More than two hundred years after the Declaration of Independence, the United States has lost its position as an independent power. While we are still without question the world’s leading military power, our predominance in weapons does not give us the freedom to act on our own. The hundreds of billions of dollars we have spent on weapons systems were simply part of an escalating process by which nuclear and conventional weapons were manufactured to deter and neutralize their corresponding equivalents in Soviet military power. Few of these weapons systems are ever likely to be used, or indeed could be used without causing unimaginable disaster to both sides. However, the drain on our economy created by the combination of high levels of defense spending, large tax cuts, and continuing growth in entitlement programs is turning the US into a historical anomaly: a first-rate military power and a second-rate economic power.
The military stalemate between the two superpowers, each with serious, though different, domestic problems, has in recent years created a new situation in which independence of action for the other advanced countries depends on the economic power generated by surplus capital, technology, education, and discipline. Japan and West Germany have been generating huge trade and capital surpluses and have become leading, independent world powers. The fact that they still rely on our military power, while we rely more and more on their capital, creates a situation of relative equilibrium and mutuality of interests between the US, Japan, and West Germany.
But this situation is changing: our dependence on foreign capital is growing while the threat of Soviet military force seems to be receding, and arms reduction agreements may be more feasible than they have been in the past. The economic power and the independence of action of Japan and West Germany, relative to the US, are bound to increase; so will our own dependence on their capital. What is at stake is not only the loss of our position as the leader of the Western democracies, but the loss of our independence of action both in economic and in foreign policy. The dependence of the US on foreign capital while it tries to maintain military superiority over the Soviet Union has eliminated the distinctions between foreign and domestic policy as well as the line between domestic economic policy and national security. Our increasing dependence on foreign capital is not just an economic issue. It is also a security issue, as well as a political issue with major implications for foreign and domestic policy.
The extent to which the US is a prisoner of foreign capital becomes apparent when we consider three facts: our net foreign debt is now the largest in the world; the outflow of financial payments (dividends, interest, etc.) is now greater than our inflow; the dollar is at, or near, its lowest level since World War II. We need not dwell on how this situation came about. For too many years the US has had consistently high budget deficits, a high rate of consumption, and a low rate of domestic savings; it resorted to foreign borrowing to finance the deficit while the dollar soared and a huge trade deficit accumulated. During the 1980s the only change in what was, in effect, a program for ultimate economic and financial hardship was the collapse of the dollar, which, over the last two years, lost more than 50 percent of its value in relation to the yen and the deutsche mark. We now conform to the classic model of a failing economic power: with increasingly high levels of foreign debt, a constantly depreciating currency, and a continuing negative trade balance, whether the dollar is rising or falling. We are about to add to this list a rapid rise in the level of US assets owned abroad.
Despite the recent bipartisan budget agreement brought about by the October stock market crash, and despite domestic economic statistics that appear reasonably stable, the underlying trends in our economy are still negative. The Congress and the President have recently created a bipartisan National Economic Commission to make recommendations with respect to these issues to the next president. The creation of this commission recognizes implicitly the difficulty of addressing such complex issues realistically and truthfully in an election year. The debt, public and private, domestic and foreign, keeps growing at a high rate; so does the annual trade deficit, despite a significantly lower deficit in November. Currencies swing wildly, responding to speculation and capital flows and central bank intervention rather than to classic commercial relationships. The gaps between wealth and poverty, worldwide, are becoming greater.
We hear much brave talk of the need for multinational cooperation to keep these trends under control, and such coordination has occurred from time to time, for example when foreign governments have tried to support the dollar. But such efforts are never broadly enough conceived or long enough sustained. The fact is that international economic coordination and cooperation, which have difficult internal political side effects, can take place only if a strong economic power can provide leadership. Whether we like it or not that leadership can only come from the US. In order to exercise it, the US must have the freedom to act independently with respect to its domestic economic and social policies. But we no longer have such freedom. We are becoming as constrained, in some ways, as other large external debtors such as Brazil and Mexico. I believe that this country will not be able to deal politically with its economic problems until a simple, basic requirement is recognized: to recapture our lost financial independence.
Financial independence would not mean that we could cut ourselves off from the rest of the world: with a national debt above $2.5 trillion and a foreign debt reaching almost $500 billion and both headed higher, our need for foreign capital will be with us for a long time. It can be extremely positive for our economy. But we must have access to that capital on normal terms. We cannot allow a situation to occur in which currency markets or foreign governments can impose terms that are increasingly onerous because our need for external capital is so critical and the size of our requirements is so vast. We are perilously close to such a situation now. We should have as our objective stabilizing the level of our foreign debt within five years.
By what means can the US recapture its independence? The first and most important is obviously through our domestic budget. Second, by stabilizing the main world currencies in relation to one another. Third, by encouraging the recycling of surplus capital to the third world, especially Latin America. Fourth, by creating balanced relationships between our trade and investment policies. All of these, by now, involve important foreign policy decisions that will have large effects on the domestic economy.
Our domestic budget deficit was, during the last few years, unquestionably the easiest problem to deal with. It would not have required great sacrifice, especially during a period of low inflation and economic growth, to eliminate much of it. Any one of the reasonable strategies of moderate tax increases and cuts in expenditures that were proposed would have reduced government borrowing by hundreds of billions of dollars over this period, reduced interest rates, and stabilized our currency as well as our trade. Such policies would not have put the domestic economy at risk and they would have remained entirely under American control.
By now, the situation is altogether different: we can expect no further action on the deficit until 1989 at the earliest (unless another financial shock comes along), and we are now at any time vulnerable to a recession that could have a dangerous impact on our domestic economy as well as on world-wide financial markets. In other words, we will have to do painfully in 1989 what we could have done easily in 1984 or 1985. The remedy will have to be accompanied by significant cuts in interest rates to reduce the risk of recession. The delay will be extremely costly.
Trade is in many ways a much more complicated problem than the budget. Technology has become easily transferable throughout the world. The components of many products assembled in the US come from different parts of the globe; manufacturing facilities are more and more dispersed geographically; the service sector continues to grow faster than manufacturing does. All of these factors, and many others, have created new realities that do not respond in the classic ways to changes in currency rates, the so-called J-curve, etc. We must not forget that the $13 billion November trade deficit that generated such euphoria would have been considered a disastrous annual deficit just a few years ago. Even though the conventional wisdom is almost universally opposed to protectionism, it is silly to pretend that a 50 percent currency devaluation, such as the US has recently orchestrated, is not protectionist in intent, even if it is deficient in actually protecting domestic industry. It is by no means certain that temporarily limiting the foreign shares of certain of our main markets to reasonable percentages, by administrative means, might not be preferable to further significant currency devaluation, especially if such temporary restrictions were coupled with important domestic investment commitments and vigorous cost control.
Our trade situation is also inevitably tied to third world debt issues. If we are not to reduce our trade deficits through either recession or blind protectionism (or both), increased US exports to third world countries, especially our traditional markets in Latin America, are critical. So is maintaining democracy in such countries as Mexico, Brazil, and Argentina. While the recent restructuring of a limited part of the Mexican debt with US government cooperation was imaginative and helpful, it covers only a small part of the debt. In addition to restructuring, the fundamental problem of finding new capital for these countries remains.
The question of foreign investment may also have to be reviewed. The inevitable result of continuing dollar devaluation will be, sooner or later, very large purchases of US assets by Japanese, German, and other foreign investors. Those assets will not necessarily be relatively passive ones, such as government bonds, real estate, or general portfolio investments. They may consist of large, possibly controlling, interests in many of our major companies and financial institutions. It is worth noting that SONY’s recent purchase of CBS’s record division for $2 billion, which seemed to be an irresistible price to CBS, represented the same amount of yen as would have amounted to $1 billion two years earlier. The dynamics of a combination of continued accumulation of capital abroad, a cheap dollar, possibly lower American securities markets, and large losses suffered by foreign institutions in US bonds can have only one result: large direct investments in US assets.