Against the Tide

XV

The U. S. Balance-of-Payments Crisis: Diagnosis and Treatment*

When a country such as the United States seems to suffer from a stubborn balance-of-payments deficit, an ailment whose symptom is loss of gold reserves, it is tempting to react in the same way as the economic layman almost invariably does react to such a process. One looks at the balance of payments as though it were a pair of scales; one notes that one pan, with payments to foreign countries, is going down, and the other, with payments from abroad, is rising; one concludes, therefore, that the trouble is that obviously there is too much in one pan and too little in the other. It follows, so the argument goes, that it is high time the government saw to it that something should be taken away from the heavier pan and added to the lighter one. From there just one more step leads to the notion that the disequilibrated scales can be set right by any measure that increases receipts and diminishes disbursements. And so there is serious talk about import restrictions and export subsidies, exchange control, incentives to capital imports, and obstacles to capital exports.

In point of fact, an alarmingly large section of opinion regarding the present balance-of-payments crisis of the United States is just at that level of lay economics, and the measures apparently under contemplation are of the same ilk. Since the U. S. trade balance continues to be in surplus, as before, the cause of the trouble is supposed to be the deficit on capital account—in other words, an excess of unilateral capital transfers from the United States to abroad. From this the conclusion is drawn that this excess must be diminished and aligned to the other side of the balance of payments. Given that a large part of the U. S. unilateral capital transfers is of a political nature, the U. S. government feels constrained to turn this tap down a little, without regard to the consequences this might have on the world political situation. At the same time, other governments are to be induced to take over some part of these political expenditures, and more especially the German government, which is regarded as eminently capable of doing so in the light of the same sort of considerations, namely, the persistent surplus in the German balance of payments. This assessment of German solvency is supported in Germany itself by those who explain the German external surplus as being in large part due to insufficient exports of German capital and to the receipt of unilateral dollar payments (maintenance costs of American troops in Germany) and who thus play into the hands of the American wishes.

All these arguments and measures are clearly flawed by an elementary error in economics, as no one who has been trained in economics can fail to see. What sort of error it is becomes quite clear once we appreciate that the whole problem is one that should be familiar to at least the older generation of economists. It is all over again the problem of the transfer of German reparations after World War I and of Germany’s capacity to pay.1 At that time, the predominating view was, at first, quite simply that Germany’s capacity to make unilateral payments to abroad depended upon its ability to achieve a corresponding balance-of-payments surplus. This thesis led to a prolonged and interesting—but now, alas, forgotten—discussion, which eventually made it clear that the balance-of-payments surplus was not the condition but the result of the German reparations, and was the measure of how much Germany was actually paying by its own efforts.

If a country—thus ran the lesson we then learned anew— makes more capital payments abroad than it receives and, therefore, runs a deficit on the external capital account, as was the case of Germany’s paying reparations and is now the case of the United States’ paying out development aid, grants, and the costs of U. S. troops stationed abroad, then this country must necessarily register a surplus on goods and services account matching the amount actually disbursed to balance the capital account. These are the key words: the amount actually disbursed to balance the capital account. Everything depends upon an appropriate volume of purchasing power having first been withdrawn from the total volume of domestic income and expenditure and upon the country’s being rich enough to take this domestic withdrawal in its stride. The problem, therefore, lies primarily not in the balance of payments but in the country’s ability to raise the required resources domestically.

Now, it is beyond doubt that nothing has happened in the United States during the last few years that might suddenly and seriously have weakened the country’s ability to make domestic resources available for foreign payments. Whether and to what extent these payments are to be made remains a political question, which it is not our business to pronounce upon. If anything, the economic margin for such payments has widened rather than narrowed, given the recent years’ continued growth in the prosperity and economic strength of the United States. If, today, the U. S. government means to ease the pressure on the balance of payments by cuts in its unilateral expenditure abroad, this would alter the structure of the U. S. balance of payments in such a way that one would expect a corresponding decrease on the credit side of the goods and services account. If, conversely, the German government meant to diminish the balance-of-payments surplus by deliberately stepping up unilateral foreign payments, this would alter the structure of the German balance of payments in such a way that one would expect a corresponding increase on the credit side of the goods and services account.

This will sound less paradoxical if we understand where the problem really lies. The problem lies in the adjustment that is necessary if sudden and major changes in the balance on capital account are to be so offset in the goods and services account that a new equilibrium comes about. Such an adjustment needs time and may entail difficulties and frictions. That these latter should not be overestimated and that in fact there are strong forces tending to re-equilibrate the balance of payments in the case of unilateral capital transfers in the content of the transfer theory on which economists eventually agreed more than a third of a century ago now.

Here we come to the heart of the matter. What is at the bottom of the U. S. balance-of-payments difficulties is a problem of equilibrium, not one of ability to pay, and it is a problem pertaining to the whole of the economy, not to the balance of payments alone. The United States is not one cent the poorer or the less able to pay because of its balance-of-payments deficit, nor is Germany one cent the richer or the more able to pay because of its persistent balance-of-payments surplus, just as France was by no means poor and insolvent so long as it ran an external deficit and suddenly became rich and solvent when it adjusted the exchange rate of the franc, stopped any further inflation and thereby turned its balance-of-payments deficit into a surplus. If the United States is today suffering from a balance-of-payments crisis, the reason is that the U. S. economy as a whole is no longer in equilibrium with the economies of other countries. This equilibrium depends upon two factors, which are, on the one hand, the American price and cost structure in comparison with that of other countries, and on the other, the exchange rates, that is, the hinge on which the price and cost structures turn.

It is wrong, therefore, to say that the United States has a payments gap because it imports too much or exports too little, or exports too much capital or imports too little of it. The correct answer is that the American balance of payments has ceased to be in equilibrium because the American economy has gotten out of equilibrium with the major countries abroad. And this has happened because in view of all the circumstances, which include more particularly the economic recovery of the European countries and their increased competitive strength, the United States has become too expensive, or less competitive, or has failed to reconcile the total volume of its domestic income and expenditure with its external payments, or whatever other form of words one might choose to indicate a state of affairs that basically turns on one fact only. That fact is that even the affluent society, to use Galbraith’s well-known description of the American economy, can eventually live beyond its means. All this is, of course, subject to the reservation that nothing is changed in the conversion factor between the United States and the rest of the world, that is, in the dollar rate.

As regards the question of the main cause of the disturbance in the equilibrium of the American economy, this is a matter on which far-reaching agreement had eventually been reached. Some of the economists who now rest content with the theory that the gap in the U. S. balance of payments is due to American foreign aid and military expenditure abroad were until a short while ago among the leading critics who warned against the effects of the wage inflation. And in fact the American payments crisis is one of these rightly feared effects, and it would seem that last year’s steel strike was the last big drop that caused the bucket to overflow. The true situation becomes quite clear if we consider the possibilities of effective treatment. In this respect there are two things that surely can hardly be doubted. One of them is that there certainly exists a dollar rate, that is, a conversion factor, that would give rise to a new equilibrium, and secondly, it is obvious that if, for thoroughly commendable reasons, the dollar is not to be devalued, equilibrium can be re-established by weakening the upward push of American costs and prices.

Given that in fact a devaluation of the dollar would, for political reasons alone, be a great misfortune for the whole of the free world, everything depends upon such a weakening of the upward push of American costs and prices. To avoid devaluing the dollar—not to speak of such an unspeakable thing as American exchange control—therefore implies a restrictive credit and financial policy in the United States. The present administration is open to the reproach that it has not done enough in this respect and has not been consistent enough. If the new Kennedy administration is to do better, it will have to be a good deal more energetic than its predecessor in turning off the taps in Washington, instead of turning them on still further, as Kennedy and his advisers have announced so far. The hopes of the United States and of the whole free world, in this as in other respects, therefore lie in the new president’s being converted from Saul into Paul—and may he soon see the light on the road to Damascus. To put it in terms of a symbol: we could all relax if the president were to replace his purely inflation-minded adviser Galbraith with a man such as Professor Haberler.

The difficulties and hardships of such a policy of adjustment by internal monetary discipline will be the less, the more cooperation the United States gets from the European countries with balance-of-payments surpluses. The country that could render the United States the greatest service is the one whose balance-of-payments surpluses are an extreme case, and that country would thereby render itself an even greater service. That country is Germany, which is being exhorted at present to relieve the United States by taking over some of the political foreign expenditure. It has been argued here that, quite apart from political misgivings, the idea of such relief rests on a mistaken diagnosis of the ailment. On the other hand, the United States could expect truly effective help from Germany if Bonn and Frankfurt were at long last to decide which of two courses to take: either to give a free rein to the inflationary effects deriving from the balance-of-payments surpluses, thus diminishing the domestic purchasing power of the currency, or else to raise the external purchasing power of the D-mark. The case of Germany is the exact opposite of the American one. Across the Atlantic an anti-inflationary damper is definitely preferable to devaluation, and equally definitely it would be better on this side to revalue rather than to let inflation rip, that is, to let the purchasing power rise externally rather than to diminish it at home.

* Neue Zürcher Zeitung, November 25, 1960.

1 See the article on the Transfer Problem in this volume.