Magazine article Modern Trader

Intervention: Going around the Mulberry Bush

Magazine article Modern Trader

Intervention: Going around the Mulberry Bush

Article excerpt

The coordinated intervention to shore up the U.S. dollar July 20 shows how inextricably linked are the members of the European Economic Community.

Following the intervention, analysts said a stronger dollar against the D-mark would ease pressure other European Monetary System (EMS) members felt after the German tightening.

In early July, the U.S. Federal Reserve lowered the discount rate to coax the U.S. economy toward recovery. Recently, stiff alarmed about the inflationary potential of the German economy, the Bundesbank raised its short-term interest rate to tighten policy.

One immediate result of those actions was significant anxiety among other EMS members. Italy raised interest rates soon after the Germans. Spain, Belgium and the Netherlands followed. Britain was torn between domestic and EMS concerns.

So the dollar intervention caused a sigh of relief. In simplest terms, when the German tightening took D-marks out of circulation by increasing the cost of credit (the U.S. easing had the opposite effect), fewer D-marks chased the same amount of goods, and there were fewer D-marks relative to the number of dollars. That weakened the dollar relative to the D-mark, but U.S. officials seemed little concerned.

But in these days of linked economies, that also means fewer D-marks relative to the number of Italian lira. Unable to allow its already weak currency to sink farther, the Italian central bank had to match the German policy move.

Then came massive intervention in which the central banks bought dollars with D-marks. …

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