A currency crisis is something that is not supposed to happen
these days. The very idea evokes images from old newsreels, with
grave statesmen in top hats emerging from limousines to urge calm
in gravelly voices. But suddenly Europe is up to its eyebrows in
And while the immediate impact on most peoples' daily lives
will be slight, it could derail the drive to European unity that
only a few months ago seemed as inevitable as tomorrow's
How could something so important have happened with so little
warning? And why are elected officials who have staked their
careers on the currency arrangement known as the European
Monetary System seemingly powerless to prevent its meltdown?
The answers lie in the basic economics of international
finance _ and the even more basic conflicts between domestic and
regional political priorities.
Francs are the coin of the realm in France. But when a French
company wants to import machinery from a producer in Manchester,
England, it must pay the bills in British pounds. And to obtain
the pounds, the company must find someone willing to exchange
British currency for francs.
The exchange rate is thus the price of pounds in francs, or
francs in pounds. And it must roughly reflect the relative
purchasing power of the two currencies in their home markets.
If, for example, a drill press costs 1,000 francs in Paris and
200 pounds in London, the exchange rate had better be more or
less 5 francs to the pound. Otherwise, both the British and the
French will buy all their drills presses on one side of the
But like life, economics rarely works out so neatly. In the
short run, currency exchange rates are influenced by many
factors, including the behavior of governments. And since the
rates have enormous impact on where goods that can be traded are
made and how much they cost, exchange rates are a matter of great
interest to the people in charge of national economies.
Most countries (including the United States) allow their
currencies to "float" against others. Voluntary transactions
between private buyers and sellers determine a currency's value.
That suits many politicians, since setting a fixed exchange rate
would force them to balance the interests of domestic producers
against those of consumers buying goods from abroad.
But European leaders are immensely taken by the idea of
maintaining very stable exchange rates within the greater
European economy, and for two reasons.
First, the system eliminates uncertainty, greasing the wheels of
commerce within Europe. A German truck maker can set a price for
its trucks in Italian lira, for delivery in six months, because
it knows what the exchange rate between marks and lira will be.
More important, a fixed exchange system imposes a collective
discipline on all the national economies linked to the system.
If, for example, Italy allows inflation at home to drive up
production costs at its factories, a fixed exchange rate with the
mark (and pound and franc) will make Italian products from those
factories too expensive to sell abroad.
Indeed, from this perspective, the only other thing better
than maintaining fixed exchange rates among European currencies
is the adoption of a single currency for the whole European
economy. And that is just what European Community leaders
proposed to do in the Maastricht agreement on European political
and economic union, which they signed last December.
The signatories at Maastricht, visionaries who generally speak
of the agreement in political terms, appeared to comprehend that
a successful currency union _ or for that matter, a stable fixed
exchange rate system _ demanded coordination of virtually all
aspects of national economic policy. …