Question: What problem do French President Francois Mitterrand, Brazilian coffee producers, oil-exporting countries and South Africa all have in common?
Deflation is one of those awkward, anachronistic words that seems to belong to another era but soon may come back into style. Deflation is falling prices. More generally, it refers to government policies designed to make prices fall -- or at least stop rising. And deflation is the Reagan administration's invisible foreign policy.
As leaders of the world's seven major industrial countries prepare for the Ottawa economic summit on July 19-21, it may become a lot more visible.
The Reagan administration is gambling that it can destroy worldwide inflationary psychology by re-establishing faith in the dollar and in money generally. It hopes that this restored faith will be its own reward: that it will renew confidence in the future, promote productive investment and growth.
Meanwhile, though, deflation hurts.
Europeans already complain that U.S. interest rates have spread to the Continent and threaten to aggravate unemployment. Developing countries now pay higher rates on their overseas dollar loans while receiving fewer dollars for their commodity exports. And the Japanese are upset because a depreciating yen makes their exports even more competitive, further fanning tensions with other countries.
All this constituents a slippery part of foreign policy. Countries coalesce around common interests. Gone is the confidence that the United States represents the bedrock of world prosperity. In its place is a new anxiety and, consequently, U.S. economic policy becomes foreign policy. As Mitterrrand said, "One cannot hope for greater political and military cohesion and then let everyone do as he pleases in economics."
There's no escaping the connection. The dollar still remains the world's major trading and investment currency. When interest rates rise in the United States, rate on Eurodollar loans -- those made with dollars on deposit outside the U.S. -- alsor rise. Likewise, funds tend to flow from other currencies to take advantage of the higher rates. f
This sets off a chain reaction. Other countries either can raise their own interest rates or let their currencies depreciate. Higher interest rates slow economic growth. But depreciated currencies reduce countries' purchasing power. Both lower demand and less purchasing power hurt commodity prices, many of which are priced and traded in dollars.
All these side effects of high U.S. interest rates have occurred in the past six months. In Europe, countries have both raised interest rates and permitted currency depreciations. Short-term interest rates in Germany average more than 13 percent now, compared with less than 10 percent in January. At the same time, the dollar is now worth 2.4 marks, up from 1.8-mark average for 1980.
The fall in commodity prices have been especially sharp. Between recent highs -- usually attained in 1980 or early 1981 --and the end of June, copper is down about one-half, tin about one-third, sugar about two-thirds, coffee about one-fifth and cocoa about one-third. Gold trades near $400 an ounce compared with a monthly high of $675 in January 1980. Gold accounts for half of South America's exports, and Brazil depends heavily on coffee and cocoa exports. Even oil prices are sliding.
Americans, incidentially, are vulnerable to similar effects. Farm prices generally have drifted down, and food exports are below expectations. In addition, the huge dollar appreciation means that U.S. manufactured goods have suffered a significant loss in international competitivenss.
Taken together, these trends could freeze the world economy. Developing countries have sustained their overseas purchases largely on credit. According to the International Monetary Fund, their debt will total $418 billion in 1981, with about two-thirds owed to private lenders, mainly banks. Interest rates generally change twice a year. A one-percentage-point increase costs the developing countries between $1.5 billion and $2.5 billion.
Protectionist pressures could accumulate. Steel imports already are projected to rise sharply in the United States. In Europe, edgy governments -- Mitterrand's in France, Margaret Thatcher's in Britain -- might attempt to cure unemployment with restrictions. Developing countries could resort to severe import controls to conserve scarce foreign exchange.
To paint this gloomy outlook is not to prophesy it. There are, at least in theory, offsetting forces. The depreciation of European currencies against the dollar has made these countries' exports more attractive; developing countries could preserve their purchasing power and stimulate growth by shopping more on the Contineent. In the United States, lower-than-expected inflation could lead to faster-than-expected expansion.
Nobody really knows what's going to happen. The issue here is not the correctness of the Reagan administration's course but rather the inevitable reaction abroad that the United States is making economic policy for the rest of the world.
Satisfying everyone all the time is probably impossible. Given the dollar's profound global influence, whatever we do is bound to be upsetting. When low interest rates led to a depreciating dollar, the Europeans complained that we were exporting inflation and threatening their export industries. Moreover, the effects of U.S. policies can be exaxaggerated. They often provide a convenient scapegoat for other ailments: domestic problems or other sources of world tension, such as oil.
But that said, the Reagan administration's tight credit policies represent a significant change in the way America projects itself abroad. The underlying premises seem clear: that U.S. power and prestige waned as confidence in the dollar eroded; that global economic instability stmmed heavily from irresponsible money policies, mainly American; and that the world economy is sufficiently flexible that deflation ultimately will promote stability and growth, not slump.
These are reasonable, but untested, propositions. The danger is that the true sources of instability lie elsewhere -- in clashing cultures and scarcities -- and that excessively tight money simply will aggravate the underlying political and social conflicts