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withdrawn from ERM (European Exchange Rate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:

Economic strength increased

Concerned about domestic inflation, set high interest
rate

The

counties in recession:

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

pound/lira

rate increase intensified stresses on

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:

Finnish Markka no longer tied to Deutsche Mark

Failed to keep Markka/Mark exchange rate and
adopted a floating exchange rate

Italy:

on Sep 8

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:
July1, 1990 toDecember 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

culture.

countries vary in language, history and

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

THANKYOU!

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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