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For at least the last 2 years, U.S. policies and/or performance have been the target of fairly shrill foreign criticism. Five main themes are dominant.
* Large U.S. budget deficits, especially when corrected for cyclical factors, have been directly and overwhelmingly responsible for high real interest rates.
* High rates are sucking in capital from abroad to finance the U.S. budget deficit, thus forcing foreign rates up, prolonging foreign stagflation, and/or threatening to choke off recovery (depending on the phase of the cycle the complainer is in).
* Capital inflow and the counterpart record U.S. trade deficit are unsustainable; they have produced an overvalued dollar, destabilized foreign exchange markets, and threaten a roller-coaster fall when the market turns.
* High U.S. interest rates and the appreciating dollar have severely exacerbated the international debt problem.
* The strong dollar has strengthened the forces of protectionism in the United States, directed mainly against developing countries and especially those which need foreign exchange to service their debts.
Evaluating the Validity of
Of all these complaints, only the last two have more than a rather superficially appealing validity. That fact alone should begin to suggest where we ought to be concentrating our efforts, both to sustain the recovery begun 2 years ago and to assure that the international economy is able to come through the severe decompression adjustment of the early 1980s with minimum disruption--however, more of that later. First, let's look more carefullt at the other criticisms to see just how valid they may be and what should be done about them.
Budget Deficits and Interest Rates. Budget deficits are bad for several reasons, but the notion they are the predominant cause of high interest rates is not one of them.
Surely they contribute marginally to upward pressure on interest rates. However, the strength of demand for credit resulting from our vigorous recovery and especially the strength of demand for capital equipment, which has characterized this recovery, are at least as important and probably more so. A third factor is some continuing skepticism in the market about the permanence of the low inflation we have been experiencing. Consider two points.
* Most of the focus of this debat is on the Federal Government deficit. But the more relevant measure would be the total government deficit, taking account of the large surpluses generated by most state and local authorities in this country--surpluses …