Woes of Europe's financial markets have global effect Here are some answers to questions about crisis

September 17, 1992|By 1992, Los Angeles Times

The turmoil that has gripped European financial markets in nTC recent days has raised serious questions 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.

Q: Will the chaos in Europe's financial markets mean a fresh blow to the world economy?

A: If it persists, the crisis over currency exchange rates and interest rates could indeed harm the global economy by increasing uncertainty, thus sapping already weak confidence levels of businesses and consumers, experts say.

But if the crisis is resolved in a matter of weeks, as expected, the impact could be relatively minor. And the ultimate result could be favorable to the United States: Europeans are being forced to revalue their currencies in relation to each other. That will most likely result in lower interest rates there, which could mean lower rates here.

But the financial tumult almost certainly sets back the goal of a unified Europe. Whether that will be good or bad for U.S. businesses in the longer run isn't clear.

Q: Are American businesses, consumers and investors immediately affected by current high European interest rates?

A: The stunning numbers Americans have read about -- such as 500 percent interest rates in Sweden -- don't affect American rates. The rates in question are on overnight bank loans in Europe, and don't apply to business loans or individual investments.

The key is that these rates are not expected to last. So most global investors who might be tempted to take advantage of the high rates are virtually ignoring them.

In fact, money is flowing into U.S. dollar investments as investors seek a safe haven from Europe's troubles. The value of the dollar rose to 1.514 German marks yesterday from 1.491 marks Tuesday, even though U.S. interest rates are far below European rates.

So for now, America is merely a bystander to the crisis. Federal Reserve Vice Chairman David Mullins yesterday said he saw "no compelling reason to believe that the situation will have any effect on us."

Q: What ultimately sparked this crisis?

A: High interest rates are just 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.

In the unification process, Europe was to have a single currency by 1997 that would in theory have replaced the various national currencies. In the interim, the Europeans had agreed among themselves to a monetary system that regulated the value of their individual currencies -- for example, how many Italian lira it would take to buy a British pound.

Q: Then what got in the way?

A: The reality that the differences among the nations of Europe are still huge: different inflation rates, different price structures, different living standards. While most Europeans seemed to agree that the idea of a single currency made sense, by last summer "people couldn't see how they were going to get from here to there," says William Dudley, economist at Goldman Sachs & Co. in New York.

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, which by definition have weak currencies, and instead took their money to Germany, which is the biggest European economy and by most accounts, the strongest.

Leaving one's money in Germany seemed to be a good way to preserve your purchasing power in the long run, especially since the Germans offered high interest rates to boot.

Q: What was the effect of the shift of investment capital to Germany?

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

Like any other commodity, the value of a currency goes up or down with demand. Demand for the mark was high, so its value naturally rose. And in the process, the British pound bought less in Germany, as did the Italian lira, the U.S. dollar and most currencies.

And because European governments had agreed years ago to keep the value of their currencies (versus one another) more or less controlled, they were obligated to take measures to try to stop the rising value of the mark and restore order.

Q: What was the European reaction?

A: Many countries raised their interest rates even higher than Germany's, to try to lure capital back. They also 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, for the first time in five years, to try and further reduce the attractiveness of German bonds and savings accounts relative to those of other European nations.

But investors refused Tuesday to rush back into weak European currencies, notes Kevin Logan, economist at Swiss Bank Corp. Instead, they continued to buy marks and dollars.

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