Continued massive federal budget deficits could cause a trade deficit next year of between $60 billion and $70 billion, creating irrestible and dangerous protectionist pressures, Martin Feldstein, President Reagan's chief economic adviser, told a press conference yesterday.
Feldstein said that the often-overlooked link between budget and trade deficits requires "even more attention than we otherwise might give to reducing the budget deficit."
The connection between budget and trade deficits stems from the higher interest rates that the Treasury must pay to finance the enormous federal deficit. Because these rates are higher than those abroad, they attract investment money from overseas, which in turn makes the dollar worth more in terms of foreign currencies.
He cited, especially, the role of record high "real" interest rates -- market rates minus the rate of inflation -- in causing the dollar to be overvalued.
"That makes exports less competitive, and give imports an edge," Feldstein said. The 1982 trade deficit is estimated at about $40 billion.
He said that a consequence of this process is that hard-hit American industries such as autos, textiles, chemicals, and steel "will continue to be depressed," even if there is a modest and generalized economic recovery -- which he expects to get under way some time in 1983.
He predicted that the trade deficit would be so large next year that, even after offsetting the red ink with the usual positive inflow from American investments overseas, the so-called "current account" deficit could be as much as $35 billion.
Historically, a current account deficit of the magnitude suggested by Feldstein -- far above any ever recorded -- would be expected to cause a decline in the value of the dollar. But in a separate interview, Feldstein said that he expects the dollar to remain strong despite massive and record trade and current account deficits.
He cited two reasons: First, the United States has come to be accepted as the best haven, or refuge, for investments; so long as this is true, the exchange rate of the dollar will be strong. And second, the world is no longer on a fixed-exchange-rate basis, where a trade deficit might create a demand for a formal devaluation.
"Today the exchange rate reflects the current supply and demand for a currency," Feldstein said in the interview.
Feldstein said he worries about trade deficits because they will be seized on by troubled industries to explain their continued depression, which for the most part can't be blamed on imports. "The ultimate danger is that we could then throw up trade barriers that would contract economic activity all over the world," Feldstein said.
"What worries me is that we will see the growth of pressures here for protectionism, which is not a [correct] response to the root cause of the problems," he explained. Even if the dollar were to adjust to the more normal relationship with other key currencies that prevailed two years ago, only about one-third of Detroit's current cost disadvantages against foreign car producers would be eliminated, Feldstein said.
Coincidentally, U.S. Trade Representative William Brock endorsed Feldstein's assessment. "Our biggest trade problem is the enormous strength of the dollar, and we can't address this issue until we deal with the budget deficit," he said.
In evaluating prospects for next week's meeting in Geneva at the General Agreement on Tariffs and Trade, Brock conceded that the United States and its trading partners "have not made the kind of progress I would have hoped for by this time."
He stressed that hedoes not have "a sense of despair," and hopes that the GATT meeting would exhibit the political will turn back protectionist pressures.