Any discussion of the economy today has to begin with the most favorable economic event of the last twenty years, the collapse in oil prices. The runaway increase in oil prices in the 1970s was an enormous tax imposed on the industrial world by the oil producers. It created the inflation and the economic crisis that caused political turmoil in the West, and laid the groundwork for the third-world debt crisis with which we are still struggling. The current collapse of oil prices has just the opposite effect. It is the equivalent of having a multi-billion-dollar tax cut without increasing our deficit. It keeps inflation rates down, thus allowing interest rates to come down, along with the dollar, despite large domestic deficits and borrowing requirements.
Just when the economy was beginning to slow down, the fall in oil prices set off a stock market boom which has created, at least on paper, hundreds of billions of new wealth capable of sustaining the economy for some time in the future. Oil prices may not stay down forever. But the fall in oil prices, along with the fall in the price of the dollar and the fall in interest rates, presents an opportunity that should be seized to set the economy on a strong footing for the long run. Important initiatives will be required both domestically and internationally.
On the domestic front, it is obvious that the strong economic stimulus provided by falling oil prices and interest rates, coupled with a stock market boom, allows considerable freedom to cut the budget deficit without an economic slowdown. Despite recent optimistic statements about the deficit, it will not disappear magically; and raising revenues through higher income taxes will be resisted by both parties. We now have, however, an opportunity to combine a gasoline tax of fifty cents a gallon, phased in over two years, with a one-year freeze on all spending, including both on military appropriations and on social security and other entitlements.
This combination would cut the deficit to below $100 billion, allow for serious reexamination of long-term spending priorities, and encourage further reductions in short-term interest rates. The tax would still leave US gasoline prices at half the price Europeans have to pay. A trust fund could be set up to collect the tax and to release the funds solely to purchase government debt, thereby reducing the temptation to use tax money to increase government spending. Some politicians and economists will be tempted to impose an oil import fee, arguing that this will bring relief to the distressed domestic oil industry and to the banks that have lent money to that industry, while such debt-burdened countries as Mexico could benefit by being exempted from an import tax. Such a temptation should be resisted; there are better ways to help the banks and Mexico. The right tax, in a time of falling gasoline prices, is a simple gasoline tax.
The other major domestic issues to be dealt with are our trade deficit and international competitiveness. In 1985 the gap between what the US buys and what it sells abroad amounted to $148.5 billion, a new record. The falling dollar will help, but it will not cure so large a deficit. To do so will require greater competitiveness on our part, strong economic recovery in the third world to absorb our exports, and fairer trade practices all around.
The need for some temporary protective measures for key American industries will still remain, particularly for such industries as steel, autos, and machine tools, all of which have been seriously threatened by foreign competition. Protection, however, whether by tariffs or quotas, or by relaxation of the antitrust laws or other special regulatory or tax relief, should be conditioned on commitments on the part of both management and labor to improve the productivity of their industries. If mergers in the steel industry are encouraged, under the protection of restrictive tariffs and antitrust exemptions, the management of the merging companies should be required to commit new capital to fully modernized steel facilities and should agree to tie price increases to inflation. Labor should make long-term concessions in wages and work rules. Funds should be set aside for retraining and relocating workers displaced by new technology. It is wasteful to provide international protection and other forms of relief for American industries unless they are willing to increase their competitiveness within a specified period.
As I have argued before,* some national entity reflecting the interests of industry, labor, and government should be available to help frame and carry out such a coordinated policy. The advantages of such national mechanisms have been amply demonstrated in Japan and Western Europe. By ignoring them, the US hobbles itself in foreign competition. Our industrial problEMS are not going to be limited to the auto, steel, and machine-tool industries. They will include computers, telecommunications, and other high-technology industries. They will ultimately include service sectors such as banking and insurance. Our willingness to carry out such policies will enable us to have a stronger negotiating position toward our foreign trading partners when we negotiate over reciprocal conditions of trade.
On the international front, the question of the dollar, the trade deficit, and the third-world debt are closely interconnected. Recent initiatives by the administration have been very constructive. After several years of a hands-off policy, reflecting a pure market attitude, strong interventions by Treasury Secretary Baker and Federal Reserve Chairman Volcker with respect to the dollar and the third-world debt have had considerable impact. The dollar has fallen by 25 to 30 percent against the main trading currencies since the Plaza meeting of the so-called G-5 countries (the United States, United Kingdom, Japan, Germany, and France) in November 1985. The US has demonstrated a new willingness both to intervene in the foreign exchange markets and to coordinate its actions with Europe and Japan, as when the recent successive reductions in lending rates by the Japanese and German central banks were immediately followed by a reduction in the Federal Reserve’s discount rate.
The new US initiative with respect to third-world debt, set forth at the IMF meetings in Seoul last October, is equally significant, but it has been less successful. It is significant because it recognizes that constant reschedulings of debt and relying on the workings of the marketplace will not resolve the debt problems in the third world—and that if they are not resolved, the vast sums owed to US banks could render its entire economy vulnerable. The US government, for the first time, is now openly committed to play an important part in resolving this situation. It has been less successful than in its initiative on the dollar because collapsing oil prices have aggravated the situation of oil-producing borrowers like Mexico to the point where stronger measures will have to be considered.
Finally, in his State of the Union address President Reagan said he was directing the secretary of the treasury to study the possibility of an international monetary conference, a new Bretton Woods, aimed at the creation of a more stable system.
All these initiatives show a new attitude—a willingness by the US government to intervene in markets and to take the lead in cooperating with our Western trading partners. Such initiatives may be the limit of what is politically possible for the moment, but more will have to be done, especially when it comes to the third-world debt.
The notion of a new Bretton Woods conference to try to evolve a more stable international monetary system is long overdue. This should be the main item for consideration on the next economic summit in Tokyo in May 1986. Such a conference should take up the subjects of exchange rates and debt. They cannot be separated. Concerning currencies, the conference should deal with both near-term and long-term objectives. For the near term, the conference should aim to establish “target zones” for the dollar, the deutsche mark, sterling, and yen—ranges in which exchange rates would be permitted to fluctuate under an agreement to keep the rates from breaking through either end of the range. At the same time, large-scale interventions in the markets to defeat speculative runs on the main currencies must be backed by a sizable and credible intervention fund. The main central banks should as soon as possible establish a $20 to $30 billion exchange stabilization fund for this purpose.
For the long term, an expansion of the European Monetary System to include sterling, dollars, and yen should be considered. The EMS, on the whole, has been successful in maintaining a level of cooperation and coordination among members. Devaluations and reevaluations have occurred, but as part of an orderly, gradual process. It is time to study how it can be expanded. In order to do so, however, the obvious fact to be faced is that the dollar now accounts for some 80 percent of the world’s currency reserves—the currency that governments and international agencies hold to finance international trade; this disproportion must be counterbalanced by larger volumes of other currencies than are available today. The European Currency Unit (ECU)—which is based on a “basket” of European currencies—and the yen offer the best possibilities.
The ECU is already actively traded. Its greater use as a reserve currency, however, would depend on much greater integration of the European economies, and would really imply the creation of a European currency with a considerable volume. Bringing about such a development would represent a difficult political challenge, one that would take years to meet. What Jean Monnet tried to do in creating the European Coal and Steel Authority, namely to unite Europe politically in response to industrial needs, might be more feasible during the 1990s in response to financial needs. No matter how difficult, this remains a highly desirable objective. On the other side of the world, Japan will also have to allow its financial markets and currency to be used in stabilizing the world monetary system, and to do so it would have to increase their size considerably.
In the long run, currencies cannot be stabilized without considerably closer coordination between nations and, in some cases, integration of their economic policies. Central to both goals will be the creation of currencies or baskets of currencies in sufficient volume to counter-balance the dollar.
In February, Mr. Héctor Hernández, Mexico’s minister of commerce, said his country would not be able to make full interest payments on its $93 billion in foreign debt. The current crisis in Mexico, only partly caused by falling oil prices, concentrates attention once again on the problem of international debt, which only recently had been considered as a thing of the past. It is not a thing of the past; it will be with us for a long time to come. How we handle it may determine whether we use the present opportunity to set the world economy on the path of long-term growth. Without growth there is no hope for political stability in developing countries and no hope that the growth of exports from the US and Europe, critically important to both, will take place.
See for example, "Time For a Change," The New York Review (August 18, 1983).↩
See for example, “Time For a Change,” The New York Review (August 18, 1983).↩