The Gnomes of Frankfurt

September 15, 1992

By cutting interest rates after insisting stubbornly it would not do so, Germany's fiercely independent central bank, the Bundesbank, is starting to face up to its international responsibilities as manager of the world's newest de facto reserve currency. Long determined to look out solely for what it perceived as German interests, it has been forced to reverse course because its policies were creating global financial turmoil and plunging all of Europe into recession.

The key reason for the Bundesbank's timing is Sunday's referendum in France on the Maastricht Treaty. Bush administration officials may be happy that the Federal Reserve Board can make another pre-election cut in U.S. interest rates, but this was a secondary consideration in Frankfurt. The Germans are focusing closer to home, where a French "no" vote on European political and monetary union could blow apart Germany's hopes to cover its economic superpower status in a less alarming cloak of regional togetherness.

For months, the Bundesbank has been an arrogant loner in its obsessive drive to hold down German inflation. By pushing interest rates higher and higher while the Fed was going lower and lower, it put its neighbors in an intolerable squeeze that resulted in the plunge and subsequent devaluation of the Italian lira. It also caught the gnomes of Frankfurt in a painful contradiction.

Consider how they have to deal with those pesky politicians in Bonn, who are trying to bring the restive former East German states up to western standards with a $130 billion subsidy this year. This requires massive borrowing, and such "unGerman" policies have forced an angry Bundesbank to counter with sky-high interest rates in disregard of the consequences elsewhere.

These same sky-high interest rates have sent other currencies plummeting. While the United States has the heft, distance and self-sufficiency to follow its own course, the likes of Italy, Britain, Sweden and Finland have been forced to push up their interest rates even amidst recession.

In recent weeks, the Bundesbank has been buying up vast quantities of weak currencies, especially the lira, in a vain attempt to keep them within limits set by the European Monetary System. This, in turn, has had the perverse effect of increasing rather than decreasing the German money supply, and the Bundesbank found itself this past weekend tripping over its own feet.

Its quarter-point reduction to 9.5 percent in its chief lending rate was the barest minimum, which may make the euphoria in world stock markets short-lived. But symbolically, the guardian of the mighty deutsche mark has at last vouchsafed a responsibility for other currencies, for the economic state of its neighbors and for

the preservation of the European idea. That's progress, provided the Bundesbank follows up with more convincing interest rate cuts and other moves that indicate it now knows what it means to be a world player.

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