Europe's Common Crisis: Money

WITH THE SPECTACLE OF SEEMING CHAOS IN ITS currency markets, Western Europe is giving the rest of the world a vivid lesson in the connection between economics and politics. Eleven of the 12 European Community states have been trying to keep the value of their money linked together while pursuing divergent domestic policies and grappling with distinct national problems. Inevitably, these internal stresses -- aggravated by well-heeled speculators -- broke the E.C.'s system of guaranteed exchange rates, forcing Britain and Italy to drop out.

Some sort of currency crack-up had seemed likely for months -- especially to the speculators. Germany's high interest rates, designed to hold down inflation while attracting investors to pay for rebuilding the former East Germany, angered Bonn's European partners, most of whom are fighting recession and prefer low rates to foster growth.

Heavy betting against the exchange system began as the Sept. 20 French referendum on the Maastricht treaty approached. If the result of this vote on the package of new steps toward European economic unity were to be non, no one wanted to be caught holding a weak currency. Banks, pension funds and private investors began selling off Italian lire, and Italy, fearful of depleting foreign reserves, was forced to devalue its currency 7%.

Then, after much roaring over a forthcoming cut in its interest rates, the German Bundesbank delivered a monetary mouse -- a reduction of only one- quarter of 1% in its key rate. That did more harm than good, and currency traders resumed dumping lire and billions of British pounds. In London Prime Minister John Major's government, determined to stay with the E.C. system in the face of the pound's continued fall, tried to lure investors at midweek with an increase in the Bank of England's interest rate, from 10% to 12%. Even when, in desperation, the rate was pumped to 15%, speculators went on selling pounds and buying marks. The government gave in, pulling the pound out of the exchange system and canceling its rate increases.

Italy dropped out the next day, promising an early return. As the tumultuous week ended, speculators turned their attention to the French franc, the Irish punt and the Danish krone, all of which neared the bottom of their permitted range in the E.C. exchange mechanism.

For all the public drama and the political damage to the governments involved, the crisis remained chiefly a European one. It can be repaired, but probably only after the E.C. agrees to broader, more flexible links for its exchange rates. That kind of loosening could slow plans for a single E.C. currency. (See related story on page 41.)

CHART: NOT AVAILABLE

CREDIT: TIME Graphic by Steve Hart

[TMFONT 1 d #666666 d {Source: Telerate}]CAPTION: LEAVING ITS MARK: VOLATILITY

Currencies against the deutsche mark