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For release on delivery
Expected at 10 a.m. (E.D.T)
May 24, 1979




Statement by

G. William Miller

Chairman, Board of Governors of the Federal Reserve System

before the

Subcommittee on International Economic Policy

of the

Foreign Relations Committee

United States Senate

May 2h, 1979




Mr. Chairman, members of this Subcommittee, I am pleased to
participate in your important hearings on the vital international economic
issues that confront the United States today.

My statement this morning

identifies an agenda of issues facing the world economy as we enter the
1980s that deserve our attention so that we may begin to develop specific
solutions to them.
We Face Common Problems, Have Common Interests
In an increasingly interdependent world economy, all countries
are affected by favorable and unfavorable developments originating in
other countries.

The world economy faces a number of economic problems

and concerns common to, and affecting, nearly all countries -- rampant
rates of inflation, the reduced availability and increasing relative
cost of raw materials, particularly energy, and sluggish investment.
Moreover, gaps in standards of living between the citizens of industrial
and developing countries persist and. even may be widening.

In meeting

the challenge of dealing with these problems that affect the welfare of
most individuals, all countries have a stake in maintaining a wellfunctioning international economic system in which goods, services, and
capital move freely to satisfy economic needs and wants.

In finding

solutions to these problem areas, it is essential that the United States -the world 1 s most important economy -~ provide creative leadership.
We cannot delay our exploration of ways to strengthen the
performance of the world economy,,

Given the medium-term nature of many

of today's underlying economic problems and the planning and implementation
lags associated with major policy initiatives, efforts must be taken soon
to affect the outcome in the 1980s.

Economies Becoming More Open and More Dependent on Each Other
In recent decades, international trade has been expanding more
rapidly than the growth of GNP, and exports and imports constitute an
increasing share of most countries 1 output and expenditure (Chart l ) .
On the whole, we all have benefited from greater international specialization,
with the availability of lower-priced imports helping to contain inflationary
pressures by strengthening the forces of competition and spurring productivity.
As economies have become more open, however, they also have become
more susceptible to external developments affecting the supply and prices
of the goods that they import.

Over time, the major economies have become

increasingly dependent on imported raw materials.

Even the United States,

which once was more self-sufficient in many raw materials than other countries,
has increased its reliance on imports of these commodities (Chart 2 ) . By
1978? net imports accounted for more than half the U.S. use of 20 important
metals and other minerals.

If the United States and other economies are not

to suffer from a secular, steep rise of raw material prices, the pace
of the absorption of the world's resources needs to be balanced by the
development of new sources of supply.
Developments in recent years affecting the price and supply of
energy have been especially troublesome for the United States and other economies.
Industrial and developing countries still are coping with the problems
resulting from the 1973-74 oil shock.

The latest OPEC price increases

are setting back the limited progress oil-importing countries have made
in recent years in containing inflation and in resuming economic expansion.
The latest OPEC price increases, moreover, weaken the stability of the
international payments system and, in particular, aggravate the financing
problems facing the non-oil developing economies.







Despite the United States f vast internal sources of energy, our
energy consumption is outdistancing our domestic energy production.

As

a result, whereas net U.S. oil imports in the early 19,50s accounted for
less than a tenth of U.S. consumption, these imports now approach nearly
one half (Chart 3 ) •
'

Moreover, the United States has relied increasingly

on oil produced by Middle Eastern and North African oil producers, so
that more than 50 per cent of U.S. oil imports last year were derived
from these sources compared with less than 30 per cent in the 1963-73
decade,,

The adverse consequences for the non-OPEC countries resulting

from such an event as the disruption of Iranian oil production reinforce
the urgency for the United States and other oil-importing countries to
reduce their dependence on imported oil and the need for these countries
to conserve energy, to expand alternative energy supplies now available,
and to develop new sources of energye
New Cha1lenges? _New Opportunit ies
The expansion of production capacities for commodities that
periodically have been in short supply could be aided by improving the
process of transferring technology from industrial countries to lessindustrialized economies.

Broadening the opportunities for the transfer

of technology in manufacturing also will help promote the economic development
of the developing countries,

The role of technology transfers would be

enhanced by the maintenance in less industrialized countries of an economic
climate that attracts foreign investment and by reaching agreement on a
code, of conduct relating to the transfer of proprietary technology and
industrial property rights.

The U.N. Conference on Science and Technology

for Development that is scheduled to convene in August in Vienna provides

an opportunity to bring the resources and skills of science and technology
better to bear in advancing the growth of developing countries, with
mutual benefit to the world economy.

It is important that the United States

play an active role at this Conference and that the Conference succeed
in reducing those barriers that impede the smooth transfer of technology
across borders.
A new challenge to the world trading system is being posed by the
emergence of newly industrializing countries as competitive exporters of
manufactured products.

This development is a logical consequence of a greater

transfer of technology and the successful efforts by developing countries to
develop their economies.

To allow their citizens to benefit from the low

cost of these goods,, the more industrialized nations must be prepared to
permit imports from these emerging countries.

Firms and workers displaced

by these imports should not be required to assume the full adjustment
burdens resulting from this development.

Appropriate measures by govern-

ments in industrial countries will be necessary in order to facilitate
the shift of their productive resources into export industries where these
countries enjoy a comparative advantage.

The emerging economies, in turn,

must be encouraged to open their markets to the high-technology goods
produced in industrial countries.
The world-wide economic downturn during 1974-75 precipitated
protectionist demands throughout the industrial world,

The Tokyo Round

of Multilateral Trade Negotiations was important not only because the world
economy will benefit from the trade liberalization it provides, but, perhaps
more crucially, because these negotiations countered the emerging tendencies
towards protectionist actions,

We must continue to be alert, however, to

the need to place the interests of the general consuming public ahead of







those few special interests that perennially seek protection from the
rigors of international competition.
Impressive Expansion of International Capital Markets
The expansion of international capital transactions, and particularly
the growth of international bank lending, has been one of the impressive
developments in international finance in the past decade (Chart 4 ) .

Inter-

national capital markets have channelled sizable accumulations of savings
in some countries to other countries that could utilize these funds effectively.
In recent years, the Euro-currency and Euro-bond markets have played an
especially important role in recycling massive surpluses of the oil-exporting
countries.

Industrial, developing, and Communist economies all have been

active participants in these markets.
Despite the generally smooth functioning and rapid growth of
the Euro-currency market in recent years, the less-regulated nature of this
market periodically has been a source of concern among policy-making
authorities.

The operations of this market have raised questions about

the market's impact on the efficacy of domestic monetary policy, about
the competitiveness of Euro-currency banks vis-a-vis national banking
systems, about the role of this market in facilitating exchange-market
speculation, and about the soundness of the banking practices followed by
banks involved in the Euro-currency market.

In recent years, central bank

and Treasury officials, both here and abroad, have focused attention on
these and related aspects of the Euro-currency market.

The objective of

these deliberations has been to ensure that this market performs its
important financial intermediary functions without at the same time weakening
the structure of national banking systems or market confidence in the
international financial system.

Several aspects of the rapid expansion of multinational banking
deserve close examination.

There is a need to improve the ability of

bank supervisory authorities to evaluate bank lending on a consolidated
basis.

For some countries, more comprehensive

statistical reports and

more thorough supervisory procedures are needed to ensure that the consolidated
operations of banks meet standards of prudence.

Supervisory authorities

in a number of countries are making progress in this area -- a development
that will benefit all.
of country risk.

In addition, there is a need for improved evaluation

It is important to both borrowers and lenders that inter-

national bank credit be extended on a scale and be. used in a manner that
ensures that funds are employed effectively and that borrowers are able to
service their debts.

Finally, there is a need to evaluate whether the

growth of Euro-banking should be controlled.

In this regard, a range of

techniques, including the possibility of imposing reserve requirements on
the liabilities of banks in the Euro-market, deserves to be explored.
Achieving Sustainable, Non-Inflationary Growth
In a world economy that has become more open, inflation and
recession in major countries have serious effects on other countries.

The

attainment of sustained, non-inflationary growth by industrial countries
not only would yield direct benefits to these countries, but also would
strengthen the world economy in various ways.

First, it would reduce the

pressures in these countries to adopt protectionist trade policies.

In

addition, the expansion of import demand by industrial countries in an
environment of non-inflationary growth would be one of the best ways to
contribute effectively and lastingly to the growth of their trading partners
in the developing world.







High rates of inflation have plagued most industrial countries
during the past decade (Chart 5 ) . Many developing countries have experienced
even higher rates of inflation than those recorded in industrial countries.
Rates of inflation in some developing countries in excess of 3° per cent
per year are not uncommon, and several of the larger developing countries
in Latin America even have experienced triple-digit inflation.

While external

influences such as high prices for OPEC oil no doubt have contributed to
worldwide inflation, in most instances these external influences only
intensify an inflation that basically is homegrown and fed by high wage
demands, business pricing practices, government regulation and spending
policies, and excessively expansionary monetary policies.
The costs of high rates of inflation are well known.

They have

resulted in arbitrary shifts in the distribution of income and wealth.

High

inflation rates also have weakened the investment climate, which, in turn,
has intensified cost pressures and contributed to sluggish economic growth.
Finally, high and divergent inflation rates among countries have been a
principal factor in generating instability in foreign exchange markets.
The inflation problem has developed over a long period and has
become imbedded in the structure of most economies.

It, therefore, would

be unrealistic to expect to eradicate it in a short time, and the disruption
to the economies and societies of trying to do so would be enormous.

This

makes it even more important for economic policymakers in the period ahead
to persist in maintaining sound fiscal and monetary policies that will
prevent further inflationary momentum to develop and to seek to lower the
inflation rates somewhat each year.

In addition, governments must avoid,

where possible, adopting other policies and regulations that have priceraising effects.

Capital formation has an essential role to play in achieving
and maintaining steady, non-inflationary growth in industrial economies.
Investment spending performs two functions in the process of promoting
non-inflationary growth.
demand.

First, it is an important component of aggregate

Second, investment spending creates productive capacity,

providing

the means to employ a growing labor force and increase the output of the
economy.

By increasing the ratio of capital to employed labor, the productivity

of labor can be raised.

Also, higher investment spending typically is

associated with an increase in the flow of innovation and brings the average
industrial plant closer to the state of "best practice" technology, further
raising the average level of productivity.

Higher productivity is an

important variable curbing or offsetting inflationary pressures.

It is

through productivity growth, of course, that real incomes can rise in the
1ong run.
A marked feature of the current economic recovery in industrial
economies has been the lower rate of productivity increases in this expansion
compared with earlier recoveries.

This, in part, reflects the weakness

of fixed investment expenditures.

For a number of industrial countries -•

e.g., the United States, Japan, Germany and Canada -- investment as a
percentage of GNP has been lower on average in the past five years, at a
time of relatively slow economic growth, than in the earlier period of
higher GNP growth (Chart 6 ) . A variety of factors has contributed to
the weakness of investment spending in recent years -- low levels of capital
utilization, the effects of the oil shock, weak profits, and uncertainty
generated by high inflation rates.
Governments can best foster increased private investment spending
by providing an economic climate that is conducive to business enterprise.







Government officials in many industrial countries are giving increasing
recognition to the need to provide more scope for market forces to operate
and to encourage private initiative.
Appropriate government policies can stimulate private investment
spending.

Cost-effective incentives -- such as liberalization of depreciation

allowances -- and the elimination of various disincentives-- such as
unnecessary and burdensome regulations -- would go far to encourage private
investment.

In addition, maintenance of sound monetary and fiscal policies

that succeed in curbing inflation, stimulate personal savings, and reduce
the pace of government spending, will provide an environment that will be
conducive to an expansion of private investment spending.

Finally, appropriate

government support to intensify the efforts by the private sector in enlarging
the role of research and the development of improved technology is likely to
have substantial pay-offs in additional investment and higher productivity.
The Evolving Monetary System
The changes in the international monetary system in recent years
aave been substantial -- managed floating has replaced the adjustable peg
system, the status of the dollar as an international asset has undergone changes, and the role of the International Monetary Fund in guiding
the international monetary system has been enlarged.
The amended Articles of Agreement of the IMF that were put into
place last year provide a framework for the evolution of the international
monetary system in the period ahead.

We must be prepared to examine objectively

our attitude towards various proposals designed to strengthen the functioning
of the international monetary system.

Despite expressions of doubt in recent years about the future role
of the dollar as an international currency, the dollar continues to play a
prominent role in private and official transactions.

About 80 per cent of

all official foreign exchange reserves are held in dollars, a comparable
fraction of private financial assets and liabilities is denominated in
dollars, and it is estimated that about half of world trade is denominated
in dollars.

Proposals to reduce the official role of the dollar in the

international monetary system, therefore, could have important implications
for the operation of the system.

The United States did not elect that the

dollar assume a key role in the international monetary system.

That role

developed as a result of an evolutionary process that now may be changing.
Proposals to reduce the international role of the dollar and to expand that
of the SDR -- such as establishing a substitution account in the IMF -should be evaluated in the context of the longer-term development of the
international monetary system.

We must ensure that any plan to reduce the

dollar's role will not restrict the freedom of the United States to pursue
appropriate domestic economic objectives, that it will facilitate the
maintenance of an open system of world trade and capital movements, and
that it will contribute to more, rather than less, international monetary stability.
It is in our mutual interest to achieve an economic environment
that avoids excessively large swings in exchange rates. World trade and
finance respond more effectively to signals that are not erratic. Where
exchange-rate adjustment on the basis of fundamentals is necessary, such
adjustment should take place in an orderly fashion.

Article IV of the

amended Articles of Agreement of the IMF provides new procedures for
international surveillance over countries1 exchange-rate policies and the







adjustment of external imbalances.

We need to explore how to make more

effective use of these procedures.
The recent strengthening of the value of the U.S. dollar on foreign
exchange markets reflects the market's favorable reassessment of underlying
trends of U.S. and foreign economic performance and policy, as well as the
effects of the November 1 measures to support the dollar.

Market participants

now recognize the willingness of the United States and its major trading
partners to engage, if required, in substantial intervention.

The November 1

measures have provided the United States a necessary breathing spell during
which its monetary, fiscal and wage-price policies can take hold in dealing
with the fundamental economic and financial factors that most influence a
country's exchange rate -- international current-account developments,
relative inflation rates, and relative rates of real economic growth.
In the final analysis, one cannot decree greater stability of
exchange rates.

Such stability will require a narrowing of inflation-rate

differentials at a lower level of inflation, as well as the achievement
of rates of economic growth and structural adjustments in national economies
that are consistent with a sustainable pattern of international payments.
Need for U.S. Leadership and Continued International Cooperation
The United States should play an active and constructive role in
international deliberations on the issues that I have raised this morning.
If the United States is to maintain its leadership role, it must set a
good example - - b y addressing and solving its urgent internal economic
problems, especially those related to inflation and energy, and by
demonstrating its support for the international financial institutions.
The economic summits held each year since 1975 have provided a
forum for strengthening the process of international consultation and

- 12 -

cooperation.

Continued cooperative efforts -- such as next month's summit

meeting in Tokyo -- will be required to deal with worldwide economic problems,
In an increasingly interdependent world economy, policymakers need to
consider the effects of their actions on others v;hcn formulating national
policies.

A frank exchange of views and policy intentions could contribute

to better-informed policy formulation in each country and set the stage for
sharing of possible solutions to common problems.




Chart 1

EXPORTS AS A PERCENTAGE OF GNP
IN SELECTED INDUSTRIAL COUNTRIES
1958—1978

'58

'60

Source: IMF, International Financial Statistics and Direction of Trade




Percent
—130

'78




Chart 2

U.S. IMPORTS OF SELECTED METALS AND OTHER
MINERALS AS A PER CENT OF CONSUMPTION
1950—1976
Percent

Manganese

100

Bauxite &
Alumina
Fluorine

75

Tungsten
Zinc
50

25

I
1950

1960

1970

1976

Source: Bureau of Mines, Mineral Trends and Forecasts, 1979

Chart 3

U.S. OIL IMPORTS
Net U.S. Oil imports as a Percentage of Consumption
1950—1378

Percent

50

40

30

* Fall in 1978 ratio caused by
the coming on line of Alaskan
production and a run-down of
extraordinary stocks accumulated
in late 1977

20

10

1950

1955

1960

1965

1975 '78

1970

Ultimate Source of U. S. Oil Imports
1963—1978

I 1Middle East and North Africa

Percent

1

C] Other

— 75

—

ill I'—i

II

II

—

I III1

ii

•

•

I li

I Mil !
i! j
I iii'i
i

I

!i|

jjjj

1963—1973

Mill'"

l!||
1974
'• '•

i ' !

|

1
!

I

LliIlia

1975

ii!

I'M

l!

!

! 1111
! 1111

ill
:

'ii 1

i!

.ii

hi• i
S! t *

1976

if I
ill

ill

||

PI

! !L

ii!

Mi

i[

il'i

I;

i, 1 | |

i

1
i l l |||
HI
1 ^ LilL

1977

!

' 'I

! I

II
i'i

i!
ii

i

i!
11 t

1!
i ; 1 • j

I I I!
mm

——oL

1

i

ihl!
Hi;!

i

1

!

ll'.lp
i

l|

!
1

!
!

|i
ii HiL_

1973

Members of the Organization of Arab Petroleum Exporting Countries plus Iran

Source: U.S. Energy Information Administration, "Crude Petroleum, Petroleum Products, and Natural Gas Liquids" and
"Supply, Demand, and Stocks by P.A.D. Districts," Annual Reports




—
_ 50

1 i

1I

i IP!

1

T

— 25

Chart 4

MEDIUM-TERM EURO-CREDITS COMPLETED DURING THE YEAR
1973-1978

Billions of dollars

All Countries

60

50

40

Industrial Countries

Non-Oil Developing
Countries

1973

1974

1975

1976

Source: World Bank with adjustments by Federal Reserve Staff.
& Preliminary figures




— 20

^<0> Oil-Exporting Countries

^—*•*"*"

— 30

— 10

-

1977

Communist Countries

1978^

Chart 5

INFLATION RATES \H SELECTED INDUSTRIAL COUNTRIES
1964—1978

Percent

20

\ U.K.

\

15

10

•..

I

1964

1966

1968

1970

Year over year percentage change in Consumer Prices.
Source: IMF, Internationa! Financial Statistics




1972

1974

1976

1978

Chart 6

INVESTMENT SHARES OF MAJOR INDUSTRIAL COUNTRIES'
1965-1978
I

Percent

[1965—1973 (annual average)

|; ! |1974—1978 (annual average)

Germany
U.S.

Japan

U.K.

France

Canada

30

20

Italy
ni!
10
lit!
iii

II!||!

ill

• Nonresidential fixed investment as a share of gross domestic or gross national product in current prices; includes government
capital formation. Data for 1978 are partially estimated for Japan, United Kingdom and United States and are not available for Italy.
The data for France refer to 1 9 7 0 — 7 3 and 1974—76. Data from national sources. OECD, and staff estimates.