Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!news.media.mit.edu!americast.com!americast.com!usa-post Newsgroups: usa-today.bonus,americast.usa-today.bonus From: usa-post@AmeriCast.Com Organization: American Cybercasting Approved: usa-post@AmeriCast.com Subject: bonus Fri, Sep 25 1992 Date: Fri, 25 Sep 92 04:37:05 EDT Message-ID: 09-25 0000 BONUS: European system has wide effects USA TODAY Update Sept. 25-27, 1992 Source: USA TODAY:Gannett National Information Network So why should the world care if the British pound slips against the German mark, if the French franc gets hammered by currency speculators or if the entire European currency system blows apart at the seams? More importantly, why should you care? HOW DOES THIS AFFECT THE AVERAGE PERSON? That's an easy question to ask at a time when newspapers and television news shows are crammed with reports on the European currency crisis. It's not so easy to answer. Unless you are a U.S. tourist heading across the Atlantic or an investor in overseas stocks, the whole thing may seem much ado about nothing much. But it could cost you your savings - or your job. DO ANALYSTS AGREE WITH HISTORY? That may sound farfetched. Most analysts say the U.S. economy is not in immediate danger because of the events in Europe. But history shows that currency troubles are usually linked to more fundamental problems in the global economy. When those problems are combined with bad economic policies - as many economists say they are now - a currency crisis is often a warning sign of disaster. WHAT IS THE WORLD IMPACT? But at a time when global investors can move their money from the USA to Europe to Japan in a microsecond by pushing a button on a computer terminal, sharp currency fluctuations can have an immediate impact on the world's financial markets. Size alone commands respect - and fear. More than $600 billion in trades are done every day in the global foreign-exchange markets. And unlike the world's stock markets, currency trading is virtually unregulated. WHAT ELSE DO CUREENCY CHANGES AFFECT? In the longer run, currency changes also influence international trade and investment. Unstable exchange rates make it harder and more expensive for U.S. companies to do business abroad. At a time when the USA is depending on export growth to bolster the economy, such instability is hardly welcome. "It is virtually impossible to have a functioning trade system when you have wild swings in currency rates," says Jeffrey Garten, a Wall Street investment banker. WHAT ECONOMIC EVENTS HAVE BEEN AFFECTED THIS CENTURY? The Great Depression of the 1930s. Some economists trace its origins to a decision by Winston Churchill, then Britain's top finance official, to return the pound to the gold standard in 1925. "It was a major factor in igniting the depression," contends Steve Hanke, an economics professor at Johns Hopkins University. The problem: by pegging the pound to gold at too high a value, Churchill crippled the British economy and shrank the world's money supply. To compensate, the Federal Reserve lowered U.S. interest rates in 1927, fueling a speculative frenzy that led to the stock-market crash of 1929. WHAT ABOUT THE ECONOMIC BOOM AFTER WORLD WAR II? A 1944 conference in Bretton Woods, N.H., led to a new global currency system. Most major currencies were pegged to the dollar while the dollar's value was set at $35 to an ounce of gold. The system lasted for the next 27 years. Some economists say that stability prompted a global rise in trade and investment that lasted until the 1970s. Others say the system was doomed because it let global inflationary pressures build until they exploded. HOW WAS INFLATION IN THE 1970S AFFECTED? The Bretton Woods system was based on the USA's willingness to exchange dollars for gold on demand. But in 1971, inflationary pressures created by the Vietnam War and domestic welfare spending led President Nixon to take the dollar off the gold standard. Bretton Woods collapsed, fueling a global inflationary surge. HOW ABOUT THE FINANCIAL BOOM OF THE 1980S? In the early years of the decade, the USA embarked on the Reagan economic experiment - adding big budget deficits to high interest rates. The dollar soared, as foreign investors flocked to take advantage of high U.S. rates. The stock market also turned bullish. But a strong dollar hurt U.S. manufacturers by making imported goods much cheaper. In 1985, world leaders met at New York's Plaza Hotel and agreed to drive the dollar down by boosting growth overseas. WAS THE 1987 STOCK-MARKET CRASH AFFECTED? Some experts say dollar instability was at least in part to blame for triggering the crash. The Plaza Accord created its own problems for the USA. It made imports more expensive, reviving fears of inflation. Early in 1987, world leaders agreed to boost the dollar again. The Federal Reserve began raising interest rates, in part to attract foreign investors back to the dollar. But rising rates spooked bond and stock markets. Result: the October crash, the worst in history. HOW DID POLICYMAKERS REACT? After the 1987 crash, world policymakers more or less decided to let the dollar float - to find its own level in the market. Major European countries, meanwhile, reformed the existing European Monetary System by pegging their currencies firmly to the German mark. Ironically, the move was intended to spur the drive to create a single market for goods and services in Europe by the end of this year. Now, three months before the deadline, trade barriers are coming down but the currency system is on the brink of collapse. WHAT ARE ANALYSTS ANTICIPATING? Some analysts say such a breakup is inevitable - and welcome. The European crisis, like the 1971 collapse of Bretton Woods, only proves that pegged systems do not work in the long run. In Europe's case, inflationary pressures spawned by German reunification led Germany's central bank, the Bundesbank, to push up interest rates. WHAT LESSON IS BEING TAUGHT? Rigid exchange rates create more problems then they solve, says Herb Stein, a former Nixon economic advisor. But floating rates - in which currency values are set by the laws of supply and demand - carry their own risks. Unchecked, such policies eventually lead to economic chaos, says Hanke. WHAT DOES A FLOATING SYSTEM CAUSE? A floating system also gives free reign to global currency traders, leaving stock and bond markets vulnerable to sudden, uncontrolled swings in exchange rates. Also at risk: The powers of the Federal Reserve and the world's other central banks. WHAT DO THE LEADERS THINK? World leaders aren't ready to embrace that idea. But they are worried about the erosion of their authority. The bottom line: Unless governments can better coordinate their economic policies, currency markets will remain unstable. A floating system may be the only way to deal with that volatility. Markets discipline nations with bad economic policies and reward those with sound ones, Hanke says. Fixed systems can only postpone the day of reckoning. Bonus Editor: Kate Coughlin. (1-919-855-3491) Making copies of USA TODAY Update (Copyright, 1992) for further distribution violates federal law. This article is copyright 1992 Gannett News Service. Redistribution to other sites is not permitted except by arrangement with American Cybercasting Corporation. For more information, send-email to usa@AmeriCast.COM