Warning From the Monetary Fund
Every April, the International Monetary Fund issues its World Economic Outlook--a book-length compendium of analysis, data, and forecasts. Despite the leaden prose that is unavoidable in such a bureaucratic production, international economists prize these volumes. They are extremely useful sources of data. The topical analysis is usually sharp and even provocative, reflecting the high quality of the IMF’s staff, and there is a kind of pleasure in reading between the discreetly euphemistic lines to figure out what the IMF really thinks.
This year’s report is a particularly interesting specimen. It comes at a time when the markets appear to be fairly optimistic about the international monetary system: The dollar is rising, bank stocks and the secondary prices of Latin American debt have risen on hopes that the plan by Treasury Secretary Nicholas F. Brady will offer a solution, fears of inflation are subsiding. It is therefore a bit of a shock to read the IMF’s outlook and discover a cautiously worded but nonetheless ominous warning. In effect, the theme of this year’s report is that things are not under control--that the current stability in the world economy is the calm before the storm.
Now of course the IMF never says this in any such forthright terms. The warning must be extracted from mind-numbing references to “the ‘tensions’ in the ‘reference scenario’.” Nonetheless, the gloominess of the IMF staff is apparent to anyone accustomed to reading this kind of document.
At the heart of the IMF’s concern is its conclusion that the balance of payments deficit of the United States and the corresponding balance of payments surpluses of Japan and West Germany are all going to get wider, not narrower, from now on. This may come as a surprise to many people--weren’t we talking about a U.S. export boom just a few months ago? But the IMF thinks that the export boom, sparked by the fall in the dollar in 1985 and 1986, has now run its course. With the boom played out, longer-term forces will cause our deficit, and the West German and Japanese surpluses, to start growing again.
Why this pessimism? The basic point is that unless something--such as the exchange rate--changes, a position of massive U.S. deficit and equally massive West German and Japanese surplus is virtually bound to get worse over time. For one thing, there is what some people call the “gap factor”: Inflation and economic growth tend to raise the dollar value of everything, including deficits and surpluses. So if you start with a big deficit or surplus, you can expect to see it get even bigger.
For example, over the next five years it is a good guess that Japan will increase the dollar value of both its exports and its imports by something like 60%--and therefore increase its trade surplus by around 60%, too. The converse is true for the United States. Since this country is so deep in the red to start with, and West Germany and Japan so far in the black, the “gap factor” implies a persistent trend toward worsening imbalances unless there are strong countervailing forces.
Instead of being offset, however, the gap factor will be reinforced by a second factor: the growing foreign debt of the United States and the growing foreign assets of West Germany and Japan. Increasingly, the U.S. deficit will be swollen by the interest we pay to foreign creditors and the dividends that U.S. subsidiaries of foreign firms pay to their owners. West Germany and Japan, as the world’s main creditor nations, will correspondingly find their surpluses magnified.
As the IMF sees it, then, the period of international optimism in 1987 and 1988, when the U.S. trade deficit finally seemed to be coming down, is going to turn out to have been a false dawn. From now on, we will be back in a world of seemingly inexorable growth in the U.S. deficit. The economic dangers inherent in such a world are obvious enough. The IMF’s guardedly described “market reaction scenario” is one in which the dollar crashes, leading to inflation in the United States and recession in the rest of the world, and precipitating a debt service crisis in the already troubled Third World. In the report, this scenario is presented only vaguely so that we have no idea quite what the potential fall in the dollar is likely to be.
But we can look at other estimates. A new book by William Cline of the Institute for International Economics carries out an analysis that looks very similar to that of the IMF and arrives at the conclusion that even in a favorable adjustment scenario the mark and the yen will need to rise 23% and 28% respectively against the dollar. In the disorderly run on the dollar that the IMF evidently regards as a serious possibility the numbers would be larger: A dollar-yen rate of 100 or even 90, compared to the current rate of about 135, is far from impossible.
The political dangers of a world where deficits start growing again are also obvious. What will even the most internationally minded members of Congress say to constituents demanding protectionist measures? What will the political reaction be as the pace of foreign acquisitions of U.S. firms accelerates, with accusations that the weak dollar is leading to a “fire sale” of our assets? What will be the consequences of worsening imbalances for our relations with West Germany and Japan, which are already strained for other reasons? Warnings about “hard landings” are nothing new in international economics. What makes this warning interesting is the source and the timing. The IMF, a supremely cautious institution, is interrupting us in a moment of apparent calm to tell us that things cannot go on as they have, that something fairly drastic has to be done.
But a call for effective action from the Big Three economies seems almost pure fantasy. In the United States, the Bush Administration evidently feels no urgency about economic policy (or much else). Meanwhile, both West Germany and Japan are ruled by weak governments whose popularity has been undermined by non-economic issues. No matter how certain the prospect that a crisis is developing, nothing is going to be done until it actually hits. When the IMF talks, nobody listens.
