'Go for the Jugular'

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>The collapse of Greece's economy, and its domino effect on Spain, Portugal, and other countries in the euro currency zone, is in many ways a replay of an earlier financial crisis--the break-up of the continent's Exchange Rate Mechanism in 1992. Then, as now, Europe's policymakers showed little patience with--or understanding of--markets. Then, as now, Germany often seemed contemptuous of  the less competitive economies on the periphery of Europe.

The 1992 crisis came to a head on Friday September 9, when currency speculators forced the devaluation of the Italian lira. By the following Tuesday, Britain was facing the same fate. In this excerpt from More Money Than God, his new history of hedge funds, Sebastian Mallaby tells the story of the crisis from inside the cockpit of George Soros's Quantum Fund. 

On Tuesday, September 15, the pound took another beating. Spain's finance minister telephoned Norman Lamont, his British counterpart, to ask him how things were. "Awful," Lamont answered.

That evening Lamont convened a meeting with Robin Leigh-Pemberton, the governor of the Bank of England. The two men agreed that the central bank should buy the pound aggressively the next morning. As the meeting wound down, Leigh-Pemberton read out a message from his press office. Helmut Schlesinger, the president of the German Bundesbank, had given an interview to the Wall Street Journal and a German financial newspaper, Handelsblatt. According to a news agency report on his remarks, Schlesinger believed there would have to be a broad realignment of Europe's currencies.

Lamont was stunned. Schlesinger's remark was tantamount to calling for the pound to devalue. Already his public statements had triggered an assault on Italy's lira. Now the German central banker  was attacking Britain. Lamont asked Leigh-Pemberton to call Schlesinger immediately, overruling Leigh-Pemberton's concern that the punctilious Bundesbanker did not like to have his dinner interrupted.

After several conversations, Leigh-Pemberton reported that Schlesinger believed there was no cause for alarm. His comments were not "authorized," and he would check the article and issue an appropriate statement when he reached his office in the morning. Lamont protested that this was a dangerously leisurely response. Schlesinger's purported comments were already on news wires; traders in New York and Asia would react overnight; Schlesinger needed to issue a denial quickly. But Germany's monetary master refused to be hurried. He was not going to adapt to a world of 24-hour trading.

That night, Lamont went to bed knowing that the next day would be difficult. But he could not imagine how difficult.

Stan Druckenmiller, the chief portfolio manager at George Soros's Quantum Fund, read Schlesinger's comments on Tuesday afternoon in New York. He didn't care whether they were "authorized;" he reacted immediately. Schlesinger had made it obvious that the Bundesbank was not going to help the pound cling onto its position inside the exchange-rate mechanism by cutting German interest rates. The devaluation of sterling was now all but inevitable.

Druckenmiller walked into Soros's office and told him it was time to move. He had held a $1.5 billion bet against the pound since August, but now the endgame was coming and he would build on the position steadily.

Soros listened and looked puzzled. "That doesn't make sense," he objected.

"What do you mean?" Druckenmiller asked.

Well, Soros responded, if the Schlesinger quotes were accurate, why just build steadily? "Go for the jugular," Soros advised him.

Druckenmiller could see that Soros was right: Indeed, this was the man's genius. Druckenmiller had done the analysis, understood the politics, and seen the trigger for the trade; but Soros was the one who sensed that this was the moment to go nuclear. When you knew you were right, there was no such thing as betting too much. You piled on as hard as possible.

For the rest of that Tuesday, Druckenmiller and Soros sold sterling to anyone prepared to buy from them. Normally they left it to their traders to execute orders, but this time they got on the phones themselves, searching for banks that would agree to take the other side of their orders. Under the rules of the exchange-rate mechanism, the Bank of England was obliged to accept offers to sell sterling, but this requirement only held during the trading day in London. With the Bank of England closed for business, it was a scramble to find buyers, particularly once word got around that Soros and Druckenmiller were selling crazily.

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Sebastian Mallaby is the Paul A. Volcker Senior Fellow for International Economics at the Council on Foreign Relations and the author of More Money Than God: Hedge Funds and the Making of a New Elite.

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