Questions and answers on the financial turmoil

September 17, 1992|By Los Angeles Times

The turmoil that has gripped financial markets in recent days has raised doubts about the health of the global economy and the faltering U.S. recovery. Here are answers to some pressing questions Americans may have about the crisis.

* Will the crisis in the European financial markets mean a fresh blow to global markets and the U.S. economy?

If it persists, yes. If it is resolved quickly, probably not. It appears that the Europeans could be forced once again to realign their currencies. That would most likely hasten the decline in interest rates there, which could mean lower rates here. The result could be good for both the U.S. and other economies.

But the financial tumult almost certainly sets back the goal of a unified Europe.

* How could U.S. businesses, consumers and investors be affected?

The stunning numbers Americans have read about -- such as 500 percent interest rates in Sweden -- aren't yet affecting American businesses and consumers. The key is that these rates are not expected to last. Also, the rates in question -- those on overnight bank loans -- don't apply to business loans or individual investments.

* What ultimately sparked this crisis?

High interest rates are merely symptoms of the real problem: The Europeans themselves, and investors worldwide, have lost faith

that Europe can figure out how to create a unified economy among its diverse nations. So chaos has replaced order, at least temporarily.

Europe was to have one currency by 1997 that would in theory have replaced the national currencies.

* Why would the Europeans want a single currency?

Imagine if, in the United States, all 50 states had separate currencies, and prices for goods and services were set differently in each state. It would be extraordinarily complicated to do business among the states. There would be constant uncertainty about what each state's currency was truly worth.

With a single currency, Europe could achieve the dream of easy commerce among nations.

* Then what got in the way?

Differences among the nations of Europe are still huge -- different inflation rates, different price structures, different living standards.

Free to move their funds around as they chose, investors increasingly began to pull their money from Britain, Italy and other high-inflation, economically weak nations and instead took their money to Germany, which is the biggest European economy and the strongest.

* What was the effect of the shift of investment capital to Germany?

Germany's mark rose sharply in value, while other European currencies and the dollar fell. The reason is simple: To buy a German bond, you first had to buy German marks. So investors were increasingly trading other currencies for marks.

* What was the European reaction?

To protect their living standards, many countries raised their interest rates even higher than Germany's, to try and lure capital back. They tried to support the value of their currencies by aggressively buying the currencies in the open market, while selling marks.

On Monday, the Germans cut their rates slightly to further reduce the attractiveness of German bonds and savings accounts relative to those of other European nations.

But the mark continued to rise as investors abandoned the pound and other European currencies.

* What happens now?

Britain finally decided it would no longer try to fight the market. Economists believe that Europeans will now be forced to let investors determine what their currencies are worth -- even if that means a devaluation of most currencies, while the German mark gets stronger still.

Until now, the Europeans have been trying to impose a value on their currencies that investors simply would not accept. But in a truly free market, the collective will of buyers and sellers wins out.

* Is there good news in that?

Yes. By giving up the idea of supporting a currency's value with high interest rates, it appears that Britain and other European countries will allow their rates to drop. That could help rejuvenate their economies and also help the United States.

But in the long run, by abandoning rigid currency controls, the Europeans make it tougher on themselves to move those currencies toward some balance, which would be necessary to create a single currency.

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