WASHINGTON -- Last week's annual meetings of the International Monetary Fund and the World Bank proved again that government bureaucracies cannot do much to influence big changes in global capital markets.
The government of the United States and other industrial countries, which basically run the IMF and the World Bank, did a little crisis management and consulting. But they could not do much to halt the wreckage in European financial markets. The huge currency markets called the shots, and in the end, officials threw in the towel and admitted they were being overpowered by events.
Daily transactions by banks and brokerages in the foreign exchange market are running as high as $1 trillion, U.S. Treasury Secretary Nicholas Brady said in a speech at the annual IMF-World Bank meetings. That is roughly one-fifth of what the United States produces in total goods and services in a year and double the total currency reserves that the major industrial countries have at their disposal to stabilize the exchange markets.
The amounts of money being thrown around in currency trading are "well beyond the resources governments can bring to bear in the markets," Mr. Brady admitted.
It remains to be seen whether Europe's Exchange Rate Mechanism, which is supposed to keep the currencies of members in line with each other to facilitate trade and investment, can be kept from collapse. That would set back efforts by the European Economic Community to unite their economies and currencies.
But what is clear is that the governments of Europe could not withstand the enormous market strains that flowed from Germany's pursuit for high interest rates to contain the inflation brought on by the costs of unification.
According to TransAtlantic Futures Inc., an economic consulting firm, German officials plan to pour about 170 billion marks, roughly $106 billion, into the country's ailing eastern region this year. The total government budget deficit, including outlays by local government, is running around 4% of gross domestic product.
"It's been costly, much more costly than they predicted at the outset." said Michael Ashford, a research manager at TransAtlantic.
Meanwhile, Germany's central bank has watched in anguish as the money supply, swollen by government subsidies and loans to pay for unification, is way over target at 9%. Inflation has reached 4%, which is higher than the U.S. rate of around 3%.
The Bundesbank, fearing inflation would get even worse, has pursued a tight monetary policy with short-term rates above 9% that put other European countries linked to the mark in a tough spot.
Italy and Britain, both of which are in recession, had to choose between letting their currencies devalue or keeping their interest rates high. It was a choice between inflation and growth, the classic central bank dilemma, and two weeks ago both nations opted for devaluation as the necessary price to pay for growth.
Britain cut its base lending rate from 15% to 10%, then to 9%, and in the process the pound tumbled against the dollar. Italy, which is plagued by huge government debt, had to settle for a cheaper lira.
France, which has a stronger economy and low inflation, took a different tack. To defend the franc, the central bank raised short-term rates to 13% from 10.5% and intervened massively in the currency markets, where it got support from the Bundesbank.
In the past, central banks of the industrial countries have worked collectively to dampen swings in the currency markets. But they were no match for the markets this time, and currency values had to crack because the traders knew the prices on the market were out of sync. The currencies of the countries with weak economies were no match for the powerful German mark and high German rates.
Fortunately, the United States could watch the wild swings in the European markets largely as a bystander. For U.S. tourists, travel will now be cheaper in Britain and Italy, and U.S. firms with business in both nations will be booking reduced earnings when they convert to dollars. Investors holding stocks and bonds in European countries with cheaper currencies will also take a hit.
But amid the wreckage, the United States comes out relatively unscathed. U.S. interest rates remain
at 25-year lows, and the Federal V
Reserve will cut rates again if there is more evidence that the economy is foundering.