It is stated that one of the major factors that triggered the crisis was high interest rates in Germany.

We should not be surprised of the developments in the European Union anymore. Today's commentary is on a page in history.

In early 1990s the Union witnessed a crisis which gave way to the revision of European Monetary System Exchange Rate Mechanism (ERM). The European Monetary System allowed the floating of exchange rate between two member countries within a certain interval. If a tendency to get beyond the interval was observed central banks were intervening in an effort to reset the exchange rate at a level within that interval. Before the crisis I mentioned above the size of the interval was around 4.5 percent. But after the crisis this rose from 15 to 30 percent.

Back then currencies of the countries in the European Monetary System were pegged to Deutsch Marc. From July 1987 to until the 1992 crisis no need was felt to reset the value of any currency against Marc. In 1 July 1990, capital controls were abolished in the majority of countries member to the European Monetary. Spain and Ireland were exempted from the decision until the end of 1992. The strategy was facing severe pressures at the dawn of 1992. 

Speculative attacks
It is major factors that triggered the crisis were high interest rates in Germany and Danish voters' refusal of the Maastricht Treaty in June. Moreover, the devaluation of US$  in that period also harm the competitiveness of countries like Italy. Many European countries face with speculative attacks.

And surprise: Italy, Spain and Portugal start to have harder time in keeping the value of currency against Marcs within the defined interval. Italy leaves the ERM. Spain and Portugal devaluate their currency.

Different than today's case, Scandinavian countries also encounter problems. On September 8, 1992 Finland allows the currency to float. Swedish banking sector suffer from significant problems since the early 1990s. High unemployment rate prevails. Speculators are aware that in such a climate Switzerland cannot raise interest rates in protect the exchange rate regime; and that even it does this cannot be permanent. 

UK case is interesting
Sweden pegging the krona to ECU in the late 1991 first tries to protect krona's value. Overnight interest rates reach as high as 500 percent! Swedish Central Bank also sells substantial amounts of foreign exchange. However, the country surrenders in November and allows krona to float.

The case for United Kingdom is also quite interesting. The country becomes a member to the ERM in 1990. Soon after, in August 1992, it faces a speculative attack.  The role played by famous speculator George Soros and his investment fund Quantum Fund in this crisis is well known. So, in order to maintain the value of sterling within the allowed interval, the Central Bank sells almost US$50 billion of foreign exchange in a couple of months. But this proves insufficient. The Bank raises interest rates in mid September. This also turns out to be insufficient. The government does not desire further hike interest rates. As a result, the UK also ends up leaving the ERM. And the sterling 'gets through' the speculative attack after 15% devaluation.

In short, such things happen. And a note: The above story does not mention Greece. The reason is quite simple: Greece became a member to the ERM in 1998. If it was earlier, I would most probably have to mention its name too.

This commentary was published in Radikal daily on 02.12.2010