankful though, the UK leaving the ERM meant the euro was dead in the UK.

tomatocracy 7y ago

The UK entered at what was the floating exchange rate at the time, although it had unofficially shadowed the DM for several years during the 80s. Ultimately the problem was that the correct price for the GBP/DM rate in 1989 wasn't the same as the correct price in 1992 - the divergence was largely because rates of inflation differed markedly between the UK and Germany and didn't converge. Also on your point re what the Germans could have done - they would have needed to cut rates to alleviate pressure. Instead they raised rates to head off inflation in Germany (this was in the context of German reunification which had led to a dramatic increase in government spending in Germany which has inflationary effects).