The currency market is also a speculative capital market where institutional investors can easily set the course of the game. Market makers, investment banks, large currency holders can influence the exchange rate of a currency pair. Moreover, the more exotic it is (for example, a pair of US dollars and South African rand), the easier it is to influence it. And here it is worth giving an example of a deal that went down in history under the name “Black Wednesday”. In the early 50s of the last century, European states decided to create an organization (the prototype of the European Union), where exchange rates will be tightly controlled in relation to each other. The basis was taken to Germany, which at that time was the most economically developed. Community members agree that they will maintain the value of their currency and the German mark with a margin of tolerance of 6% of the agreed rates. The most effective mechanism for maintaining the exchange rate in the agreed corridor was the interest rate and own reserves of foreign currency.
In 1990, Great Britain began to have economic problems: high inflation, a decline in production, and low competitiveness in the foreign market — all this forced the country’s government to nevertheless join the “European mechanism for regulating exchange rates.” From that moment, the British pound was not subject to market conditions but agreed with the rest of the community. Having entered the community at a rate of 2.95 DM, the UK committed to supporting it in the corridor of 2.78 – 3.13 marks.
In the UK, they hoped that joining the community would become a kind of “autopilot” that could point out the right way to solve economic problems. In the first two years, this happened: due to the fact that the government could not arbitrarily control the money supply, the inflation rate decreased, unemployment decreased. But in 1992, the country was covered by a world recession. The British government could not do anything, because it was bound by the terms of the agreement. It became clear that the British pound was overvalued and the exchange rate at an acceptable minimum was maintained exclusively through guarantees from the Central Bank.
On September 16, 1992, the opinion of the president of the German Federal Bank that some European currencies were around the corner from the devaluation and the attempt to support Germany would not solve the problem was published in the media. Investors took this as a signal. The George Soros Foundation Quantum Fund pledged more than $ 1.5 billion to drop a pound, later raising its short position to $ 10 billion.
How it works. Suppose you have a partner who is willing to lend you a British pound at a small percentage. You borrow 10 pounds and buy 29.5 German marks on them. Now it’s beneficial for you to make the pound cheaper relative to the brand, because then, having sold 29.5 marks, you get back not 10, but 12 pounds (conditionally). True, you need to be sure that the course will go down.
The Soros Foundation has borrowed more than 10 billion British pounds, selling it. Otherworld hedge funds followed immediately. By the time a business day began in Britain on September 17, billions of pounds were sold. The price of the national currency was rapidly falling. The Bank of England did not have enough reserves – the Bank simply could not buy up the proposed volume of pounds at the exchange rate established in accordance with the agreement. To force investors to buy pounds, the government raises the discount rate by 5%, but there is no result – the market is already firmly convinced of the weakness of the pound. Bottom line: the UK withdraws from the agreement and releases the pound, which immediately fell by 15% against the mark and 25% against the US dollar.
This story is a great example of how the psychological conviction of the market affects the course: if several hedge funds have more capital than the Central Bank’s reserves, then they can radically affect the exchange rate and the Central Bank’s instruments are not enough to stabilize the exchange rate.
Conclusion The exchange rate is influenced by many local and global factors that a professional trader is required to foresee and constantly monitor. Do not forget about the likelihood of artificial manipulation through the media. How hard is keeping track of everything? Difficult. Therefore, here you can give only one piece of advice: to gain experience, intuition and diversify risks. This is exactly what I recommend you try in practice by opening a demo account and using the recommendations in the article. If the review interests you, there are any questions or comments, join the discussion after the article!