BUSINESS/ECONOMY

Stumbling into a crisis

MICHAEL SALTER August 5 1985
BUSINESS/ECONOMY

Stumbling into a crisis

MICHAEL SALTER August 5 1985

Stumbling into a crisis

It began as a calm day on Italy’s currency markets, but by early afternoon on Friday, July 19, foreign exchange traders in Milan and Rome were in a panic. The lira was staggering, and by 1.30 p.m. the Italian currency had lost 20 per cent of its value against the U.S. dollar. Half an hour later the Italian Treasury intervened, closing the country’s foreign exchange markets. The next day at a hastily called meeting in Basel, Switzerland, central bank officials of the European Community (EC) agreed to officially devalue the lira by eight per cent within the European Monetary System (EMS), which links the values of eight European currencies. When currency trading resumed last week the crisis was over: the lira traded quietly and even recovered some of its value against the U.S. dollar.

Still, the incident focused worldwide attention on the failure of Italy’s fiveparty coalition government, led by Socialist Prime Minister Bettino Craxi, to deal with mounting economic problems. Although Italy’s gross domestic product is growing by 2.6 per cent for the second year in a row, the increase came largely as a result of massive jumps in government spending and the nation’s publicsector deficit, which is forecast to reach $75 billion (Cdn.) by the end of 1985. But strong domestic growth, coupled with Italian industry’s inability to meet local demand, resulted in a costly surge in imported goods. In the first five months of 1985 Italy’s trade deficit stood at $10.9 billion—75 per cent of last year’s record trade deficit of $14.3 billion. And the

overvalued lira made it difficult for Italian manufacturers to sell abroad.

Earlier this year the Craxi government-after two years in office it is the country’s longest-running administration since the Second World War—acknowledged the need to deal with the public-sector deficit and surging imports. But the government was only midway through discussions to develop a new economic program when the currency crisis struck.

The lira’s dramatic fall began when one of Italy’s largest banks, San Paolo di Torino, tried to buy $125 million in U.S. funds. The bank was acting for Ente Nazionale Idrocarburi (ENI), the stateowned energy company. Both ENI and San Paolo asked the Bank of Italy to supply the dollars. The bank refused and advised the two corporations to delay the operation. What the bank did not reveal was that the government was planning a lira devaluation in order to make imports more expensive to Italian consumers. As a result, San Paolo began buying dollars on the Milan exchange. But currency traders soon found that there were not enough dollars available to fill the huge order. As they started dropping the price of the lire in order to attract more dollars, the disastrous slide began. Last week Craxi ordered an investigation into the crisis. But economists and bankers hoped his next step would be to make some hard economic decisions.

— MICHAEL SALTER, with SARI GILBERT in Rome.

SARI GILBERT