Page 50 - Global Political Economy_Understanding The International Economic Order

THE NATUR E OF PO LITIC AL ECO NOMY
potentially risky situation was exacerbated when additional restric-
tions were placed on exchange rate flexibility within the ERM. These
economic developments laid the groundwork for the crisis. Political
developments that raised questions about the movement toward Eu-
ropean monetary unity included the Danish rejection in June 1992 of
the Maastricht Treaty. This startling action was followed in Septem-
ber by the narrow (51 percent) passage in France of a national refer-
endum on the Treaty. However, the most important developments
leading to the financial crisis were the several decisions of the German
Central Bank (Bundesbank), from November 1990 on, to raise Ger-
man interest rates substantially in order to offset the inflationary con-
sequences of German reunification. Then the American Federal Re-
serve lowered interest rates in early 1992 to stimulate the stagnant
American economy. Also, in order to stay within the ERM currency
bands, the British government had attempted to maintain an overval-
ued pound and thereby caused the worst British recession in the post-
war era. These political developments raised serious doubts that the
British could continue to maintain the value of the pound.
The large gap between Germany’s excessively high and America’s
excessively low interest rates, plus the economic troubles of Italy and
Great Britain, created a disequilibrium in exchange rates. Hedge-fund
managers like George Soros of the Quantum Fund saw an opportu-
nity for a huge windfall and fled from the overvalued lira and pound
to the mark. Others followed suit in what economists have called a
“speculative overreaction.” Thus, although it is correct to say, at one
level of analysis, that Italy and Great Britain were overwhelmed by
market forces, at a deeper level of analysis it is equally correct to say
that the financial crisis was due to policy decisions taken by Ameri-
can, German, and British financial authorities. Government decisions
and the actions of individual economic actors were responsible for
that crisis. Indeed, French government officials, economic nationalists
to the core, denounced the financial crisis as an “Anglo-Saxon plot”
to destroy the movement toward European unity.
The 1992 financial crisis illustrates that both impersonal market
forces and the deliberate actions of a few powerful states can deter-
mine the dynamics of the world economy. While Italy and Great Brit-
ain were overwhelmed by market forces, deliberate policy decisions
by American and German central banks produced such economic fun-
damentals as the differentials in interest rates. Interactions of imper-
sonal markets and state policies constitute the driving forces in the
world economy and the subject matter of the study of international
political economy. Whereas market forces are the domain of eco-
37