U.S. trade deficit surges, A2.In yet another shock to the drive for European economic union, Italy Thursday joined Britain in abandoning the European currency system and allowed the lira's value to be dictated by market forces.
Spain, whose currency had been kept strong through the intervention of the nation's central bank, devalued the peseta by 5 percent.The currency crisis, triggered by tremors on the German market, has threatened to topple the government of British Prime Minister John Major, who broke with his predecessor, Margaret Thatcher, to embrace the concept of European monetary union.
After Britain's failed attempts Wednesday to prop up a plummeting pound by raising interest rates, the European Community's central bank directors met in emergency session to try to salvage the system that binds their countries' currencies.
EC financial officers, after a six-hour overnight meeting, announced the moves by Italy and Spain and stressed their "unanimous commitment to the European Monetary System as a key factor of economic stability and prosperity in Europe."
The system sets maximum fluctuation rates for EC currencies and forces members to raise interest rates and buy large amounts of their own currencies in order to stay within the allowable range.
The arrangement facilitates trade among community nations by enabling companies in one country to know that the prices of goods in another will not vary radically from one day to the next.
It also is also designed to inspire confidence in still-closer monetary cooperation in the future - including a single European currency - and is an important psychological symbol of European cooperation in general.
This week's dramatic fluctuations in currency values, especially if they prove to be short-term, may have little direct effect on prices. They could, however, still have a strong psychological effect in undermining confidence in the future of European economic organ-ization.
On Wednesday, Britain's leaders decided that adhering to the system was just too damaging for their recession-ridden economy. Within hours Italy followed suit, after devaluing the lira by 7 percent over the weekend.
The result was a further erosion in the value of both currencies.
White House spokesman Marlin Fitzwater told reporters Thursday that the Bush administration was keeping an eye on the crisis.
The dollar's gain over the past two days proves the American economy "is still the leader of the world," Fitzwater said. "We still have a strong economy that's a safe haven for foreign capital."
The pound recovered partially against the dollar Thursday, but continued to fall against the German mark. In early afternoon trading, the pound was quoted at $1.7720, up from $1.7385 in the morning, but well below the level of $1.8083 from late Wednesday. The pound was at 2.6400 German marks in early afternoon, after falling through the exchange system floor of 2.7780 marks late Wednesday.
The lira, which was 1,246.50 to the dollar on Wednesday, dropped to 1,288.50 in London.
Stock indexes rose in Tokyo and London, and prices for gold, a traditional haven in times of turmoil, were higher.
In Frankfurt, the German Bundesbank said Thursday it was leaving its key interest rates unchanged, despite the turmoil that high German interest rates have caused in the European currency system.
In London, government officials pointed fingers at Germany's central bank, accusing it of undermining confidence by persistently leaking indications that the pound was overvalued.
Major met with his Cabinet in emergency session, and a senior official later said the ministers stood behind Chancellor of the Exchequer Norman Lamont, despite demands that he resign. The crisis is the most severe Major has faced in the 22 months he has been in power, especially since his Conservative Party argued before the April elections that the rival Labor Party was incompetent to manage the economy.
Britain has given no indication when it might return to the exchange system. Italian officials say they will return the lira on Tuesday.