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For release on delivery
^'ri?"f,r>'1:ir4F,tQ0.-p^fCST (5:00 PM EST)
, 1986

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

Commemorat i ng
The Dedication of John E. Simon Hall
Washington University
St. Louis, Missouri

April 15, 1986


I am delighted to be here this afternoon on this
special occasion.
Your presence here today reflects the esteem in which
you all hold John Simonf the importance of Washington University,
and its constant quest to keep abreast of —
the needs of the community and the nation.

and to anticipate

The new building isf

in the first instance, a place for students and scholars.


is the central aspect of what a university is all about.





a professional school, and particularly a School of Business and
Public Administration, seems to me also something more.



teaching and learning have a direct application to improving
the well-being of all of us, working together productively.
That's not a new thought for either the University or
St. Louis.

They have both long been blessed with a sense of

energy and destiny since the days this city became the gateway
to the West.
one aspect.

The national reach of much of your industry is
The strength and support of the University is

-2I'm tempted to add to that the quality of your baseball.
I first came to fear that as a Brooklyn Dodgers fan in the 1940s,
Then, as a a Mets fan there was 1985,

But 1986 will, of course,

be a little different in that respect.
The fact that the John E. Simon Hall is the largest
academic building on the campus of Washington University and
the new cornerstone of the Hilltop community seems to me symbolic.
It defines your faith in the American economic system itself
and the ability of a trained citizenry to make it better.
That economic system is again showing its innate vitality.
We are now well into the fourth year of economic expansion.
That in itself is about as long as the average for postwar

Moreover, today, more people are employed relative

to the working age population than ever before.
What is more unusual is that the expansion has been sustained
without any pickup in the rate of inflation.

Indeed, with oil

and other energy prices sharply lower, concerns about a resurgence
of inflation seem to be receding, rather than the opposite.

-3That has helped set the stage for strong increases in both bond
and stock prices, and interest rates have returned to their
lowest level in many years.
I am a cautious central banker.

I get a little suspicious

when there is so much ebullience in financial markets.

But that

is welcome to the extent it reflects well-founded confidence in
longer-run prospects.
that view.

Many have set out the evidence to support

To be sure, growth in recent quarters has been less

vigorous than had been generally expected.

But after 3-1/2 years

the signs that in the past have signalled the onset of cyclical
downturns are still generally absent.
With only a few prominent exceptions, industry appears to
have inventories under control.

Pressures on productive capacity

by and large are limited or non-existent.

Wage restraint in

many industries and lower commodity prices have kept costs
under control.

As the period of low inflation is prolonged --

as we become accustomed to more stable prices —
sustaining stability seem to me to improve.

the chances of

It can become a habit

-4In that context, the prospects for extending the expansion
also have probably been enhanced, by recent developments in the
world financial and energy markets and on the budgetary front.
Our massive and rising trade deficit has been one obvious
and serious flaw in an otherwise strong economic advance,
Manufacturing industry, open to foreign competition, has simply
not shared in this phase of economic expansion, tending to
retard growth generally.

But, with the foreign exchange value

of the dollar falling by some 30 percent over the past year,
the international competitive position of American industry is
now improving.

Inevitably, such a depreciation in the dollar also

has inflationary risks.

But the sharp break in oil prices is

providing an important offset to higher import prices.

And the

lower prices for gasoline and other fuels will over time in the
process release real purchasing power that American consumers will
spend for other goods and services.

-5Rising stock prices and lower interest rates also reduce
costs of capital and should also help to support further growth.
And, _ f we carry through on the expressed intention to cut the
budget deficit significantly year by year, a potential source
of renewed pressure on interest rates as the economy grows more
rapidly would be alleviated.
Both economic theory and common sense suggest that these
forces, in combination, could help provide a solid base for
sustained growth with greater price stability.
So there is a lot to cheer about.
But I also get paid to worry.
be happy.

Central bankers have a

We have a haunting fear that someone, someplace may
There is plenty that could go wrong if we collectively

let down our guard -- if Ve forget the effort that was necessary
to deal with accelerating inflation; if we fall into the trap of
stagflation —

an ugly word for an ugly situation —• or if we

fail to deal with points of pressure and strain, here and
abroad, in our financial system and in the real economy.

-6Then we will not have earned all the confidence that financial
markets are displaying.
Take the case of lower oil prices that has engendered so
much optimism in most parts of the economy.

I say "most parts"

advisedly, because it is also obvious that sizable parts of the
country heavily dependent on energy exploration and development
have been catapulted into recession-like conditions.

The oil

companies are slashing capital spending plans and laying off

The effects on foreign energy producers undoubtedly

are as acute, and their imports —

our exports —

will be further

New questions have been raised about the pressures on

some financial institutions.

By contrast, the higher spending

expected to flow from the increased purchasing power of American
consumers and augmented cash flow of oil-consuming businesses
may take awhile to materialize.
That is one reason the incoming economic data have been so

On the positive side, employment continues to rise briskly;

housing activity is surging in response to the sharp declines in

-7mortgage rates? and consumer spending generally has been wellmaintained.

But other indicators of activity —

business investment —


are much less favorable.

There has plainly been overbuilding of offices in a number
of areas? spurred in part by the generosity of tax benefits.
Agricultural production has been growing world wide, and prices
have been under downward pressure, threatening important parts
of our farm economy despite its vaunted efficiency.

And the

relatively recent depreciation of the dollar is only one factor,
important as it is, in our prospects for trade.
As we try to sort out these cross currents in the economic
scene, several points stand out, each indicating unresolved,
or only partly resolved, problems.

Failure to deal with them

effectively could undercut our growth, our stability, or both.
The first of those questions revolves around our trade problems
and relative rates of economic growth, here and abroad.

During most

of this expansion, domestic demand growth in the U.S. has been

-8outstripping the increase in what we produce by a sizable margin.
The difference between growth in our demand and our output is a
reflection of the enormous increase in imports and our rising
trade and current account deficits.

We have created about 11

million jobs in just over three years in the United States, but
we have also turned to importing, net, more than 3 percent of our
gross national product, equivalent to a current account deficit
of almost $150 billion by the end of 1985,

That process has, in

effect, created export opportunities and stimulated job creation

The irony is that, even so, new jobs in Europe and

Japan have lagged far behind ours, and their rate of GNP growth
has been slower.
That process of the U.S. acting as motor for the world economy
cannot be sustained indefinitely.

The trade and current account

deficits become both politically and economically intolerable.
Protectionist pressures have been stronger than at any time
during the postwar period, threatening to undercut the liberal
trading order upon which the prosperity of all countries depends.

-9Meanwhile, we have become utterly dependent upon a need to borrow
abroad to cover the massive current account deficit.

That is never

a comfortable positionf however strong the country.
We have been fortunate that funds from abroad have flowed
so freely to the United States in recent years.
has reflected relatively high interest rates.

Partly, that
But it has also

reflected to a considerable extent widespread confidence in our
economic prospects and in our political stability.

And the avail-

ability of that foreign money has helped keep interest rates lower
than would otherwise be possible at a time when we have been
borrowing much more than we save.
Fortunate as we have been, it is clearly not healthy for
the largest and richest country in the world —
interest or that of others —

in its own

to run so large a trade deficit,

to use up so significant a fraction of the world's savings to finance
that deficit, and incidentally to count on foreign funds to help
finance, directly or indirectly, our budget deficit as well.


-10lending abroad has practically stopped.

We have become a debtor

Our competitive edge and investment in manufacturing

had eroded.
The recent depreciation of the dollar can help deal with the
competitive problem.

But, however necessary, a depreciating

currency is hardly a free ride.

Over time, it carries an

inflationary potential, and can undercut the confidence that is
necessary to attract capital.

As our trade balance does improve,

as we hope and expect, we will no longer need to borrow abroad.
That, in itself, would be healthy, but it also implies that we
will need to find some other way to finance our domestic needs.
There is, in my judgment, really only one practical option
in dealing with that problem.

Economic history gives little basis

for counting on a great increase in the rate of domestic savings.
We want to maintain high levels of business investment and housing
that absorb large amounts of those savings.

The remaining option

is to cut our budget deficit which, today, diverts so much of our
savings potential.

-11That is why so much is at stake in the perennial budgetary
debate in Washington.

The impetus generated by the Gramm-Rudman-

Hollings legislation needs to be maintained.

Just the expectation

of cuts in future budget deficits, and correspondingly lower
claims on world savings, seems to have contributed to a decline
in interest rates since last summer, especially long-term

We must ensure that those expectations of future cuts

in our budget deficit are not disappointed.
But, important as they are, exchange rates and action on
the budget 'deficit cannot be the entire answer to our external

We also need to look toward strong and growing markets

abroad, particularly among our main trading partners in Japan
and Europe.

Therein lies a major continuing question.


recent years, when those countries have had growing exports to
the United States, they will need to rely on more "home grown"
Looking at the industrial countries as a group, there has
been some progress in that direction, particularly when measured

-12against the turmoil and instabilities of the 1970s and the start
of this decade.

By dint of hard and continuing effort, virtually

all of them have made remarkable progress against inflation.


Germany and Japan, it is possible consumer prices will be
essentially stable this year.

Employment is now growing almost

In that sense, there is a good foundation upon which to

But it's also plain that unemployment is still far too

high in most other industrial countries, averaging more than
10 percent in Europe.

Even so, economic growth has been less

than earlier in the postwar period, and the appreciation o£
their currencies, to the extent it restrains their exports, acts
as a further restraining influence on their economic activity.
The case for greater domestically led expansion seems
particularly strong in Japan, given its enormous trade surpluses
and high level of domestic saving.

By every economic characteristic, it should also be

able -— in its own interest —

Japan is the second largest

to help lead the world toward

-13more open markets rather than feeding protectionist instincts
in the United States and elsewhere.

Happily, there are increasing

signs that need is recognized by the Japanese Government itself.
But in my judgment, it is also late in the day for action,
A second area of continuing concern also reflects a difficult
situation abroad.

A number of developing countries in Latin America

and elsewhere are plagued by heavy debt burdens, in large part
to international banks here and abroad, but also to governments
and international institutions.

Clearly, it is in our interest

that those debts be serviced in an orderly manner, and it is even
more basically in their interest.
Little in the economic world is more precious than creditworthiness, because trade and growth are ultimately dependent
on the availability of credit, for a nation as for an individual.
And it is equally true that heavy debt burdens can be managed
effectively only in a context of growth —

growth in one's own

economy and growth in the markets in which one's products must
be sold.

Indeed, no part of the world would reap greater

-14benefits from sustained expansion in the industrial worldr
from more open trade, and from lower interest rates than the
middle-income countries of the developing world.

Butf to take

advantage of that more benign economic climate abroad, they will
also need to be prepared to take full advantage of those markets.
By and large, the heavily indebted countries achieved
exceptional growth records in the 1970s and early 1980s.


in a large number of instances, that growth entailed very heavy
borrowing from abroad.

Too much of that foreign capital, rather

than contributing to additional investment and efficiency,
supported consumption or simply replaced a chronic outflow of
their own savings.

It cannot be entirely coincidental that

countries that did manage to create a hospitable environment
for investment and to effectively utilize the savings of their
own citizens -- the Koreas, the Taiwans, the Singapores, the
Malaysias —

are those that, in the 1980s, have been able to

manage their debts most easily and have continued to grow.

-15I cannot help but be encouraged by the sense that many of
the most important leaders of Latin America —

and today they

are democratically elected leaders -- have spoken out forcefully
about the need for structural change —

for more competition

to spur efficiency, for more private initiative and investment,
and less governmental and bureaucratic domination of their
economies, and for more "openness/1 at home as well as in trade.
I know there is a long distance from recognition of a problem
and from generalized statements of intent to practical policy
changes -- changes that mean a departure from deeply embedded
ways of doing business and domestic political traditions.
I also know that even in the best of circumstances, sustained
growth by developing countries will require some margin of
external financial support.

The more certain that necessary

external support, the easier it should be for the borrowing
countries to marshal the will and the effort to make the fundamental
policy changes needed at home.

And the clearer and more effective

-16the policy measures, the easier it will be to obtain the needed
external support from international financial institutions.
Recognition of those interlocking needs for discipline and
structural change at home and for a margin of external financial
support provides the essence of a solution.

It is precisely that

framework that was set out by Secretary Baker last October at
the World Bank and IMF meetings in Seoul as the basis for a
constructive approach toward the debt problem.
That approach does not imply a
common recipes for each country.

simple cookbook with

Reality is too complex for

that -- each country has unique problems and potential, its own
political traditionsf and different needs.

But there are

common elements.
The World Bank and regional development banks will need to
step up their lending sharply in support of promising policy

Those institutions are financially capable of responding

to the need.

Moreover, the exposed commercial banks, as in the

past, have a key part to play in restructuring existing loans

-17and providing some margin of new money in support of well-conceived
economic programs that, over time, will enhance the creditworthiness
of the borrowers.
Years of good growth —

growth that can be sustained without

the kind of massive injections of new money characteristic of
the 1970s and early 1980s —
for solving the debt problem.

would be the best possible environment
It would, at one and the same time,

reduce the interest burdens of the borrowers, relative to the
size of their own economies, and reduce the exposure of banks,
relative to their capital and assets.
The challenge is clear.

Each part of the overall effort -

by borrowers, by international institutions, and by banks —
essential to the success of the whole.


And it would be unrealistic

to anticipate that any part could proceed for long without the
support of the others.
All of that implies a very large cooperative effort.


a large number of banks from many countries, with different
exposures and particular interests, develop a common approach

-18responsive to the needs and reflecting their basic community
of interest?

Can the borrowing countries themselves develop

policies that will first of all command the confidence of their
own citizens, stop capital flight, and build sustained growth?
Can the international institutions effectively encourage and
assist that process, acting in the interest of world development
and growth?
It's obviously a tall order -- but neither are we starting
with a blank piece of paperf building from scratch*

We have by

now a lot of experience in dealing with the debt problem, and
some concrete successes,

I think the answer to these questions

is yes.
The basic concepts incorporated in Secretary Baker's initiative are widely accepted*

Indeed, the approach was reconfirmed

by the financial leaders of the world at international meetings
in Washington last week.

The major banks from around the world

have voiced their support for the initiative, while the World

- 19 Bank is proceeding actively to approve loan programs to help
finance structural adjustment initiated by the borrowing countries,
Much more, however, must be done.

And it must be done not

just in the context of lower interest rates, which clearly are
helpful, but also lower oil prices, which, for the developing
world, are hardly an unmitigated blessing.
There are, of course, winners and losers from the decline in
oil prices.

But the impact is not really symmetrical.

There is

no real offset or balance to the failure of a major borrower to
maintain continuity in debt service from moderate improvement
for others.
Mexico, our neighbor to the south and a major oil producer,
obviously faces the greatest challenge.

I do not underestimate the

That country has for several years been engaged in

a difficult adjustment effort, and large sectors of the population
have seen living standards eroded.

At present oil prices, Mexico,

in terms of government revenues alone, is losing something like 4

- 20 percent of its GNP.

And that comes on top of other adverse

budget trends last year.
At the same time -- and I want to emphasize this —

I see

nothing in the situation created by the new oil prices that
undermines the basic validity of the approach I have outlined.
It only makes more pointed the need to combine stabilization
measures with structural reform —

more open, competitive

economies; a more hospitable climate for investment, domestic
and foreign? and for restoring and reinforcing confidence in
their prospects.

In that context, financing external needs

should remain feasible, within the capacity of private and
official international institutions.
In the last analysis, those complementary approaches need
need to be grounded in the perceived interest of the borrowing
countries themselves

and of the creditor.

Solutions cannot

be imposed by fiat from outside, by the United States, or by
anyone else.

What we can do collectively is to find the common

ground among the parties at interest, just as was done when the

- 21 debt crisis first broke in 1986*

That search for common ground

and complementarity in actions is where the U.S. can play a helpful

It is the basis for all our conversations with the debtor

countries and creditors alike*
In the context of this overall, joint approach to the debt
problem, the external financing needsr even taking account of the
oil shock, seem to me manageable, and probably manageable within
the context of the overall amounts of new bank credit and the
multilateral lending effort set out by Secretary Baker six months

Naturally, some countries may require somewhat more financing

than was contemplated earlier? others, however, benefit from
both lower oil prices and interest rates and will need less.
One further point.

The progress in the world economy can

be undermined by political as well as economic strains.


trade deficits, excessive borrowing, inability to deal with the
pressures of debt in the developing world, and inadequate growth
are all prime breeding grounds for political frustration.


precisely the wrong response would be to permit those frustrations

- 22 to boil over in shortsighted actions —
and inflation.

protectionism, defaults,

Those approaches could only undermine cooperation,

reverse the progress that has been achieved, and set back prospects
for growth for years to come.
Those dangers have been repeatedly recognized by the responsible leaders in almost every country.
have been resisted.

By and large, the temptations

But we must not neglect the larger task of

dealing with the economic imbalances at their source, and do so
with a sense of urgency.
No doubt there is a human tendency to look to the other
fellow, or to the other country, to do its part, and hope that's

No doubt, the needed measures are also politically


But there is also no doubt that, if we are to be

successful, it will have to be a joint effort, with recognition
of the complementary roles for all the leading countries.
In the end, the success of that effort, like so much else,
will depend on progress in a number of directions.

The prospect

for sustaining growth and working toward lower interest rates

- 23 in the United States and elsewhere rests in large part on whether
there is a willingness to work together.

Within the United

States, as our trade balance improves and we borrow less from
abroad, we need complementary action to reduce our budget deficit
in the United States.

That, among other things, will also reduce

the risk of renewed inflation.
Other industrial countries need to help carry the torch
of growth.

Those in the strongest external position can,

by opening markets, help us all resist the siren song of

All of that, more certainly than any intervention

in exchange markets, would help ensure a better international
balance and well-aligned exchange rates.
This is not just a time of opportunity, but of danger as

We cannot expect perfection in the timing and execution of

every policy -- the world is too uncertain, and our abilities too
frail, for that.
But we do not need perfection.
sense of the right direction —

What we do need is a strong

and I think we have that.

-24We need to realize how the actions of each country fit
into a coherent whole -- and I think we are gaining that.
And, of course, we need practical action.
the hardest part.

But there is too much at stake to fail to

carry through.

That's sometimes