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.
Under normal circumstances foreign investment should flow freely to the US, the more the better, and this is especially the case when we depend upon such investment to finance our budget deficits. It may no longer be so clear if depressed currency and securities markets cause foreign investment to shift significantly from US government bonds to purchases of major interests in our larger institutions, in amounts many times greater than at present.
The value of the dollar is clearly a new factor. For example, the Fuji Bank has a current market value of about $60 billion; Morgan Guaranty Trust Company of about $6 billion. Toyota’s market value is about $40 billion; Chrysler’s about $4 billion. Matsushita Electric’s market value is about $30 billion; Westinghouse’s about $6 billion. These market values reflect both the value of the yen and the level of the Tokyo stock market. It does not require a great leap of imagination to see that Japanese companies, taking advantage of a high yen and a high Tokyo stock market, are able to acquire controlling interests in major American companies at relatively small cost to themselves, in relation to their own equity values. No other major industrial power in the world, certainly not Japan, and not even Great Britain, allows major companies of strategic importance to be acquired by foreign interests without government approval.
Sooner or later we may find it necessary to establish a legal mechanism to review such potential acquisitions from the point of view of the national interest, if they occur in highly concentrated industries or other sensitive parts of the economy. We currently have a review mechanism for foreign acquisition of companies with defense-related activities. It would be logical to extend that kind of national security mechanism to other sensitive industries. For instance, should we allow SONY to acquire control of Time Inc. instead of CBS Records? Would we allow purchase of foreign control of the Morgan Bank?
To give such review mechanisms serious consideration should not be viewed as a xenophobic reaction. If currently distorted market conditions create a trend toward such acquisitions, a highly selective review mechanism may become necessary; but this would not cause the flight of foreign capital any more than such procedures have caused capital flight from the UK, Germany, or Japan. Most foreign investments pose no difficulties, and create employment as well as other beneficial economic activity; but Americans may legitimately feel that some major institutions should be protected from foreign control.
I know that it is heretical even to suggest that some limitation on freedom of trade and investment is worth considering, and I am not recommending that any restrictions now be adopted. I suggest, however, that we may have to look at some unpleasant choices, unless there is a significant change in our own financial condition and our relationship with the rest of the world.
The U.S. should maintain open trade markets and open financial markets for the benefit of all parties; but our partners and allies in Europe and Japan should be called upon to make two kinds of major financial contributions, in addition to truly reciprocal open trade and investment policies. The first is obvious: to participate to a greater extent in our defense burden, especially the cost of our forces overseas. Maintaining troops in Europe and in the Far East now costs tens of billions of dollars each year. That cost will obviously rise significantly with the depreciation of the dollar. While we must continue our current defense commitments, our allies in Western Europe and the Far East are sufficiently strong, economically and politically, to pay at least half of these costs themselves.
Secondly, our allies should finance most of the new capital requirements of the principal third world debtors through major contributions to the capital of the World Bank. This could significantly improve our trade balance by enabling these countries to import US-made goods in much larger quantities. In addition to contributing to defense costs, countries with a capital surplus should therefore be asked to provide at least $50 billion of new financing over the next five years to the World Bank and other multinational financial institutions. This, together with existing debt restructuring such as the recent arrangement with Mexico, would provide part of the new capital that will be required to ensure third world growth. Japan’s former prime minister Nakasone talked of such an approach last year but, so far, little seems to have come of it.
Only when major steps have been put in place to stabilize our own as well as the world economy can we expect currencies to be stabilized effectively. An under-valued dollar is neither a symbol of strength nor an unmixed economic blessing. Another Bretton Woods conference is needed to agree on predictable (not necessarily fixed) relationships between the European currencies, the dollar, and the yen. It is obvious that the swooping currency movements of the last decade have been highly destructive. Stabilization of currencies at a given level, however, requires a willingness on the part of the major countries to coordinate fiscal and monetary policies, as well as the capacity on the part of national banks to intervene strongly in financial markets. When there is no leader to set the tone, as the US did until the 1970s, the history of coordination and cooperation is not encouraging. Japan has not been inclined to take strong international initiatives or responsibilities. That leader can only be a financially independent US.
“Nations have no friends,” said Charles de Gaulle. “Nations have only interests.” De Gaulle was right. Friendships are important, as are cultural and historical affinities. But interests will always carry the day. That is why it is critically important for the US to regain its economic independence and its freedom of action. It is now in Japan’s interest to support our economic growth, but we must be able to carry on our business whether or not it is in Japan’s interest to finance our deficits; whether or not it is in Europe’s interest to share in our defense burden; whether or not the Soviets are accommodating on arms reduction.
Our domestic economic policies must therefore be geared to the overriding goal of regaining greater freedom of action. To do so will require not only lower budget deficits and lower foreign borrowing, but higher savings and lower consumption. In order to limit government spending, it may well be that the president should be able to veto particular budget items, the so-called line-item veto, something that I have always had misgivings about, but which may be the only way to assure fiscal accountability. Our tax structure as well as our regulatory systems should be reviewed so as to encourage investment and reduce speculation and wasteful consumption. Pension funds, banks, insurance companies, savings and loan associations should be encouraged to go back to constructive longterm investment policies instead of speculating in junk bonds and playing the takeover game.
If the US is to behave as a great power, it needs investment for the future in order to be competitive and to provide opportunity for all its citizens. Growth requires a strong currency and low interest rates rather than the reverse. The United States needs investment, in both the private and the public sector. Public investment, in some ways, has declined even further than private investment. Public education, infrastructure such as roads and water supplies, the quality of our cities, the protection of the environment—all of these matters require greater attention. In order to deal with them, we have to balance our foreign commitments with our domestic requirements; we have to limit our immediate consumption and our paper speculation to make room for long-term investment.
Independence, however, does not mean abandoning our international influence. On the contrary. We should, for instance, participate vigorously in efforts to promote global regulation for the financial markets as well as for the commercial banking system. This will be even more important if the Glass-Steagall Act is repealed and the line dividing the securities industry from the commercial banking industry is eliminated. The need to impose consistent regulation, capital requirements, and margin requirements, among other rules, on the markets is obvious.
The recent report of the Brady commission laid out a frightening picture of the chaos in the markets created by computer-driven trading as well as institutional speculation in futures and options. We must start to regulate financial markets more effectively, and reduce such speculation, by, among other actions, imposing sharply higher margins on futures and options. Capital requirements throughout the securities industry should be increased to support the sectors of the business involving serious risk, among both specialists and member firms. The Federal Reserve Board would seem to be the logical regulator with respect to margin and capital requirements since it is, in reality, the lender of last resort to the securities industry as well as to the banking community. The SEC, on the other hand, would appear to be the logical regulator for securities as well as for futures and options. One of the lessons of the October 19 crash is that a failure in a major link of the world market puts the entire system at risk. Last time it was the US. Next time it may be Japan. The time has come for an overall review of the securities markets with particular attention to global markets and constantly changing technology.
The US should be doing much more to create a stable system of international currency. We should be supporting the greater use of the ECU as a European currency, as the French finance minister recently suggested, as well as studying the possibility of expanding the European Monetary System to include sterling, the dollar, and the yen. We should support the expansion of the World Bank and other multilateral institutions. We should build on our trade agreement with Canada and create a special economic and trade relationship with Mexico. Mexico poses one of the most important challenges for economic and foreign policy during the next decade, and it has to be treated as such. Certainly we must also maintain our international security commitments and a wholly credible defense. Emphasis will have to be placed on achieving a balance of conventional forces with the Soviet Union.
The coming years are going to bring large changes in international relationships, many of them unpredictable. The Soviet Union’s attempt to modernize its economy appears to be a very positive development, but it nonetheless presents many risks and uncertainties, not least in the effects it may have on Eastern and Western Europe. It is not at all unthinkable that new, organic, economic relationships will spring up between the European Common Market and Eastern Europe; that West Germany will turn more to the East; that Japan, Korea, and Taiwan will dominate large, Far Eastern markets such as India and China, and in addition have rising economic influence in Latin America. We may have to respond to Soviet requests for credits and technology or lose that potential market to Europe and Japan. We will have to consider the role of the Soviet Union as a potential member of the international financial community. We must bear in mind, however, that $58 billion of Western credits extended to Poland and Yugoslavia are now in virtually hopeless condition and that credits to Communist countries may, in the future, require government involvement. Between now and the year 2000 such challenges will be at least as great and as consequential for the future of the US as its military competition with the Soviet Union.
The next administration will find that all of its domestic problems are closely tied to the international issues I have mentioned. Obtaining the funds necessary for education and improving infrastructure may hinge on our sharing the burdens of military security with our allies. The prospects for improving US domestic employment rates and trade will partly depend on new Japanese capital flowing to such nations as Mexico and Brazil. The largest question of all may still be whether the Soviet Union can act as a serious long-term negotiating partner in reducing the wasteful investments in weapons by both countries and diminishing international tensions.
These will be the central issues for the 1990s. In my view, none can be dealt with satisfactorily unless we achieve once more what we lost during the last decade—economic independence. The price we may have to pay for such independence will be cheap compared to the consequences if we do not regain it.
February 18, 1988