Economic Growth for Many Countries Dependent on Obese U.S. Trade Deficit

By Volcker, Paul A. | THE JOURNAL RECORD, September 7, 1985 | Go to article overview

Economic Growth for Many Countries Dependent on Obese U.S. Trade Deficit


Volcker, Paul A., THE JOURNAL RECORD


The massive U.S. trade deficit, which has rapidly developed over the recent period of economic expansion, is the most obvious and concrete reflection of this country's underlying economic imbalances.

The trade deficit, in an immediate sense, has been primarily related both to the strength of the dollar in the exchange markets and to relatively slow growth elsewhere in the world. In effect, muchof the world has been dependent, directly or indirectly, on expanding demand in the United States to support its own growth.

Put another way, growth in domestic demand in Japan, Canada, and Europe has been less than the growth in their Gross National Products, which is the converse of our situation.

Even with surging exports to this market, output has been increasing too slowly to cut into high rates of unemployment in Europe and elsewhere. As a consequence, the demand of others for our products has been relatively weak.

The strong competition from abroad, in an immediate sense, had benefits as well as costs for this country. It has been a powerful force restraining prices in the industrial sector and in encouraging productivity improvement.

The related net capital inflow has eased pressures on our interest rates and capital markets. We have been able to readily satisfy the higher levels of consumption driven in party by the budget deficit.

However, those benefits cannot last. Sooner or later our external accounts will have to come much closer toward balance. Indeed, as our debts increase, we will have to earn more in our trade to help pay the interest.

In the meantime, the flood of imports, and the perceptions of unfairness which accompany it, foster destructive protectionist forces. The domestic investment we will ultimately need is discouraged while our companies shift more of their planned expansion overseas.

The larger the external deficits and the longer they are prolonged, the more severe the subsequent adjustments in the exchange rate and in our economy are apt to be. We will have paid dearly indeedfor any short-term benefits.

These considerations have tempered the conduct of monetary policy for some time. Specifically, our decisions with respect to providing reserves and reducing the discount rate have been influenced to some extent by a desire to curb excessive and ultimately unsustainable strength in the foreign exchange value of the dollar.

We have also, however, had to recognize the clear limitations and risks in such an approach.

The possibility at some point that sentiment toward the dollar could change adversely, with sharp repercussions in the exchange rate in a downward direction, poses the greatest potential threat to the progress we have made against inflation. Those risks would be compounded by excessive monetary and liquidity creation.

There is little doubt that the dollar could be driven lower by "bad" monetary policy - a policy that poses a clear inflationary threat of its own and undermines confidence. But such a policy could hardly be in our overall interest. It would, in fact, be destructive of all that has been achieved.

The hard fact remains that so long as we run massive budgetary deficits, we will remain dependent on unprecedented capital inflows to help finance, directly or indirectly, that deficit. The net capital inflows will be mirrored in a trade deficit - they are Siamese twins.

As things now stand, if our trade deficit narrowed sharply, both the budget deficit and investment needs would have to be financed internally, with new pressures on interest rates and a squeeze on other sectors of the economy.

Some of these are now doing relatively well, such as housing. Some, such as farmers and thrift institutions, are already under strong financial pressure. The implications for our trading partners and for the heavily indebted developing countries would be severe as well. …

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Economic Growth for Many Countries Dependent on Obese U.S. Trade Deficit
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