1. The European Currency Crisis 1992-1993
Cynthia Diaz
Hazel Gonzalez
Daniel Monge

2. Introduction of European Union
1970’s, Collapse of the Bretton Woods System
The European Economic Community (EEC)
(Germany, Italy, France Netherlands,
Belgium and Luxembourg)
European Union
Added Portugal, Denmark, Spain, U.K., Finland Greece, Austria, Sweden, and Ireland,.
30 yr Transition : European Monetary System (EMS).

3. European Monetary System
Exchange rate variability / Monetary stability
EMS: 1. European Currency Unit (ECU)
2. Exchange Rate Mechanism (ERM)
Floating the exchange rate.

4. What is the purpose for EMS?
Europe in the global economy.
Create Europe Bond
Common Agricultural Policy (CAP).
To control fluctuations of the currency and improve coordination of monetary policy decisions among countries apart of the union.

5. Effect of the EMS EstablishedCentral exchange rates for each currency
Brought responsibility of countries in the EU to stay with band rates.
Stable currency of the group ‘German Mark’
Unofficial reserve currency: The Deutsche Mark (DM)
German Central Bank (Bundesbank)

6. Factors Behind the Crisis
Deutsche Mark became the anchor in the European Monetary System (EMS)
Due to Germany's strong economy after the split of East and West Germany
Deutsche Bundesbank had low inflation
Germany Gained Economic Strength
Became free to set monetary policy for itself
Other countries had reduced control due to reserves needed to adjust to the edge band of the mark.

7. The Crisis Reunification of Germany (East & West)
Merged large rich economy of the West with poor smaller economy of East
West Germany transferred savings to the East
Caused the government budget deficit to rise from 5% to 13.2%
Government increased money supply and initiated many development projects to gain economic growth
German interest rates rose about 3% in 1991 and to try to ease inflation

8. Germany’s Effects
Germany’s high interest rates made European countries worse
Britain, France, Italy and other countries were restrained from taking corrective monetary policy actions.
Britain, France, & Italy economies suffered such high deficits that they were forced to adopt a low interest rate policy
currency devaluation would help the devaluing country by boosting exports, and allowing the country to regain the flexibility it needed to stimulate its economy through interest rate cuts

9. Speculation
Analysts speculated that these countries might soon give up their support for the ERM
Due to speculations and a weakening currency
September 16, 1992 : Black Wednesday
UK’s prime minister and cabinet members tried all day to boost up the sinking pound and avoid withdrawal from the ERM

11. Black Wednesday Outcome
The British government raised the interest rate from 10% to 12% to try to get speculators to buy pounds
Market knew that the government could not afford to keep interest rates high for long
Investors kept selling the pounds and eventually Britain was forced to withdraw from ERM
Britain Treasury spent approximately ₤27 billion of reserves in trying to defend the pound by selling Deutsche Mark and buying pounds.
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12. Speculative Attacks Continue
Speculative assaults
helped traders make billions at the expense of European central banks
caused Spain and Portugal devalue their currencies against the German Mark.
French Franc was a major target because they had
high interest rate, slow growth, & rising unemployment
political pressure before elections demanded a cut in the French interest rates
speculators betted that France would devalue the franc or withdraw from the ERM

13. The Fall of the French Franc (₣)
Speculative attack against the Franc
made the central banks of France and Germany intervened aggressively
central banks tried to hold their exchange rate
central banks kept buying Francs and selling Marks.
The countries succeeded momentarily but France’s foreign currency reserves were nearly depleted

14. The Fall of the French Franc (₣) Continued
Speculative attacks continued to hit the Franc
speculators knew France needed lower interest rates to help stimulate the economy and reduce unemployment.
France’s and Germany’s central bank continued
to intervene directly to support the Franc
Interest rates were raised to defend the Franc
Germany and France gave up defending the
exchange rate link.

15. After the Fall Speculators won
They secured huge profits by buying back the devalued Franc
The EU finance ministers and central bankers
allowed the widening of the currency trading bands to fluctuate within 15% around a central rate
A total of about 60 billion Mark ($35 billion) was spent by the German trying to prop up the French currency

16. Maastricht Treaty
Signed on February 7, 1992 in Maastricht, Netherlands
Set the convergence criteria for a country to qualify for participation in EMU
Inflation within 1.5% of the best three of the European Union for at least a year
Long-term interest rates must not be more than 2% points higher than the lowest inflation member states
Being in the narrow band of the ERM ‘without tension’ and without initiating a depreciation, for at least two years
Government deficit to GDP must not be more than 3% and a government debt/GDP ratio of no more than 60%
The treaty entered into force on November 1, 1993.

17. European Monetary Institute
Established as the forerunner of the European Central Bank
intended to strengthen monetary cooperation between the member states and their national banks
supervise ECU banknotes.
European Council
adopts the Stability and Growth pact to ensure budgetary discipline
establishes a new Exchange Rate Mechanism (ERM II) to provide stability with the Euro and other national currencies.
European Central Bank (ECB) is created
Conversion rates between the 11 participating national currencies and the euro are established