The European Crisis: Nerve, reserves and endless cash: How the currency battle is fought

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The Independent Online
THE overwhelming point to grasp about the battle between the foreign exchange markets and the Banque de France is the sheer scale of the selling. We are talking about billions and billions of francs every hour. The total trading in foreign exchange in London alone each day is dollars 187bn ( pounds 108bn), according to a survey five years ago.

But the reserves of foreign currency which the Banque de France can use to buy up francs and stop the fall against the mark were a mere dollars 33bn before the crisis, excluding gold which is a useless concession to France's penchant for the precious metal. Not surprisingly, there was a rumour yesterday that the reserves had run out. It could, some said, be only hours before the franc went the way of the lira and the pound.

There is, though, a difference. This time, Germany's Bundesbank has put its reputation on the line. In a statement yesterday, it said the present exchange rate with the franc was correct. It also bought up francs during the morning when the French currency was above the 'floor' of its permitted range within the exchange rate mechanism, a signal that it was serious. Moreover, the marks that it sold in the foreign exchange markets soon landed back in Germany's money markets looking for an interest rate return. But the Bundesbank let the cash push down German interest rates, making the currency less attractive compared with the franc's new high interest rates.

The question which the professional dealers have to ask is whether the Bundesbank is serious, and whether it is prepared to sacrifice all its other objectives in the defence of the franc. If it is, no one doubts that it can save the French currency. It can print as many marks as it likes. By expanding the supply of marks, it can control the price.

The problem is that the marks come back to Germany, and boost the money supply. Since the Bundesbank is the teutonic shrine of monetary rectitude, it heartily dislikes money supply growth above its ceiling of 5.5 per cent. Yet the latest figures showed money growth of 9 per cent, and this week's support alone could add another 4 per cent.

The Bundesbank has helped another currency before, although it was not proud of the experience. In 1978, it pumped out so many marks to stop the dollar falling that money supply grew by more than 20 per cent. The question this morning is whether the Bundesbank's nerve will crack.

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