NEWS ANALYSIS : Tiny Shift Offers Opportunity to Spur Recovery
If anyone still needed proof that we live in an interdependent global economy, it was provided Monday in dramatic fashion.
Germany cut interest rates by a mere quarter of a percentage point, and world markets erupted as if a new global prosperity were assured.
That likely is not the case. But the German action does offer U.S. policy-makers an opportunity to spur the economic recovery. And by helping to revive growth among European countries, it could bolster U.S. exports and create jobs.
Still, many Americans must wonder why a shift in interest rate policy in Frankfurt can make their lives better by, for example, bringing down rates on mortgages in the United States.
The reason is today’s global markets, where $800-billion worth of stocks, bonds and currencies are traded round the clock every day. Investors doing the trading represent governments, banks, corporations, pension funds, mutual funds. If you have a company pension, you are part of the global market. And if you have a mortgage, the rate you pay is determined in those markets.
Most times, the constant trading yields an equilibrium, with interest rates and currency values reflecting economic conditions within each country, and world conditions overall.
But lately, rate and currency relationships got out of balance as the Bundesbank pushed German interest rates above 9%. At the same time, the Fed drove U.S. rates down to 3%. The rate gap attracted global funds to invest in German bonds and thus transfer into marks, while selling U.S. securities and fleeing from the dollar.
And so the dollar fell at one point to 1.37 marks--meaning the mark had risen to 73 cents from less than 50 cents only a year ago.
Ordinarily, a low dollar makes prices of U.S. export goods attractive. But this time, with the strong mark hobbling European customers, American exports lagged, too.
Americans didn’t feel the impact directly unless they went on a European vacation. But with global investors fleeing the weak dollar, U.S. policy-makers were painted into a corner. They were limited in using lower interest to inject money into a flagging domestic economy.
High German interest rates hurt the other European countries because they tie their currencies--the British pound, French franc, Italian lira, etc.--to the deutschemark. These nations have been forced in recent years to throttle their own economies with high interest costs as the Bundesbank drove German rates to 9.75% and thus raised the value of the mark.
Now, even though the German rate cut was small--one quarter of 1% to 9.5% on the key Lombard rate--it was enough to inspire hope.
Some foreign exchange experts saw a shift in direction. “The trend of German interest rates, which has been rising since the fall of the Berlin Wall in 1989, has now changed to a declining trend,” said Kenneth McCarthy, head of Economic Intelligence Co., a financial advisory firm.
Europe would soon be a place of easy money and brisk business according to that scenario.
Others attached significance to the fact that the German central bank had yielded to international pressure.
“For the first time, the Bundesbank has acted European, not just German,” exclaimed John Hickling, manager of the Fidelity Europe stock mutual fund. “That the Bundesbank bowed to international considerations is historic,” said Carin Pacifico, a foreign exchange adviser at Wells Fargo in Los Angeles.
For a time, the Bundesbank resisted pressure from the U.S. and European governments. Bundesbank President Helmut Schlesinger reminded the world of the central bank’s responsibility to guard against inflation, which even at 4% holds a particular terror for Germans who remember 1923 when wheelbarrows full of reichsmarks were needed to purchase a loaf of bread.
But international critics focused on the reason for Germany’s inflation, which is the bad deal the German government in Bonn made with the former East Germany at reunification in 1990. Bonn pumped excess purchasing power into the East by giving too many deutschemarks to citizens of the collapsing regime.
Since then, the Bundesbank has tried, through high interest and credit restraints, to keep that excess money supply from sparking inflation. It was a policy geared to Germany’s domestic economy, but it discomfited the world’s economies.
The significance of Monday’s action is that the world’s economies prevailed and the Bundesbank had to retreat--just as the U.S. Federal Reserve in 1985 had to shift policies in response to global objections.
Granted, some analysts Monday saw Germany shifting only grudgingly, agreeing to a minimal cut in interest rates only after recession-torn Italy agreed to devalue the lira. “What’s the cost of the next rate cut going to be?” asked Fidelity’s Hickling rhetorically. By that analysis, nothing much really has changed.
But other experts saw new relationships, and perhaps new growth emerging. There is the obvious connection between the Bundesbank’s action and a national referendum in France next Sunday on a treaty to create a closer European union and a single European currency. Germany has benefited from Europe’s economic ties and would not like to see French voters reject the treaty, as polls indicate they might.
