PART III: U.S. INTERNATIONAL ECONOMIC POSITION-DATA AND ANALYSIS CHANGE IN THE U.S. INTERNATIONAL ECONOMIC The decade of the 1980s ushered in a period of deterioration in the U.S. external accounts to a degree unprecedented in modern U.S. history. The balance on the U.S. merchandise trade and current accounts turned sharply into deficit, and the United States became the world's largest debtor country in the space of just a few years. To be sure, the United States had confronted serious challenges on the international economic front before. In 1971, following substantial downward pressure on the dollar and in the face of the first U.S. merchandise trade deficit since 1893, President Nixon suspended the convertibility of dollars into gold or other reserve assets, imposed a 10-percent surcharge on imports, and called for negotiations with major trading nations to lower the fixed exchange rate of the dollar in order to restore U.S. international competitiveness. That action, and the inadequacy of the newly agreed exchange rate system, led to the total collapse of the postwar Bretton Woods system of fixed exchange rates in 1973. The experience of the 1980s differed substantially from that of the 1970s, however. In the 1980s, the world was operating under a system of largely floating exchange rates (although some currencies remained fixed), which was expected to provide automatic adjustment of payments imbalances through appreciation or depreciation of currencies in response to changes in countries' international competitive positions. In addition, substantial deregulation of, and innovation in, private capital markets meant that tremendous volumes of funds could be shifted across national boundaries in seconds, totally outside the control of governments. Under such a system, exchange rates are not determined by government fiat; and payments imbalances do not lend themselves to correction by import surcharges or other measures imposed solely at national borders. Instead, they are brought about and corrected by more fundamental aspects of countries' domestic and international economic competitive positions. CAUSES OF THE U.S. TRADE and Current ACCOUNT DEFICITS The emergence of large U.S. trade and current account deficits beginning in the early 1980s has been attributed widely to several major factors. First, in 1982, the world was in the midst of the worst economic downturn in the postwar period, with accompany ing stagnation in world trade growth. The United States was the first major country to emerge from recession; its real gross national product (GNP) grew by a healthy 3.6 percent in 1983 and a robust 6.8 percent in 1984, up from a negative rate of 2.5 percent in 1982. Strong U.S. economic growth, which substantially outstripped that of its trading partners, stimulated U.S. import demand, while overseas demand for U.S. exports remained sluggish. Between 1982 and 1984, U.S. imports rose 33 percent, while U.S. exports rose only 3 percent. Second, the developing country debt crisis beginning in 1982 resulted in a sharp decline in U.S. exports to debtor countries, particularly in Latin America where much of the debt problem initially was concentrated. The inability of key countries in Latin America and elsewhere to service their debt-which had increased substantially following the oil shocks of the 1970s and had been exacerbated by the very high interest rates of the late 1970s and early 1980s-meant that they simply did not have sufficient foreign exchange to continue purchasing goods and services from abroad. Between 1981, when U.S. exports to the region hit a then all-time high, and 1983, U.S. exports to Latin America fell 62 percent. (It was not until 1988 that U.S. exports in nominal terms exceeded their 1981 levels.) At the same time, debt-strapped nations of Latin America took dramatic steps to restore their solvency and improve their ability to export, including exchange rate depreciation (since their currencies had remained pegged to the dollar in many cases). U.S. imports from Latin America rose 26 percent between 1982 and 1984 alone. A third important factor affecting U.S. international competitiveness in the early 1980s was the substantial rise in the value of the dollar against other major currencies. Funds flowing into the United States (or capital inflows) push up the value of the dollar on foreign exchange markets. Funds flowing out of the United States (or capital outflows) push down the value of the dollar. Beginning in the early 1980s, foreign capital inflows grew much more rapidly than capital outflows, resulting in substantial dollar appreciation. On a trade-weighted, inflation-adjusted basis, the dollar rose 16 percent between 1981 and 1983, and 27 percent between 1981 and 1984. When the dollar peaked in 1985, it was 31 percent above its average 1981 level. Dollar appreciation eroded the competitiveness of U.S. exports by raising their price on world markets, while simultaneously improving the price competitiveness of imports in the U.S. market. There are a number of explanations that have been given for dollar appreciation in the early to mid-1980s, although economists disagree over the relative weight which should be given to them. Some of the factors leading to increased flows of foreign funds into dollar assets or reduced outflows of U.S. funds into other currencies include the following: Strong U.S. economic growth made investment in the United States highly attractive for both U.S. and foreign investors. Liberalization of government controls in foreign financial markets, particularly Japan, resulted in a significant increase in foreign purchases of U.S. assets, particularly U.S. Government securities. The role of the U.S. dollar as a "safe haven" investment in times of economic and political uncertainty undoubted ly also was a factor affecting the flow of foreign funds into dollar assets. "Capital flight" from the debtor countries of Latin America and elsewhere buoyed the value of the U.S. dollar, as residents of those countries sought safe investments in a currency other than their own. In response to defaults on debt payments by major debtor nations and other uncertainties, U.S. commercial banks sharply reduced their overseas lending after 1982. (The total flow of private capital out of the United States fell from $113 billion in 1982 to $50 billion in 1983 and $22 billion in 1984.) Finally, the U.S. budget deficit rose sharply, growing from 2.6 percent of GNP in 1981 to 6.3 percent in 1983 (including both on- and off-budget Federal expenditures). The rising budget deficit resulted in a growing gap between U.S. savings and U.S. domestic investment needs. That gap was filled by funds from abroad, a gap which continues today. In response to the major factors described above, the U.S. merchandise trade deficit rose from $22 billion in 1981 to a peak of $153 billion in 1987. The U.S. current account-the balance of trade in goods and services, net investment income, and net unilateral transfers (such as social security payments to citizens living abroad)-shifted from a surplus of $6.9 billion in 1981 to a deficit of $162 billion in 1987. In response to rapidly rising foreign investment in the United States and slower growth of U.S. investment overseas, the net investment position of the United States also moved into deficit in 1985.1 This shift meant that in 1985 the United States became a net debtor for the first time since 1914, when the economy still was in a phase of rapid industrialization. RECENT DEVELOPMENTS AND OUTLOOK Major changes on a number of fronts-exchange rates, developing country debt, and world economic growth rates-began to take place in the mid- to late-1980s, resulting in a steady decline in U.S. trade and current account deficits through 1990. Exchange Rates. In September 1985, the finance ministers and central bank governors of the Group of Five (G-5) 2 industrial nations met at the Plaza Hotel in New York City and agreed to cooperate in efforts to reduce further the value of the dollar on foreign exchange markets. (The dollar had begun a generalized decline against most foreign currencies in February 1985.) Following the so-called "Plaza Accord," the dollar continued its decline against major foreign currencies through 1988. The dollar rose again in 1989 but resumed a generally downward trend through 1990, ending the year about 11 percent lower on a trade-weighted, inflation-adjusted basis than at the beginning of 1990. Overall, dollar depreciation after 1985 brought the dollar in 1990 to the lowest 1 A number of recent studies have raised questions about the method used to calcalute the net international investment position of the United States (see note on Table 6 in the data section.) The Department of Commerce's Bureau of Economic Analysis is revising the methodology used to value the various components of investment flows into and out of the United States. Those revisions are likely to result in a reduction in the reported level of U.S. net international indebtedness. Despite questions as to the precise magnitude of the U.S. net investment position, however, the deteriorating trend is clear, as is the strong probability that the United States is a net international debtor. 2 The G-5 countries include: France, Germany, Japan, United Kingdom, United States. level of the decade. This substantial dollar depreciation helped restore the price competitiveness of U.S. exports and reduce the attractiveness of imports to U.S. buyers. Developing Country Debt. Although overall levels of developing country indebtedness have increased throughout the 1980s, internal economic reforms, lower interest rates, assistance from international financial institutions, and other measures have helped reduce the debt service burden on many debtor countries. Öne result has been an increased ability of those nations to finance imports from abroad, including from the United States. Between 1986 and 1990, U.S. exports to Latin America rose 70 percent (while our imports from the region rose by just under 50 percent). During the same 5-year period, U.S. exports to Mexico rose 130 percent. Economic Growth Rates. Finally, the second half of the 1980s saw greater symmetry of growth between the United States and its trading partners. As foreign economic growth rates increased, demand for U.S. exports also grew. Between 1985 and 1990, U.S. exports grew by 80 percent, nearly twice the rate of growth of U.S. imports. Significantly, in 1990, U.S. exports accounted for 88 percent of U.S. GNP growth. The net effect of these developments has been to put the United States on a path of steadily declining external deficits over the past few years. The U.S. merchandise trade deficit peaked in 1987 at $153 billion and fell to a level of $101 billion in 1990. The U.S. current account deficit declined from its 1987 peak of $162 billion to $99 billion in 1990. These improvements have been driven primarily by strong U.S. export growth, coupled with slower growth in imports. Given projected rates of growth of the United States and its trading partners, exchange rates, and other key factors, the United States may see continued, albeit slow, improvement in its trade and current account deficits in the immediate future. However, absent more substantial changes in the outlook, any improvements may stall out or even begin to reverse in the not too distant future. UNITED STATES AS A DEBTOR COUNTRY The U.S. dollars that flow out of the United States through its trade and current account deficits are approximately equal to the U.S. dollars that flow into the United States as a foreign capital inflow. Why? A current account deficit means that Americans are buying more from overseas than they are selling, thereby putting dollars into the hands of foreign firms and individuals. Those dollars do not disappear into thin air; they flow back into U.S. assets. As long as the United States continues to "live beyond its means"-i.e., continues to buy more (from abroad) than it produces at home, and remains dependent on foreign capital to fill the gap between what Americans save and what they invest-then the United States will continue to run trade and current account deficits and to increase its net foreign debt. An increasingly important component of the U.S. current account is interest paid to foreigners on the U.S. assets that they hold. In fact, in 1989, for the first time in modern U.S. history, U.S. interest paid to foreigners ($128.4 billion) exceeded U.S. interest earned from assets held abroad ($127.5 billion). In 1990, U.S. payments on foreign assets in the United States totalled $121 billion while U.S. earnings from overseas assets totalled $129 billion. As the net indebtedness of the United States grows, our net payments to foreigners also will grow. How can the United States begin to reverse the trend of growing net international indebtedness which it has experienced since 1985? As the previous discussion has suggested, a wide variety of factors affect the international competitive position of any economy, including the U.S. economy. Not all of the factors are subject to the control of any one government or group of governments. However, a number of factors can be cited which would have an important bearing on the future international economic position of the United States. Further dollar depreciation would lend additional impetus to U.S. exports and help dampen the U.S. appetite for imports. However, because dollar depreciation also raises concerns about inflation (e.g., through more costly imports of oil and other goods and commodities), such an adjustment is not without potential costs. Moreover, it is not at all certain that U.S. trading partners, a number of which have seen their current account positions deteriorate in recent years, would support joint efforts to reduce the value of the dollar against their currencies, to the possible detriment of their own export competitiveness. Continued U.S. recession would reduce U.S. demand for imports (along with demand for domestically produced goods). If combined with strong growth overseas and concommitent strong demand for U.S. exports, slow U.S. economic growth could lead to further improvement in the trade and current account deficits. For obvious reasons, however, a prolonged U.S. economic recession is hardly a desirable means to correct the country's external deficits. The single factor most amenable to action by U.S. Government policymakers remains the Federal budget deficit. As noted above, U.S. domestic savings currently are inadequate to fund the broad range of Americans' consumption and investment activities. The gap between the U.S. supply of savings and its demand for investment funds is filled by foreign investors. Some of those foreign funds are used to make direct investments (e.g., in plant, equipment, and other real estate), while other funds flow into U.S. Government securities, commercial bank deposits, and corporate stocks and bonds. To the extent that foreign funds are used to finance and build U.S. productive capacity, those funds will help generate future income with which to pay interest on U.S. foreign debt. Unfortunately, a substantial portion of the foreign funds that have flowed into U.S. assets thus far have been used to finance American's current consumption. In essence, American's current consumption will be paid for by future generations, and the growth in Americans' future standard of living will be lower than it otherwise would be. The Federal Government is an important element in this picture. The Federal budget deficit diverts a substantial portion of personal and corporate savings that otherwise could be put to more productive use as a source of domestic financing for U.S. private invest 40-401 0-91--31 |