Remember George Soros vs. Bank of England in 1992?

Ichiro Suzuki

In the early 1990s, the United Kingdom was locked into the European Exchange Rate Mechanism (ERM), an agreement designed to stabilize in preparation for the 1999 launch of the euro,  a single currency. The British pound was pegged at an artificially high rate against the Deutschemark. The British economy, however, was struggling amid high inflation and a recession. The global economy in general suffered a sharp economic downturn at the outset of the 1990s, because of high interest rates in response to the inflation. Higher rates hit the real estate market around the world hard. Japan suffered an especially severe property bust. In fact the adjustment period eventually lasted for a generation. Elsewhere, the English speaking world and Sweden were hit hard, too. The U.K. was no exception. The British economy looked feeble compared to that of Germany that didn’t have real estate boom and bust. Therefore, holding onto an artificially high exchange rate against the D-mark, the pound looked grossly overvalued. 

Recognizing the structural weakness of the pound, George Soros’s Quantum Fund began aggressively shorting it. Soros quietly built short positions on the pound throughout the summer of 1992. Then came Black Wednesday on September 16, when the Bank of England jacked up interest rates from 10% to 15% in a desperate attempt to defend the exchange rate. The Quantum Fund continued to sell the pounds faster than the BOE could buy them. The relentless selling pressure overwhelmed the central bank’s foreign exchange reserves. By the evening, the British government surrendered and announced its withdrawal from the ERM. Against the U.S. dollar, the pound fell from roughly 2.0 to 1.5. on the Black Wednesday. 

Three decades later, the Japanese government is making some frenetic efforts to defend the currency, reminding market participants of the U.K. back then. A historic slide of the yen that began in the spring of 2022 brought the Japanese currency to the lowest level against the dollar since 1986, the year that followed the Plaza Accord. Being aware of the critical juncture to which the yen has been cornered, the Ministry of Finance made several attempts to stem the fall of the yen, to ‘fight against the speculators.’  The MOF’s efforts via the Bank of Japan have been largely ineffective. On each new intervention in the market to sell the dollar, the market’s reaction becomes weaker. The last intervention at the beginning of May pushed the yen higher only by a few percentage points, as opposed to a 20% surge on the first intervention in October 2022. The more they do it, the less effective an intervention has become. In the old days, the MOF made frantic attempts to step the rise of the yen against the dollar, by selling the yen and buying the greenback in the market. These efforts were plain vanilla operations. The Japanese authorities are able to print as much yen as they want, to dump it into the market in order to weaken the currency. Buying the dollar, however, is an entirely different story. The BOJ has to sell the dollar by liquidating Japan’s foreign exchange reserves, whose size becomes interventions’ ceiling. Though Japan is the largest creditor to the United States, all it can sell is capped by the amount of U.S. Treasury securities it holds, and is far from unlimited. The MOF may one day runs out of T-notes to sell to stem the yen’s fall. A number of developing countries fell into this trap, wishing to prop up their own currency by burning their precious foreign exchange reserves in the market, with absolutely zero effect on the currency beyond a few weeks. ‘Speculators’, or the market, knows it. Not even Japan is capable to playing this game indefinitely. This is why every intervention delivers smaller results. 

While Japan’s finance minister always condemns ‘speculators’ on the yen’s weakness, the currency is moving in response to macro economic fundamentals. There simply are not enough inflows of capital to Japan, as opposed to outgoing flows from the country. On the surface, Japan is enjoying a vast amount of current account surpluses primarily on interest earned on Treasury notes and profits earned by Corporate Japan’s overseas subsidiaries. Such interest and profits tend to be reinvested locally for expansion of business or simply to buy more T notes. They don’t come back to Japan causing little foreign exchange transactions to buy the yen. On the other hand, Japanese retail investors are waking up from decades of conservatism and invest a greater amount of of their savings into foreign securities, which have delivered superb performances over the last decade and a half. There is more than a reasonable chance, therefore, that Sanae Takaichi suffers the same fate of John Major, who as Britain’s prime minister witnessed a sharp fall of the country’s currency even if ‘speculators’ this time would not be represented by a single big name such as George Soros. 

About the author: Mr. Suzuki is a retired banker based in Tokyo, Japan.