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For Release on Delivery Monday, June 24, 1968 12:00 N o o n , E . D . T . DOMESTIC STABILIZATION A N D THE U . S. BALANCE OF PAYMENTS Remarks by A n d r e w F . Brimmer Member Board of Governors of the Federal Reserve System Before the Economic Society of South Florida DuPont Plaza Hotel M i a m i , Florida June 24, 1968 DOMESTIC STABILIZATION AND THE U . S . BALANCE OF PAYMENTS By Andrew F . Brimmer* The fiscal restraint p r o p o s a l s , finally adopted by Congress after nearly a year of d e b a t e , should make a major contribution toward the restoration of economic stability at home and the improvement of our balance of p a y m e n t s . H o w e v e r , while higher income taxes and reduced Federal expenditures will begin immediately to dampen the pace of domestic economic a c t i v i t y , the benefits to the balance of payments will come more slowly. The principal effect of the new fiscal measures on the balance of payments should be an expansion in our trade surplus: while exports should be stimulated somewhat, there should be a noticeable moderation in imports. For the year 1968, the trade surplus m a y be $200 million better - with the added fiscal restraint in place -- than without it, and by the fourth quarter of 1968, the trade surplus may be running at an annual rate of $400 m i l l i o n better than it otherwise would have b e e n . Furthermore, the trend of trade -- and also of domestic prices and costs -- should be substantially better as we go into 1969. All of these developments will have beneficial implications for confidence in the dollar and for capital flows as well as for the current a c c o u n t . ^ M e m b e r , Board of Governors of the Federal Reserve System. I am grateful to M r . John Reynolds of the Board's Staff for assistance in the preparation of these remarks. In any effort to improve our balance of p a y m e n t s , the expansion of our trade surplus must play a vital role. In his N e w Year's Day Message on the Balance of P a y m e n t s , the President stated that: " . . .we are determined to achieve a substantial improvement in our trade surplus over the coming y e a r s . In the year immediately a h e a d , we expect to realize an improvement of $500 million." The President made clear that, among other a c t i o n s , it would be necessary . .to enact the anti-inflation tax which I have sought for almost a y e a r . Coupled with our expenditure controls and appropriate monetary p o l i c y , this w i l l help to stem the inflationary pressures which now threaten our economic prosperity and our trade surplus." In these r e m a r k s , I shall examine the consequences for foreign trade and the balance of payments of the domestic inflation which has emerged during the last few y e a r s . I will also appraise the beneficial effects which we might expect if domestic stability is restored. F i r s t , I w i l l review the long-run importance of trade to the balance of payments. S e c o n d l y , I w i l l examine the adverse impact of the Vietnam war on our balance of payments. T h i r d l y , I w i l l appraise the implications of domestic stabilization policies for foreign trade and the balance of payments. F i n a l l y , I w i l l assess the consequences of these balance of payments developments for confidence in the dollar abroad. 1 -3- Foreign Trade and the Balance of Payments: A Long View Throughout the last decade of over-all deficits in U . S . international t r a n s a c t i o n s , it has been evident that the international competitiveness of U . S . goods in world markets was the crucial factor. M e r c h a n d i s e exports and imports are by far the largest items in the U . S . balance of international p a y m e n t s , amounting in 1967 to about $31 billion and $27 b i l l i o n , respectively. H e n c e , small changes in the relative rates of advance of imports and exports can have large effects in dollar terms on the size of the trade balance and the over-all d e f i c i t . For example, if exports were to rise from present levels by only 1 per cent a year faster than imports, the trade surplus would increase by about $300 million a y e a r , whereas a 1 per cent faster rise in imports than in exports would have the opposite e f f e c t . T h u s , even a rather gradual worsening in the trade position could, over time, outweigh relatively large improvements in nontrade sectors of the balance of payments — for example, on capital account and travel. C o n v e r s e l y , a slow but steady increase in the trade surplus could suffice, over time, to reduce g r e a t l y , and ultimately eliminate, our payments d e f i c i t . F u r t h e r m o r e , in a growing world economy, trade adjustments that are large in dollar terms but small in percentage terms can be accomplished I with a minimum of economic disturbance, and without governmental control or interference. From 1960 to 1967, U . S . merchandise exports increased by $11 b i l l i o n , or 56 per c e n t , while merchandise imports increased by $12-1/2 billionj -4- or 84 per c e n t . If exports and imports had each increased over this period by 60 per cent — growth rates only marginally different from those actually experienced — the trade surplus would by 1967 have been $7-1/2 billion instead of the $3-1/2 billion actually recorded, and the over-all payments deficit would probably not have remained an intractable problem. Impact of the Vietnam W a r The acceleration of military activity in Vietnam in mid-1965 brought in train considerably adverse consequences for our trade surplus and the balance of payments. Experience shows that exports and imports respond fairly promptly to changes in levels of demand at home and abroad. They also r e s p o n d , although more slowly and to a degree less easily m e a s u r e d , to changes in relative prices and costs, which in turn are influenced partly by demand pressures and supply constraints. From 1959-60 to 1963-64, exports increased much more rapidly than imports, and the trade surplus nearly d o u b l e d , from about $3 billion a year to about $6 billion a y e a r . This was a period during which foreign economic activity and demand for goods of all sorts was expanding B u t U . S . activity was also expanding strongly. strongly. A key element in the improvement of the trade balance over this period was the stability of U . S . price and cost levels in contrast to generally rising price-cost levels in leading foreign countries. For example, during the years 1960-65, consumer prices in the United States rose by an -5- average of 1.3 per cent per y e a r . In those leading industrial countries who are our principal competitors, the annual percentage increases during the same years were considerably larger: J a p a n , 6.0; I t a l y , 4.9; F r a n c e , 3.8; United K i n g d o m , 3.5; G e r m a n y , 2.8; C a n a d a , 1.6. Also during this p e r i o d , U . S . manufacturers had sufficient capacity beyond that required to meet domestic demands so that they could fill foreign orders reasonably p r o m p t l y . Beginning in 1965, h o w e v e r , demand conditions and the competitive situation c h a n g e d . The addition of Vietnam war demands to an economy already fully employed produced inflation at h o m e , a huge surge in imports, and a reduction in excess capacity which hampered exports. Meanwhile, Britain and Germany slid into a mild recession and excess capacity abroad increased. Price increases accelerated here and slowed a b r o a d . During the two years ending in 1967, the annual rise in consumer prices in this country averaged 2.9 per cent -- or more than double the rate of increase registered in the first half of the d e c a d e . A g a i n , except for C a n a d a , percentage changes in prices in those countries which give us the strongest competition in international markets moderated during the two years 1966-67: appreciably J a p a n , 4.6;. I t a l y , 2.8; F r a n c e , 2.7; United K i n g d o m , 3.2; G e r m a n y , 2.5; C a n a d a , 3.7. Partly as a result of these developments in p r i c e s , in imports and in domestic demand and supply conditions, the U . S . trade surplus shrank from nearly $6 billion a year in 1963-64 to about $3-1/2 billion a year in 1966-67. -6- F u r t h e r m o r e , excess demand and inflationary pressures have increased -- not diminished -- during the first half of this year. the circumstances, the trade surplus has deteriorated further. Under During the first quarter, exports rose by 6 per cent, but were only 3-1/2 per cent higher than a year earlier. Simultaneously, imports rose by nearly 10 per cent in the first quarter, to a level 17 per cent higher than a year earlier. C o n s e q u e n t l y , the annual rate of trade surplus shrank further by roughly $1 billion dropping from $1.3 billion in the final quarter of last year to only $300 million in the first quarter of 1968. Since exports and the trade surplus were depressed by the New York port strike in M a r c h , the first four months of this year provide a better indication of the trend. Even so, the annual rate of trade surplus in the January-April months was still only $1 billion -- far below the $4 billion rate of early 1967. Stabilization Policy and the Foreign Trade Outlook Success in increasing the trade surplus sharply, as we need to do, from these very low recent levels, will require the attainment of two related domestic policy objectives. First, expansion of aggregate domestic demand must be held down to the amount by which output can be expanded, given the available resources of labor and capital. Second, the rapid increases recently experienced in the level of u . S. prices and costs must be greatly slowed d o w n . The first will contribute to the second, but may not suffice, since price-cost increases, once u n d e r w a y , acquire a momentum of their own. Hence the President's stress in his New Year's Day Message on the urgent need for business and labor -7- . . to exercise the utmost responsibility in their wage-price d e c i s i o n s , which affect so directly our competitive position at home and in world markets." On the other h a n d , business and labor will find it much more difficult to exercise the self-restraint that the national interest requires if aggregate demand is excessive than if vigorous fiscal and monetary restraints are applied in a timely m a n n e r . Given the uncertainties of forecasting economic events, it is not possible to state with any assurance precisely how large imports and exports will be in 1968. However, it is possible to sketch briefly the general effects on our trade surplus of the enactment of greater fiscal restraint, as compared with what might otherwise have happened. For this purpose, it should be kept in mind that, with the long delay in the adoption of the tax proposal, the Federal Reserve made considerable use of monetary restraint as an imperfect substitute. And if the fiscal package had not finally been enacted, still greater monetary restraint would have been unavoidable. As we know, tighter credit conditions bear unevenly upon different sectors of the economy, affecting construction outlays in particular, and also state and local government spending, while having less effect on consumer spending. A l s o , monetary restraint undoubtedly works more slowly than a tax surcharge to slow down the advance of prices and costs. I| The end result of using monetary policy during the first half of the year as an imperfect substitute for fiscal restraint may be that the total volume of goods and services produced and purchased during 1968 (i.e., real GNP) may be only moderately higher than what would have been produced and purchased with a tax surcharge in effect during the entire year. But its composition will be different — with less construction, which has a relatively low import content, and more of other things with a higher import content. A l s o , prices will be a little h i g h e r , and m a y still be rising faster by year-end than would have been the case if fiscal action had been taken earlier. imports will probably be h i g h e r . For this reason also, M e a n w h i l e , exports might be a little lower by year-end than if the tax surcharge had been enacted earlier in the year -resulting in less erosion in the competitiveness of U. S. prices. All these tendencies would have gone further if fiscal restraint had been further d e l a y e d . On the basis of these assumptions, we can derive come indication of the quantitative importance of the income surtax for the trade surplus. For the full year 1968, imports may now be $150 million lower with the tax surcharge than they would have been without it, and by year-end they may be running $300 million a year (one per cent) lower. Exports for the full year may be only $50 million higher for the full y e a r , but by year-end they may be running $100 million (or 1/3 of one per cent) higher. The trade surplus may be larger by about $200 million for the full year, and may be running $400 million a year larger in the fourth quarter. M o r e o v e r , prospects for the trade surplus next year — during 1969 -- will be better by considerably more than $400 m i l l i o n , as compared with what they would have been in the absence of tax action, and the prospective trend of the trade surplus will probably be favorable instead of adverse. Concluding Remarks In the m e a n t i m e , our trade surplus remains much too small, and the deficit in our balance of payments remains too large. Last year, the -9- deficit amounted to $3.6 billion (on the liquidity b a s i s ) , having risen sharply from $1.4 billion in 1966 and $1.3 billion in 1965. It is still far too early to have a firm estimate of the probable outcome for the U . S. balance of payments this y e a r . compared with a year ago. There most likely will be some improvement In the first three months of this y e a r , despite the adverse effect of the New York port strike on the trade surplus, the liquidity deficit was at an annual rate of $2.4 billion, compared with last year's $3.6 b i l l i o n . On the other h a n d , it also seems clear that the improvement of at least $3 billion visualized in the President's New Year's Day Message w i l l not be achieved. While substantial gains m a y be recorded with respect to private capital flows, there appears to be no prospect of attaining the projected expansion of $500 million in our trade surplus from 1967 to 1968. As noted above, the deterioration in the trade position during the January-April months was particularly disturbing. Even with a considerable improvement in the remaining months of the year, the trade surplus in 1968 will be lower than the $3.5 billion reached in 1967. T h i s , of course, makes all the more urgent those actions that can be taken to remove excess pressures on resources and to slow the pace of inflation. Unless we can bring about greater domestic stability, we cannot hope to achieve and maintain a trade surplus of the size necessary to help us to erase the deficit in our balance of payments. This failure in turn -10- m i g h t generate disturbingly adverse effects on capital m o v e m e n t s . Hope- fully, the adoption of higher income taxes and reduced Federal expenditures (although the action came much later than needed) will help us restore domestic stability and bring about some improvement in our international payments position as w e l l .
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