NEW YORK -- Smelling blood after the German central bank declined to lower a key interest rate, currency traders and speculators ganged up on the European Community's monetary system yesterday, nearly cracking the keystone of European unification.
In Europe, North America and Asia, traders placed billion-dollar bets that Western Europe's system of fixed exchange rates could not last the weekend. Several European central banks fought back and appeared late yesterday to have staved off the immediate collapse of the Exchange Rate Mechanism, which was created to tie the 12 nations' currencies together.
French and German officials said they would not allow the system to collapse.
"There are rules, and these rules are working well. They are made for situations like this very one," French Prime Minister Edouard Balladur said, according to Reuters.
The monetary system seemed so weak, however, that observers said it could not survive unless the relative values were recalibrated or suspended for several months or years.
The turmoil caused many investors to seek a haven yesterday. They helped drive the spot gold price up $9.20, to $407.00 an ounce, in New York, its highest level since Iraq invaded Kuwait in 1990. European stock markets soared, while the Dow fell nearly 28 points. The dollar hit a new low against the yen.
While the developments marked one of the darker days in Europe's efforts to unify economically, they could be a short-term boon to Europe's recession-plagued economies by freeing European countries to drop interest rates, thereby spurring their economies and increasing demand for U.S. goods.
"From the point of view of economic growth, it's crucial, because it will eliminate some of the tensions in their economic system. Politically, however, it's a major setback," said Francis Scotland, editor of the International Bank Credit Analyst, a Montreal-based newsletter and forecasting service.
The European Monetary System was designed in 1979 to bring Europe's economies closer together by linking their exchange rates. The goal by the end of the decade is the creation of a single European currency run by a central European bank.
But for more than a year, the plan has been unraveling as the monetary system has been unable to bind together Europe's divergent economies. Britain and Italy left the system last fall, while Portugal, Spain and Ireland have remained inside the mechanism but have devalued their currencies.
The most recent round of trouble started Thursday, with the German central bank's decision not to lower the key discount rate. The dominant Bundesbank -- effectively the central bank for continental Europe until the new central bank is created -- was under pressure from other countries to lower its discount rate, which would have allowed them to lower their rates as well.
But the Bundesbank decided that inflation was too high in Germany and balked, sending Europe's out-of-whack exchange rates further out of synchronization.
Speculators bought marks and sold francs, Danish crowns and Spanish pesetas, betting that those countries would have to leave the German-dominated system of fixed exchange rates, a move that would drive down the value of their currency and increase the value of the mark.
"We're buying marks against the weaker currencies. We're betting that the Spanish and Portuguese will leave the system, and maybe the French too," said a currency trader with Sanwa Bank in New York.
As investors unloaded francs and bought marks, the two currencies began to trade outside their band on the Exchange Rate Mechanism, which is designed to make exchanging
currencies more predictable by holding exchange rates within a narrow band. In New York late yesterday, the franc-mark rate was right at the 3.4305 floor, or the equivalent of 0.2915 francs to the mark.
The Belgian franc, the Danish krone, the Spanish peseta and the Portuguese escudo were also pegged at or close to their floors in trading yesterday.
Central banks tried to compensate for the currency traders' actions yesterday. Overall, traders estimated that the central banks of Germany, France, Belgium, Denmark, the Netherlands, Spain and Portugal spent about 30 billion marks, or $17.25 billion, supporting the weak currencies, the New York Times reported.
Rumors began circulating that the European Community would be forced to call an emergency meeting today or tomorrow to tackle the crisis, though these were later doused when the Belgian finance minister said no such meetings were planned. Spanish officials, however, declared that a meeting was necessary to sort out the crisis "so that we can start Monday under different conditions."
As of last night, no meeting had been called, and the rates held, but currency traders were almost unanimous in declaring that the system was badly wounded.