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If the Greek CB wanted to put downward pressure on the D-Mark/Drachma exchange rate, they would sell into the open market, not bilaterally to the BuBa. And if the BuBa defended against it, the spread between the Greek attack bid and the BuBa defense bid would go to some arbitrageur, who would accumulate some combination of D-Mark and Drachma, which he would then either spend on goods (giving him a free lunch at the expense of the Greek and German citizens), or (more likely) exchange for other currencies in the open market, putting downward pressure on the D-Mark/Drachma couple.

Eventually one of the principal participants would bow out, the other would set whatever discount it wanted relative to the rate at which the former stopped defending its discount. You would have discovered the exchange rate which neither central bank could feasibly attack (and since the central banks, collectively, have greater pricing power than any speculator, by inference also from speculative attack).

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Tue Apr 10th, 2012 at 04:59:38 AM EST
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