Big Deficits Stymie Fed, Volcker Says : Actions Are Limited in Face of Borrowing, Imports, Panel Is Told

The Federal Reserve is reaching the limits of what it can do to help the American economy as the government continues to borrow huge amounts, and other nations rely on U.S. business, Chairman Paul Volcker said today.

In testimony to a subcommittee of the House Banking Committee, Volcker said Americans are borrowing in order to enhance their standard of living, buying imports that have increased 60% in inflation-adjusted terms in the last three years.

Because of the government borrowing and other factors that turn a strong dollar into a trading disadvantage, imports are now equivalent to 21% of the U.S. production of goods, Volcker said.

Accommodated Until Now

The Fed, up to now, has accommodated the process, confident that the additional money supply growth is not fueling stronger inflation.

But managing the money supply is getting harder, Volcker said.

While flying by the seat of the pants may not be the best way to do it, “it is the world in which, for the time being, we find ourselves,” he said.

“The hard fact remains that so long as we run massive budgetary deficits, we will remain dependent on unprecedented capital inflows to help finance, directly or indirectly, that deficit,” Volcker said.

Borrowing Is Trade Deficit

The borrowing from foreigners is represented by the trade deficit. “They are Siamese twins,” he said. But Volcker said getting rid of one twin, the trade deficit, would harm the other, necessary twin, the borrowing from foreigners, and raise interest rates to the further detriment of farmers, savings and loans and foreign countries heavily indebted to the United States.

Volcker chided Americans for not being able to do what many smaller, poorer countries are being forced to do by the U.S.-dominated International Monetary Fund: reduce the federal deficit.

“There is a certain irony in observing the enormous difficulties in our own political process in achieving--so far without success--deficit reductions equivalent to 1% to 2% of our gross national product while much poorer countries with much greater demands upon them are cutting their deficits by much larger relative amounts,” he said.