“I’m not here to give advice, I’m here to lend support,” said President Bush about his economic discussions with Japanese Prime Minister Koizumi.
That showed unusual tact for a leader not given to diplomatic niceties. Whatever the two leaders said in private on Monday, the president had the good sense not to harangue his counterpart in public.
But the phrasing of Bush’s message of “support” overlies a more fundamental issue. When one government pressures another to change its macroeconomic policies, such urging seldom has any effect.
Moreover, the reasons why such international cajoling is usually fruitless tell us a lot about the obstacles that regional economic integration schemes such as the European Union, North American Free Trade Agreement and the Mercosur face. Domestic political considerations trump the urgings of global economic partners time after time.
Consider some historical examples.
After World War II, the economic system agreed upon at Bretton Woods called for the currencies of major countries to be tied to the U.S. dollar while the dollar was tied to gold at the rate of $35 per ounce. Any other countries that ended up with U.S. dollars could turn them in to us for gold.
That system required the United States to exercise restraint in expanding its money supply, and worked well in the initial post-war period. But in the 1960s, U.S. budget deficits increased to finance Lyndon Johnson’s Great Society and the Vietnam War. The Federal Reserve let the money supply grow to keep interest rates low despite increased Treasury borrowing.
A U.S. money supply growing faster than those of other major nations implied that the U.S. dollar eventually had to fall in value compared to other currencies. The leaders of other governments repeatedly urged successive U.S. administrations to raise taxes and curb the monetary expansion.
But no one paid any heed to such advice and “support.” Each party saw that raising taxes or calling for tighter money would cost it support in successive presidential or congressional elections. Other countries continued to cash in dollars for gold until U.S. reserves were largely exhausted.
In 1971, during the first Nixon Administration, Treasury Secretary John Connally abruptly announced that the deal was off. The United States would no longer keep the promises it had made at Bretton Woods. There was no prior consultation with the other nations affected, and no effort to craft a multilateral successor to Bretton Woods. The dollar, of course, immediately fell in value compared to other currencies.
In the early 1980s, the Reagan administration wanted tax cuts and higher military spending.
The Democratic-controlled Congress didn’t want to give up social programs. The result was an explosion of Federal budget deficits. The 1983 deficit, compared to GDP, was greater than a $600 billion deficit today.
But the Federal Reserve, headed by Paul Volcker, had no intention of funding federal deficits as it had in the 1960s. Interest rates went up, and higher rates in the United States drew in savings from around the world.
Our country borrowed 14 percent of the total net savings of all other industrialized countries in the world between 1983 and 1988. U.S. demand for borrowed money forced up interest rates in other countries, slowing their economies.
Germany, France, the United Kingdom and other nations either had to increase their own money supplies, threatening inflation, or let rates rise, choking off growth. They rightfully complained that their central banks were being asked to do what the U.S. Federal Reserve was refusing to do—fund a U.S. spending spree.
But their complaints found little sympathy in the Reagan Administration. Treasury Secretaries Donald Regan and James Baker stiffed their counterparts among our allies because no one was willing to tell the president or Congress that they couldn’t have it all.
The large flows of capital to the United States strengthened the U.S. dollar, which effectively subsidized steel and auto imports and priced U.S. agricultural exports out of world markets. U.S. industry and agriculture paid the bill.
When the “Superdollar” began to fall in value late in the 1980s, Baker hectored other nations to intervene in foreign exchange markets to keep it from falling too far, pushing up the price of U.S. imports and stoking domestic inflation.
The Germans were particularly incensed by the cavalier attitude that the Reagan administration took about the damage caused by its “borrow and spend” policies. But when German reunification came along a few years later, the Federal Republic essentially emulated Reagan policies by borrowing huge sums and driving up interest rates across the EU. France, Italy, the Netherlands and the United Kingdom complained that they were being forced to finance German reunification and the Christian Democrats’ political fortune, but Chancellor Kohl turned a deaf ear.
The lesson?
In modern democracies domestic political agendas override concerns about collateral economic damage to other countries virtually every time. This is still, perhaps increasingly, true in the EU.
It is true in Mercosur, and would be true in any future Western hemisphere economic integration blocs. Unfortunately, it will also be true in Japan for the foreseeable future.
© 2002 Edward Lotterman
Chanarambie Consulting, Inc.