While the stridency that has increasingly characterized North-South economic relations was somewhat muted in 1978, the tensions that have troubled economic relations between the industrialized nations in recent years were sharpened. This increase in tensions was largely a spillover into the international arena of unresolved problems of domestic economic management. Slow growth, sluggish investment and persistently high rates of unemployment and excess productive capacity continued in most major industrialized countries; only the United States sustained its recovery pace of growth from the sharp recession of 1974-75. As regards inflation, the shoe was on the other foot; in most of the advanced economies the rate was declining or relatively stable, while in the United States it accelerated significantly during the course of the year.

The international reflections of these domestic difficulties included reduced world trade growth, an escalating threat of protectionist attitudes and policies, widening payments imbalances, and increasing instability in foreign exchange markets. These last two developments were attributable in large measure to divergent rates of inflation and real growth between the United States on the one hand and other leading industrialized nations - particularly Germany and Japan - on the other.

Two sets of issues were acute during the year. One set involves such "macroeconomic" questions as the coordination of domestic stabilization policies and the operation of the international monetary system, including the exchange-rate regime. In the other or "microeconomic" sphere, especially in trade and commercial policies, measures to restrict or cartelize world trade proliferated even as the year-end deadline facing the multilateral trade negotiations in Geneva drew closer. In both spheres, the rapid increase in economic interdependence of recent years was straining political and institutional structures, both domestic and international, as nations tried to minimize the threat such interdependence posed to national economic autonomy.

For the United States, whose dominance of the international economic system during the quarter century following World War II has declined significantly in recent years, questions relating to its changing role became especially acute. A common theme pervades all of them: the trade-off between policies that would promote the achievement of specific national economic or political goals, on the one hand, and those likely to promote the viability of a coherent international economic system in the long run on the other. This question is not a new one for the United States, but it was thrust into sharp relief by the events of 1978.

II

1978 is likely to be remembered above all as the year of the declining dollar. The U.S. payments deficit associated with this development is often attributed to the "oil problem" - the fact that the United States continues to import increasing percentages of its petroleum. However, in terms of the global payments situation, the evolution in recent years has actually been somewhat more complex. Immediately after the "oil shock" of 1973-74, the payments deficit which mirrored the massive surplus of the OPEC nations was shared among virtually all petroleum-importing nations, both industrialized and developing. By 1975, widespread recession among the industrialized countries had reduced their external deficits and increased the pressure on the payments positions of oil-importing developing countries. With the uneven economic recovery of 1976-78, however, the payments position of the oil-importing developing nations improved and the largest payments imbalances were concentrated among the industrialized group of nations.

Differences in adjustment policies and in the pace of economic recovery then created a situation in which, by 1978, the major imbalance was the huge current account deficit of the United States - roughly equal in magnitude to the entire OPEC surplus, which had declined to about $15 billion from its 1974 level of $70 billion - as against the very large surpluses of Germany, Japan and Switzerland.

Although the rates of exchange between the currencies of major industrialized countries have, since the end of the Bretton Woods system of pegged rates in 1971, been intermittently managed rather than freely floating, changes in countries' external positions, or in the market's evaluation of those positions, are nonetheless mirrored in exchange-rate movements. And the image reflected in that mirror during 1978 was one of pervasive uncertainty and short-term volatility, dominated by a cumulative weakening of the dollar against virtually all major currencies, and a particularly sharp appreciation of the currencies of countries with strong current account positions, good inflation records, and relatively slow real growth rates.

Heavy selling pressure on the U.S. dollar began in September 1977, and continued more or less unremittingly for more than a year. Expressions of concern about the situation by President Carter in January 1978 and again in March and mid-August, accompanied by announcements of various measures aimed at shoring up the dollar's position, brought only brief respites. During a little more than a year, the dollar declined by nearly 40 percent against the Swiss franc, by nearly 35 percent against the Japanese yen, by more than 25 percent against the German mark, and by 12 percent on an effective basis (that is, against a trade-weighted average of 15 major currencies). The decline accelerated during October 1978, despite signs of improvement in the U.S. trade deficit, the passage of long-awaited energy legislation, and the President's announcement of an anti-inflation program involving both a tightening of the Administration's fiscal stance and a program of voluntary wage-price guidelines.

On November 1, confronted with increasing disorder and signs of generalized panic in the foreign exchange markets, the Administration decided to take really firm action. Forsaking the monetary gradualism and the hands-off attitude toward direct intervention in exchange markets that had characterized U.S. government behavior for some time, the Administration announced a dramatic package of measures designed to rescue the dollar. One part consisted of traditional measures to tighten bank credit - a full percentage point increase in the discount rate, and establishment of a supplementary reserve requirement on large time deposits. These had the aim not only of increasing the demand for dollars by attracting foreign funds into the U.S. financial market, but also of enhancing the credibility of the President's anti-inflation program, by rectifying the omission of monetary policy from the October 24 statement addressed to that issue. The second part consisted of moves to make some $30 billion in foreign currencies available to the United States for buying up dollars in the foreign exchange markets.1 These actions were coordinated with the central banks of the three major surplus countries, which had been pressuring the United States to take such steps.

The exchange markets responded promptly to these actions. During November, the dollar rose by from eight to 15 percent against the three major currencies and by almost six percent on an effective basis, wiping out nearly one-half of its effective decline over the preceding 12 months. This rise was bolstered by an estimated six to ten billion dollars of central bank intervention in support of the dollar - partly by the Federal Reserve and partly by foreign central banks - but it was clear that the attitudes and behavior of private participants in foreign exchange markets had been significantly affected by the events of November 1. Apparently, the rescue package had bought essential time to allow improvements in underlying conditions to effect a more durable stabilization of the dollar's position.

There can be little doubt that the more active exchange market stance adopted by the U.S. government was justified in the short run - indeed required - to counter disorderly conditions in exchange markets. Whether these moves also signaled a more durable shift in the U.S. position is not yet clear.2 But to the extent that they heralded a commitment by our government to more active management of the dollar exchange rate, we may be witnessing a significant shift in the rules of the game as regards the international monetary system, and one that raises some important questions. Such active participation by the United States could raise anew the possibility of inconsistency among the exchange-rate goals of the major countries and thus of exchange-rate policies operating at cross-purposes to one another. Perhaps more important, there is a longer term danger that the dollar could once again become overvalued - that effective appreciation of the dollar could erode the gains in our competitive position before the imbalance in our external position is eliminated.3

The immediate danger faced by the United States, however, lay in the opposite direction. If the anticipated improvement in the fundamentals did not soon become clear to all, the dollar might resume its slide and the $30-billion "war chest" could be rapidly exhausted.

One important element of such an improvement appeared to be already underway, however, in the form of a shrinking U.S. trade deficit. Clearly, the shift of the U.S. trade and current account positions from substantial surplus in 1975 to unprecedentedly large deficit in 1977 was a major factor in the weakening of the dollar. Initially, it was thought that the increasing dependence of the United States on imported petroleum was the major cause of this deficit, and that the enactment of an effective U.S. energy policy, leading to a reduction in petroleum imports, was the essential corrective action. Later, however, as American oil imports actually declined, non-petroleum imports soared, and non-agricultural exports rose very modestly indeed, it became clear that broader problems of trade patterns and competitiveness were involved.

At least two forces were at work here. In the period from 1975 to mid-1977, appreciation of the dollar against other major currencies (at least to mid-1976), plus the continuing higher relative pace of inflation in the United States, created a real (inflation-adjusted) effective increase in dollar prices that has continued, during much of 1978, to affect the pattern of trade flows.

Second, and probably more important, the real growth of the American economy since the 1974-75 recession has been faster than that of most other industrialized nations, averaging nearly five percent annually over the past three years, as contrasted with an average annual rate of only 3.5 percent for its major trading partners. This development reversed the pattern of the 1960s, when U.S. real growth averaged only about four percent annually, compared with a 6.5 percent average for the rest of the industrialized world. This economic expansion has tended to suck imports into the United States, while the persistent stagnation experienced by some of our major industrialized trading partners has restrained their imports and, therefore, our exports. Ironically, then, the weakness of their domestic recoveries has strengthened the external positions of such countries as Germany and Japan.

Whether the deterioration of the U.S. trade position also involved a longer term "structural" or non-price weakening of U.S. competitiveness is a matter of continuing discussion and controversy. But, while the U.S. trade and current account deficits for 1978 as a whole exceeded those of 1977, by the end of the year there were clear signs of improvement. The trade deficit for the third quarter of the year was substantially smaller than that for the first quarter and slightly less, at an annual rate, than that of 1977.4 A pickup in manufacturing as well as agricultural exports and a slowdown in the rate of increase in imports, including a significant drop in petroleum imports, all contributed to this favorable development. Presumably the improvement in the American competitive position arising from the substantial real depreciation of the dollar vis-à-vis the currencies of other major industrialized nations since September 1977 had begun to have the desired effect.

Whether the improvement in our trade position continues and, more broadly, whether the stabilization of the dollar is more than a nine-day wonder, turns primarily on what happens to these rates. One obvious factor in the decline of the dollar was, of course, differences in national rates of inflation: during 1978, prices (as measured by the Consumer Price Index) rose by some nine percent in the United States, as compared with four percent in Japan, just over two percent in Germany, and one percent in Switzerland.5

This is hardly the whole story, however, since the changes in exchange rates that actually occurred far exceeded what would have been required to compensate for these inflation differentials, and the dollar depreciated also vis-à-vis the currencies of several countries whose inflation rates equaled or exceeded that of the United States. The fact is that exchange markets, like stock markets, appear to take account not only of the past and present but of the future as well, or at least of expectations regarding it. It became increasingly apparent during 1977 and early 1978 that inflation was accelerating in the United States, while it was relatively stable or declining in the strong currency countries. Undoubtedly, exchange-rate movements during the year incorporated expectations of a continued widening of the inflation gap - plus concern that the United States might be caught in the kind of vicious circle we shall examine in the next section, in which external currency depreciation and domestic inflation may feed on each other.

The long-standing international role of the dollar makes it particularly vulnerable. To the extent that foreigners lack confidence in the ability of the United States to manage its economy wisely and restore the position of the dollar as a store of value, they will attempt to reduce their holdings of dollars and increase their holdings of alternative reserve assets. A certain amount of such diversification was to be expected as a rational response to the move from pegged to floating exchange rates in 1971-73, quite apart from changes in the desirability of the dollar relative to other currencies.6 However, there can be little doubt that the future position of the dollar in foreign exchange markets will depend to a significant extent on the elusive but critical factor of confidence: confidence that U.S. economic policy will be conducted in a manner that will make the dollar an attractive asset for both official and private holders.

III

Although movements in real exchange rates during 1978 were in the right direction for bringing about adjustment of unsustainably large payments imbalances, the events of the year make clear why exchange rates cannot be counted on as the alpha and omega of the payments adjustment process. This is partly because they are far from completely free: in 1977-78, in particular, Germany, Italy, Japan and the United Kingdom poured enormous sums into exchange market intervention aimed in part at curbing or preventing appreciation of their currencies.

Furthermore, even if they were entirely unmanaged, flexible exchange rates could not alone fulfill two of the functions expected of them by some of their proponents in the late 1960s and early 1970s. That is, exchange-rate movements cannot, in a world of high international mobility of capital, insulate a country fully against economic disturbances originating abroad, or, conversely, confer autonomy on national stabilization policies in an interdependent world. Nor do they provide an automatic and painless mechanism of balance-of-payments adjustment, although they play a critically important role in both the buffering and the payments equilibration functions.

One of the problems is that, while changes in exchange rates do appear to have an equilibrating effect, they do so only with substantial lags; expenditure patterns and therefore trade flows respond only sluggishly to changes in relative prices, and the effects are likely to be spread out over two years or more. In the interim, the impact of these changes on the balance of payments may actually be perverse, as well as uncomfortable for the domestic economy.7

In countries like Germany and Japan, where the manufacturing sectors are heavily dependent on exports, the short-run effects of an appreciating exchange rate include severe pressure on profits in the export and import-competing sectors. This further weakens already lagging business investment and makes it more difficult for these countries to escape the slow growth and high unemployment that currently plague them. Ultimately, as patterns of demand and supply adjust, the effect of an exchange-rate appreciation should be not only to reduce the current account surpluses of these countries, but also to make it possible for them to reduce high unemployment and excess capacity with less of the inflationary pressures they fear.

Such adjustments do not come quickly or easily, however, and a situation of continued volatility in exchange rates may lead surplus countries to try to buffer the impact on their domestic economies through increased protectionism: limiting imports or subsidizing exports in an effort to cushion - or subvert - the adjustment process. The specter of such a no-win situation is a major stimulus to the search for effective means of restoring greater foreign exchange stability.

Volatile exchange rates also complicate the task of domestic economic management for depreciating countries. As production and expenditure patterns shift in response to changing price relationships, the effect is not only to improve the trade balance of the depreciating country but to stimulate domestic output and employment. But again, these shifts take time, and the most immediate impact of depreciation on the domestic economy is likely to be inflationary. These pressures are likely to be greater in countries where foreign trade is large in relation to the total economy. But even for a relatively self-sufficient country like the United States, the effect of depreciation on the domestic rate of inflation appears to be considerably greater than was generally thought a few year ago. Recent estimates suggest that a ten percent depreciation of the dollar can be expected to raise domestic prices by about 1.5 percent for any given level of unemployment.

As an example of these various effects, notice what appears to be happening to the automobile market as a result of the sharp depreciation of the dollar vis-à-vis the German mark and the Japanese yen. The number of imported VWs and Toyotas has dropped sharply and the number of American automobiles sold abroad has increased, an essential step toward reducing the U.S. trade deficit and the German and Japanese surpluses. At the same time, the average price of an automobile sold in the United States has been pushed upward, not only because imported automobiles now cost more, but because domestic automakers are enjoying a relaxation of the price competition formerly exerted by German and Japanese rivals, and can raise prices more than they would otherwise. This impact on domestic prices occurred before our trade balance had begun to turn around. In a country where inflation is currently the leading economic problem, such an exacerbation of domestic inflationary pressures is, to say the least, unwelcome.

What recent events have forcefully demonstrated is that changes in exchange-rate relationships can alter international competitive positions and reduce trade and payments imbalances only to the extent that nominal changes result in real changes, that is, to the extent they are not offset by changes in a country's rate of inflation relative to that of its trading partners. If the domestic price of American autos, or steel, or whatever, goes up by ten percent in a given period, these products will not attract foreign customers in countries with level prices, whose currencies have risen, say, eight percent against the dollar in the same period.

This truism, combined with the fact that exchange-rate movements inevitably tend to exacerbate inflationary pressures in depreciating countries and mitigate them in appreciating ones, has produced a new concern. May not high-inflation countries with persistent current account deficits and chronically weakening currencies find themselves trapped in a self-reinforcing process of depreciation and inflation, while low-inflation countries with strong external positions may, in contrast, enjoy the additional anti-inflationary assist of a chronic upward tendency in their currencies?

Although the development of such "vicious" and "virtuous" circles is by no means logically inevitable, the fear is that, once they get started, they will drive countries with initially different inflation rates along ever diverging paths and thus create cumulative instability in exchange rates and in the world economy. Certainly, it is increasingly apparent that changes in exchange rates can equilibrate payments imbalances only if they are reinforced by appropriate domestic monetary and fiscal policies in both surplus and deficit countries. As we shall see in the next section in more detail, during 1977 and 1978 neither set of countries performed as it should have done - Germany and Japan, for domestic political as well as economic reasons, resisted raising their growth rates, while the United States, for similar reasons, resisted at least until November a really clear anti-inflation policy.

In addition to posing economic management problems for both appreciating and depreciating countries, excessive reliance on exchange-rate movements to equilibrate payments imbalances might, if it perpetuated large fluctuations or rapid movements in exchange rates, pose difficulties for the international system as a whole. In June of 1978, most of the OECD countries renewed a 1974 pledge to eschew the unilateral introduction or intensification of trade restrictions to improve their balance-of-payments positions. But, as we shall see, a variety of measures have in fact had a protectionist flavor, and the pressure for increased protection continues strong. More broadly, there is a widespread feeling that the general climate of economic uncertainty may be contributing to the sluggishness of investment that currently plagues most industrialized countries.

Because the United States is the world's largest economy and trading partner, such fears are particularly intense where the dollar is concerned. The unique role of the dollar as an international currency also poses some special problems. In particular, there is widespread concern that chronic dollar weakness may propel worldwide inflation. One channel through which this might occur is oil prices: because these prices are denominated in dollars throughout the world, the fear is that continuing dollar depreciation, by reducing the purchasing power of OPEC oil revenues, may lead these countries to raise dollar-denominated prices more rapidly, affecting not only the United States but all other oil-consuming countries whose currencies are not appreciating vis-à-vis the dollar. At the end of 1978, the OPEC countries did in fact announce that they would raise oil prices in 1979 by progressive steps cumulating to 14.5 percent, considerably more than expected. The extent of the planned increase reflected the late-1978 political difficulties that had cut Iranian output and created a prospective market squeeze, however temporary. But the decline of the dollar during the year was undoubtedly also a factor.

Second, insofar as strong-currency countries try to prevent or limit the appreciation of their currencies by buying up dollars, they create an inflationary increase in their own domestic liquidity. That they are free to abstain from this sort of behavior (at the cost of seeing their currencies rise freely) does not necessarily alleviate their resentment of what they see as an American-caused dilemma.

Whatever the intellectual merits of the concerns described in the preceding paragraphs, the fact that they are widely held implies that an unstable or chronically weakening dollar is likely to complicate the United States' relations with other industrialized nations. We shall examine in a later section the measures taken during 1978 by the European Economic Community (EEC), and the U.S. response.

IV

Let us turn now more specifically to developments during the year in the area of coordination of macroeconomic policies among the industrialized countries. Since 1975, such coordination has been attempted primarily through a series of annual "summit" meetings among the political leaders of the seven largest noncommunist industrialized countries. The general rationale underlying the coordination strategy of the past few years has been that the countries with relatively low inflation rates and strong external positions should take a lead in stimulating and maintaining world economic recovery, while those with poorer inflation records and weaker external positions should concentrate on improving them, even at the cost of somewhat slower growth of the domestic component of total demand.

At the 1978 summit meeting, held at Bonn in July, the strong surplus countries, Germany and Japan, as well as France, Italy and the United Kingdom, whose inflation rates and balance-of-payments positions have recently shown substantial improvement, promised to try to achieve somewhat higher rates of domestic real growth, while Japan pledged in addition to try to restrain the growth of its exports temporarily in order to reduce its large trade surplus. Meanwhile, the major deficit country, the United States, pledged that reduction of inflation would be its major priority, and that it would also take other steps - such as passage of energy legislation and more vigorous promotion of exports - to improve its negative trade balance position.

Annual economic summitry has made clear both the widespread perception that coordination of macroeconomic policies is essential in an interdependent world, and the difficulties that confront efforts to implement the concept. Both Germany and Japan fell far short of the real growth targets agreed to at the London summit in 1977. Although participants in the 1978 summit eschewed quantitative targets, recognizing their potential for embarrassment and ill feeling, it is now clear that the 1978 growth rate of the major surplus country, Japan, will again fall substantially short of what had been hoped, although the rate of economic activity does appear to be picking up in a number of West European nations. On the other side, it became increasingly apparent as 1978 wore on that the United States would not make significant headway against inflation before the end of the year.

There is debate whether the inability of the leading countries to meet their macroeconomic coordination targets is due to insufficient effort, to the growth-retarding effects of rapid currency appreciation and the inflationary effects of depreciation already described, or to fundamental inadequacies of traditional macroeconomic policies in the current economic environment. At issue are both intellectual disagreements and a perceived conflict of interest.

If, as it often appears, surplus and deficit countries alike regard export-led stimulus as more desirable than an equivalent dose originating at home, then a genuine impasse emerges, since the reduction of some countries' deficits inevitably requires the reduction of other countries' surpluses. However shaky the logical foundations of such preferences may be in the general case - and there is in fact nothing magical about exports that makes a dollar's worth of additional demand originating abroad any less inflationary or more employment-creating than a dollar's worth arising from domestic consumption or investment - it is true that countries whose growth has traditionally been heavily export-based, like Germany and Japan, are likely to experience transitional difficulties in accelerating the real growth of their economies and reducing export growth at the same time.

Even more fundamental is the disagreement and confusion surrounding the relationship between inflation and unemployment. Germany has traditionally tended to be super-cautious as regards inflation even at some cost in terms of real growth, and the same has recently been true to some extent of Japan. Furthermore, doubts have been growing recently as to whether the traditional Keynesian trade-off between inflation and unemployment in fact exists at all. An alternative view - that inflation will over the longer term make the achievement of satisfactory levels of employment and output more problematic rather than less - has been gaining increasing support.

Such disagreement reflects the tremendous uncertainty that currently prevails regarding the impact of the traditional tools of demand-management policy in an environment of persistent stagflation. Until some general consensus once again emerges, and until reliable ways are found to sustain or stimulate real growth while restraining inflation, divergent national views and preferences are bound to impede further progress toward the international coordination of domestic macroeconomic policies among the leading industrialized nations.

Furthermore, we should not expect too much of reduced differentials in real growth rates between the industrialized countries as a means of eliminating payments imbalances. Recent studies suggest that even if other industrialized countries achieved the same growth rates as the United States in relation to their underlying potential, this would reduce our current account deficit (expected to total some $17 billion in 1978) by only two to five billion dollars. Treasury Secretary Blumenthal has recently forecast a reduction of 50-60 percent in the U.S. current account deficit in 1979, an optimism shared by the leading international organizations and by most private forecasters, and only moderately dampened by the unexpectedly large OPEC price increase. Some anticipated convergence of growth rates should contribute to this improvement, but the major factor underlying it should be the improved competitive position stemming from the substantial depreciation of the dollar in 1977-78, whose trade effects were beginning to become apparent by the latter half of the year.

V

The apparent shift in Administration policy heralded by the dollar-rescue package of November 1, from a long-standing policy of what many regarded as "benign neglect" of our external payments position to a strong commitment to stemming the dollar's decline, highlighted a perennial question. Is there an inherent conflict between the needs of the U.S. economy and the requirements of the dollar as an international currency?

As regards the monetary tightening measures that formed part of the package, those (including this author) who regard the reduction of inflation as the most overwhelming priority domestically see no fundamental conflict. Those who fear that increased fiscal and monetary stringency are likely to precipitate recession argue the contrary.8

As regards the parts of the November 1 announcement dealing with exchange-market intervention and the value of the dollar internationally, the issue is somewhat different. Clearly, a brake on the dollar's accelerating decline was essential both to restore order to foreign exchange markets and to reduce inflationary pressure on the domestic economy. However, if intervention directed toward strengthening the dollar in its international financial role results in once again overvaluing the dollar, thus undermining our international competitive position and hampering adjustment of our imbalance on current account, it will ultimately prove counterproductive not only for the U.S. economy but for the international role of its currency as well. The story of the dollar's adjustment is far from over.

The question of whether the international role of the dollar is a special burden or, in the words of General de Gaulle, an exorbitant privilege, has intermittently complicated U.S.-European relations for several decades. The end of the Bretton Woods system in 1971 meant that the accumulation of dollars by other nations through exchange market intervention is now voluntary rather than mandatory, but this has not abolished the problem. In fact, both sides continue to display a certain amount of schizophrenia regarding the role of the United States as the world's banker and of the dollar as the leading international currency. The Europeans and the Japanese, for their part, insist that the United States must become more competitive and bolster its current account position, but often appear unwilling to accept a concomitant weakening of their own trade and current account positions. The United States, for its part, insists that the dollar should have the same freedom of exchange-rate movement as any other currency to eliminate imbalances in our external position. At the same time, we seem reluctant to contemplate a reduction in the reserve currency role of the dollar, a role which places a premium on dollar stability.

With these divergent attitudes, and to a large extent in response to European concerns about the dollar, the European Economic Community took the major step during the year of developing new plans for a European Monetary System. In brief, the EMS is designed to consist of a set of rules limiting exchange-rate movements between the currencies of EEC countries within a specified band; a new, composite European unit of account called the écu; and a European Monetary Fund, in which a significant portion (perhaps 20 percent) of the member countries' reserves would be pooled. The resulting fund, which would probably total about $30 billion, could be drawn on by member countries to support their currencies in exchange markets.

The proposal was initially greeted with widespread skepticism, reflecting not only the failure of several earlier attempts along these lines but also the formidable difficulties confronting any attempt to stabilize exchange rates between countries whose rates of inflation currently range from two to 13 percent. With the apparent resolution of French-German disagreements on the operation of the system, the probability appeared high that it would in fact be introduced early in 1979 (with Britain opting to remain outside for the present), although whether it will in fact evolve into something significantly beyond an extension to more countries of the present currency "snake" is still uncertain.9

To some extent, such a move toward monetary unification can be seen as a logical next step in the institutional evolution of the European Community and a stimulus to political cooperation. But the fact remains that a major reason for the formation of the EMS was negative rather than positive: a sense that attempts to establish a stable international monetary system centered on the dollar had failed, and that the domestic economic difficulties and international problems engendered or exacerbated by prolonged exchange market instability required the EEC nations to create their own regional self-help mechanism. Whether a stabilized dollar would interrupt these plans once political momentum had been created is still uncertain, but there is little question that the EMS proposal was born of disillusion with the performance of the dollar and the dollar-centered international monetary system.

Perhaps predictably, the U.S. response to the prospect of the EMS was ambivalent and cautious. A number of concerns have been voiced as the basis for this reserved attitude, including the possibility that the EEC nations might attempt jointly to limit the movement of the dollar exchange rate, that the requirements for maintaining tightly linked exchange rates might prove excessively deflationary, and that the new arrangements might undermine the influence and authority of the International Monetary Fund. But I suspect that another unspoken factor is the continuing reluctance of the United States to see the emergence of a potential alternative asset (the proposed écu) that might spur reserve diversification and reduce the dollar's international role. Nor are the Europeans entirely free of the same ambivalence: while some would clearly welcome the emergence of a European alternative to the international dollar, others regard the proposed EMS as a second-best solution born of despair that stability can be restored to a dollar-centered system.

Whatever the doubts on all sides, and however the latest proposal for European monetary union fares, two facts seem clear. One is that the dollar is likely to continue as the world's major reserve asset for the foreseeable future. The second is that even if this role were to disappear overnight, the sheer size of the United States and its importance in world trade and investment would continue to impose on it special responsibilities for the health of the global economy.

VI

While attention was focused primarily on the macroeconomic aspects of relations between industrialized nations, 1978 was also a year of significant developments in the more traditional spheres of international economic diplomacy: trade relations and commercial policies. Although there were fewer headline-grabbing events in these areas, the issues that crystallized during the year may prove just as critical to the world economy as what happened to the dollar.

Certainly, 1978 was a year of paradox for international trade, with protectionist pressures in the leading industrialized countries threatening to erode the foundations of the postwar international trading system even as the latest round of multilateral negotiations directed at further liberalization of international trade crescendoed toward their final phase in Geneva.10 The ironic interplay underscores both the importance and the difficulty of bringing the negotiations to a successful conclusion.

In discussing the politics of international trade, it is helpful to bear in mind the three different functions of such trade. First, there are the aspects of trade beloved of economists: trade as a vehicle for increasing specialization, enhancing competition, enabling each country to concentrate on what it does best and thus increasing potential output, income and living standards throughout the world. Second, there is trade as an instrument for adjusting payments imbalances, invoked most recently by President Carter's announcement of a program to stimulate U.S. exports as a means of reducing our payments deficit and alleviating pressure on the dollar. And, finally, there is trade as an instrument of foreign policy, a time-honored role that has never been entirely absent from the American scene, but which has received increased attention during the Carter Administration. The inherent tension among these three different and at times conflicting functions has greatly complicated the formulation of trade policies and the conduct of trade between the industrialized countries, which are one another's most important trading partners.

Government interference with trade by means of import restrictions or export subsidies is hardly a new phenomenon in the industrialized nations (or anywhere else, for that matter), but it received new impetus and took on some new and complex forms during the past year. Probably the most widely noted example was the so-called trigger price mechanism, introduced late in 1977 to control steel imports into the United States, in response to a threatened deluge of dumping complaints by the domestic steel industry. It operates first by establishing a "trigger price" for imported steel, based on the production costs of the most efficient producer, Japan. Sales of imported steel at prices below the trigger level are then regarded as a signal for the institution of an immediate investigation by the U.S. Treasury Department, leading under the law to the imposition of anti-dumping duties on imported products found to have been "dumped," or sold in the U.S. market at a price below cost or below that prevailing in the producer's home market. Given the uncertainties and apprehensions the program creates among foreign producers, its practical effect has been to establish a minimum price for imported steel.

Steel imports into the United States rose in 1978 over 1977 despite the introduction of the trigger price mechanism, but the market share accounted for by imports declined as U.S. production increased, the excess capacity of the U.S. steel industry was rapidly reduced, and the profits of American steel firms rose substantially. The trigger price mechanism has, however, altered the geographic pattern of imports, cutting into the Japanese share of the U.S. market to the advantage not only of European producers, which was part of the original intent, but of such fast-growing newcomers as Brazil, Korea and Taiwan.11

The most striking impact, however, of a trigger price mechanism based on Japanese costs, given the rapid appreciation of the yen, has been to raise prices. Trigger price levels rose by more than ten percent in 1978, almost entirely as a result of the yen's appreciation, and were scheduled to rise by another seven percent on January 1, 1979. Domestic steel prices rose at about the same rate during the year, and a five percent increase was announced for the first quarter of 1979. In the words of the head of the EEC's steel producers' group, Eurofer, the trigger price mechanism "has raised steel prices all around the world."

Other trade-limiting measures introduced recently by the United States include the negotiation of so-called orderly marketing agreements (OMAs) with Japan, limiting its exports of color television sets to the United States, and with Korea and Taiwan limiting their exports of footwear. In addition, there has been somewhat tighter application of the 1974 Trade Act as regards three major categories of import restrictions. These include antidumping duties, already described, countervailing duties imposed to offset the price-reducing effects of other countries' export subsidies, and escape clause actions, involving the imposition of higher tariffs, quotas or "voluntary" export restraint agreements to mitigate injury to domestic producers from increased imports.

The 1974 Act broadened the conditions under which U.S. producers might be entitled to import relief or adjustment assistance, and speeded up the timetables within which the government was required to act in response to their petitions. The effect was to create a more favorable climate for appeal to the courts in instances where domestic producers were not satisfied with the response of the executive branch. Indeed, one of the reasons for the establishment of the steel trigger price mechanism was to forestall the institution of a rash of anti-dumping actions by U.S. steel producers, with a high probability of leading to a number of court suits.

In another situation, an explosion of countervailing duty actions was threatened by a 1977 decision of the U.S. Customs Court in New York, in the so-called Zenith case, that Japanese tax exemptions for television sets sold overseas constituted a subsidy requiring the imposition of countervailing duties. If this decision had stood, it would have rendered a broad range of European manufactured exports vulnerable to similar action because they receive a rebate of the value-added tax. Such a development would doubtless have seriously disrupted the multilateral trade negotiations and provoked significant retaliation against U.S. exports. On June 21, 1978, however, the Customs Court's Zenith decision was overturned by the U.S. Supreme Court.

A similar tendency toward increased restrictiveness has also been apparent in the European Economic Community, concentrated primarily in some of the same particularly sensitive industries as have already been mentioned in connection with U.S. trade policy. In particular, the EEC, whose steel industry was suffering from problems similar to those of its U.S. counterpart, was developing a full-fledged cartelization plan, involving proposals for minimum prices, production controls, market-sharing quotas, and the "rationalization" of the industry's structure, including reductions in capacity. If this so-called Davignon Plan (named for its originator, the EEC Commissioner for Industry) can be implemented for the steel industry, the idea is to extend the general concept to other industries currently suffering from excess capacity and slack demand on a global scale, such as shipbuilding and synthetic fibers, and then to try to multilateralize these cartelization schemes.

Japan, whose domestic markets are less open to imports than those of any other non-communist industrialized nation, has introduced no significant new trade restrictions. However, its liberalization efforts have not so far proved effective in opening up its domestic market.12

At the multilateral level, the extension of the multi-fiber agreement covering trade in textiles for the period 1978-82 appears on the whole to be significantly more restrictive than its predecessor. Overall, 1978 must surely have seen a significant increase over the best available end-1977 estimate, that three to five percent of world trade, amounting to some $30-40 billion, was then "being adversely affected by import restrictions introduced, or seriously threatened, by the industrially advanced countries."13 Far broader than the direct effects of new restrictions, however, is their indirect impact: the chilling effect of uncertainty on production for export and the tendency of restrictive trade policies to proliferate as countries take defensive actions to protect domestic producers whose access to foreign markets are curtailed by other nations' restrictions.

The reasons underlying this increase in protectionist pressures in the industrialized nations are many and varied. Among them is the fact that a number of painful adjustments have already been required of these countries.

The sudden post-1973 increase in the relative price of energy exacerbated the stagflation problem in most industrialized nations and led to intensified export drives to protect the balance of payments in a number of countries. And there has been a continuing significant shift of comparative advantage in the production of a growing list of manufactured products, first toward Japan and then toward an emerging group of "new Japans" - such advanced developing countries as Brazil, Hong Kong, Korea, Singapore and Taiwan. With this shift has come a rapid increase in import penetration of the industrialized countries, necessitating significant structural adjustments in these economies at a time when, for a variety of reasons, they are finding it increasingly difficult to make such changes.

One reason for this increasing rigidity - in the United States and elsewhere - is the growing political and social preoccupation with economic security and distributional equity, as opposed to a primary focus on economic efficiency and rapid growth, which places a premium on adaptability. In particular, the narrowing of wage differentials, combined with a low rate of population growth, tends to increase the rigidity of the labor market, making it more difficult to move people from one occupation or industry or geographical area to another in response to changing patterns of demand. A stiffening of the regulatory climate in many of these nations has also reduced flexibility.

In effect, the inadequate recovery in most industrialized countries from the severe recession of 1974-75 has brought about an interaction of cyclical difficulties with longer term structural problems. Persistent high unemployment and excess capacity, both in the aggregate and in particular sectors, low rates of investment and profitability, and a climate of increased uncertainty stemming in part from persistent inflation and in part from upheavals in the international economy, have all contributed to slower growth and a pervasive sense of insecurity. These have in turn engendered pressure for measures to slow down the process of adjustment-forcing change, particularly change in the form of new patterns of import competition - change "foreign" in a psychological as well as an economic sense.

There are, of course, elements of another vicious circle here. Slower growth tends to make adjustment more painful and difficult, but barriers to change reduce the efficiency of the allocative mechanism and lead to slower growth. For example, much of the industrial overcapacity that has catalyzed pressures for trade restriction and cartelization is itself the product of previous government intervention, in the form of protection, subsidies or, in some instances in Europe, outright nationalization, to rescue inefficient firms or aging industries.

It is perhaps natural that, against a background of continued ideological commitment to liberal international trade, some confusing Newspeak and Double-think has now arisen to rationalize such defensive economic nationalism. Orderly marketing agreements and voluntary export restraint programs restricting trade are introduced preemptively, presumably to forestall more restrictive unilateral import restraints; "adjustment policies" and "rationalization schemes" frequently turn out to be income maintenance measures for threatened industries; and the French concept of "organized free trade" turns out to rest primarily on substituting multilaterally agreed trade restraints and market-sharing agreements for unilateral restrictions. In this environment, the explicit recognition by the industrialized countries of the need for "positive adjustment" policies that actually facilitate economic change in response to market forces, rather than insulating particular segments of the economy from the need for it, is a welcome and hopeful sign.14

Against the background of mounting protectionist pressures, a successful outcome of the so-called Tokyo Round of GATT-sponsored multilateral trade negotiations is particularly crucial. Although agreement on the key non-tariff issues had been reached by the negotiators for the major industrialized countries, subject to ratification by their respective governments, by the end of the year it appeared that completion of a comprehensive negotiating package by all participants would require several months more.

A last-minute development which complicated the discussions was that the authorization of the 1974 Trade Act permitting the United States to waive countervailing duties for four years in cases where active trade negotiations were under way was to expire on January 3, 1979. The U.S. Congress adjourned in October without enacting the expected extension of this waiver authority, a situation that would presumably force the U.S. Treasury to impose countervailing duties on some $700 million of subsidized exports at the beginning of the new year. The U.S. negotiators, while acknowledging that the failure to extend the waiver was inadvertent, argued that it made multilateral agreement on the limitation of export subsidies all the more imperative, while the French took the view that the negotiations could not be brought to a successful conclusion until the U.S. Congress had removed this sword of Damocles hanging over the heads of our trading partners. As of mid-December, it seemed that this impasse was being resolved, but the outcome was necessarily uncertain until the new Congress convened in January.

Even without this gratuitous complication, the Tokyo Round negotiations were particularly complex. In earlier rounds of postwar trade negotiations, the focus was on increasing the scope for market-directed international trade, mainly by reducing the tariff barriers in industrialized nations on imports of industrial products. But by this last round, although tariff reductions averaging some 25-30 percent, to be phased in over an eight- to ten- year period, were expected to emerge from the negotiations, tariffs had ceased to be the main instrument for limiting or distorting trade. They have been superseded by a wide variety of non-tariff barriers (NTBs) instituted by nations as part of their efforts to manage domestic agricultural policy, to minimize adjustment costs in the face of domestic stagflation, or to correct for "market failure" in such areas as preserving environmental quality.

In a series of codes covering non-tariff measures, the Geneva participants addressed many of these complexities. They extended GATT coverage to significant new areas and laid the basis for broader international supervision of trade practices. With respect to a number of national policies and practices directly affecting trade, including customs valuation, government procurement, and product standards and technical regulations, the draft codes of behavior emphasized the need to harmonize national policies and to minimize trade distortions arising from their implementation. At the insistence of the United States, which has always felt that the transparency or explicitness of its own NTBs put it at a negotiating disadvantage with nations whose barriers tend to be more "occult" (that is, informal and harder to pin down), "transparency" was made an explicit goal.

Agricultural trade, which is of particular importance to the United States as a major agricultural exporter, had never been effectively incorporated into previous rounds of GATT negotiations. This time, the negotiators agreed to establish an overall framework for consultation on agricultural policies and the development of mechanisms to assist the stabilization of agricultural prices and incomes. This general framework is to be supplemented by commodity agreements covering four critical product groups: wheat, coarse grains, meat, and dairy products. In addition, the United States reached agreements with Japan and the EEC on the liberalization of tariffs and quotas on a variety of agricultural products, liberalizations that will be extended to all GATT member suppliers under the most-favored-nation (MFN) principle. Although these concessions were less than had been hoped, their realization would represent more significant achievements in the agricultural area than have emerged from most earlier GATT rounds.

As one major element in a meaningful code of conduct covering trade policies, the United States has long urged the broadening and strengthening of multilaterally agreed criteria and procedures covering the so-called safeguards, or escape-clause actions, that countries currently apply to protect domestic industries from injury associated with import competition. In this area, a principal issue was the European contention that countries should be free to apply such safeguards selectively against particular suppliers, which would contravene the fundamental GATT principle of nondiscriminatory (most-favored-nation) treatment. The United States has itself initiated an increasing number of orderly marketing agreements and voluntary export restraint programs in recent years with selected countries whose rapidly growing exports to this country of particularly sensitive products have created serious domestic difficulties. But the United States remains concerned about serious compromise of the MFN principle, of which it has long been the main supporter, and holds that such selective safeguards should at least be subject to strict international review and surveillance. As of the end of the year, the standards and procedures to embody this general principle had not yet been fully worked out.

Perhaps the most sensitive bone of contention between the United States and its industrialized trading partners has to do with export subsidies and the countervailing duties imposed by importing nations to offset them. The negotiators agreed, under strong American prodding, to strengthen and clarify existing GATT limitations on direct subsidies to industrial exports, to develop international guidelines designed to minimize trade distortions arising from subsidies granted for legitimate domestic reasons, and to establish the principle that countries' subsidies for agricultural exports should not be used in such a way as to distort historical trade patterns and market shares. The United States undertook, in turn, to bring its countervailing duty law into closer alignment with those of our major trading partners; at present, we alone among the major industrialized countries have no injury test - that is, provision for evidence of damage to domestic procedures - as part of that legislation. Agreement on these principles represents a significant achievement, but the knotty question of when a legitimate exercise of national policy (such as tax breaks for new plants in a lagging region of a country) distorts trade and thus is the legitimate object of countervailing duties remains to be argued out on a case-by-case basis.

Although it is not encompassed in the Geneva negotiations, the problem of government-subsidized export financing suggests some of the difficulties that may be encountered in implementing the principles regarding subsidies enunciated at Geneva. Early in 1978, at the urging of the United States, 22 industrialized nations and the EEC agreed, under OECD auspices, to try to end the competitive escalation of subsidized export financing by accepting a list of mutually agreed limitations on such subsidies. The agreement was quickly breached by at least one of our industrialized competitors, and the United States has taken additional steps to try to expand its scope and tighten its terms.

This country has taken the position that, while we would prefer to see this increasingly expensive competition effectively limited, if that proves impossible it is our intention to match our competitors' terms. Indeed, increased resources for the U.S. Export-Import Bank, whose financing has already been increased fivefold during the past two fiscal years, are a key point in the export promotion program announced by President Carter in September.

VII

Although not addressed intensively in the GATT negotiations, the question of export restrictions and assured access to supplies of commodities in international trade has in recent years taken on new importance. The oil embargo of 1973 focused attention dramatically on this issue, which during most of the postwar period had taken second place to concern about limitations on imports and assuring access to markets, but less startling instances of such restrictions have also proliferated among the industrialized countries in recent years. And the United States, which has traditionally eschewed export controls except where national security is at stake, has not stood entirely aloof from this new trend. For example, our short-lived embargo on the export of soybeans in the summer of 1973, intended to alleviate domestic inflationary pressures, made our foreign customers extremely nervous and lent support to protectionist forces in Europe and Japan that had long advocated reducing dependence on U.S. agricultural exports by promoting high-cost domestic self-sufficiency.

More recent developments have raised anew issues involving the United States' use of trade as an instrument of foreign policy. These issues include U.S. government goals and attitudes regarding nuclear proliferation, the Arab boycott of trade with Israel, relations with the Soviet Union, bribery as a business tool, and human rights generally. This is not the place for a comprehensive evaluation of these complex questions. But there can be no doubt that the insistence that U.S. companies operate under special rules not applicable to foreign competitors has had a negative impact on U.S. exports, and raised questions about U.S. reliability as a supplier.

The magnitude of these effects is hard to quantify. Even before the Carter Administration's stress on the nonproliferation issue, earlier government stop-and-go policies on exports of enriched uranium had created difficulties for the nuclear industry. In 1977-78, the Administration and now especially the Congress have imposed extremely tight controls on future American nuclear exports, subjecting them specifically to new conditions respecting nuclear reprocessing activity in recipient countries. The Carter Administration has recently taken pains to reassure other countries that we are in fact sensitive to their energy needs and will indeed be a reliable supplier of nuclear fuels. But we have by no means eradicated foreign suspicions regarding the motives underlying American nonproliferation policy, nor the anger engendered by the temporary embargoes we have from time to time imposed on shipments of enriched uranium to foreign customers.

Similarly, there is uncertainty about the commercial impact of new legislation relating to the Arab boycott, making it illegal for U.S. companies, in effect, to participate in business involving the application of secondary boycott provisions. Supporters note that American exports to boycotting countries have continued to rise since passage of the anti-boycott legislation; opponents counter that the exports of our major competitors to these rapidly expanding markets have risen even faster, and that no similar legislation is operative in Europe or Japan.15

Restrictions on U.S. trade with the Soviet Union in the interests of national security have long been an integral part of U.S. foreign policy - indeed, for most of the postwar period, such trade was essentially embargoed entirely. Over the past decade, however, economic relations between East and West have been expanding and, by the heyday of détente, U.S. restrictions were largely confined to items having a direct military application. Most recently, the Administration has attempted a broader balancing of the trade-offs between the effects of a particular export decision on restraining Soviet expansionism, U.S.-Soviet relations, and the United States' trade competitiveness and world leadership position.

For example, the Commerce Department in 1978 licensed the export to the Soviet Union of a sophisticated plant for making oil-drilling equipment only after a heated debate on these issues. In December, the Secretary of Commerce announced in Moscow that her department was now prepared to grant licenses for a number of high-technology oil and gas equipment exports that had been held up for some months. These developments took place, however, within the framework of President Carter's 1978 order to the National Security Council to scrutinize carefully all commercial transactions with the Soviet Union involving the transfer of sophisticated technology.

With the passage of the Jackson-Vanik and Stevenson Amendments of 1974 prohibiting the extension of most-favored-nation tariff treatment and severely limiting Export-Import Bank financing for trade with the Soviet Union until that nation liberalized its policies on the emigration of Soviet Jews, a new consideration entered the U.S. trade picture: human rights. And in the summer of 1978, President Carter vetoed the sale of a Sperry Univac computer to the Soviet news agency TASS, explicitly linking his action to the recent trials of Soviet dissidents. The immediate results of these moves were not encouraging: Jewish emigration from the Soviet Union declined sharply in the wake of the 1974 amendments, and TASS promptly solicited bids from European firms. Thus, the basic issues involved in defining and implementing the optimal relationship between U.S. trade and U.S. foreign policy remain unsolved.

In September of 1978, President Carter addressed himself directly to the encouragement of U.S. exports, keeping a promise he had made at the Bonn summit two months earlier. One section of his statement dealt with expanding direct assistance to U.S. exporters through the Export-Import Bank, the Small Business Administration, and the Departments of Commerce, State and Agriculture. Another focused on American efforts to reduce foreign import restrictions and export subsidies through the Multilateral Trade Negotiations in Geneva. But the bulk of his policy statement was devoted to a detailed discussion of U.S. domestic barriers to exports, including government regulations, export controls for foreign policy purposes, the Foreign Corrupt Practices Act, antitrust laws, and environmental reviews. In general, the President promised a careful scrutiny of the impact on U.S. exports of current policies and practices in each area, efforts to reduce the uncertainty they create for actual or potential exporters, and minimization of their trade-impeding effects to the extent consistent with their basic goals.

With one exception - an Executive Order explicitly exempting the bulk of U.S. exports from the requirement of environmental impact statements relating to potential effects in other countries - the President's language regarding domestic barriers to exports is general rather than specific. Thus, it remains to be seen how it will be implemented and what its actual impact on U.S. exports will be. But the attention devoted to this particular issue, and the balanced, pragmatic language in which it is discussed, indicate a new willingness on the part of the U.S. government to confront explicitly the multiple goals and complex trade-offs involved.

VIII

The United States has served throughout the postwar period as the major supporter of a liberal (that is, market-oriented and nondiscriminatory) multilateral system of trade and payments in the economic sphere, along with what has been termed "world order politics," including a significant role for international institutions, in the political sphere. A desire to halt the erosion of the GATT framework for international trade underlay U.S. leadership of the most recent round of Multilateral Trade Negotiations, and a similar desire to preserve the authority of the International Monetary Fund helped shape the cautious view of the United States toward the proposed European Monetary System.

The same concern for the institutional role of the IMF, rather than a belief that an increase in world liquidity is necessary or even desirable in strictly economic terms, underlay the crucial American support for a substantial increase in the IMF's resources and for a new issue of Special Drawing Rights totaling $12 billion over the next three years (along with a significant relaxation of restrictions on the use of SDRs), both of which were agreed to at the annual meeting of the World Bank and the IMF in September. The position of the IMF was also enhanced by the ratification in April 1978 of the Second Amendment to its Articles of Agreement. The United States was one of the original proponents of this Amendment, which legalized the practice of managed floating and endowed the IMF with responsibility for surveillance of member countries' exchange-rate policies.

The U.S. commitment to the principles of economic liberalism and world order politics has never been unqualified. Our own policies and actions have run counter to these precepts on many occasions, and the struggle between an executive branch committed to international institution-building and a Congress in which the forces of nationalism, both political and economic, are far more apparent, has been a prominent feature of American political life for decades. But the events of 1978 suggest a sharpening of the tension between our commitment to these long-term principles on the one hand and our pursuit of specific short-term economic and political goals on the other.

This problem is hardly unique to the United States, of course; indeed, the forces of defensive economic nationalism appear to be stronger in most other industrialized nations than they are in our own. But the situation confronting this country is unique in at least one respect. Despite the significant decline in American economic hegemony over the past two decades, U.S. support of the international economic system continues to be a necessary (though no longer a sufficient) condition of its survival. Should the United States decide that defensive economic nationalism is the new order of the day, and therefore sacrifice to particular economic and political interests its sense of responsibility for a viable international system, its behavior, more than that of any other single nation, would have the character of a self-fulfilling prophecy.

Whether the postwar framework of international economic relations can survive the mounting pressures on it depends on many factors, including the attitudes and behavior of several important actors outside the present circle of industrialized nations. But there can be no doubt that the first prerequisite is effective management of the domestic economies of the major industrialized nations. Satisfactory growth rates, high levels of employment, and reasonable price stability will do more than anything else to make macroeconomic coordination between countries feasible and microeconomic adjustment within countries acceptable.

Historically, it has been in the absence of these conditions that trade and payments problems have become intractable and international economic relations increasingly problematic. Should the industrialized countries fail to solve the problem of stagflation domestically, a liberal and coherent international economic system will be among the early casualties and, with it, the economic fortunes of the numerous developing countries heavily dependent on the markets of the industrialized world.

Footnotes

1 The $30-billion package included enlargement of reciprocal currency ("swap") arrangements between the Federal Reserve System and the foreign central banks of Germany, Japan and Switzerland; sale of Special Drawing Rights (SDRs) from U.S. reserves; drawings on our line of credit at the International Monetary Fund; and sales to foreigners of U.S. Treasury obligations denominated in foreign currencies. The first such issue, of $1.6 billion of three- and four-year bonds denominated in deutschemarks, was successfully marketed in December. An increase in sales of gold from U.S. reserves was also announced, to begin in December.

2 In December 14 testimony before the Joint Economic Committee, Secretary of the Treasury Blumenthal stressed that recent actions were not attempts "to peg exchange rates or establish targets or push the dollar beyond levels which reflect the fundamental economic and financial realities." In contrast, Chairman William Miller of the Federal Reserve Board recently stated that the dollar "is in a zone now that is acceptable," and Charles Schultze, Chairman of the Council of Economic Advisers, stated that the United States is "still committed to avoiding disorderly and unwarranted changes in exchange rates" (emphasis added).

3 These concerns may appear farfetched at the moment, but it is worth remembering the experience of recent years, which is replete with reminders of the need to avoid "policies or practices which are designed to limit exchange rate movements but may eventually lead to an undesirable degree of exchange rate instability." See Jacques de Larosière, Managing Director of the International Monetary Fund, in a speech entitled "The Fund and Surveillance," to the Chicago Council on Foreign Relations, November 14, 1978.

4 A rise in the monthly merchandise trade deficit to $2.1 billion in October, due primarily to a drop in exports of non-manufactured goods, particularly gold, did not alter the general consensus that our trade position is continuing to improve.

5 The comparisons are roughly similar if Wholesale Price Indices are used, except for Japan, where the level of wholesale prices actually declined during 1978.

6 What is surprising, in fact, is that the share of dollars in global foreign exchange reserves held steady at roughly 80 percent between 1970 and 1977. Presumably the reason is that acquisitions of other currencies for diversification purposes were in the aggregate offset by dollar acquisitions arising from exchange market intervention for the purpose of restraining the appreciation of particular currencies vis-à-vis the dollar.

7 This so-called J-curve effect occurs because depreciation's most immediate effect is to raise the domestic-currency cost of imports for the depreciating country and thus temporarily to worsen its balance of payments. It is only as the country's volume of now-cheaper exports increases and its volume of imports declines that its balance of payments improves. The opposite of this perverse effect applies to appreciating countries, where the balance of payments temporarily improves because of the higher foreign-currency prices of its exports, and then worsens as its trading partners shift from its exports to lower priced competitors, and domestic consumers buy larger quantities of cheapened imports.

8 The position of the AFL-CIO, for example, is that direct controls on imports and capital outflows would be preferable to domestic monetary stringency as a means of trying to improve our balance-of-payments position. Questions of effectiveness aside, such controls would hardly be consistent with the desirable characteristics of an international currency.

9 The planned inauguration of the EMS on January 1, 1979 was postponed when France insisted that the long-standing issue of agricultural subsidies ("compensatory payments") within the EEC be resolved before the new monetary system comes into operation.

10 A target deadline of December 15, 1978 was announced at the Bonn summit for agreement among the negotiators at Geneva on a package to take home for ratification. The U.S. negotiating authority does not expire until the end of 1979; it is hoped that congressional ratification of an agreed trade package can be obtained before that date. As this is written, it appears that the negotiations will not be completed before the spring of 1979.

11 Because trigger prices are based on Japanese production costs, the rapid appreciation of the yen has required substantial quarterly adjustments - i.e., compensating increases - in U.S. trigger price levels. This offered an opportunity to other foreign producers with higher initial costs, or whose currencies were appreciating less rapidly vis-à-vis the dollar, to dump legally, that is, to sell in the United States at prices above trigger levels even though they were below their own costs of production.

13 Address by Olivier Long, Director General of the GATT, to the Zürich Economic Society, GATT Press Release No. 1199, November 9, 1977.

14 The need for positive adjustment measures was explicitly acknowledged by the participants in the Bonn summit, shortly after a detailed discussion of such measures and their relation to economic growth was annexed to the June 14 communiqué of the OECD Council.

15 What appears to trouble the business community most is the complexity of the rules in this area and the uncertainty they create for decision-making, along with some apparent inconsistencies between the requirements of the Export Administration Act, the Ribicoff Amendment to the Tax Reform Act, and the antitrust statutes as all three relate to boycotts. Although the broader philosophical issues would remain unresolved, presumably the commercial impact of U.S. anti-boycott legislation could be minimized, with no erosion of its purpose, if the relevant statutory provisions were clarified and rendered mutually consistent.

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  • Marina v. N. Whitman is Distinguished Public Service Professor of Economics at the University of Pittsburgh, currently on leave as a Fellow of the Center for Advanced Study in the Behavioral Sciences, in Stanford. She was a member of the President's Council of Economic Advisers in 1972-73, and is the author of a forthcoming volume, Reflections of Interdependence, and other works.
  • More By Marina van Whitman