Badass

Pop Quiz: What do George Soros and Hong Kong have in common?

They're both badasses.

I've been reading Paul Krugman's book, "The Return To Depression Economics," and I've been thoroughly enjoying it. There's a ton of great stuff in there, but the two most amazing amazing stories so far that I've read are of how George Soros kicked the pound's ass and of how Hong Kong kicked the collective asses of a bunch of speculators that were trying to cash in on it's fumbling economy.

Let's begin with George Soros. George Soros is a Hungarian refugee turned American entrepreneur, and through his Quantum Fund (a hedge fund), he became a billionaire. The way he did this was absolutely amazing. In 1990, England joined the European Monetary System's Exchange Rate Mechanism, which fixed exchange rates throughout Europe in order to create a unified European Currency. The problem with Britain's entry to the ERM is that the exchange rate at which it entered was too high (making it difficult to sell products abroad), and it was in the middle of a deep recession. This lead to the possibility that Britain would drop out of the ERM, but there was doubt as to whether or not this would happen. Soros recognized that if Britain dropped out of the ERM, there was a way he could make money on it.

First, through Quantum Fund, he quietly borrowed about $15 billion worth of pounds and converted them into dollars. In other words, he established a short position on pounds (if the pound collapsed, it would be much cheaper to pay back, and he'd make money). Next, he started a very loud, very forceful attack on the pound, saying that he had short sold, was 100% positive that it would crash, and so on. This generated a run on the pound, and Britain had to spend almost $50 billion in order to defend in. Eventually, Britain left the ERM and allowed the pound to float, which devalued it. Soros made roughly a billion dollars in about a month.

Next, we have Hong Kong. Hong Kong used to be considered one of the greatest free market societies in the world. It had a wide open economy more or less free of government intervention, and operated on the currency board system (currency was backed by other currency, in this case 7.8 Hong Kong dollars to 1 USD). To put it crudely, it was Milton Friedman's wet dream. Of course, as Japan slumped in the 90s, Hong Kong began to slump, due to the fact that it's currency board made the goods it sold more expensive compared to other countries goods and the fact that foreign investors couldn't invest due to the high exchange rates created a very deep recession, and hedge fund's tried to take advantage of it (note the use of the word "tried" here).

What funds did is they sold Hong Kong stocks short, meaning they borrowed stocks from their owners with promise to return them later and sold them in Hong Kong dollars, hoping that when the prices dropped, they could buy them back and make a profit. Then, they took the Hong Kong dollars that they made and traded them for U.S. dollars, similar to what Soros did with the pound. In this way, they were betting that 1 of 2 things would happen. Either Hong Kong would devalue its currency, meaning that they would make money on the currency speculation (trading the HKD to USD) or the Hong Kong Monetary Authority would raise interest rates to defend the currency, causing the stock market to drop, and they would make money on their short positions in the market. Because Hong Kong was such a free market society, there was no WAY they could lose.

NOTE: Not everything that the hedge funds did was legal. When they sold HKD, they did so in very large amounts, making sure everyone noticed. Hong Kong officials also accused them of planting stories suggesting that the HKD was on the verge of devaluation. Basically, they were trying to start a run on the currency.

Well, what happened? Hong Kong decided enough was enough and decided to kick some ass. The Hong Kong Monetary Authority happened to have a HUGE amount of reserves. Remember, every 7.8 HKD was backed by 1USD, so the HKMA had to have enough USD to back what was in the system. However, they had way more than necessary. So, they took the money that was in the reserves and started buying local stocks, driving the price up so that the hedge funds lost money on their short positions. Eventually, Hong Kong realized that it couldn't continue to buy stocks, so they forced hedge fund owners to give back the borrowed stocks, meaning the hedge funds had to buy back the stocks at the elevated prices.

Of course, the backlash from this was incredible. After all, Hong Kong was once heaven for classical economists. Now, with all of the intervention in the stock market and the controlling of prices and the restrictions on short selling, it was insane, according to Milton Friedman.

One fact remains: Hong Kong had beaten the speculators. True, they sacrificed their standing as the one of the greatest free market economies in the world, but they beat the speculators.

And for the aforementioned actions, I would like to award the Nobel Prize for Badassery to George Soros and the Hong Kong Monetary Authority. You earned it!


NOTE: All credit for this blog post goes to Paul Krugman and his book "The Return to Depression Economics and the Crisis of 2008." All the information above is from his book, and I highly recommend reading it, as it is probably one of the best books I've read. For those of you who are not big on Economics, it is an incredibly easy to understand, and you will not be lost while reading it.


-The Economist (who does not want to be sued for plagiarism)