Drowning in a World of Floating Values

The industrialized world switched to a system of floating-exchange rates in 1973 in the hope of ending the disruptive crises that had become almost routine with rigidly fixed currency values. But the floating-rate system--under which currencies pretty much find their own value in the market--is proving that it too can suffer, if not a crisis, then a period of turmoil. The troubles are pallid by past standards: central banks are spending only millions, rather than billions, to defend their countries' currencies, and no exchange offices are refusing to accept tourists' foreign money. Nonetheless, some currencies are not so much floating as drowning.

For the first time ever, the British pound has plunged below $2. It dropped to $1.915 before rising slightly to $1.928 at week's end. The Italian lira has lost 18% of its value since January; it now stands at 806 to the dollar, v. 633 only one year ago. Beset by economic troubles, Spain devalued the peseta by 10% last month. There are strong indications that the French franc may also be forced into devaluation.

Crucial Test. Even as the weak grow weaker, the strong currencies become yet stronger (see chart). The value of the Swiss franc, the world's solidest currency, has increased 5% since last September, while the West German mark has risen 3%. The dollar, which had been suffering only two years ago, now has won new respect abroad as Europeans become increasingly impressed with the vigor of the U.S. economic recovery.

Floating is, in fact, a crucial test of the strength of a nation's economy. Now that central banks no longer intervene in money markets as frequently and forcefully as they once did, currency values are determined by supply and demand, which reflects international confidence--or lack of it--in a nation's economy. Britain and Italy, both troubled by rapid rates of inflation (16% and 12%, respectively), high unemployment (6.1% and 6%) and severe balance of payments problems, have failed to pass the test.

The precipitous decline of the pound highlighted the tensions within the ruling Labor Party. The Conservative opposition combined with rebellious left-wingers to defeat a government White Paper outlining sharp cutbacks in social services--a key part of Prime Minister Harold Wilson's program to slow the inflation that is eroding the pound. As a test of strength, Wilson called for--and won--a vote of confidence. He intends to press ahead with his austerity policy, which has the backing of the trade union leaders. The government seemed, in fact, to welcome the cheapening of the pound as an automatic devaluation that would make British exports more competitive on the world market. But the Bank of England intervened at several points to keep the pound from sinking still lower.

The lira jitters were set off by last January's long Italian political crisis. As the country drifted for 35 days without a government, panicky Italians smuggled lire into Switzerland, often lugging them there by the suitcase. To halt the losses, the Italian Treasury in January closed the official foreign-exchange market. Shortly before it reopened

March 1, the lira skidded to 808 to the dollar. After the market reopened, the currency recovered slightly to the 790 range, mainly because the Italian central bank spent $300 million to buy up unwanted lire.

The rescue operations have reduced Italy's foreign-exchange reserves to less than $1 billion, while the nation has $15.5 billion outstanding in foreign loans, many of them coming due soon. The U.S. and the European Economic Community are insisting on tough anti-inflationary policies, including wage restraint, as a precondition for granting more credit. The Italian government fears that unpopular austerity is hardly the way to stave off Communist ambitions to participate in the government.

Below the Snake. Measured against the pound or lira, the French franc looks strong. Measured against the deutsche mark, it seems weak--mostly because prices are rising more than 31 1/2 times as fast in France (an annual rate of 9.6%) as in Germany. France is a member of the "snake," a group of eight European countries that have pledged to keep currency-exchange rates within a 4.5% range of fluctuation; the franc is trading right at the bottom of that range. Some French industrialists would welcome a devaluation as a means of making French products cheaper abroad, and some currency traders expect a 5% to 10% markdown to take place some time this year.

President Valery Giscard d'Estaing would regard devaluation as a defeat and will hold out as long as he can--with some reason. A drop in a currency's value makes imports more expensive. That aggravates inflation, which tends to weaken the currency still further. The floating-rate system has made adjustments in money values smoother and continuous; it has not made them painless.

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