MONEY: A New System's Big Test

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THE international agreement last December that devalued the dollar and established a new set of exchange rates for major currencies was delicately balanced. It stipulated not only what the dollar was worth in terms of other currencies, but how many German marks a Dutch guilder would buy, how many Japanese yen a French franc would equal, and so on. It was inevitable that sooner or later doubts about the value of at least one of these currencies would put the system to a severe test. The test came last week, when an explosion of currency speculation left the whole network of rates badly shaken, and moneymen scurried to shore it up.

The trouble started with the British pound, which had been weakened by rampant inflation. Denis Healey, financial spokesman for the Labor Party, predicted in a speech in Parliament early last week that the Tory government would devalue the pound in July or August. Currency speculators—mostly commercial bankers and treasurers of multinational corporations—took Healey's forecast as confirmation of their worst fears and began to unload pounds. On a single day, Thursday, about $1.2 billion worth of pounds were sold by speculators. In order to keep the pound's price in other currencies from dropping too sharply, European central banks had to pay out some $2.5 billion.

By Friday morning the government of Prime Minister Edward Heath had had enough. Rather than continue using up its foreign currency reserves, it announced that it would let the pound temporarily "float"—that is, trade on international exchanges at any price set by supply and demand. That move in effect devalued the pound, and it quickly sank as low as $2.46 in New York City. The drop canceled two-thirds of the increase in the pound's dollar value, from $2.40 to $2.6057, that was agreed upon in Washington, D.C., in last December's realignment of currencies, called the Smithsonian agreement.

Halting Trading. Far from calming the markets, the British move set off a stampede of speculation that within hours forced currency markets in Europe and Japan to slam shut their exchange windows; they were not scheduled to open again until Tuesday of this week. The dollar, which most money traders consider to be the weakest currency after the pound because of the gigantic U.S. balance of payments deficit, quickly came under attack. The West German Bundesbank had to buy almost $900 million in 90 frenzied minutes Friday morning before officials finally halted trading. In Switzerland, monetary authorities decided not to buy dollars to hold up the price, letting the dollar float down against the Swiss franc. As the situation worsened, French Finance Minister Valéry Giscard d'Estaing conferred with President Georges Pompidou and then announced that Common Market central bankers would meet in emergency session in Paris over the weekend to consider what to do.