Transcript The European Monetary Crisis

THE EUROPEAN CURRENCY
CRISIS---1992-1993
Presented by:
Renee Wang
Xintian Wu
Yu-fa Chou
INTRODUCTION



War in Europe: late September, 1992
Central Banks
vs
Investors
Sell: Deutsche Mark
Sell: British Pound
Buy: British Pound
Italian Lira
Italian Lira
Buy: Deutsche Mark
Aim: To maintain/destroy the exchange rates
between Mark/Pound and Mark/Lira
Result: Pound and Lira were forced to be
withdrawn from ERM (European Exchange Rate
Mechanism)
HISTORY BACKGROUND
What is EMS?

Most members of the European Economic
Community (EEC) linked their currencies to prevent
large fluctuations relative to anothers.

European Currency Unit (ECU): a basket of
currencies, preventing movements around parity in
bilateral exchange rates with other member
countries above 2.25% (6% for Italy)

Deutsche Mark became the de facto "anchor" in the
European Monetary System (EMS) due to
Germany's strong economy after the merge of East
and West Germany and the low-inflation policies of
the Deutsche Bundesbank.
THE CATALYST OF THE CRISIS

Germany:
–
–

The counties in recession:
–

Economic strength increased
Concerned about domestic inflation, set high
interest rate
Want more stimulative policies to lift their
economies out of sluggish growth
But
–
Those countries must keep their own rates high to
maintain the value of their currencies against the
Deutsche Mark
The contradiction led to the crisis
THE FUNDAMENTAL CAUSE OF THE CRISIS



The relative economic strength of EEC members
is not constant.
Change in economic strength of a country
demands corresponding adjustment in the weight
of its currency in ECU.
Although currency weights are set to adjust every
5 years, unsynchronized strength and weight
could lead to crisis.
DEVELOPMENT OF THE CRISIS: PRELUDE



Germany government increased money supply and
initiated many development projects to spur economic
growth after the merge of East and West German.
This, however, led to a greater possibility of inflation
Contrary to expectations, Germany increased its
discount rate to 8.75% to ease inflation stress.
British and Italian economies were in trouble with
double digit deficits, forcing them to adopt a low
interest rate policy.
DEVELOPMENT OF THE CRISIS: PRELUDE

A prospect for a single European currency was
shadowed
Denmark's rejection of Maastricht Treaty in June
1992.
– Reports projected voters in France might also vote
"no".
–

Critical contradiction.
pound/lira were overvalued
– weak economic strength of UK and Italy.
–

Germany's rate increase intensified stresses on
pound/lira
DEVELOPMENT OF THE CRISIS: SPREAD

The EEC finance ministers Sep 5, 1992
–

Equivocated on the currency realignment issue at
their meeting in Bath, UK
Finland: on Sep 8
Finnish Markka no longer tied to Deutsche Mark
– Failed to keep Markka/Mark exchange rate and
adopted a floating exchange rate
–

Italy: on Sep 11
Italian lira was hit by speculators and fell below its
ERM floor.
– The Germans and the Italians met and opted for a
7% devaluation of the lira and modest cuts in shortterm German interest rates.
–
DEVELOPMENT OF THE CRISIS: SPREAD



UK: The Bundesbank made no attempt to contact the
British over the weekend about a broad realignment.
On Sep 15, sterling closed at 2.778 DM, only 1/5
pfennig above its ERM floor
– As the French referendum (scheduled Sep 20)
approached, panic spread in the market.
– Nervous investors sold massive amount of weak
currencies in ERM for DM.
On Sep 16 (Black Wednesday),
– Bank of England raised short-term interest rates
from 10% to 12% and to 15% on the next day.
– Although an estimated 15 billion pound was poured
into the market, the landslide of sterling could not
be reversed.
DEVELOPMENT OF THE CRISIS: ANALYSIS
Why can't rate hikes stop investors
from selling sterling?
 The market knew that the UK could not afford to
keep interest rates high for long in the midst of a
British recession.
 The UK was not prepared to lose all of its
currency reserves simply to stay in a seriously
flawed ERM, either.
DEVELOPMENT OF THE CRISIS: RESULT

Sep 16,1992
Bank of England rescinded interest rate increases.
– UK and Italy opted out of ERM.
–

Sep 20, 1992
–
France approved the ratification of the Maastricht
Treaty.
Yes: 13,165,475 (51.04%)
No: 12,626,700 (48.96%)
A NEW WAY OUT
The development of Euro
Stage One:
July 1, 1990 to December 31, 1993
– Stage Two:
January 1, 1994 to December 31, 1998
– Stage Three:
–
January 1, 1999 and continuing
Stage One
Maastricht Treaty
–
Signed on February 7, 1992 in Maastricht,
Netherlands
–
Setting a number of Maastricht convergence
criteria
–
Leading to the creation of the European Union
Stage Two
European Central Bank (ECB) is created .
 New currency (the euro) is created
 The duration of the transition periods are decided

Stage Three
From the start of 1999, the euro is now a real
currency.
 The national currencies have already ceased to
exist.

ADVANTAGE OF THE EURO


Produce a greater degree of European market
integration than fixed exchange rates.
More considerate of other countries’ problems
–
The European Central Bank would replace the
German Bundesbank under EMU

Removing the cost of exchanging currency.

Convenience in transaction
–
Banks in the Euro-zone must charge the same for
intra-member cross-border transactions as purely
domestic transactions for electronic payments.
DISADVANTAGE OF THE EURO



European countries vary in language, history and
culture.
The level of fiscal federalism in the EU is too
small to cushion member countries from adverse
economic events.
Hard to handle through monetary policy.
Economic diversity in the Euro-zone
– Euro-zone interest rates have to be set for both lowgrowth and high-growth Euro members
–
CONCLUSION


Certainly, the fault of the crisis cannot all be
attributed to Germany. However, although
various economic contradictions among countries
aggravated day by day, countries can be
coordinated only in economic integration.
The international cooperation and policy
coordination has already become the irreversible
trend now. Therefore, economic policies of
adopting coordination of various countries will
promote the development of international
economy.
REFERENCES
Treasury and Federal Reserve foreign exchange
operations - Treasury Dept, Federal Reserve
Bulletin, Jan 1993
 The Search for Security: A U.S. Grand Strategy
for the Twenty-First Century by Max G.
Manwaring, Edwin G. Corr, Robert H. Dorff

THANK YOU!
Maastricht convergence criteria

The Maastricht convergence criteria for a country
to qualify for participation in EMU are:
Inflation within 1.5% of the best three of the
European Union for at least a year
 Long term interest rates are required to be within 2%
points of the best three in the European Union for at
least a year
 Being in the normal band of the ERM without severe
tension and without initiating a depreciation, for at
least two years
 A budget deficit/GDP ratio of no more than 3% and a
government debt/GDP ratio of no more than 60%.

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