America needs a program to end its dual deficits.

• Author: Hale, David (American economist)
• Position: International

America needs a program to end its dual deficits During the last two of three years, America has been importing $150 billion of foreign capital per year. This is a record share of our national income. It is equal to about 3.5 percent of our gross national product. It compares to a previous high of only 1.5 to 2 percent back in the 1870s and 1880s, when America was a developing country and importing capital from Great Britain to build the western railways.

Commentators from Wall Street or the financial media have been predicting that this external borrowing process would end unhappily--in a severe recession or even a depression. Many even blame the stock market crash of 1987 on the fact that we were borrowing money overseas.

I think it important, therefore, to analyze the reasons why America has emerged as a big external borrower--and why the process has so far gone so well. Some of the factors that caused us to become a big borrower were transient and cyclical in nature and are now fading away, while others are more structural in nature and could endure well into the 1990s.

America has emerged a s an external borrower on a large scale becuase there is now for the first time since World War I a truly global capital market. From the late nineteenth century into the early decades of this century, it was commonplace for financial institutions around the world to invest a significant portion of their assets in other countries. Then, this process of global financial integration was broken for half a century by two world wars, the great depression, and a series of capital controls enacted after the two world wars. Only here in the 1980s have we reconnected to the world that we lost before 1914.

History revisited

Why has this happened? First, we've had a worldwide movement towards financial deregulation, which has liberalized not just domestic financial institutions but also, in the last decade, international capital flows. A recently as 10 years ago, it was illegal for most Japanese investors to own U.S. Treasury bonds. But in 1980, Japan phased out many of its capital controls, as did Germany in the '60s. The U.K. had abolished exchange controls in 1979, and we did the same in 1974 by phasing out the interest equalization tax.

To understand the American financial markets in the next 10 years, it helps to understand that the real parallels for the stock market crash of 1987 were not 1962 or 1929, which was the common comparison 12 months ago, but the bear markets of the late nineteenth century. All of them revolved around sudden changes in capital flows to the U.S. from London. They centered either on a financial crisis in Britain that shut off money flows or an event in this country that called into question the value of the American dollar and the safety of foreign assets in this country.

When we introduced in the 1890s an experiment in currency depreciation by going to a bimetallic silver and gold standard, foreign investors became frightened. In 1893, there was a capital flight from New York, and the New York/London interest rate differential went from 100 basis points to about 1,000. In 1896, President Grover Cleveland lost control of his party to a populous movement under the leadership of William Jennings Bryan, who was committed to severing our ties to the British financial community.

We think of Bryan's famous speech in Chicago that won the nomination as the "cross of gold" speech. But if you read it, you'll see that much of it was an attack on the Bank of England for giving us high interest rates. In fact, various striking similarities exist between the Bryan speech of 1896 and James Baker's press conference that occurred the weekend before the October 19 stock market crash--when Baker attacked the Germans for pushing up their interest rates and threatening to cause a hike in our interest rates.

The second reason this country has emerged for the first time since the turn of the century as...