Courtesy Reuters

The United States and the World Economy

The year 1986 severely tested the ability of the United States to provide the leadership needed to prevent a threatened breakdown in the ever more closely integrated world economic and financial system. Dangers to the system have resulted from the high volatility of exchange rates, huge imbalances in trade and growing protectionism; these have been compounded by the inability of developing countries to meet their debt obligations, continuing fears of inflation in the midst of sharp declines in oil and commodity prices, sluggish growth in the industrial and developing countries alike, persistent overcapacity and unemployment. Aggravating the strains of clashing national interests were uncertainty and conflict among the major nations of the West over the right policies for solving this complicated set of problems.

If solutions are to be found, it is crucial that the leading industrial nations come to a common understanding of how to avoid repeating the mistakes that caused the Great Depression and the political disasters that flowed from it.

After World War I, and the inflations released by it, the major countries adopted highly restrictive monetary policies, which by the end of the 1920s choked off economic growth. The trend toward world deflation was reinforced by countries’ mistaken foreign-exchange policies. In Britain the pound sterling had fallen to $3.44 in November 1920, but it was restored to its prewar dollar parity of $4.86 when Britain returned to the gold standard in 1925. Britain felt compelled to adopt excessively tight money to hold it there. The results were falling prices, economic slump, climbing unemployment and "the dole." In France, by contrast, the franc was undervalued after the war, and the large inflow of gold and foreign exchange put intense pressure on other countries, including the United States. In the United States restrictive tariff legislation was passed, especially the 1930 Smoot-Hawley Act, which hurt other countries and forced them to engage in severe deflation to maintain the exchange rates of their currencies. The Great Depression stemmed from the postwar boom—and from the deflationary measures

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