Let’s consider the curious case of George Soros and how he made the ‘deal of the century’ – Straight Talking

Welcome again to our regular Straight Talking column – written by senior financial planner at ipac WA, Bob Miller

Let’s consider the curious case of George Soros, the legendary investor who made more than US $1 billion by shorting the British pound way back in 1992… and then, according to a report from the Wall Street Journal, ¹ lost nearly US $1 billion by apparently shorting shares in the aftermath of Donald Trump’s election victory.

By understanding the things Soros do right in 1992, described as the “deal of the century”, and the things he did wrong in the unmitigated disaster of late 2016, we cab grasp some of the key fundamentals of successful investing.

By 1992 George Soros’ Quantum Fund had been in existence for 22 years and both he and his deputy, Stanley Druckenmiller, were considered wealthy, though far from billionaires. By then Britain had joined Europe’s Exchange Rate Mechanism, a system where each member country agreed to fix their exchange rate against the strongest economy in Europe, Germany.

Australia had adopted a market-driven [or floating] currency in 1983 and observers were well aware that while a country’s currency might fall a lot and cause embarrassment for some of its inhabitants, government interference was not the way to go. It was better to accept the fact that a country’s currency ultimately reflected economic fundamentals. Besides, a belted currency gives a big boost to the export sector.

Soros correctly saw that horrible things can happen if a country’s currency does not reflect economic fundamentals. He knew that the British economy was in trouble. Amid a global recession, Britain’s productivity was low and inflation was high.  Exports were subsequently uncompetitive and Soros, along with many economists, was convinced that the pound was too high, further inhibiting exports.

Soros knew that Britain was in an exquisite quandary: economic fundamentals did not justify the high official price, but the British government could only do two things to support the pound. First, it could raise interest rates to attract foreign capital and second it could use a lot of ts international reserves to buy to its own currency on the open market.

Sadly for the British economy, the authorities did both as they desperately sought to stave off the inevitable depreciation of the pound. Meanwhile, German authorities were quoted as saying that, despite everything, the value of the pound was too high.

While many currency observers were convinced that the British government, by propping up the pound, was running out of international reserves, they were also concerned that continued interest rate rises represented economic and electoral suicide. But only Soros appeared to realise that a vast fortune could be obtained by shorting the pound.

Soros arranged to borrow about £5.7 billion worth of US dollars and, following the short-selling exercise, received the sum of US $10 billion in return. Then, as the British authorities finally stopped supporting the pound, all Soros had to do was wait for the inevitable crash in the value of the pound. Following the under devaluation, Soros needed to fork out less than US $9 billion to acquire the necessary £5.7 billion and repay the original lenders. After the payment of interest on the borrowed pounds, the difference was pure profit.

Observers were staggered by Soros’ transaction. In truth, however, his strategy was a no-brainer: The British government simply could not keep up its defence of the pound. Soros’ bet really was a ‘stone bonker’, a sure thing. Nevertheless, it took a lot of courage to bet US $10 billion in 1992.

Fast forward to November 2016 and George Soros is a bona fide billionaire, a well-known supporter of the Democrat Party and a financial supporter of Hillary Clinton. Furthermore, he has a special anitpathy towards Donald Trump.

While the result of 2016 election was a huge surprise for many, there was clear evidence that the sharemarket would look favourably on Trump’s promises to slash company tax rate and spend a cast amount of money on infrastructure projects. Indeed, George Soros’ former colleague Stanley Druckenmiller made a lot of money by trading on the assumption that the share market would rise strongly after the election result. But Soros, anticipating a sharemarket slump, apparently shorted the market and ended up nearly US $1 billion out of pocket when the market surged.

So what did Soros get so right in 1992 and so wrong in 2016? In 1992 he had an impeccable understanding of both the economics and the politics of the pegging of the pound to the Deutschmark. Soros understood that the economic forces of supply and demand, left to their own devices, would lead to a a plunging pound. He also knew that the Bank of England had already spent a vast amount of its international reserves buying ever-depreciating pounds and that British taxpayers were already up for £3.3 billion on these transactions. All in all, he knew that the British government would lose enormous electoral support if it persisted in its crazy defence of the indefensible.

In November 2016 Soros appeared to misunderstand both the economic and the politics of the Trump victory. Surely a wily investor would understand the broad impact of Trump’s economic proposals? Much lower corporate tax rates are always likely to instigate a wave of productivity-enhancing investment spending and additional employment. And when wouldn’t a huge infrastructure spending program bring a smile to the faces of associated business people and the sharemarket itself.

If we logically assume Soros understood the economic aspects of a Trump victory, we are left to conclude that he misjudged the politics of it. Perhaps he succumbed to groupthink of the anti-Trump brigade: something along the lines of “the regards for this guy is so low that even investors will be turned off.”

Notwithstanding, it was amazing that George Soros was prepared to bet close to US$1 billion on an outcome that had, at best, a 50/50 chance of success. While Soros was a true investor in 1992, he was a reckless punter in 2016. Furthermore, despite his legendary status, he may have been swayed by emotion.

If you would like to discuss anything that you read here, feel free to contact an ipac WA financial planner today to meet with us in our Perth offices and see how change can impact you.


¹ The Wall Street Journal. 2017. Billionaire George Soros Lost Nearly $1 Billion in Weeks After Trump Election. [ONLINE] Available at:https://www.wsj.com/articles/billionaire-george-soros-lost-nearly-1-billion-in-weeks-after-trump-election-1484227167

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