so-called "Plaza Accord," the dollar continued its decline against major foreign currencies through 1988. The dollar rose again in 1989 but resumed a general 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 back to its 1980 level. 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 $102 billion in 1990. The U.S. current account deficit declined from its 1987 peak of $164 billion to $90 billion in 1990. These improvements have been driven primarily by strong U.S. export growth, coupled with slower growth in imports. The United States' 9th post-war recession that began in mid-1990 and continued through mid-1991 greatly dampened the demand for imports. This effect became most evident in 1991 as the merchandise trade deficit fell substantially to $66 billion. An even greater fall occurred in the current account deficit which shrank to a mere $4.0 billion in 1991, reflecting, in addition to the effects of recession, a $40.0 billion inflow of transfers from our allies to support the Iraq-Kuwait war. The inflow of such large transfers has now stopped and with the emergence of economic recovery raising the demand for imports, the merchandise and current account deficits are expected to again swell. The relatively weak value of the dollar does make American exports very competitive in the world market, but pervasive economic weakness abroad will likely lead to only a moderate nearterm expansion of U.S. export sales. The projected effect, absent substantial policy changes, is a steady swelling of the current account deficit to the $75 to $100 billion range, and of the merchandise deficit to the $100 to $150 billion range by mid-decade. An enduring reduction of the trade deficit will occur when the U.S. permanently narrows the imbalance between domestic savings and investment. The most direct path to this goal would be to raise domestic savings via a sizeable reduction in the Federal budget deficit. 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; if not used to purchase U.S. goods they must be used to purchase 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. These payments have grown from $53 billion in 1981 to about $120 in billion in 1990. With the onset of recession and falling interest rates, these payments shrank to about $110 billion in 1991. Receipts on U.S. assets abroad continue to exceed payments, but the surplus in the category has been halved, going from $33 billion in 1981 to near $16 billion in 1991 as a result of growing foreign indebtedness. As large trade deficits cause the net foreign indebtedness of the United States to grow so will our interest payment to foreigners. Such payments of foreign debt service ultimately represent an outflow of real goods from the U.S. and can be a potential detriment to domestic living standards. 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 reduces the real wages of U.S. workers as it raises the relative price of imports, such an adjustment carries a clear and significant cost to the U.S. economy. 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. Another U.S. recession would reduce U.S. demand for imports (along with demand for domestically produced goods). If combined with strong growth overseas and concomitant 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 fundamental cause of the trade deficit is the shortfall of U.S. savings relative to the need for investment. That gap is now filled by an inflow of foreign savings. 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 have been used to finance Americans' current consumption. In essence, Americans' 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 contributor to the shortfall of domestic savings relative to investment. 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 investment needs.* Continued reduction of the Federal budget deficit would help reduce the gap between U.S. savings and investment, thereby reducing the U.S. trade deficit, and beginning to reverse the deterioration in the U.S. international debt position. Many economists have expressed concern that heavy U.S. dependence on foreign capital makes the U.S. economy vulnerable to actions by foreign investors. For example, U.S. interest rates must be kept sufficiently high to compete with (recently rising) interest rates overseas, in order to continue attracting foreign investors and to keep U.S. investment funds at home. Moreover, any uncertainties about the U.S. ability to service its large and growing foreign debt could cause foreign investors to halt new investments or to pull out old ones, potentially causing rapid and substantial dollar depreciation, inflation, and recession in the United States. While the risks of heavy U.S. dependence on foreign capital are real, a cautionary note is in order concerning the prospects for such an abrupt shift in investor confidence in the United States. While overall U.S. debt levels-both domestic and foreign-are high, they are not as high as a percent of GNP as the debt levels experienced by many countries of Latin America, Eastern Europe, and elsewhere. The level of U.S. net foreign debt is just over $300 billion representing a relatively modest 7 percent of GNP; the debt of Latin American countries taken as a whole reached levels that were four times that high, with individual countries' debt levels reaching even higher peaks. There is little sign so far that foreign investors question the ability of the United States to service its debt. Nonetheless, the deteriorating trend is cause for concern. * A related concern is the steady decline throughout the 1980s of total personal and corporate saving-from 18.4 percent of GNP in 1981 to 14.5 percent in 1990. Just like every other debtor country, the United States has only one way to reverse its continuing slide into greater foreign indebtedness. The United States ultimately must produce more than it consumes. This means that the United States will have to run a surplus of trade in goods and services. Because manufactured goods currently constitute about 60 percent of world trade, much of the turnaround in the U.S. deficit will have to come in the manufactured goods area. New export opportunities for services also would help reverse the U.S. deficit position. The longer that an improvement in the U.S. savings/investment gap and reduction of the trade deficit is delayed, the higher the adjustment cost will be. As net U.S. international debt continues to rise, the size of the surplus in goods and services that will be required-not just to service the debt but to reduce it as well-also will rise. Therefore, early action on factors affecting the U.S. trade and current account deficits and U.S. international indebtedness will help reduce the risks entailed by heavy U.S. reliance on foreign capital and help forestall the need for even greater, and potentially more disruptive, adjustments at a later date. |