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Currency Turmoil Rattles Europe

Extreme exchange-rate fluctuation eludes the control of nations' central banks

EUROPEAN Community governments have launched a drive to find a fresh formula to ensure the long-term stability of their countries' currencies and stave off the collapse of their commitment to economic and political unity.

After a week of turmoil on European money markets, EC finance ministers held an emergency meeting in Brussels yesterday amid indications that the exchange rate mechanism (ERM) set up in 1979 to stabilize European currencies was on the point of collapse.

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What a British banker described as "the critical phase" of the crisis was triggered on Thursday when, against widespread expectations, Germany's Bundesbank in Frankfurt failed to lower its key interest rate - a move that would have eased pressure on the French franc.

This produced a run on the franc and the currencies of Belgium, Spain, Portugal, and Denmark and forced central banks to mount massive interventions as billions were traded across the exchanges. The banks spent an estimated $57.9 billion last week trying to prop up the beleaguered currencies, a London broker said.

After a meeting of EC officials and bankers on Saturday, British sources forecast that the ERM would have to be restructured to allow the franc and other weak currencies to fluctuate more widely in relation to the strong German mark.

George Soros, an international financier who made $1 billion in currency speculation last September before Britain was forced to devalue the pound in an earlier round of currency turmoil, said: "The ERM in its present form is dead. A new system must be found."

Attempts to confront what British and other EC bankers say is Europe's worst currency crisis since 1945 have two main aims. In the short term, EC governments are determined to put an end to what Gavin Davies, chief economist of Goldman Sachs, called "savage buying and selling" on European markets. There were concerns the foreign-exchange markets would be even wilder today.

EC governments' longer-term aim is to salvage the goal of achieving a single currency enshrined in the Maastricht Treaty on European integration.

The ERM was intended as a step towards a single currency, and its collapse would mean EC leaders having to begin all over again to find a formula for creating the "ever closer union" envisaged in the treaty.

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The Bundesbank's failure to cut its key discount rate by the one-half percent that had been confidently expected in Paris and other capitals angered French Prime Minister Edouard Balladur, French government sources said. Earlier in the week he had said he would resign if the franc had to be devalued.

CLOSE relations between the Bonn and Paris governments are widely seen as a cornerstone of EC unity. A French Foreign Ministry source said: "Ties have been placed under enormous strain by the Bundesbank's determination to take its own decisions, regardless of what the German government or any other government wants."

Throughout the 1980s, France, under its so-called "franc fort" policy, stuck to the view that the franc and the mark had to stand together as Europe's strongest currencies. Last September, after Britain's ERM withdrawal, the Bundesbank came to the aid of the franc when the French currency came under intense pressure. Mr. Balladur was reported at the weekend as interpreting the Bundesbank's failure to lower interest rates last Thursday as a radical departure from the former supportive policy.

A French diplomat said: "We have to ask what has changed, and wonder why preservation of the ERM no longer appears to be a high Bundesbank priority."

A reform of the rules allowing currencies to vary in value in relation to the German mark is likely, British analysts say.

The franc and most other EC currencies have been required to fluctuate within a band of 2.25 percent above or below the mark. Last Friday the extent of the crisis became clear when five ERM currencies fell below their trading limits or hit their floors.

EC finance ministers yesterday were urged by officials to widen the band of permissible fluctuation to 6 percent. Other ideas under consideration, sources say, include floating the French franc, temporary suspension of the ERM to permit currencies to find their own levels, splitting the ERM into two tiers, and a limited realignment of the currencies. But, officials say that even these measures might not solve the problem.

A British source in Brussels said that "high interest rates are the real menace. Germany must prevail on the Bundesbank to lower its discount rate, otherwise the ERM in any form is doomed."

The Bundesbank is charged with safeguarding the German economy, and has defended its interest-rate policy, arguing that reunification has made high rates necessary.

Valery Giscard D'Estaing, a former French president and one of the European monetary system's founders, once described it as a "zone of monetary stability." EC governments have grown used to seeing it as an instrument for containing inflation.

After Britain withdrew from the ERM and allowed the pound to float, John Major, the British prime minister, pointed to "faultlines" in the system.

Mr. Major was reflecting the view of critics of the ERM who have continued to claim that the system was too rigid and was bound in the end to fail.

Sir Alan Walters, who advised Margaret Thatcher when she was prime minister, said yesterday: "The ERM was an attempt at fixing a price. Like all price-fixing, it created great shortages and surpluses. I always thought the mechanism was perverse and would end in tears."

Kenneth Clarke, Britain's chancellor of the exchequer, attended yesterday's Brussels meeting. One of his officials said: "We shall merely be relaxed spectators."

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