European Currency Crisis 199293

1
European Currency Crisis (1992-93)

• Another Hurdle in Europe? Devaluations WSJ
  (4/2/1992)
• As Players Refocus on European System WSJ
  (1/4/1993)
• Germany and France Vow to Defend Link WSJ
  (1/6/1993)
• If the Franc Collapses, So Will Europes BW
  (3/29/1993)
• Europes Stormy Currency Markets Turn WSJ
  (8/3/1993)

2
Another Hurdle in Europe? Devaluations WSJ
(4/2/1992)

• Even with the high yields on European bonds, U.S.
  investors should think twice before jumping in.
  They should watch out for likely currency
  devaluations later in the year.
• To rein in inflationary pressures from rising
  wage demands and the immense cost of rebuilding
  Eastern Germany after reunification, Germany was
  keeping domestic interest rates inordinately
  high. Such high interest rates were also needed
  for Germany to raise capital to finance the
  reconstruction.
• While German was combating inflation, Britain,
  France, Italy, and other European countries were
  facing an increasingly difficult economic
  environment with stagnant growth and rising
  unemployment. High interest rates made their
  situations worse.
• These other countries were restrained from taking
  corrective monetary policy actions, however.
  High German interest rates prevented these
  countries from lowering their own high rates to
  boost domestic demand and spur growth.
• Because of the political developments (including
  political elections) in Britain, France, and
  Italy, politicians were under increasing
  pressures to offer some policy solution. As a
  result, some analysts speculated that these
  countries might soon give up their support for
  the exchange rate peg against the German mark. A
  currency devaluation would help the devaluing
  country boost exports. This would also allow the
  country to regain the flexibility it needed to
  stimulate its economy through interest rate cuts.

3
As Players Refocus on European System WSJ
(1/4/1993)Germany and France Vow to Defend Link
WSJ (1/6/1993)If the Franc Collapses, So
Will Europes BW (3/29/1993)

• In mid-September 1992, speculative attacks forced
  Britain and Italy to pull the pound and lira out
  of the European ERM. The speculative assaults,
  in which traders collectively made billions of
  dollars at the expense of European central banks,
  also prompted Spain and Portugal to devalue their
  currencies against the German mark.
• Currency speculators singled out the French franc
  as their next target. With the French elections
  coming soon in two months, political pressures
  were mounting for a cut in French interest rates.
  Speculators were betting that France would
  devalue the franc or withdraw it from the ERM
  rather than maintain painfully high interest
  rates at a time of slow growth and rising
  unemployment.
• Traders already expected the franc to be stronger
  than the pound or lira. As part of the core
  currency link under the ERM, France and Germany
  would do what they could to defend the franc. A
  decoupling of the French currency from the ERM
  could doom the whole plan of European monetary
  union.
• Indeed, when the Franc came under attack in
  September 1992, the central banks of France and
  German had intervened aggressively to hold their
  exchange rate link by buying francs and selling
  marks. Although they succeeded in defending the
  French currency, Frances foreign currencies
  reserves were seriously depleted.

4
WSJ (1/4/1993), WSJ (1/6/1993), and BW
(3/29/1993)(Continued)

• The French franc came under new attack.
  Speculators bet that the next French elections in
  March could yield a new government less attached
  to keeping the franc level against the mark at a
  time when France needed lower interest rates to
  help stimulate its economy and reduce
  unemployment.
• To defend its currency, the Bank of France raised
  interest rates. Both Frances and Germanys
  central banks also intervened directly to support
  the franc.
• Nonetheless, these moves against currency
  speculators could only be a temporary solution, a
  way just to buy time. In the process, France
  would pay a dear price since raising interest
  rates could actually hurt the French economy even
  more. As a result, traders continued to doubt
  about the durability of the exchange rate link
  and did not think the link could last much
  longer.
• The root of the problem remained unresolved
  namely, German interest rates were too high.
  Only a cut in German interest rates could save
  the franc.

5
Europes Stormy Currency Markets Turn WSJ
(8/3/1993)

• Because of another intense speculative attack
  against the French currency, Germany and France
  gave up defending the exchange rate link. After
  a marathon 10-hour meeting, EU finance ministers
  and central bankers decided to widen currency
  trading bands substantially, allowing their
  currencies to fluctuate within 15 around a
  central rate.
• Speculators finally won and locked in their
  profits by buying back the devalued franc.
  Before giving in to speculative selling, German
  central bank had spent about 60 billion mark (35
  billion US) trying to prop up the French
  currency.
• Despite the return of market stability, analysts
  warned that the tranquility might not last long.
  It was because people still saw the need for
  Germany to lower interest rates in the near
  future. The question was not whether Germany
  would cut interest rates, but how early Germany
  would cut rates.