It was predictable: Once the stock market crashed, Congress and the White House would try to make a new deal on the budget. In the 1980s, popular thinking about economics has degenerated into a theory of original sin. All evil flows from big federal budget deficits. Presto: The crisis would end if the sinners repented and reduced those immoral budget deficits.
Alas, the solution isn't so simple. We live in an era of global economics and local politics. Nervous stock markets reflect more than exasperation with Washington's perpetual budget paralysis. There's a more basic fear that the world economy is slowly grinding to a halt. Even with deep deficit cuts, the United States alone can't dispel that fear. A vibrant world economy doesn't depend only on the United States. The question is whether the major economic powers -- the United States, Japan and West Germany -- can overcome parochial political pressures to adopt policies that achieve solid global expansion.
Everyone knows the basic problem and the rough outlines of what ought to be done. The United States has been promoting growth in the rest of the world by running massive trade deficits, while other countries have been accumulating vast surpluses. This pattern couldn't continue indefinitely. West Germany, Japan and other countries should now grow faster, while the United States should reduce its trade and budget deficits. But these needs collide with politics. Each country responds to its own prejudices, customs and vested interests. The U.S. budget stalemate has lasted five years. Although West German inflation is nonexistent, Germans cite inflation fears in resisting U.S. pleas for higher growth. In Japan, protection for farmers impedes growth by keeping food prices too high and reducing consumers' purchasing power.
Blaming the U.S. budget deficits for all the world's economic problems is simplistic. But strangely, it's reassuring to both Americans and foreigners. Americans feel uneasy with concepts like economic interdependence. We want to be in control. Blaming the stock-market crash on the budget deficits makes the crisis understandable and manageable. The necessary responses -- raising taxes or cutting popular programs -- may be unpleasant. But at least they're clear-cut and within our power. For foreigners, focusing on the U.S. budget deficits absolves them from any responsibility for the world's economic troubles.
Foreigners sneer at the recklessness of American spending and the resulting trade deficit. Much of this criticism is disingenuous. Europe's export surplus to the United States has prevented the Continent's stagnation from getting worse; its unemployment has exceeded 10 percent since 1983. For Asian countries, selling into the American market has been a mainstay of the region's boom. In 1986 both Japan and South Korea sent 39 percent of their exports to the United States. More than being hypocritical, though, these explanations obscure the true causes of the huge U.S. trade deficit and other nations' surpluses.
Budget deficits don't automatically lead to trade deficits. If they did, most countries would run trade deficits -- an impossibility -- because most countries run government budget deficits. What primarily caused the U.S. trade deficit was something else: the dollar's role as the world's chief international currency. This leads to unintended consequences. In the early 1980s, for example, foreigners started to invest more dollars in U.S. bonds and stocks. The result was to foster lopsided world growth. By not converting export earnings into local currencies, foreigners didn't boost local spending and the demand for imports. Nor did the dollar depreciate, making U.S. exports more competitive. Indeed, the clamor for dollars in the early 1980s was so intense that the dollar appreciated more than 60 percent between 1980 and 1985. American products became even less competitive. The U.S. trade deficit inevitably grew, while foreign surpluses mushroomed.
Some economists say budget deficts caused high U.S. interest rates and the dollar's appreciation. This, too, is mostly a myth. High "real" (inflation-adjusted) interest rates in the 1980s stemmed primarily from the Federal Reserve's anti-inflationary policies. The Fed tightened credit enough to break inflation. If budget deficits had further increased interest rates, consumers and businesses would have had trouble borrowing. They didn't. Indeed, they went on a borrowing binge. Both business and household debt rose about 12 percent annually between 1983 and 1986. Low inflation enabled the Fed to foster easy credit conditions. The flood of imports and lingering unemployment from the 1981-82 recession restrained wage and price pressures. For many borrowers, the tax deductibility of interest cut true borrowing costs.
The American economy is supposedly growing weak and uncompetitive. The lesson here is the opposite. In a sense, the basic problem of the world economy in the 1980s has been that the U.S. economy has been too strong and other economies have been too weak. Part of the surge in American spending reflected the stimulus of budget deficits, but only part. And it was soft growth abroad that prompted foreigners to invest in dollars. Who caused the world's great trade imbalances? Everybody.
So everybody must help end them. The United States can't singlehandedly solve the world's economic problems. Suppose we lower our budget deficits. That might slow the U.S. economy and its ravenous appetite for imports. The trade deficit might drop. But in isolation, that would only hurt economies in Europe and Asia that have become dependent on our markets. In turn, their recession might boomerang on us. The Third World debt crisis would worsen, because debtors couldn't earn dollars to service their loans.
Can we, then, ignore our budget and trade deficits? Sorry. That's not a choice either. Inevitably, foreign investors have tired of absorbing rising amounts of dollar securities into their portfolios. Consider Japanese insurance companies, which have been heavy dollar investors. They pay policyholders in yen. They can't prudently put all their investments in dollars. The dollar's high exchange rate couldn't last. It had to depreciate, as it did again during the past week. Ignoring the trade deficit would aggravate the depreciation, risking higher U.S. inflation and foreign recessions. Our imports would become more expensive, their exports less competitive.
The danger is a gridlocked global economy. The easiest escape from this impasse lies in faster growth abroad. Other countries would offset their loss of exports to the U.S. market, stimulate demand for American exports and ease pressure on the dollar. Will we get that faster growth?
It's easy to see an unhappy future of political paralysis and poor growth. Europe is content with its sluggish prosperity, placating its unemployed with generous welfare benefits. Japan's energies have been focused on exports; the need for "consensus" makes change difficult. Most developing countries are politically unstable or overloaded with debt. They can't be expected to help the world economy. Since the late 1960s, global growth has generally slowed. The great propellants of postwar expansion in Europe and Japan -- rebuilding, catching up with U.S. technology and moving millions of small farmers into more productive industrial jobs -- are gone.
Of course, there's a more optimistic view. The panic on the world's stock markets, it's said, is precisely the catalyst needed to frighten governments into constructive change. Adversity makes people more conscious of choices and more willing to decide among lesser evils. Even now, there are some signs that a broad global accommodation could emerge. While Congress and the White House bargained last week over the U.S. budget, West Germany's president suggested that Europe might embark on a "sensible growth policy."
The world's stock markets have tentatively registered their opinion. Stocks have declined because investors have grown increasingly pessimistic about solutions to these problems. What's at issue is one of the great conflicts of our time: the collision between sovereign states and stateless economic forces. No one can say how this economic and political drama will end, but the theme is clear. Interdependence is more than a cliche.