soros 2

the autumn of 1988, Stan Druckenmiller agreed to join Soros Fund Management. His friends had advised him against entrusting his future to Soros, and Druckenmiller half expected the relationship to break down within a year or so.1 Soros had been dangling offers, saying that Druckenmiller was a genius who would take over his fund. But his record suggested that he would have trouble ceding real authority, and Druckenmiller wondered how far to rely on Soros’s assurances. The day before he started the new job, Druckenmiller went out to see the great man at his weekend home in Southampton. There on the front lawn he encountered Soros’s son, Robert. “Congratulations,” he was told, “you’re my father’s ninth permanent successor.”2 Soros and Druckenmiller were stylistic opposites. If Soros’s hobby was to write philosophical books, Druckenmiller’s was to watch the Pittsburgh Steelers butt heads at Three Rivers Stadium. But as investors the two men were an ideal fit. Like Soros, Druckenmiller came out of a stock-picking background. Like Soros, he was not really attached to it. Druckenmiller began his career as an equity analyst at the Pittsburgh National Bank, but his rapid progression prevented him from mastering the tools that most stock experts take for granted. Promoted to the position of research director at the grand old age of twenty-five, he never spent 148 MORE MONEY THAN GOD long enough in the trenches to develop an edge in analyzing corporate balance sheets.3 Instead, his forte lay in combining different disciplines. To a solid sense of equities he added a strong feel for currencies and interest rates, picked up from the PhD course in economics that he had begun before deciding that the ivory tower was not to his liking. As one admiring colleague put it, Druckenmiller understood the stock market better than economists and understood economics better than the stock pickers; it was a profitable mixture. By following equities and speaking regularly with company executives, Druckenmiller got advance warning of economic trends, which informed his view of bonds and currencies. By following economies, he got advance warning of the climate for stocks. If a currency was heading downward, export stocks would be a buy. If interest rates were rising, it was time to short real-estate developers. To his sense of companies and economies Druckenmiller added a third skill: technical analysis. His first boss in Pittsburgh had been a student of charts, and although most stock pickers disdained this pattern recognition as voodoo, Druckenmiller soon found it could be useful. It was one thing to do the fundamental analysis that told you that a stock or bond was overvalued; it was another to know when the market would correct, and the charts hinted at the answers. Technical analysis taught Druckenmiller to be alert to market waves, to combine the trading agility of Paul Tudor Jones with the stock-picking strengths of Julian Robertson. He survived the crash of 1987 and profited richly in the days after. The same could not be said for any of the managers who came out of a pure equity background—not even Soros. After four years at the bank in Pittsburgh, Druckenmiller gave a presentation in New York. At the end of the meeting he was accosted by an impressed member of the audience. “You’re at a bank! What the hell are you doing at a bank?” After chatting with Druckenmiller for a few minutes, the man asked: “Why don’t you start your own fi rm?” Druckenmiller didn’t have enough capital behind him, but the man persisted: “I’ll pay you ten thousand dollars a month just to speak to you.”4 W H I T E W E D N E S D AY 149 And so in February 1981, at the age of twenty-eight, Druckenmiller launched Duquesne Capital Management and began to hone his style as a macro trader of the new school, blending views on companies and economies with a sense of the charts to create a freewheeling portfolio. Four years later he attracted the attention of the mutual-fund company Dreyfus, which invited him to manage several funds while also running Duquesne; one Druckenmiller fund shot up 40 percent within three months, turning the young manager into a Wall Street celebrity. In 1987, when the publication of The Alchemy of Finance revealed Soros’s blend of fundamental and technical trading, Druckenmiller saw that the master had a style that resembled his approach. The two men met over lunch at Soros’s offi ce and experienced an instant meeting of the minds. By the end of that fi rst encounter, Soros had made his first attempt at hiring Druckenmiller. When Druckenmiller eventually accepted, Robert Soros’s derisive welcome on the lawn seemed at fi rst to be well founded. Quantum’s incumbent analysts, who included some earlier “permanent successors,” clashed with the new pretender to the throne, never mind the fact that he was built like the pro footballers he loved to watch on Sundays. To make matters worse, Soros seemed to regard Druckenmiller as an S&P 500 specialist, even though he had traded bonds and currencies as well as equities. One evening in August 1989, Druckenmiller flew to Pittsburgh, where he still maintained Duquesne, and discovered that his bond position at Quantum had been sold out behind his back. He called up Soros and exploded down the phone. There was no way he could succeed with a boss who second-guessed him.5 “I feel cramped by your presence,” Druckenmiller was yelling at Soros. “I’m intimidated and I feel dissatisfi ed because I don’t think I’m doing as well as I could. “I want to leave,” he said finally. That outburst might have ended Druckenmiller’s tenure at Quantum. But instead it provoked one of the best Soros gambles ever. “Don’t leave,” Soros responded. “I’ll leave.” Showing a coolness that was all the more remarkable given that he owned much of the money in Quantum, Soros moved his family to 150 MORE MONEY THAN GOD London. “I’m going to Europe,” he told Druckenmiller as he went. “Now we’ll find out whether I’ve just been in your hair too much or whether you really are inept.”6 The next few months gave Soros ample reason to feel pleased with his gamble. The Berlin wall came down, and the move to London gave him the freedom that he craved to focus on philanthropy in eastern Europe. Meanwhile, the collapse of the wall created the sort of market turbulence that Druckenmiller relished, and his returns entered an astonishing period. He was up 31.5 percent in 1989, followed by 29.6 percent, 53.4 percent, 68.8 percent, and 63.2 percent in the next four years; he was like Bob Dylan in the midsixties, producing one hit album after the next, as a colleague put it.7 Assets in Quantum leaped from $1.8 billion to $5 billion, and Soros Fund Management opened new funds alongside its fl agship, so that by the end of 1993 its total assets under management had soared to $8.3 billion.8 Soros had the sense to recognize his good fortune. He learned a lesson from Druckenmiller’s early outburst and took care not to undermine him; he had wanted a permanent successor, and he had been lucky to fi nd a talent like this one. Throughout the 1990s, Soros behaved as the younger man’s coach; he prodded his protégé with questions and advice, but he left him to pull the trigger. To satisfy the craving to make his own bets, Soros retained a pot of capital that he traded on the side, but Druckenmiller was firmly in control of the much larger Quantum fund.9 If journalists continued to attribute Quantum’s success to Soros, that was partly because Soros did little to discourage their error—and partly because Druckenmiller detested the limelight as intensely as Soros enjoyed it.10 From the moment Soros moved to London, Druckenmiller’s approach was an extension of the coach’s. He had absorbed the teachings in Alchemy and had spoken to Soros continually for two years; he had learned everything there was to learn about his methods. Following Soros’s practice, Druckenmiller invested Quantum’s capital in a long/short equity portfolio, then used borrowed capital to trade S&P 500 futures, as well as bonds and currencies. Following Soros’s practice too, Druckenmiller stayed in touch with company executives, reckoning that on-the-ground W H I T E W E D N E S D AY 151 stories from firms could provide early warning of trends in the economy. And following Soros’s practice, Druckenmiller seized opportunities with both hands. If there was one thing that the disciple had learned from the master, it was to pile on with all you’ve got when the right moment presents itself.11 Soon after Soros decamped with his family to London, the collapse of the Berlin wall created such a moment. Joyful East Germans fl ooded into the freer and richer West, expecting jobs and social benefits; the associated costs seemed certain to force the German government to run large budget deficits. Other things equal, budget deficits fuel infl ation, eroding a currency’s value; based on this logic, traders dumped deutsche marks after the wall came down, and the currency dipped against the dollar. But Druckenmiller took a different view. He recalled the passage in Alchemy on Reagan’s early budget deficits: Rather than weakening the dollar, those deficits had indirectly strengthened it.12 The reason was that Reagan’s loose budgets were offset by tight policy from the Fed; high interest rates encouraged investors to hold money in dollars, strengthening the currency. Druckenmiller saw that Germany would follow the same pattern. Loose budgets would drive Germany’s hawkish central bankers to raise interest rates, and the deutsche mark would rally. And so, after the wall fell, Druckenmiller went headlong into the German currency, buying a $2 billion position in the space of a few days. Over the course of the next year, the mark rose by a quarter against the dollar.13 The beauty of this trade was that it built on a version of Paul Tudor Jones’s insight: If you understand the other players in a market, you can identify trades with hugely attractive risk-to-reward ratios. Jones’s early specialty was to see how private traders were positioned; but Druckenmiller was onto a bigger and more attractive game—understanding governments. Central banks, in particular, could be a gift to a trader. Their intentions were often evident—the Bundesbank, for example, made no secret of its determination to fi ght inflation—and their actions could move markets. In November 1989, it was enough for Druckenmiller to see that the Bundesbank would raise interest rates. This fact alone would be sufficient to create a trend that he could ride profi tably.14 152 MORE MONEY THAN GOD The Deutsche mark trade fueled Quantum’s 29.8 percent return in 1990; but it was merely a dress rehearsal. Two years later, Druckenmiller staged the greatest coup of his career, shattering the European monetary order and establishing hedge funds as a rising force in global fi nance. GERMAN UNIFICATION DID NOT MERELY CAUSE THE Bundesbank to act in a deliciously predictable manner. It exposed the central bank’s conflicted role as the anchor of the deutsche mark and simultaneously of Europe’s exchange-rate mechanism. This system had been set up in 1979 to dampen currency fluctuations within Europe, allowing companies to invest and trade without worrying that wild exchangerate swings would upend their business models. For more than a decade, the mechanism worked well, stabilizing currencies without going to the extreme of unifying them. Participating currencies were allowed to move against one another within narrow bands; and if that flexibility was not enough, a country could negotiate devaluation with its European partners. These rules afforded national governments some room to use interest rates to manage their economic cycles. The system balanced the objectives of exchange-rate stability on the one hand and interest-rate fl exibility on the other. German unification strained this compromise. It created infl ationary pressure within Germany, pushing the Bundesbank to raise interest rates. But the German rate hikes came at a time when other European economies were experiencing a recession that cried out for lower interest rates. High interest rates in Germany coupled with relatively low rates elsewhere caused money to flow into deutsche marks; as a result, the weaker European currencies, notably the Italian lira and the British pound, traded near the bottom of the band permitted by the exchange-rate mechanism—and threatened to break out of it. This presented Europe’s governments with two options. Germany could cut its rates in order to attract less capital, while the Italians and British did the opposite. Or central banks could intervene in the currency markets, selling marks and buying lire and W H I T E W E D N E S D AY 153 pounds. If both interest-rate adjustment and currency intervention failed, Italy and Britain would be forced into devaluation. In the summer of 1992, Druckenmiller began to ponder these tensions. He was particularly focused on Britain, where a young Quantum portfolio manager, Scott Bessent, had studied the volatile housing sector and shorted several of the stocks in it. Bessent pointed out to Druckenmiller that interest rates on British mortgages were generally not fixed; when the Bank of England raised rates, families felt the pinch immediately in their home payments. Because of this transmission mechanism, high German interest rates would put Britain in an especially tight bind. If the Bank of England raised rates to protect the pound’s position within the exchangerate mechanism, the instant hit to mortgage payers would dent consumption at a time when Britain was already in recession. Druckenmiller saw an opening for one of those bets that could scarcely go against him. There was a significant chance that the British authorities would balk at higher rates and allow sterling to devalue. On the other hand, there was virtually no chance that sterling would rise against the deutsche mark; with Britain’s economy in the doldrums, the Bank of England would certainly not raise rates more than it had to. Seizing on this asymmetrical bet, Druckenmiller loaded up on deutsche marks and sold pounds, investing $1.5 billion in this position by the end of August.15 Thus far the sterling trade had employed three Druckenmiller skills. It involved, first, an appreciation for equity research as a source of insights into economic trends; like Soros, but unlike the Commodities Corporation trio, Druckenmiller focused on companies as an important harbinger of an economy’s performance. It involved, second, an understanding of currencies and interest rates; like Soros, but unlike Julian Robertson, Druckenmiller was an equity trader who was equally at home trading other instruments. And it involved, finally, an eye for the institutional factors that created bets with good risk-to-reward ratios: Just as Paul Jones had seen the asymmetrical bet created by the expectation that Japanese fund managers should clear a hurdle of 8 percent per year, so Druckenmiller 154 MORE MONEY THAN GOD grasped the significance of Britain’s floating mortgage rates. But the next stage of the sterling bet drew upon a different talent. It required Druckenmiller to understand the financial politics of Europe, starting with the pressures that swirled around the Bundesbank. Ever since the hyperinflation that had fueled Hitler’s rise, the Germans had prized monetary stability. In the United States, the Federal Reserve’s statutory mandate requires it to target both low inflation and full employment; in Germany, the Bundesbank’s mission was exclusively to fi ght inflation. For this reason, it was clear that the Germans’ fi rst instinct would be to refuse to cut interest rates so long as the costs of reunifi cation were causing budget deficits; and if Germany hung tough, the pressure on sterling would grow ever greater. But there was at least a chance that, for political reasons, the Bundesbank would soften its stance. Europe’s leaders had recently signed the Maastricht Treaty, which envisaged the eventual creation of a single European currency, the euro. Germany’s government supported this project. It would have to think twice before fighting infl ation with such zeal that Europe’s monetary order splintered. When Druckenmiller made his first bets against sterling, it was not obvious how the Bundesbank would weigh its traditional anti-infl ation stance against its responsibility toward Europe. But German intentions soon became clearer. On September 4 and 5, European Community finance ministers and central-bank officials met in the pretty English town of Bath. Desperate to create space for lower British interest rates, and egged on by Italian and French counterparts who were also battling recession, the British finance minister, Norman Lamont, pressed repeatedly for an easing of German monetary policy. He banged his fist on the table and shouted at Helmut Schlesinger, the Bundesbank president: “Twelve finance ministers are all sitting here demanding that you lower your interest rates. Why don’t you do it?” Schlesinger was so shaken that his first instinct was to walk out. He prized the independence of the Bundesbank, to which he had devoted his career; he resented political pressure, especially from a foreigner. When Schlesinger eventually recovered his composure, he ventured that, W H I T E W E D N E S D AY 155 although he didn’t plan to cut interest rates, he saw no reason to raise rates, either. Lamont seized upon this statement and presented it to the media as a concession, even though nobody expected interest rates to rise anyway.16 In a pattern that was to repeat itself over the next few days, Lamont’s overreach infuriated Schlesinger. The Bundesbank president felt compelled to correct the impression that he had compromised his institution’s independence. On September 8, after a central bankers’ gathering in Basel, Schlesinger declared publicly that he could make no guarantees about the future course of interest rates. Far from conceding that Germany would modify its monetary policy to make life easier for its neighbors, he warned that he had little confidence in the fixed relationships among European currencies. As if to underline the point, Schlesinger alluded particularly to the unsoundness of the Italian lira. Seated in the audience as Schlesinger made his remarks was none other than George Soros. To make sure he had heard the Bundesbank president correctly, Soros approached him after the speech was done. To gauge the German commitment to European harmony, Soros asked Schlesinger what he thought of the ECU, the notional European currency that preceded the euro. Schlesinger replied that he liked the concept of a European currency but didn’t like “ECU” as a name. He would have preferred to call it the mark. Schlesinger’s answer was as clear as Soros could have wished for.17 The Bundesbank was open to the idea of monetary union, but not at any price; its first priority was to preserve the proud tradition of the infl ation-proof deutsche mark, and if other economies could not stomach the austerity that this implied, well, then they should devalue. Soros suspected that Schlesinger would be perfectly content to see his hard line on infl ation sabotage the plans for European monetary union, since that union would involve the creation of a European central bank, which would supplant the Bundesbank.18 All bureaucracies are motivated by self-preservation, Soros reflected; and Schlesinger, a career Bundesbank official, was surely the personification of this tendency. In a state of some excitement, Soros 156 MORE MONEY THAN GOD called Druckenmiller in New York and told him that the lira was heading for a fall. Druckenmiller quickly added a bet against the Italian currency to his existing bet against sterling.19 When Soros returned to New York, he called Robert Johnson, a currency expert who was in the process of moving from Bankers Trust to Soros Fund Management. Soros was convinced that the lira was going down, but now he was looking beyond that. Perhaps the rules of Europe’s game were changing. “What do you think about sterling?” Soros asked. “I think I better come and see you,” Johnson answered. He did not want to keep talking on the phone because Bankers Trust recorded its traders’ conversations. Johnson took a cab to the run-down Soros offices at 888 Seventh Avenue. There was duct tape on the carpet and a couple of screens by Druckenmiller’s desk. Johnson, Soros, and Druckenmiller sat around a small conference table. Soros asked Johnson to describe the risks in betting against sterling. “Well, sterling is liquid, so you can always exit losing positions,” Johnson responded. “The most you could lose is half a percent or so.” “What could you gain on the trade?” Druckenmiller asked. “If this thing busts out, you’d probably make fifteen or twenty percent,” Johnson answered. “How likely is that to happen?” Druckenmiller pressed. “On a three-month time frame,” Johnson responded, “about ninety percent.” By now Druckenmiller and Soros were looking at each other. They could hardly stay sitting in their chairs.20 “How much would you do in your own fund?” Soros asked, referring to a portfolio that Johnson ran for Bankers Trust. Johnson indicated that he would leverage himself up to take advantage of this trade. He might do three to five times capital. “Oh my God,” Druckenmiller said quickly. His eyes had widened and his huge frame was taut. You could almost hear the big inhale that a basketball player takes before he springs for the basket. W H I T E W E D N E S D AY 157 “Well, they only have twenty-two billion pounds’ worth of reserves,” Johnson continued, a sum equivalent to some $44 billion. Quantum could only sell sterling so long as someone was willing to buy it. Given Schlesinger’s comments, there were few private buyers left; the main buyers were the Bank of England and other central banks that were trying to support sterling. Once the Bank of England ran out of reserves, it would be impossible to place further bets against sterling. So $44 billion might be the limit. “Maybe we can get fifteen of that,” Druckenmiller said. He was suggesting that he might multiply his existing sterling bet fully ten times over.21 “How long do you think they can hold out?” Soros asked. Not more than a few months, Johnson estimated. Then Druckenmiller got Scott Bessent on the conference phone to ask his opinion. Bessent went even further than Johnson. The British government had no stomach for higher interest rates. Given a choice between an even deeper recession and devaluing the pound, the government would choose devaluation.22 The British might let sterling go sooner than anyone expected. Johnson left the meeting with a sense of premonition. He could feel the coiled energy of the two men. When the right moment came, they would destroy the British currency.23 THE NEXT FEW DAYS M ARK ED A WATERSHED IN THE RELAtionship between governments and markets. A fi nancial tidal wave broke across Europe, demonstrating how huddles of traders in midtown Manhattan could have consequences globally. Druckenmiller and Soros were the central players in this drama, but they were not the only ones. Other hedge funds that traded currencies, including the Commodities Corporation trio, joined in the attacks on Europe’s weaker currencies; so did the trading desks of banks and the treasury departments of multinational companies. Through the 1970s and 1980s, nobody had imagined that these private players could overwhelm powerful central banks—the Plaza 158 MORE MONEY THAN GOD accord of 1985 had confirmed governments’ influence over exchange rates. But since the mid-1980s, cross-border flows of money had roughly tripled.24 Hedge funds and other players now commanded large war chests, and the balance of power had shifted. In August 1992, the administration of George H. W. Bush orchestrated the concerted purchasing of dollars by eighteen central banks. But by now so much private capital was sloshing through the currency markets that the central banks’ efforts failed to budge the dollar.25 In early September, the consequences of central banks’ new nakedness cascaded across Europe. In conversations like the one among Druckenmiller, Soros, and Johnson, traders convinced one another that recessionbattered economies pegged to the deutsche mark were now hopelessly vulnerable. On Tuesday, September 8, the day that Schlesinger declared he could make no promises on German interest rates, a wave of speculative selling overpowered the Finnish central bank, forcing the government to abandon its peg to the ECU; the Finnish markka fell nearly 15 percent that day, handing traders instant profits and whetting their appetite for the next victim. On Wednesday there was a run against Sweden, which managed to attract capital back into the country by raising overnight interest rates to the extraordinary level of 75 percent; then the electronic herd stampeded the Italian lira. Italian interest rates stood at 15 percent, which ordinarily would have been enough to keep capital in the country, but the vast growth of currency markets had changed the game: Italy’s currency presented an asymmetrical bet; the trend cried out to technical traders to get on their surfboards; and smart speculators sensed that the wave of money crashing down on Italy’s authorities would overwhelm their best efforts to respond to it. By Friday, September 11, the lira had broken through the bottom of the band permitted by the exchange-rate mechanism. Over the weekend that followed, Italy negotiated the formal devaluation of its currency. The lira’s collapse was especially sobering. Finland had not been formally part of Europe’s exchange-rate mechanism, and so could not expect the help of other European central banks when the speculators came after it. But Italy was a different case: Its devaluation represented the fi rst time W H I T E W E D N E S D AY 159 that a member of the exchange-rate mechanism had been so bloodied by the markets.26 Italy’s membership in the mechanism entitled it to support from the mighty Bundesbank, which bought DM 24 billion ($15.4 billion) worth of lire in the week before devaluation, an unprecedented intervention.27 But speculative selling of the lira overwhelmed the Bundesbank’s efforts, and traders bagged another payout. Even after the lira’s fall, European offi cials struggled to come to terms with the new order. On Saturday, September 12, while the Italians negotiated devaluation with visiting German officials, Norman Lamont, the British finance minister, kept to his schedule as though nothing were amiss; that evening he honored a national musical ritual by attending the Last Night of the Proms and singing “Rule Britannia” with great gusto.28 After learning of the fate of the lira, Lamont assembled his Treasury advisers the next morning for a breakfast of croissants; but he and his team still did not believe that they were facing an immediate crisis. Indeed, one British press account of the breakfast described Lamont as “cock-a-hoop.” As part of the deal on lira devaluation, the Bundesbank was promising an interest-rate cut of a quarter of 1 percent. That might actually boost sterling. Given the assumptions of the times, Lamont’s cheerfulness was not surprising. Financial analysts and journalists were arguing that Italy and Britain were not comparable cases: The first was the most shambolic rich country in Europe; the second was governed by a Conservative Party that had transformed Britain’s economic performance. The Bank of England had successfully fended off market pressure on sterling since August, and on September 3 it had improvised a new weapon against the electronic herd: Just as hedge funds attack currencies using borrowed money, so Britain announced it was borrowing 10 billion ECUs (£7.25 billion, or $14 billion) to expand its ability to defend sterling. The day of that announcement, the pound had experienced a sharp rise; currency traders believed that the government now had the fi repower to fight off the speculators.29 To Soros and Druckenmiller, this was faintly amusing: The amount that Britain had borrowed to buy sterling was equal to the amount that the Quantum Fund alone aspired to sell.30 But in early September 1992, 160 MORE MONEY THAN GOD nobody outside the Soros offi ces could conceive that a single hedge fund, employing fewer than fi fty people, might muster a war chest comparable to a government’s. When the markets opened on Monday, September 14, Lamont’s optimism appeared vindicated. The Bank of England spent $700 million to support the currency; coming on top of the German interest-rate cut, that relatively modest intervention was enough to lift sterling slightly. But to an extent that Lamont and his advisers failed to grasp, Monday’s trading sealed Britain’s fate. Sterling’s small rise confirmed the speculators’ premise. Bets against currencies anchored by shaky pegs could be leveraged aggressively, because the worst that could happen was that they would move against you slightly. Sure enough, the pound took a beating the next day. Spain’s fi nance minister telephoned Lamont to ask him how things were. “Awful,” Lamont answered.31 That evening Lamont convened a meeting with his Treasury team and Robin Leigh-Pemberton, the governor of the Bank of England. They agreed to support sterling aggressively the next morning; if that did not work, they would consider raising interest rates. As the meeting wound down, Leigh-Pemberton read out a message from his press offi ce. Helmut Schlesinger had given an interview to the Wall Street Journal and a German fi nancial newspaper, Handelsblatt. According to a news agency report on his remarks, the Bundesbank governor believed that a broad realignment of Europe’s currencies would have been better than a narrow adjustment of the lira. Lamont was stunned. Schlesinger’s remark was tantamount to calling for sterling to devalue. Already his public statements after the Bath meeting had triggered the assault on the lira. Now the German 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 completing the phone call, Leigh-Pemberton reported that Schlesinger had granted the interview on the condition that he could check quotations attributed to him, but he had not yet found the time to do that. W H I T E W E D N E S D AY 161 Lamont protested that this was a dangerously leisurely response. Schlesinger’s purported comments were already on newswires; traders in New York and Asia would react overnight; Schlesinger needed to issue a denial quickly. Leigh-Pemberton placed more calls to Germany, but to no avail. The Bundesbank press office explained that the Schlesinger quotations were “unauthorized,” since they had not yet been approved; Schlesinger said he would check the article and issue an appropriate statement when he reached his office in the morning. Lamont seethed, but there was little he could do. Germany’s monetary master was in no hurry to adapt to a world of twenty-four-hour trading. That night, Lamont went to bed knowing that the next day would be difficult. But he could not imagine how difficult. As he recounts in his memoir, the thought that Britain would be forced out of Europe’s monetary system the next day “simply did not cross my mind.”32 DRUCKENMILLER READ SCHLESINGER’S COMMENTS ON Tuesday afternoon in New York. He didn’t care whether they were “authorized” or not: He reacted immediately.33 Schlesinger had made it obvious that he was perfectly happy to see the pound ejected from the exchange-rate mechanism. The Bundesbank was not going to indulge weak neighbors with further interest-rate cuts. Given the recessionary forces in Britain, sterling’s devaluation was now all but inevitable. Druckenmiller walked into Soros’s office and told him it was time to move. He had held his $1.5 billion bet against the pound since August and had started to do more since the conversation with Robert Johnson. Now a trigger had arrived, and Druckenmiller announced that 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 news story was accurate and there was almost no downside, why just build steadily? Why not jump straight to $15 billion? “Go for the jugular,” Soros advised him. 162 MORE MONEY THAN GOD 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.34 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.35 Under the rules of the exchange-rate mechanism, the Bank of England was obliged to accept offers to sell sterling for DM 2.7780, the lowest level permissible in the band, 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. Banks that got vast sell orders from Quantum would alert their own currency traders, who would soon start selling too, and as their calls rippled out around the world, everybody understood that an avalanche was starting.36 Pretty soon the pound was knocked out of its permitted band, and it became almost impossible to find buyers of the currency.37 Late that day, Louis Bacon called Stan Druckenmiller. The two talked about how the drama might play out, and Bacon said he was still fi nding ways to dump sterling. “Really?” Druckenmiller blurted out. He told Bacon to wait, and a few seconds later Soros joined the call. “Where did you get the market?” Soros demanded furiously.38 SOROS AND DRUCKENMILLER EVENTUALLY WENT HOME, leaving their traders to search for opportunities to sell more sterling. Asleep in his New York apartment, Robert Johnson was beeped by Quantum’s head trader; he slipped out of bed and quietly returned the call, anxious not to alert his wife to the conversation since she was an official at the New W H I T E W E D N E S D AY 163 York Fed. Around two the next morning, Druckenmiller returned to the office. He wanted to be at his desk when London trading reopened and the Bank of England would be forced to resume purchases of sterling. Scott Bessent, the portfolio manager who had been based in London, arrived shortly after Druckenmiller. He could see the hulking outline of the boss standing in his dark office. Druckenmiller was taking off his coat, and the nighttime Manhattan skyline stretched out behind him. The only light in his office came from the telephone: Soros was on the line, and Druckenmiller had hit the speaker button. A disembodied eastern European accent filled the dark room. Soros was urging Druckenmiller to leverage himself up and redouble his selling.39 When the markets opened in London, the expectation of Bank of England support restored sterling to its band, but it was flat on the bottom of it. Acting on the plan that Lamont had authorized the previous evening, the Bank of England intervened twice before 8:30 a.m., each time buying £300 million. But the buying had absolutely no effect. Druckenmiller was manning his cockpit on the other side of the Atlantic, clamoring to sell sterling by the billion, and his clamor was driving legions of imitators to sell also. The Bank of England carried on intervening, not realizing how completely it was outgunned. By 8:40 a.m. it had purchased a total of £1 billion, but sterling still refused to budge. Ten minutes later, Lamont told Prime Minister John Major that intervention was failing. Britain would have to raise interest rates in order to protect sterling. To Lamont’s frustration, Major refused to authorize a rate hike. He had been responsible for taking Britain into the exchange-rate mechanism. He feared that his credibility would collapse if the policy was seen to be failing; he might face a leadership challenge from a member of his own cabinet. Major pleaded that new economic data would come out later that day. He told Lamont to hang tough in the hope that the markets would subside eventually. By now central bankers the world over were on high alert. Another call went out to Robert Johnson’s apartment, this time from the New York Fed; Johnson’s wife spent the remainder of the night monitoring the crisis, unaware that her husband had helped cause it. The Bank of 164 MORE MONEY THAN GOD England continued to buy pounds because it was obliged to do so by the rules of the exchange-rate mechanism. But it no longer aspired to lift the currency off its floor; it was merely providing liquidity to Druckenmiller and his cohorts.40 Every hour that went by, hedge funds and banks sold more sterling to the Bank of England, which was being forced to load up on a currency that seemed sure to be devalued soon. Britain was presiding over a vast financial transfer from its long-suffering taxpayers to a global army of traders. At 10:30 a.m. Lamont called John Major again to urge a rise in interest rates. While Lamont was calling the prime minister, British officials did their best to project confi dence. Eddie George, the number two at the Bank of England, went ahead with a long-scheduled meeting with David Smick, a financial consultant who fed political intelligence to Druckenmiller and Soros. Smick showed up at the Bank of England’s exquisite building on Threadneedle Street to find George in apparently fine form, decked out in a checkered shirt and striped tie in the manner of a London banker. “We have it all under control,” George said cheerily; in the extreme case, which was unlikely, to be sure, the Bank of England would raise interest rates by a full percentage point to see off the speculators. Smick wondered whether George understood the weight of the money that was crashing on Britain. The avalanche had begun. It might be too late to stop it. Smick summoned up his nerve and asked George straight out: “Aren’t you worried that you may have slipped too far behind the curve on this thing?” George’s look betrayed mild annoyance. He was about to respond when the telephone rang. After a minute of intense conversation, he hung up. “I’ve learned we’ve just raised interest rates by two hundred basis points,” he said softly—a full two percentage points. Then he rose and shook Smick’s hand and left the room running.41 Lamont’s plea to the prime minister had succeeded this time, and the announcement of the dramatic rate hike had been set for 11:00 a.m. A few minutes before the appointed hour, Lamont walked over to his outer offi ce at the Treasury to watch the Reuters screen. But when the announcement came, the pound did not respond at all. The line on the screen remained W H I T E W E D N E S D AY 165 totally flat. Lamont felt like a surgeon who looks at a heart monitor and realizes that his patient has expired. All that remained was to unplug the system.42 Lamont had no time to negotiate a realignment of sterling within Europe’s exchange-rate mechanism. A realignment would involve lengthy coordination with other European governments; but with every minute that ticked by, the vast transfer of wealth from taxpayers to traders continued. Italy had been lucky to get into trouble on Friday, just before the respite of the weekend. But now Britain found itself on the edge of the same cliff, and unfortunately it was Wednesday. Lamont’s only recourse was to quit the European exchange-rate mechanism unilaterally. But this would require the prime minister’s approval. The prime minister was not immediately available. Lamont had his staff call Major’s office repeatedly to stress the urgency of a meeting, but no audience was granted. Eventually Lamont led a team of advisers over to Admiralty House, the fine Georgian building that was serving temporarily as the prime ministerial residence; there they cooled their heels for at least another quarter of an hour before Major would see them. Lamont calculated that the nation was losing hundreds of millions of pounds every few minutes, but his boss looked annoyingly relaxed. He began the meeting by wondering aloud whether there was room for further fi nancial diplomacy with Germany, then added that several other government ministers would shortly be joining the meeting to add their various perspectives. A meandering discussion ensued. Could Britain withdraw from the exchange-rate mechanism without offending its European partners? If it did withdraw, would there be calls for ministers’ resignations? It became clear that Major’s objective was to share responsibility for the crisis with the other people in the room—“We were there to put our hands in the blood,” one minister later commented.43 It was a shrewd maneuver, and from Major’s perspective it served to neutralize potential rivals to his throne. Meanwhile, Druckenmiller and Soros were adding to their positions. The Admiralty House meeting broke up without the decision to quit the exchange-rate mechanism that Lamont had wanted. Instead, Major 166 MORE MONEY THAN GOD insisted on another interest-rate hike—this time of three percentage points, effective the next day—as a last-ditch effort to save sterling. Again Lamont watched the news break on the Reuters screen. Again there was no effect on sterling’s value. At their desks on the other side of the Atlantic, Druckenmiller and Soros saw the rate hikes as an act of desperation by a dying man. They were a signal that the end was nigh—and that it was time for one last push to sell the life out of the British currency.44 Lamont proceeded to warn his fellow finance ministers in Europe of sterling’s plight. His Italian counterpart, Piero Barucci, suggested that rather than quitting the exchange-rate mechanism, Lamont suspend markets to give himself time to negotiate a realignment. Lamont had to point out that it is not in the power of a modern finance minister to suspend currency markets that trade continuously and globally. That evening, Lamont called a press conference in the Treasury’s central courtyard. At 7:30 p.m., facing a massive battery of TV cameras from all over the world, he announced Britain’s exit from the exchange-rate mechanism. The markets had won, and the government had at last recognized it. DURING THE FIRST HALF OF SEPTEMBER, THE BANK OF England spent $27 billion worth of reserves in its efforts to defend sterling, and much of that sum was drained away during the last day of the crisis.45 After the pound left the exchange-rate mechanism, it fell about 14 percent against the deutsche mark, so British taxpayers could be said to have lost around $3.8 billion on their purchases of sterling.46 An army of banks and hedge funds were on the other side of that trade, but hedge funds led the charge, and Quantum was easily the biggest. By the time sterling broke, Druckenmiller and Soros had succeeded in selling about $10 billion of sterling short—less than the $15 billion they had aspired to dump, but still a monumental position.47 Of the almost $4 billion loss to British taxpayers, an estimated $300 million flowed to Bruce Kovner, the senior member of the Commodities Corporation trio, and $250 million to Paul Jones; the top seven currency desks at U.S. banks were said to have W H I T E W E D N E S D AY 167 bagged $800 million among them.48 But Soros Fund Management’s profi t on the sterling bet came to over $1 billion.49 Soros’s startling payout was unknown in the immediate aftermath of the pound’s devaluation. But in October, Gianni Agnelli, the Italian industrial magnate, let slip to journalists that his investment in Quantum would earn him more that year than his takings from Fiat, his car company. The next day, Saturday, October 24, Britain’s Daily Mail newspaper ran a photo of a smiling Soros, drink in hand, and a headline proclaiming, “I Made a Billion as the Pound Crashed.” When Soros opened his front door that morning, he was met by a throng of reporters, and over the next months the press drooled over his winnings. Soros was said to have enlarged his personal fortune by $650 million in 1992, and one magazine observed that it took Soros five minutes to earn what the median American family could expect for a full year of labor.50 A few years earlier, people had reacted with horrified fascination to the $550 million earned by Michael Milken, the champion of junk bonds; but now Milken had been surpassed. Soros became known as the man who broke the Bank of England, and hedge funds began to displace the 1980s buyout kings as the objects of popular envy. The full profits of the Soros funds were considerably larger than outsiders imagined. Just as Paul Jones had coupled his shorting of the equity market during the crash of 1987 with a profitable bet on bonds, so Druckenmiller built out from his sterling coup. As the pound came under pressure, Britain’s equity and government-bond markets were hit too; traders reasoned that the flight of capital from Britain would damage other asset prices. But Druckenmiller took a different view. Britain’s ejection from the exchange-rate mechanism would free the government to cut interest rates, which would drive government bonds up; and a weaker currency and lower interest rates would be good for equities. As he sold sterling on Tuesday and Wednesday, Druckenmiller was buying British government bonds and equities. Sure enough, Druckenmiller’s bets paid off. Over the next two months, both markets were up steeply. Britain was not the sole focus of Druckenmiller’s attention. In the wake of sterling’s fall, speculators mounted an attack on the French franc, but 168 MORE MONEY THAN GOD this time Druckenmiller believed that the central bank would win out against the markets. Unlike British homeowners, French families were not exposed to floating mortgage rates, and the French state had myriad ways of subsidizing its people: As a result, it would be easier for the French to fight off speculators with temporary interest-rate hikes than it had been for the British. Acting on this theory, Druckenmiller bought armfuls of French bonds, which soared in 1993, helping to explain why Quantum’s extraordinary 69 percent return in the year of the sterling bet was followed by a 63 percent return the year after. But Quantum’s greatest poststerling coup was also the most discreet. Thanks to Robert Johnson, who had by now joined the fund full-time, Quantum shorted the Swedish krona before its devaluation in November 1992, again pocketing upward of $1 billion. Having learned a lesson from the publicity following the sterling trade, Soros and Druckenmiller made sure that nobody spoke publicly about their killing in Sweden.51 The triumph of macro trading proved, if further proof was possibly needed, that the efficient-market hypothesis missed a large part of the story. If markets were dominated by rational investors seeking maximum profits, then efficiency might possibly prevail; but if markets were driven by players with other agendas, there was no reason to expect effi cient pricing. Macro trading exploited a prime example of this insight: Governments and central banks were clearly not trying to maximize profi ts. At the height of the sterling crisis, John Major effectively bought sterling from Stan Druckenmiller at a price both knew to be absurd. Major did this for a reason that appears nowhere in financial texts: He wanted to force political rivals to share responsibility for devaluation. Druckenmiller’s coup also served to show that currency pegs were vulnerable in a world of deep and liquid markets. During the 1950s and 1960s, the system of fixed currencies worked well because regulations restricted the flow of capital across borders; but now that these controls were gone, it was time for governments to accept the limits to their power over money. They could either use interest rates to manage the value of their currency, so dampening exchange-rate swings, or they could use them to manage their economic ups and downs, so dampening recessions. W H I T E W E D N E S D AY 169 Attempts to have it both ways via “flexible pegs” such as the exchangerate mechanism were likely to backfire: The contrast between the United States and Europe illustrated the point vividly. When the Bush administration had tried and failed to lift the dollar in August, no calamity had ensued; the dollar was floating anyway, so there was no sudden break in its fortunes. But the currency pegs of Finland, Italy, Britain, and Sweden were a different matter; they presented speculators with targets that were too appealing to pass up, exposing their economies to wrenching dislocations. In committing to the exchange-rate mechanism, European governments had made a promise that they lacked the ability to keep. They had bottled up currency movements until a power greater than themselves had blown the cork into their faces. The implications of a world featuring Druckenmiller and other macro investors were not immediately absorbed by policy makers. As happens after every financial crisis, the first instinct was to vilify the markets rather than to learn the awkward lessons that they teach: in this case, that currency pegs were dangerous. The week after the pound’s devaluation, when the French franc came under pressure, French finance minister Michel Sapin suggested that troublemaking traders should be guillotined, as during the French revolution.52 The following summer, after the exchange rate mechanism suffered another round of disruptions, French premier Edouard Balladur argued that governments had an economic and moral responsibility to curb speculators. In Belgium, foreign affairs minister Willy Claes chimed in that Anglo-Saxon financiers were plotting to divide Europe.53 In characteristic fashion, Soros accepted much of the attack on his profession. On the one hand, he had proved himself more ruthless than any other market player: Whereas bank trading desks had to live with regulators, and therefore were reluctant to assail governments too violently, Soros had no such inhibitions.54 On the other hand, Soros was intellectually disposed to see markets as wild things, constantly at risk of boom and bust, constantly destabilizing. Shortly after the pound’s devaluation, Soros saw Jean-Claude Trichet, the governor of the French central bank, and told him that, out of concern for the destabilizing effects of his own trading, he would not attack the franc.55 The claim to selflessness was a bit 170 MORE MONEY THAN GOD much, since Quantum had correctly calculated that the franc would hold and was about to make a killing on this prophecy. Nevertheless, Soros’s overture dramatized the mood that followed sterling’s fall. The greatest speculator of them all was unwilling to defend speculation.56 Druckenmiller did not share Soros’s misgivings. The British press had dubbed the day of sterling’s humiliation “Black Wednesday.” But Druckenmiller thought “White Wednesday” would have been more apposite. Britain had been freed from the yoke of the Bundesbank’s high interest rates—freed to pursue the recession-fighting policies it needed. The London stock market’s reaction to the devaluation made Druckenmiller’s point: The FTSE index jumped by almost a fifth in the two months that followed. To be sure, Druckenmiller’s trading had upended the economic policy of the British government, but this was not necessarily bad. The high interest rates accompanying German unification had created a situation in which sterling needed to exit the exchange-rate mechanism. Britain’s rulers had failed to recognize this truth until Druckenmiller had recognized it for them. The fact that John Major had transferred $1 billion plus of taxpayers’ money to the Soros funds was not entirely Druckenmiller’s fault. If somebody had fleeced the country blind, it was the prime minister, not the speculator. The Soros-Druckenmiller divide anticipated a debate within economics. In the years before the sterling trade, economists argued that currency crises were triggered by bad economic policy: The villain was not speculation but government mismanagement. But during the 1990s, the academic consensus shifted—from Druckenmiller’s view to Soros’s. The new view emphasized that traders might attack currencies that were decently managed, and that the attacks might prove self-fulfilling. The spectacular collapse of sterling created a tipping point in this debate. Druckenmiller was correct in saying that Britain had invited the crisis by imposing untenably high interest rates. But once his own trading had demonstrated the power of speculators over governments, the risk that speculators might abuse that power became obvious. Whereas before traders might only have attacked currencies that were doomed by economic fundamentals, now they might feel empowered to have a go at stable ones. When French W H I T E W E D N E S D AY 171 politicians complained that hedge funds were amassing dangerous and excessive power, their concerns were not totally baseless. Whatever this danger, little was done to reduce it. Clamping down on speculators—guillotining them, as the French finance minister had urged—would have involved taming the waves of cross-border money on which the speculators surfed: It would have involved a return to Bretton Woods and the reimposition of capital controls. Most policy makers viewed this option with horror. If free trade in goods and services was beneficial, surely free flows of capital were good for the same reason; just as trade allowed car manufacturing to be concentrated in the countries that did it best, so cross-border capital flows funneled scarce savings to places that would invest them most productively. Moreover, capital controls might be impractical as well as intellectually suspect. In the week after the sterling crisis, Spain and Ireland tried to dampen speculative attacks on their currencies by restricting banks’ freedom to trade them. The controls were quickly circumvented. If capital controls were off the table, there was one remaining way to prevent speculative attacks on national currencies—abolish them. “Speculation can be very harmful,” Soros told an interviewer in the wake of sterling’s bust; a single European currency “would put speculators like me out of business, but I would be delighted to make that sacrifi ce.”57 Europe eventually unified its currencies in 1999, but not everybody learned. Emerging economies in Asia and Latin America stuck with the policy of pegging, creating immense opportunities for hedge funds later in the decade.