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Remarks by
Paul A, Volcker
Chairmanf Board of Governors of the Federal Reserve System

at the
Annual Dinner of the Japan Society
New York, New York

I well remember sitting here a year ago listening to
Prime Minister Nakasone address this Annual Dinner on his
way home from the Williamsburg Summit.

He spoke with firmnessf

both about the possibilities of a world recovery then still
in its early stages, and about Japanese intentions with
respect to its economic relations with the United States
and others.
Well, you won't have the benefits of a Prime Ministerial
perspective tonight*

But a lot has happened in the last year to

bear out his foresight.

Indeed, by broad measures of economic

performance, developments in both the United States and Japan
have at least lived up to —

and mostly exceeded —

any reasonable

standards that would have been set a year ago,
In this country, the rate of economic growth over the
past 18 months has actually been as great as during any
comparable period in the past 30 years: 6 million more people
are employed, industrial production is up by 21 percent; and
the unemployment rate has dropped by more than 3 percentage

points from the peak.

Moreover, the trend of costs and prices

has remained more favorable than for a decade*
In Japan, growth has been more subdued than here,
reversing the relative pattern vis-a-vis the United States of
most of the last twenty years*

But the Japanese economy did

not, of course, start from a point of so much unemployment
and excess capacity.

And Japan has led the industrial world

in combining near price stability with low levels of unemployment
a matter that remains a great challenge for all of us.
For all of that progress, it is easy to sense widespread
disquiet about where we might be headed —- whether, in fact, the
favorable patterns can be sustained*

These days, those

familiar words of Charles Dickens -- "It was the best
of times? it was the worst of times518 —

come readily to mind.

As I see it, the simple fact is, after years of strain
and difficulty, we have enormous opportunities before us.
there are equally obvious risks and dangers.



Opportunity and danger, we are told, make up the Chinese
character for crisis, and I understand it is the same in

If we are to seize those opportunities and repel

those dangers, there is a lot to do on both sides of the
Pacific -- and the Atlantic as well.
Looked at from the perspective of our bilateral
relations, we are faced with a familiar -- but still growing


imbalance in our trade accounts, reaching an annual rate of
about $30 billion in favor of Japan recently.

For a time,

that imbalance has not been without certain benefits to both

Rising Japanese exports to the United States, as

with other countries, have helped pull the Japanese economy
into stronger growth.

And Japanese competition has helped

keep our inflation rate down.
But an obvious and relevant question is whether it is at all
sustainable. And that question looms even larger when we look at
the matterf as we should, in a world-wide perspective, not simply

-4as a matter of bilateral relations.

The Japanese surplus with us

is a Icirge part, but still only a part, of a broader pattern
of a persistent and rising Japanese trade surplus, which appears
to be moving to a record level of some $40 billion a year.
At the same time, our trade appears to be headed for a deficit
of well over $100 billion*

That deficit amounts to about 3 percent

of our total GNP, and close to 50 percent of our total exports.
As always, "special18 factors must be taken into account.
The United States has absorbed the largest share of the sharp
import reductions and the export increases in Latin America
as those countries have necessarily had to undertake strong
economic adjustment programs.

With different phasing of the

economic cycle, our growth over thc^ past 18 months has been
more than twice the average of other industrial countries,
tending to make imports grow faster than exports.


ahead, those forces should diminish -- they are diminishing.
But they alone cannot account for the size of the swing. We

— 5—

have to recognize, and deal with, problems that will only
yield to more fundamental policy adjustments,,
For Japan, those old questions of achieving more open
markets —• for goods and for money -- remain, even though, as
Prime Minister Nakasone promised a year ago, some real progress
has been made•

But behind the matters of external commercial and

financial policy lie other questions of economic management.
We all envy the high Japanese savings rate*

But in

recent years a much less familiar consequence of that high
savings rate has arisen.

As Japanese growth has trended

lower, savings generated in ternally are not being absorbed
domestically, even though the budget has been in sizable

Instead, capital has spilled out overseas, including

to the United States.

As it has done so, the value of the

yen externally has not seemed to reflect the strength of
Japan 1 s trade and current account, or of its economy generally.

More limited domestic sources of growth and the highly
competitive exchange rate have both contributed to the rising
trade surplus.
Viewed in that lightf one wonders whether Japan is fully
meetina its domestic potential and whether it is not now too
reliant on stimulus from abroad*
In the United States, we see the other side of the coin*
As the economy grows rapidly, we can't meet both our domestic
investment needs and a huge government deficit from a savings
rate that has remained stuck in a channel of 6-1/2 to 9-1/2
percent of the GNP for many years, with no apparent evidence
of change.

During this period of remarkable expansion, we

have resolved the problem in a way without much precedent for
us —

we have become dependent upon an extraordinary net inflow

of capital from abroad.

Currently that inflow is running at

a rate of more than 2 percent of the GNP; it is supplementing
net domestic savings by about a quarter.

— 7—
We currently rely on that foreign capital, but substantial
costs are involved in the process.

The capital is attracted in

part by the extraordinary level of dollar interest rates*


interest rates likely would be still higher without the capital
inflow, those same flows have, over the past year, been reflected
in a further appreciation of the dollar even as our trade and current
accounts have deteriorated.

In a sense, then, both our inter-

nationally exposed industries and our financial markets are
held hostage to the fact that we can only cover our investment
needs by drawing on large amounts of capital from abroad.
For the time being, the situation has been manageable in
domestic terms.

Moreover, we have provided a rapidly expanding

market for developing countries faced with severe external
debt servicing problems? so far the favorable effects of our
economic expansion on their current accounts appear to have
outweighed the negative effects of our higher level of interest

-8Nonetheless, there are elements in the current
situation that cannot be sustained indefinitely.

For one

thing^ the enormous trade deficits breed pressures for protection
from those sectors of the economy that are not sharing fully
in the expansion of the U.S* recovery*

In the circumstances,

I can only welcome the initiative taken by the President and
other national leaders in London to counter those pressures.
Instead of turning inward, they have begun to prepare the ground
for another round of negotiations to relax, rather than to
increase, trade barriers in the future..

Nevertheless, the

potential obstacles to that course here and elsewhere will be
great so long as the underlying imbalances are not resolved.
For the United States, as for Japan, those external
imbalances are in the end, a reflection of imbalances at home
between the capacity to generate domestic savings and the
propensity to invest and run deficits.
clearer here.

And the remedies seem

To put the issue at its simplest, we cannot forever
continue to invest what we would like in plants in housing, and
in inventory and cover prospective federal deficits, in amounts
far larger than our domestic savings.
We can try to increase savings —
that is a slow process at best*

Something has to give.

but the record suggests
We don't want to see lower

investment, least of all by means of a squeeze on financial
markets, prolonged high interest rates, or a sluggish economy.
The remaining alternative —

reducing the federal deficit as

fast as we can -- is by all odds the safest and surest approach;
I am tempted to say it is the only realistic approach, in our
own interest and that of others.

The efforts of the Administration

and the Congress to agree on a "down payment" against future deficits
during this election year represent the beginnings of a constructive
response, and we will need to build upon it.
The problem is reflected and amplified by the sense of
growing concern expressed by many recently about the problems
of international debt.

That reaction is understandable in

-10the light of the sensitivity of the most heavily indebted
countries to dollar interest rates*
But in another sense, the heightened degree of concern
is ironic , for it comes at a time when, signs of progress in
dealing with the debt problem have been more evident than at
any time in the last two years.
This isn't the time or place to linger over all the
origins of the difficulty —

the successive oil crises, overly

enthusiastic borrowing and lending policies fostered in substantial part by an inflationary environment and inflationary
expectations, failures to encourage more direct investment
in developing countries, an undermining of confidence that led to
m s i e . . capital flight from other countries, and other factors •
Suffice if; to say all of us, borrowing and lending countries
alike, have an enormous stake in seeing to it that the problem
is managed successfully, in the interest of maintaining a
favorable climate for extending the current expansion and

-11in the longer-term interest of the economic development and
trade of the borrowing countries themselves,
One dangerous temptation is to see the debt issue only as
someone else's problem —- for the borrowing countries themselves
or for the big international banks, or for one country as
opposed to another, or for one set of banks alone.

But the

fact is all have a stake, directly or indirectly, and the
solution requires effort over a wide front,
The success of one borrowing country in making necessary
adjustments and restoring external financial stability will
help another, not just by example but because they trade
with, and help finance, each other.

The reverse is true as well,

Taking heavily indebted developing countries in Latin
America and elsewhere and Eastern Europe-1 as a whole, the large
bank,^1 around the world -- certainly including those in Japan and
the U* S. -- have a broadly similar exposure, and they are all
dependent on the stability of the whole international financial


Corrective policies, by industrialized and developing

countries, by banks and by. international institutionsf must
be mutually supporting and reinforcing.
Another temptation is to seek an "out11 from the slogging,
continuing process of negotiation and refinancing country by
country in some sweeping new initiative to settle the problem
once and for all.

Those proposals seem to me based on unrealistic

assumptions -- typically on an expectation that someone else
will assume large new burdens*

I do not sense, in that

connection, any willingness on the part of the U. S e Congress,
or other parliaments, to undertake massive new aid programs
for countries that, in the economic hierarchy of developing
countries, are among the most advanced,

Lending banks under-

standably do not volunteer to provide large interest subsidies
for, or to write down, loans that can, after all, be serviced;
nor is that necessarily in the interest of countries that will.
be looking to international markets for credit to support
growth in the years ahead•

To take the other side, we also

— 1 " —
J 3

cannot expect borrowing countries to make necessary adjustments
to get their houses in order without reasonable prospects that
good performance will result in continuing access to the new
credit and the debt restructuring they need*
The truth is that successful management of the problem
within these constraints can continue so long as certain
fundamentals are respected -- continuing growth among the
industrialized countries as a whole, maintenance of open
markets for the products of developing countries ready to
compete fairly in world markets, reasonable stability in
financial markets (or better yet declining interest rates)
which in turn rest on keeping inflation under control, and
persistent and effective adjustment efforts by the borrowers,
None of that requires perfection in every respect, and none
of it will produce sudden and complete success in every case
across the board*

The process will take time*

But it is

We need to guard against waves of euphoria and undue
optimism that the problem is behind us because some important
milestone has been passed -- such as the successful initial
response to the Mexican debt crisis*

But neither are there

grounds for pessimism because for a few months interest rates
have increased in the midst of a strong economic advance, or
because one country or another has had a setback in adjustment.
Nor do such developments suggest a brand new strategy must be
concocted, despite the frustrations and complexities inherent
in developing particular programs for particular countries•
The fundamental reason for the complexity is that many countries
are in fact involved, with diverse histories,, needs,* and

Their unique problems are not susceptible to

simplistic, universal and sudden solutions*

But they are

susceptible to patient effort, and by now there is quite a
lot of concrete evidence to that effect.

-15The core of that effort lies in the adjustment efforts
of the borrowing countries themselves -- all else rests on the
perception and the reality of their own efforts to rebuild a
base for sustained growth.

In most cases, as you know, those

actions have been framed in cooperation with, and have received
the financial support of, the International Monetary Fund, and
that is a crucial ingredient in building further financial support.
In some cases, countries have reduced their budget
deficits, as a share of GNP, by 5-8 percent in one year


the equivalent of moving the U. S. budget deficit into surplus.
In order to correct long-standing distortions in relative prices,
they have undertaken sharp depreciation of their currencies and
raised the prices of goods and services produced by the public

In the process, a number of countries that had grown

accustomed to rapid expansion of economic activity have,
perhaps inevitably, experienced a contraction.
positive results are appearing as well.

But much more

-16The combined current account deficit of the non-OPEC
developing countries was almost cut in half between 1981 and
1983 -- the reduction in the deficits of those countries that
have been operating under IMF-approved stabilization programs
has been even larger*

Some key debtor countries —

Mexico and

Venezuela in Latin America, Yugoslavia and Hungary in Eastern
Europe -- have actually moved into current account surplus.


others, notably Brazil, trade surpluses are exceeding expectations,,
One frequently hears complaints about the size of these
adjustments —

they certainly have been a factor in the enlarge-

ment of the U* S. current account deficit, and have been achieved
in part by massive and unsustainable reductions in imports by
the deeply indebted countries.

The justification for those

programs must be clear *— to lay the base for export expansion
and renewed growth*

And that process is now underway in some

important countries, particularly those who started effective
adjustment programs earlier and who have been able to take
advantage of growing markets in the United States and elsewhere«


All this has set the stage for a new phase in financing
programs tailored to the progress and circumstances of individual

The bulk of the financing has been, and will continue

to be, provided by commercial banks, and is a matter for negotiation by borrowers and lenders.

But I'm glad to see that, recognizing

the progress made in Mexico, the banks are now prepared to enter
into negotiations for a multi-year restructuring of Mexican debt on
terms that both reflect the stronger credit-worthiness of that
country and that can pave the way for Mexico to deal with any
limited further needs for new money in the years ahead through
more normal and spontaneous market processes•

Other countries,

while at an earlier stage, are finding needs for new money
appreciably reduced.
At the other end of the spectrum, to be sure, effective
adjustment programs still need to be put in place and financing
is in abeyance•
smooth process —

My point is not that it is all a simple and
that vision is an illusion*

The difficulty

-18is typically greatest in those countries where past policies
have not engendered the confidence of their own citizens,
with the result that capital sorely needed at home flowed

Effective measures —

means strong measures —

which in practical terms

must sometimes be shaped in the

midst of blossoming democratic movements.

That implies the

need for a high degree of consensus -- no simple task even for
those of us who have enjoyed stable democratic governments
for many years.

But democracy is also not likely to flourish

in the midst of accelerating inflation and economic isolation.
What the borrowing countries seem to appreciate —
they must appreciate to sustain the effort —


is that economic

growth over a long period ahead, and prospects for political
stability, are dependent on an ability to function effectively
in an interdependent world.

In that world, credit-worthiness

and credit availability are essential to support trade and

-19investment, and once lost, those qualities are hard to restore.
In the end, the ultimate test of a successful economic program
will not be whether at a moment in time it is acceptable to
the IMF or to bank lenders, but whether it in fact can restore
and maintain the confidence of a nation's own citizens, and
whether, as a consequence, its own savings are employed
productively at home and returned from abroad *
Meanwhilef lenders need to appreciate that countries
launching an adjustment effort will need financial support
from abroad for a time that will not be forthcoming spontaneously -that is by the uncoordinated action of individual banks and

Indeed, as debt problems first became apparent? the

understandable reaction of individual lenders we\s to pull
back abruptly,? under the pressure of directors, accountants,
and public opinion suddenly conscious of risks that had not
been so apparent only a short while before*

But experienced

bankers quickly realized that that approach would guarantee

-20precisely the result they feared —

that borrowers would in

fact be unable to repay so suddenly, that their economic
futures would be jeopardized,, and as a result the basic
value of existing credits undermined*
By cooperation, and at times with transitional support
from governments and central banks, a coordinated and constructive
approach has been maintained, resting on analysis that new
credits, and extension of old credits? can be justified when
necessary adjustments are undertaken and long-term debt servicing
capacity maintained and enhanced.

That kind of approach is not

new for bankersj a similar appraisal is necessary with domestic
credits in difficulty.

What is new is the level of complexity

when hundreds of lending institutions, various governments,
and international .institutions are all involved with many
differing interests and historical lending relationshipso
The one feature that tends to bind all these efforts together
is a common appreciation that the success of the total effort
depends on cooperation by every significant participant*


I frankly draw much more encouragement from this performance of the past and present than I do from dreams of any
radically new approach, grounded more in

highly generalized

abstractions than in the practicalities faced by those with a
financial or legislative responsibility.

Nor do calls to

"politicize" the issue here or elsewhere carry more promise;
indeed, they carry the obvious risk of impeding a flow of
private finance, now and in the future, with no obvious
substitute available•
I do not minimize the real strains or, almost as
important, the sense of fatigue that can set in when a large
and complicated effort needs to be sustained and results take

That is one reason why, as progress and performance

justify it, it seems to me critically important to move to a
new phase in which individual borrowers be able to refinance
maturing debt for some period ahead at reasonable terms,
permitting both borrowers and lenders to have a more certain

and stable base for planning.

As the initial adjustments

under the aegis of the IMF are m a d e , the role for the World
Bank and the regional development banks should become relatively
more important, both in helping borrowers develop appropriate
investment strategies and seeing to it that they can be
appropriately financed.

We should be alert to the possibilities

of developing varied financing t e c h n i q u e s , including so-called
co-financing by international institutions and private l e n d e r s ,
methods acceptable to borrowers and lenders of protecting
against surges in interest rates analogous to those used in
domestic m a r k e t s , and the like.

All of this would represent

a natural e v o l u t i o n , providing both a transition to "normalcy"
and a basis for constructive new patterns of international

After a l l , we have learned from bitter experience

that all was not right in those halcyon days of easy


lending in the 1 9 7 0 ' s .
Whether or not "crisis" in fact can be converted into
opportunity will rest on the efforts of no single country,


borrower or lender alone, but on the joint efforts of many*
Certainly, both the governments and banks of the United States
and Japan have a key role in this process.

We have, in fact,

been working cooperatively, together and with others, and no
bilateral frictions

in other economic

areas should


that encouraging fact.
The progress of the past is the best justification for
renewed and
time, both

the United






States and Japan -- the two largest

economic powers -- have no less important work to do at home
to achieve a better balance in our own economies.
We have come too far, at too much
seize the opportunities now.

cost, to fail to