-11-

Nor did the banks go beyond conventional wisdom when they geared their lending policies to the expectation of a continued rise in oil prices and hence continued inflation.

-- No doubt many developing countries grievously mismanaged their economic policies. Without reform of the economic policies of most debtors no amount of help from banks or governments can possibly be effective. But this reform requires a subtle and sensitive judgment of what, especially in fledgling democracies, the traffic will bear. The objective is or should be to encourage democratic, market-oriented, responsible governments. We must not in the name of debt settlement bring into power governments that challenge the whole concept of free economies and free peoples. That is not a role in which banks (even central banks) or international institutions are either comfortable or secure.

Nevertheless, the governments of the industrial democracies have stood aloof from a process which will determine the future of North-South relations and the stability of the international system for a long time to come. This ostrich-like policy has come to the end of its possibilities. Debt management based on purely financial criteria and negotiated by financial institutions involves the political survival of too many governments in developing countries; the problem by definition is not purely economic. In a conflict between banks and governments it is foolhardy to assume that governments will never follow the populist demand to restrict foreign financial institutions or to declare some form of unilateral rescheduling. To rely on the existing system of debt negotiation indefinitely is to play Russian roulette.

The conventional analysis--particularly in the United States--holds that the worst is over, that the most heavily indebted countries are on the way to recovery.

The past two years have indeed witnessed considerable progress. The external deficit of several key debtor countries has contracted markedly, at first through austerity produced by the reduction of imports; more recently through an expansion of exports. The increase in debt has slowed. Massive amounts of public and private debt have been re-scheduled. Some corrective economic policies have been put in place sharply reducing the hemorrhage of capital. There are even faint but hopeful signs of economic growth in countries like Mexico and Brazil.

-12-

Many of the bankers in this room would also add, I am sure, that no significant debtor has defaulted or unilaterally rescheduled on non-market terms.

All this represents an extraordinary achievement in crisis management. Jacques de Larosiere and Paul Volcker have earned the gratitude of the international community for their courageous and farsighted handling of the emergency that has been thrust upon them by the reluctance of governments to touch the hot potato. The lending banks have cooperated with them to an extraordinary degree.

Still, I believe that the current system of debt management is reaching its inherent limit. The issue is not whether the financial terms which now seem to be emerging from commercial bank debt renegotiations are inappropriate. The banks have made a maximum effort to take into account the economic pressures on debtor countries. My concern is that the political dynamics of the process are now beyond what even the wisest and most farsighted financial institutions can reasonably be expected to handle by themselves.

The record of the last few years argues against the hopeful view that any one settlement will be final. In each round of seemingly unending negotiation creditors have felt obliged to yield a little more ground. Rescheduling agreements are reopened; terms negotiated in good faith yesterday are renegotiated today. Inevitably, they may be viewed as adjustable tomorrow as well. Such a process involves a high risk, at some point, of running out of contol.

It is this uncertainty--coupled with worries about what future international economic and financial conditions might be--which in my view is at the heart of the apparent fragility of contemporary international financial markets.

The very flexibility of recent terms means that the banks have conceded almost the limit of what a profit-making institution can sustain. This would not matter had we reached the end of the process. I doubt seriously that we have for two reasons. The history of the thirties suggests that the crisis in debt problems occurs not at the height of the crisis but when matters are improving. As the adjustment process begins to work the political incentive to sustain it will weaken--even though in many cases the underlying economic imbalances will continue for a long time. Just as the U.S. and other major industrial democracies seem unable to divorce economic policy from short-run political concerns, developing countries--many of whom, especially in Latin America, are themselves moving toward democracy--could

-13-

become caught in a dilemma that bad economics seem to make good politics, at least in the short run. And the banks have little leverage left once the repayment of principal has been stretched out into the indefinite future.

Future debt discussions will take place in an increasingly difficult political climate if the present framework is not changed. Many governments, most politicians, political parties and media in the debtor countries are adopting harshly nationalistic, anti-IMF, anti-bank rhetoric. One can try to console oneself that this rhetoric is for domestic consumption, that serious leaders know better, that unilateral rescheduling will make financial matters worse. This argument has undoubtedly merit. But in our world rhetoric tends to create its own reality. And if only one major country kicks over the traces it will be difficult for the rest to sustain the current course--unless the violator is made to pay a huge price which in turn could start a political crisis thwarting the objective of sustaining moderate, democratic, pro-market governments.

The adjustment programs demanded by the IMF are not technically unreasonable; what they lack is a political context beyond the power or responsibility of the IMF or banks and which these institutions have had to improvise because of the abdication of governments.

Sooner rather than later the terms of reference of the debt debate must be changed. The current ad hoc debt strategy led by private institutions and the IMF has given both creditors and debtors some much needed breathing space. The time should be used to change the framework of the dialogue. Debt service is after all not an end in itself. It can even act against the long-term interests of the creditors if it results in the drain of capital from the poor to the rich. Viewed only from the narrow perspective of debt service the creditors and debtors have somewhat conflicting objectives. On the other hand global growth -- without which debt service is primarily an accounting exercise-- is a goal which farsighted leaders from both North and South should share. Such an approach should take account of two realities:

- Without improvement of the economic policies of the debtor countries no outside program of assistance private or public can have any long-term impact. Economic reform is needed in most debtor countries not for the sake of the banks or of the IMF but for their own welfare.

- The debtors should not be expected to extricate themselves from their difficulties by reform and austerity alone. The creditor countries must recognize that fundamental economic imbalances caused by forces outside the debtors' control contributed to the accumulation of excessive

-14-

indebtedness. The explosion of oil prices in the seventies and of interest rates in the eighties turned a difficult situation into a crisis. These imbalances can only be resolved by a strategy of global growth. A cooperative effort between the industrial democracies and the principal debtor countries on the political level is therefore essential.

The challenge is to recognize that the developing countries cannot grow without considerable access to foreign savings in a world which seems less and less prepared to invest in developing countries. Seen from this perspective, the economic and political elements of the strategy would change dramatically. Throughout the seventies the banks were asked to play a role--that of development financiers--for which they were not designed. But long-term development finance, which is what most of the highly indebted countries need today, involves a major governmental responsibility--however unpopular such a view is in most industrial democracies, including our own. The economic cost of such a program would be minor compared to the consequences of a global financial and political crisis. If both creditors and debtors lift their sights there is here the prospect of a compact that could put the relationship between the industrial democracies and the developing world on an entirely new basis.

## Conclusion

We meet at a period of substantial American recovery. The economies of most other industrial democracies are improving as well, if more slowly. There seems to be at least some maneuvering room with respect to the debt problem. All this creates an opportunity to point the world economy towards greater coherence and brighter vistas.

One obstacle to this goal is the tendency of all democracies to make economic policy almost exclusively in a domestic context. Because of our vast economic power this is a particular problem for the United States policymakers and their constituents. Most of the American public still view this country as being relatively unaffected by international economic developments. Our political process has not yet adjusted to the reality that the U.S. is steadily becoming more integrated into an international economy that is becoming more global. We must resolve the dilemma if we are to overcome chronic international economic instability. For our time and our opportunity require dramatic U.S. leadership.

In 1944 the United States threw its influence behind building international institutions. A new and dynamic economic system gave impetus to an extraordinary global recovery. Today the need is the same and the stakes are even higher for many more countries are now principal participants in international economic affairs.

The spirit that produced Bretton Woods reflected the realization that in the long run the national welfare can only be safeguarded in the framework of the general welfare.

All great achievements were a vision before they were a reality. There are many in this room better qualified to fill in the many blanks for an overall design. My major point is that the world needs new arrangements. A new burst of creativity is needed to eliminate our dangers and fulfill our promise.

[Y]

# MOCATTA LECTURE

IT IS WITH GREAT PLEASURE THAT I ACCEPTED THE INVITATION TO DELIVER THE FIRST MOCATTA LECTURE. IT IS NOT OFTEN THAT I FIND MYSELF BEFORE A CAPTIVE AUDIENCE OF ECONOMISTS AND BANKERS--FOR REASONS SOME OF MY FORMER COLLEAGUES WILL BE HAPPY TO ENUMERATE AND CONSIDER COMPELLING. YOU SHOULD UNDERSTAND THAT I DO NOT CLAIM TO BE A TECHNICAL EXPERT ON ECONOMICS. MY PREOCCUPATION IS WITH INTERNATIONAL ORDER: WHAT MAKES AN INTERNATIONAL SYSTEM FUNCTION, THE CAUSES OF ITS DISLOCATION AND THE POSSIBLE REMEDIES. MY THEME HERE IS THAT THE POLITICAL AND ECONOMIC GLOBAL SYSTEMS ARE NO LONGER CONGRUENT. AS A RESULT A SUFFICIENT NUMBER OF COUNTRIES CAPABLE OF UPSETTING THE EQUILIBRIUM LACK A CONSISTENT DOMESTIC DISCIPLINE AND PURE INCOMPATIBLE POLICIES. AND THE GLOBAL ECONOMIC SYSTEM SEEMS INCAPABLE OF GENERATING-- INDEED IT DOES NOT EVEN ATTEMPT--A COHERENT UNITED STRATEGY FOR OVERALL GROWTH.

2

THE NINETEENTH CENTURY WAS A PERIOD OF UNPRECEDENTED ECONOMIC GROWTH WHICH PRODUCED WHAT WE NOW CALL THE "DEVELOPED" WORLD. THE PRINCIPAL CAUSES WERE A COMBINATION OF TECHNOLOGICAL BREAKTHROUGHS AND THE COMPATIBILITY BETWEEN POLITICAL AND ECONOMIC PHILOSOPHIES IN THE COUNTRIES THAT SHAPED WORLD AFFAIRS. GOVERNMENTS ACTED ON THE PREMISE THAT THE ECONOMIC SPHERE WAS BEYOND ITS POWER OR EVEN COMPETENCE. THE ACCUMULATION OF CAPITAL WAS LEFT TO THE OPERATION OF THE MARKET. THE MECHANISM OF ADJUSTMENT BETWEEN ECONOMIES WAS PROVIDED BY THE GOLD STANDARD TO WHICH ALL MAJOR TRADING NATIONS SUBSCRIBED. ALL THIS HAD THE ADVANTAGE OF AUTOMATICITY. THE MARKET--EXPRESSED IN THE FLOW OF GOLD--GAVE THE SIGNAL WHEN ECONOMIC ADJUSTMENT WAS NEEDED; NO ADDITIONAL POLITICAL DECISION WAS REQUIRED TO TRIGGER ADJUSTMENT POLICIES. POLITICIANS COULD EITHER ACCEPT THE GOLD STANDARD OR REJECT IT. BUT ONCE THAT DECISION WAS MADE, THEY

WERE FORCED TO CONFORM SPENDING, TAXING, AND MONETARY
POLICIES TO ITS DISCIPLINE.

THERE WERE OF COURSE COSTS, SOMETIMES HEAVY HUMAN
COSTS. SEVERE UNEMPLOYMENT AND PERIODIC DEFLATION WERE
CONSIDERED "NATURAL"; THE BUSINESS CYCLE WAS BELIEVED
TO FOLLOW LAWS BEYOND THE CAPACITY OF GOVERNMENTS TO
REPEAL OR AMEND. INTERNATIONAL TRADE WAS DOMINATED
BY A VERY FEW COUNTRIES WHOSE COMPETITION WAS MORE OFTEN
GOVERNED BY STRATEGIC THAN BY ECONOMIC CRITERIA. COLONIAL
EMPIRES PROVIDED THE SAFETY VALVE OF ASSURED MARKETS
AND SOURCES OF RAW MATERIAL. SINCE ALL GOVERNMENTS
BELIEVED IN LAISSEZ-FAIRE ECONOMICS AND ACCEPTED NO
RESPONSIBILITY FOR SOCIAL WELFARE, THERE WERE FEW POLITICAL
OBSTACLES TO PERMITTING INTERNATIONAL MARKETS TO OPERATE
FREELY.

BUT THIS COMBINATION OF GOLD, COLONIALISM AND LAISSEZ-
FAIRE IS NOT THE CURRENT CONDITION. IN THE 19TH CENTURY

THE ECONOMIC WORLD ORDER WAS ESTABLISHED BY A VERY FEW
DOMINANT COUNTRIES WHICH SET THE RULES OF THE GAME,
THAT IS OF THE MARKET. INDUSTRIALIZATION HAD BEEN INVENTED
IN GREAT BRITAIN WHICH FOR A WHILE HAD A NEAR MONOPOLY
ON THE RELEVANT TECHNOLOGY; FREE TRADE IS EASY TO MANAGE
FOR THE MONOPOLIST. THE CIRCLE OF INDUSTRIALIZED COUNTRIES
GRADUALLY EXPANDED (INITIALLY ALWAYS BEHIND TARIFF WALLS)
BUT THE ECONOMIC SYSTEM REMAINED UNDER THE CONTROL OF
A SMALL GROUP OF EUROPEAN COUNTRIES WITH SIMILAR
POLITICAL SYSTEMS AND ECONOMIES. EVEN THEN THE DOMINANT
COUNTRIES DID NOT ADJUST GRACEFULLY TO THE EMERGENCE
OF RIVALS. AT THE TURN OF THE CENTURY BRITAIN HAD TROUBLE
ACCOMMODATING GERMANY. IN THE 1920'S AND 30'S WHEN
RISING ITALY AND JAPAN WANTED "A PIECE" OF THE ACTION,
THE FAILURE OF THE ECONOMIC SYSTEM TO ACCOMMODATE THEM
CONTRIBUTED IMPORTANTLY TO RAMPANT ECONOMIC NATIONALISM.
IN THE '50'S AND '60'S THE UNITED STATES BECAME THE

5

BALANCE WHEEL OF THE WORLD ECONOMIC ORDER. BACKED BY
THE INDUSTRIAL DEMOCRACIES IT WAS STRONG ENOUGH TO MAKE
AND ENFORCE INTERNATIONAL RULES. THIS ARRANGEMENT COLLAPSED
IN THE '70'S UNDER THE TWIN BLOWS OF RESURGENT ECONOMIC
NATIONALISM (INCLUDING AMERICAN) AND THE OIL CRISIS.

THE ECONOMIC WORLD ORDER OF THE PAST CAN NOT BE RESURRECTED
AND A NEW ONE CANNOT BE CREATED BY THE OLD PLAYERS.

TOO MANY NEWCOMERS INSIST ON PARTICIPATION. CHINA,
BRAZIL, INDIA, KOREA, IN TIME MEXICO AND INDONESIA TO
NAME JUST A FEW WILL INSIST ON HELPING TO SHAPE THE RULES
WHICH AFFECT THEIR ECONOMIC AND HENCE THEIR POLITICAL
DESTINY.

THE TASK OF CONSTRUCTING A NEW INTERNATIONAL ECONOMIC
ORDER IS MADE MORE CHALLENGING BECAUSE THE MOST IMPORTANT
ECONOMIC POWERS ARE GOVERNED BY A KIND OF POPULAR DEMOCRACY
UNKNOWN IN THE 19TH CENTURY. SUFFRAGE IS UNIVERSAL;
THE PUBLIC INSISTS THAT GOVERNMENTS ASSUME RESPONSIBILITY

TO ALLEVIATE SUFFERING AND TO IMPROVE THE QUALITY OF LIFE,
IF NECESSARY EVEN AT THE COST OF SLOWING ECONOMIC GROWTH.
FEW, IF ANY, EXCUSES ARE TOLERATED; THE POLITICAL LANDSCAPE
OF THE LAST TEN YEARS IN EUROPE AND IN THE UNITED STATES
IS LITTERED WITH THE WRECKAGE OF GOVERNMENTS THAT FAILED
TO PRODUCE ECONOMIC RESULTS ACCEPTABLE TO THE ELECTORATE--
REGARDLESS OF WHO WAS AT FAULT. AFTER THE FALL OF THE
SHAH TRIGGERED A NEW INFLATIONARY SPIRAL, NO NATIONAL
LEADER IN OFFICE IN A MAJOR DEMOCRACY SURVIVED THE NEXT
ELECTION.

FOR THIS REASON ALONE THE PRESENT INTERNATIONAL POLITICAL
ENVIRONMENT IS HOSTILE TO AUTOMATIC MECHANISMS. UNLIKE
THEIR 19TH CENTURY COUNTERPARTS OFFICE HOLDERS TODAY
ARE NOT WILLING TO LIMIT THEMSELVES TO "ON OR OFF" DECISIONS;
THEY INSIST ON CONTROLLING THE ECONOMIC POLICY LEVERS
DIRECTLY IN ORDER TO ACHIEVE IMMEDIATE POLITICAL GOALS.

7

THIS PROCESS PUTS A PREMIUM ON SHORT-TERM APPROACHES;
IT ENCOURAGES LEADERS TO WAIT FOR CRISES TO MATURE UNTIL
ACTION IS UNAVOIDABLE; SIMULTANEOUSLY IT TEMPTS THEM
TO SHIFT THEIR ECONOMIC PROBLEMS TO OTHER COUNTRIES
FOR AS LONG AS POSSIBLE.

THE GROWING POLITICAL NATIONALISM RUNS COUNTER
TO THE DOMINANT _ECONOMIC_ TRENDS OF THIS CENTURY. FOR
THE FIRST TIME IN HISTORY THE WORLD ECONOMY HAS BECOME
TRULY INTERNATIONAL. NO GEOGRAPHIC REGION IS EXCLUDED
FROM INTERNATIONAL COMMERCE; EACH, WITH THE POSSIBLE
EXCEPTION OF AFRICA, CONTAINS SOME MAJOR ACTOR. BUT
NONE ARE STRONG ENOUGH TO IMPOSE ITS DESIGN. THEY COMPETE
THROUGH NATIONAL DECISIONS WHILE BEING SIMULTANEOUSLY
LINKED BY GLOBAL MARKETS. NOT EVEN THE SHARP POLITICAL
DIFFERENCES BETWEEN THE SOVIET BLOC AND THE WEST HAVE
PROVED AN OBSTACLE TO THESE DOMINANT TRENDS. A CONSERVATIVE
AMERICAN ADMINISTRATION HAS AVIDLY ENCOURAGED SOVIET

GRAIN PURCHASES. MANY EUROPEAN INDUSTRIALISTS PURSUE
IN THE LESS DEVELOPED ECONOMIES OF THE SOVIET BLOC THE
OPPORTUNITY OR THE MIRAGE--DEPENDING ON ONE'S POINT
OF VIEW--OF A MARKET SHELTERED FROM JAPANESE AND U.S.
COMPETITION.

THE INCONGRUITY BETWEEN THE INTERNATIONALIZATION
OF THE WORLD ECONOMY AND THE DOGGED STRENGTHENING
OF NATIONAL AUTONOMY IN ECONOMIC DECISION-MAKING IS
BOTH STRIKING AND THE DEEPEST CAUSE OF THE GYRATIONS
OF MARKETS AND EXCHANGE RATES. TAX, SPENDING, SOCIAL
EMPLOYMENT, INDUSTRIAL AND TRADE POLICIES ARE INSULATED
BEHIND NATIONAL BORDERS DESPITE THE FACT THAT SUCH DECISIONS
HAVE GLOBAL CONSEQUENCES IN DIRECT PROPORTION TO THE
ECONOMIC IMPORTANCE OF THE COUNTRY INVOLVED. A CASE
IN POINT IS THE UNILATERAL DECISION BY THE UNITED STATES
IN 1971 TO SUSPEND THE CONVERTIBILITY OF THE DOLLAR
AND TO IMPOSE A 10 PERCENT IMPORT SURCHARGE. THE EFFECT

(N)

9

WAS TO OVERTHROW THE BRETTON WOODS ARRANGEMENT AFFECTING
ALL COUNTRIES--WITHOUT PRIOR CONSULTATION OR NOTICE
TO ANYONE. COMPARABLE UNILATERALISM HAS MARKED THE
JAPANESE RESTRICTIONS ON FOREIGN INVESTMENT AND EUROPE'S
MANAGEMENT OF AGRICULTURAL POLICY.

WE LIVE WITH THE PARADOX OF A GLOBAL ECONOMY WHICH
LACKS A SYSTEM FOR RESOLVING DISPUTES OR FOR SETTING
LONG RANGE / AGREED GOALS. AUTOMATIC MECHANISMS TO FORCE COORDINATED
DECISIONS HAVE PROVED POLITICALLY UNACCEPTABLE. BUT
THE INDUSTRIAL DEMOCRACIES HAVE RECOILED AS WELL FROM
THE ALTERNATIVE OF POLITICAL COORDINATION OF FISCAL
AND MONETARY POLICIES. FORUMS WHERE NATIONAL ECONOMIC
POLICY MAKERS MEET EXIST, OF COURSE: THE BANK FOR INTERNATIONAL
SETTLEMENTS, THE INTERNATIONAL MONETARY FUND AND MOST
DRAMATICALLY THE ECONOMIC SUMMITS. BUT THESE OCCASIONS
PROVIDE LITTLE MORE THAN AN OPPORTUNITY FOR AN EXCHANGE
OF NATIONAL VIEWS; THEY HAVE NOT SUCCEEDED IN SHIFTING

THE FRAMEWORK OF THINKING AND ACTING TO A GLOBAL PERSPECTIVE.

IN RECENT YEARS THOSE CHARGED WITH INTERNATIONAL MONETARY ARRANGEMENTS HAVE TRIED TO FIND AN ALTERNATIVE BY ESTABLISHING THE INTERNATIONAL MONETARY FUND AS THE GLOBAL DISCIPLINARY FORCE. THE 1976 AMENDMENT OF THE FUND'S ARTICLES OF AGREEMENTS, WHICH GREW OUT OF DISCUSSIONS AT THE RAMBOUILLET ECONOMIC SUMMIT, GIVE THE IMF THE AUTHORITY TO "PROMOTE STABILITY BY FOSTERING ORDERLY UNDERLYING ECONOMIC AND FINANCIAL CONDITIONS" AS WELL AS "TO SEEK ORDERLY ECONOMIC GROWTH WITH REASONABLE PRICE STABILITY." IN THEORY AT LEAST THIS IMPLIES THE RIGHT TO REVIEW NATIONAL ECONOMIC POLICIES FOR THEIR INTERNATIONAL COMPATIBILITY. IF THIS "TECHNICIANS' AUTOMATICITY" WORKS BETTER, IT EXISTS IN THEORY RATHER THAN IN PRACTICE. THE FUND, THOUGH IT MAY POLICE A FEW TROUBLESOME NEIGHBORS, IS FAR FROM BEING A GOVERNOR OF THE GENERAL SYSTEM. THE

11

U.S. AND OTHER MAJOR INDUSTRIAL DEMOCRACIES HAVE BEEN UNWILLING TO MODIFY THEIR POLICIES IN RESPONSE TO IMF CRITICISM. IN FACT THE U.S. HAS BEEN TACITLY CONCEDED A DOMINANT ROLE FOR THE DOLLAR AND A DISPROPORTIONATE AUTONOMY FOR ITS DECISIONS. IMF DISCIPLINE HAS IN PRACTICE BEEN APPLIED PRIMARILY TO THOSE COUNTRIES IN ECONOMIC TROUBLE; MOST RECENTLY TO DEVELOPING COUNTRIES FACING A MOUNTING BURDEN OF INTERNATIONAL DEBT.

IN THEORY, OF COURSE, NO MECHANISM SUCH AS THE FUND OR A COMMODITY SUCH AS GOLD SHOULD BE NECESSARY. THE MARKET SHOULD BE AN INCORRUPTIBLE JUDGE OF THE APPROPRIATENESS OF ECONOMIC POLICIES. IN PRACTICE, HOWEVER, THE DOMINANCE OF THE UNITED STATES IN ECONOMIC AFFAIRS, THE IMPERFECTIONS OF FINANCIAL MARKETS AND THE ABILITY OF COUNTRIES TO DELAY REMEDIAL ADJUSTMENT THROUGH BORROWING HAS MEANT THAT THE MARKET CAN BE IGNORED AT LEAST FOR A WHILE. TO BE SURE THE ULTIMATE

(N)

12

RECKONING IS ALL THE MORE SEVERE. BUT THE TEMPTATION
OF GOVERNMENTS TO DELAY THE BITTER MEDICINE OF REFORM
OF ECONOMIC POLICIES--USUALLY INVOLVING SOME CONTRACTION
OF NON-AFFORDABLE EXPENDITURES--BEYOND THEIR ELECTORAL
PERIOD TENDS TO BE IRRESISTIBLE.

IN THESE CIRCUMSTANCES THE ECONOMIC SYSTEM OPERATES--
IF AT ALL--AS CRISIS MANAGEMENT. THE RISK IS, OF COURSE,
THAT SOME DAY CRISIS MANAGEMENT MAY BE INADEQUATE. THE
WORLD WILL THEN FACE A DISASTER ITS LACK OF FORESIGHT
HAS MADE INEVITABLE.

THE BIGGEST POLITICO-ECONOMIC CHALLENGE TO STATESMEN
IS TO INTEGRATE NATIONAL POLICIES INTO A GLOBAL PERSPECTIVE
TO RESOLVE THE DISCORDANCE BETWEEN AN INTERNATIONAL
ECONOMY AND A POLITICAL SYSTEM BASED ON THE NATION STATE,
STATED AS SIMPLY IT IS DIFFICULT TO ACHIEVE:
THE GOAL OF A DYNAMIC AND FREE GLOBAL ECONOMY WHICH WILL BE SUSTAINED
BY KEY DEVELOPED AND DEVELOPING COUNTRIES BECAUSE THEY

HAVE A STAKE IN IT.

IN WHAT FOLLOWS I WILL DISCUSS THIS CHALLENGE IN
RELATION TO THREE ISSUES: TRADE, EXCHANGE RATES AND
INTERNATIONAL DEBT.

ACCORDING TO THE MAXIMS OF THE PREVALENT TRADE
THEORY, THE FREE EXCHANGE OF GOODS AND SERVICES POTENTIALLY
BENEFITS EVERYBODY; TARIFFS AND OTHER TRADE BARRIERS
REWARD INEFFICIENCY, RESTRICT COMMERCE AND LOWER THE
OVERALL STANDARD OF LIVING. THE PROFESSED OBJECTIVE
OF ALL TRADING NATIONS IS TO REMOVE POLITICAL OBSTACLES
TO TRADE AND TO RELY ON COMPARATIVE ADVANTAGE. BUT
THE GAP BETWEEN THEORY AND PRACTICE IS WIDE. MANY NATIONS,
WHILE PAYING LIP SERVICE TO FREE TRADE, SYSTEMATICALLY
IMPEDE IT IN PRACTICE. CLEARLY IMPORTANT POLITICAL
REALITIES ARE AT WORK.

FOR ONE THING, ADAM SMITH AND DAVID RICARDO DEVELOPED THEIR THEORIES WHEN BRITAIN HAD AN EFFECTIVE MONOPOLY ON INDUSTRIALIZATION AND A LARGE ADVANTAGE IN THE GENERATION OF ENERGY BASED ON COAL. THERE IS NO DOUBT THAT FREE TRADE BENEFITS A COUNTRY WHICH ENJOYS SUCH A COMPARATIVE ADVANTAGE. INEFFICIENT INDUSTRIES ARE REPLACED BY MORE EFFICIENT ONES *WITHIN* THE SAME NATIONAL BORDERS; LABOR CAN MOVE, AT LEAST THEORETICALLY, FROM ONE SECTOR TO ANOTHER. PRODUCTIVITY, INCOME, GROWTH AND EMPLOYMENT

*ARE* CERTAIN TO BENEFIT--THOUGH THE ADJUSTMENT PROCESS *IN THE FACE OF* EVEN THEN WAS NEVER AS FREE OF FRICTION AS THE THEORY MAINTAINED. THIS STATE OF AFFAIRS CONTINUED FOR A WHILE AFTER OTHER EUROPEAN STATES INDUSTRIALIZED. CULTURAL HOMOGENEITY PREVENTED ANY COUNTRY FROM ACHIEVING A UNILATERAL ADVANTAGE AND COLONIAL EMPIRES CUSHIONED THE SHOCK OF COMPETITION. EVEN WITH THESE SAFETY VALVES THE GERMAN-BRITISH TRADE RIVALRY CONTRIBUTED TO THE TENSIONS

16

PROVISION OF EVERY IMF ADJUSTMENT PROGRAM IS TO LIMIT IMPORTS AND TO ENCOURAGE EXPORTS. BUT BY DEFINITION IT IS IMPOSSIBLE FOR _EVERY_ NATION TO PURSUE SUCH A STRATEGY WHICH IS IN EFFECT MERCANTILISTIC. THE LIMITATION OF IMPORTS MUST BE AT _SOMEBODY'S_ EXPENSE, ESPECIALLY IF COUPLED WITH THE SYSTEMATIC PROMOTION OF EXPORTS. AND IF THE STRATEGY WORKS DEVELOPING NATIONS ARE TRANSFERING REAL RESOURCES TO THE INDUSTRIALIZED ONES, THE PRECISE OPPOSITE OF WHAT IS NEEDED FOR GLOBAL DEVELOPMENT.

TWO RESULTS ARE PROBABLE: EITHER THE QUASI-MERCANTILISTIC STRUCTURE WILL COLLAPSE BECAUSE THERE IS SIMPLY NOT ENOUGH DEMAND TO SUSTAIN THE _REQUIRED EXPORTS OF THE DEVELOPING WORLD_. OR THESE EXPORT SURPLUSES WILL BE SUSTAINED ON A TEMPORARY BASIS BY _OTHER UNFAVORABLE TRADE BALANCES IN A VERY FEW COUNTRIES, ESPECIALLY BY THE UNITED STATES_. THE U.S. TRADE DEFICIT IS OFFICIALLY FORECAST TO EXCEED $120 BILLION THIS YEAR--A LEVEL

UNIMAGINABLE UNTIL VERY RECENTLY. SUCH A SITUATION
CANNOT POSSIBLY BE MAINTAINED WITHOUT CAUSING OUR GOVERNMENT
TO TAKE SOME REMEDIAL, PROBABLY PROTECTIONIST, STEPS
WHICH COULD COLLAPSE THE WHOLE FRAGILE EDIFICE OF CURRENT
INTERNATIONAL TRADE PRACTICES.

IN SHORT, FREE TRADE IS BEING STIFLED BY THE SAME
POLITICAL FACTORS WHICH PREVENT AUTOMATICITY AS THE
ADJUSTMENT MECHANISM OF THE ECONOMIC SYSTEM. THE GROWING
INFLUENCE OF DOMESTIC POLITICAL CONSIDERATIONS IN ALL
DEMOCRATIC COUNTRIES THREATENS THE OPEN TRADING SYSTEM
AS WE HAVE KNOWN IT. PROTECTIONISM, TRADE RESTRAINT
AND UNFAIR TRADE POLICIES ARE ON THE MARCH.

A PARADOX FOLLOWS FROM THESE CONSIDERATIONS: FOR
FREE TRADE TO WORK, GOVERNMENTS COMMITTED TO IT MUST
TO A DEGREE RETREAT FROM COMPLETE LAISSEZ-FAIRE. INTERNATIONAL
RULES ARE NEEDED TO AVOID MONOPOLIES, RESTRICT DUMPING,
INHIBIT EXPORT SUBSIDIES, PREDATORY PRACTICES AND EXCESSIVE

UNCERTAINTIES. NATIONAL POLICIES MUST EASE THE ADJUSTMENT IMPOSED BY FOREIGN COMPETITION AND DISTRIBUTE THE BENEFITS OF FOREIGN TRADE EQUITABLY. OTHERWISE THE SYSTEM WILL NOT FUNCTION; IT WILL BE OVERWHELMED BY THE POLITICAL PROCESS.

TO STATE THESE PRINCIPLES IS TO ILLUSTRATE HOW FAR THE NATIONAL BEHAVIOR OF THE MAJOR TRADING NATIONS HAS STRAYED FROM THEM. AS FOR THE UNITED STATES, REMAINS FORMALLY COMMITTED TO FREE TRADE BUT IT CLEARLY LACKS A COHERENT STRATEGY TO DEAL WITH THE DISTORTIONS CAUSED BY THE PROTECTIONIST AND MERCANTILISTIC MEASURES OF OTHER NATIONS. HENCE IT IS UNABLE TO INSIST ON A COORDINATED POLICY. IN PRACTICE OUR TRADE POLICY IS A SERIES OF DISCONNECTED AND HOC DECISIONS TAKEN LARGELY IN RESPONSE TO THE SPECIFIC COMPLAINTS OF POLITICAL INTERESTS MOST DIRECTLY AFFECTED. THESE ARE BY DEFINITION USUALLY THE LEAST COMPETITIVE SECTORS. SO LONG AS

THE IMPETUS BEHIND POLICY IS THE DESIRE TO LOCALIZE
THE PAIN OF A PARTICULAR ECONOMIC SECTOR, THE RESULT
CAN ONLY BY ACCIDENT BE THE PROMOTION OF THE COMMON
GOOD OF EITHER THE UNITED STATES OR OF THE WORLD ECONOMY
AS A WHOLE.

WHEN THEORY AND PRACTICE DIVERGE ONE OR THE OTHER
MUST GIVE WAY. MY STRONG PREFERENCE WOULD BE FOR A
FIRMLY BASED SYSTEM OF LIBERAL FREE TRADE. BUT THIS
CANNOT OCCUR BY PERPETUATING THE STATUS QUO. IT REQUIRES:
MAJOR SPECIFICally
AN ACT OF INTERNATIONAL STATESMANSHIP. THIS WOULD ESTABLISH
NEED TO BE ESTABLISHED
NEW AND BINDING INTERNATIONAL RULES WHICH ENCOURAGE DIRECT
FOREIGN INVESTMENT WHILE DEFINING CODES OF CONDUCT FOR
MULTINATIONAL CORPORATIONS. THESE SHOULD
TO INTERNATIONAL TRADE IN SERVICES AND PERHAPS EVEN
TO IMMIGRATION. A MAJOR EFFORT TO ACHIEVE A REAL AND
GENERAL APPLICATION OF GATT RULES IS NEEDED TOGETHER
WITH THE CREATION OF INSTITUTIONS THAT WOULD GIVE THEM

20

A BINDING CHARACTER.

No GATT MUST BE REVAMPED TO BRING IT CLOSER TO THE IDEALS OF THE INTERNATIONAL TRADE ORGANIZATION WHICH WAS PROPOSED BY BRETTON WOODS BUT PROVED STILLBORN. IT SHOULD BE GIVEN GREATER AUTHORITY TO ACT AGAINST RESTRAINTS ON TRADE AND INVESTMENT AS WELL AS PREDATORY TRADE PRACTICES. THE NEWLY INDUSTRIALIZED NATIONS, LIKE BRAZIL OR MEXICO, SHOULD BE DRAWN INTO MORE ACTIVE PARTICIPATION.

BUT IF SUCH A POLICY PROVES UNACHIEVABLE THE WORST COURSE WOULD BE TO PAY LIP SERVICE TO A THEORY DEFEATED IN PRACTICE BY POLITICAL ATTEMPTS TO MAXIMIZE NATIONAL ADVANTAGE--IN SHORT A MERCANTILISTIC WORLD.

JAPAN SEEMS TO HAVE COME TO THIS CONCLUSION. IT MAKES LITTLE PRETENSE THAT THEIR FOREIGN ECONOMIC POLICY IS GUIDED BY A COMMITMENT TO THE FREE PLAY OF MARKET FORCES. IT IS INSTEAD MORE OR LESS EXPLICITLY

21

GEARED TO MANIPULATE THE TRADE SYSTEM AS IT REALLY
OPERATES TO THE NATIONAL ADVANTAGE. JAPAN IS THEREFORE
WIDELY CRITICIZED FOR ACTING COUNTER TO EXISTING
ECONOMIC THEORY. IN FACT, IT IS POSSIBLE TO ARGUE THAT
IT IS SIMPLY PLAYING THE DE FACTO GAME MORE SYSTEMATICALLY
AND WITH GREATER COHERENCE THAN ANYONE ELSE.

BUT IF WE ARE DRIVEN TO IT WE CAN PLAY THE SAME
GAME, HOWEVER RELUCTANTLY, AND THEREBY ENHANCE OUR
COMPETITIVE POSITION IN A WORLD OF UNILATERAL TRADE
PRACTICES AND BILATERAL AGREEMENTS. WE NEED NOT FEAR
SUCH A WORLD; ITS CHIEF PERIL IS IF WE FAIL TO RECOGNIZE
ITS EMERGENCE. AT SOME POINT THE SHEER WEIGHT OF THE
UNITED STATES IN COOPERATION WITH LIKE-MINDED COUNTRIES,
MANAGING ITS FOREIGN TRADE INTERESTS WITH DETERMINATION
AND VISION, WILL PROBABLY CONVINCE THE REST OF THE WORLD--
TO PUT IT POLITELY--OF THE NEED FOR MORE COORDINATED
TRADE AND ECONOMIC POLICIES. WE WOULD THEN HAVE ACHIEVED

A MORE COHERENT WORLD TRADING SYSTEM BY THE BACK DOOR.

EXCHANGE RATES and International Cooperation

EVER SINCE THE UNITED STATES ABANDONED THE BRETON WOODS AGREEMENT BY UNILATERAL DECISION IN 1971 THERE HAS BEEN A DEBATE ABOUT THE RELATIVE MERIT OF A FLOATING SYSTEM AS AGAINST FIXED PARITIES AND AT THE MARGIN EVEN OF THE ADVANTAGES OF A RETURN TO THE GOLD STANDARD.

I WILL NOT ENTER INTO THE DEBATE OVER THE ECONOMIC MERIT OF THE TWO SCHOOLS OF THOUGHT. THE ORIGINAL ARGUMENT THAT THE FLOATING SYSTEM WOULD AUTOMATICALLY PRODUCE STABILITY WAS FALSIFIED BY THE OIL SHOCKS WHICH CAME SOON AFTER. NO EXCHANGE SYSTEM COULD HAVE PRODUCED STABILITY WHEN THE PRICE OF OIL QUINTUPLED WITHIN A TWO-YEAR PERIOD. BUT EVEN AFTER THE OIL PRICE LEVELED OFF THE FLOATING SYSTEM HAS NOT WORKED AS SMOOTHLY AS

ITS PROPONENTS HAD PREDICTED. COUNTRIES, IT WAS HELD,
WOULD NOT ACCEPT AN OVERVALUED CURRENCY BECAUSE IT
WOULD REDUCE THE COMPETITIVENESS OF EXPORTS OR AN UNDER-
VALUED ONE FOR FEAR OF GENERATING INFLATIONARY PRESSURES.
HENCE, ALMOST LIKE THE GOLD STANDARD, THE FLOATING SYSTEM
WAS EXPECTED TO FORCE AN ADJUSTMENT OF IRRESPONSIBLE
OR EXTRAVAGANT POLICIES NEARLY AUTOMATICALLY.

THIS HAS NOT HAPPENED BECAUSE THE IMPACT OF THE
MARKET HAS BEEN PARTIALLY OBSCURED BY POLITICAL
DECISIONS. IN ORDER TO ESCAPE--AT LEAST FOR A WHILE--
THE NEED TO TOUGHEN INTERNAL ECONOMIC POLICIES, GOVERNMENTS
OFTEN IGNORED THE MARKET'S WARNING SIGNALS AND BORROWED
TO FINANCE CURRENT ACCOUNT DEFICITS. AND COUNTRIES
PROMOTING THEIR EXPORTS HAVE, TO PUT IT MILDLY, AVOIDED
STRENUOUS EFFORTS TO CORRECT UNDERVALUED EXCHANGE RATES.

IN A SENSE, OF COURSE, THE DEBATE ABOUT THE RELATIVE ~~MERIT OF EXCHANGE RATE SYSTEMS MISSES THE FUNDAMENTAL POINT~~

WHICH IS THAT EXCHANGE RATES TEND TO REFLECT, NOT CAUSE, DOMESTIC ECONOMIC CONDITIONS. ~~BOTH THE ADVOCATES OF FIXED RATES (OR OF GOLD) AND OF THE FLOATING RATE SYSTEM SEEK TO~~

HARMONIZE NATIONAL ECONOMIC POLICIES BY *THEIR* APPROACH. *IN THOSE DAYS*, IF THAT COORDINATION DOES NOT EMERGE NEITHER SYSTEM WILL PRODUCE STABILITY. *INCOMPATIBLE NATIONAL ECONOMIC POLICIES INEVITABLY*

*AND*

LEAD TO UNEVEN DEVELOPMENT/CRISES WHICH WILL BE REFLECTED IN THE CONSTANT NEED FOR EXCHANGE RATE ADJUSTMENTS. *THE UNITED STATES*

*IS THEREFORE SURELY RIGHT IN ARGUING THAT CORRECT ECONOMIC POLICIES ARE THE IRREDUCIBLE PRECONDITIONS TO EXCHANGE RATE STABILITY. A CONFUSION AND GROWING RESENTMENT RESULT HOWEVER WHEN*

(N)

25

THE US INSISTS THAT IT IS THE SOLE JUDGE OF WHAT IS THE RIGHT MIX OF ITS OWN ECONOMIC POLICIES WITHOUT REGARD TO THEIR IMPACT ON THE REST OF THE WORLD.

THE PROBLEM BECOMES MORE ACUTE BECAUSE WE HAVE THE STRENGTH TO IMPOSE OUR VIEWS--AT LEAST FOR AWHILE. THE DOMINANCE OF THE AMERICAN ECONOMY EXPLAINS THAT NO MATTER WHAT THE VALUE OF THE DOLLAR [illegible] ALLEGEDLY HARMFUL IMPACT ON THE WORLD ECONOMY, [illegible] CRITICIZED FIVE YEARS AGO AT THE IMF MEETING IN YUGOSLAVIA THE WEAKNESS OF THE DOLLAR WAS THE DOMINANT THEME. TODAY THE STRENGTH OF OUR CURRENCY IS BLAMED FOR OUR PRESUMED POLICY TO USE THE CAPITAL OF THE REST OF THE WORLD TO FINANCE THE DEFICITS WHICH STIMULATE OUR ECONOMY. IN THE SEVENTIES THE "MARKET" BELATEDLY CORRECTED THE IMBALANCE

BUT NOT UNTIL THE FEDERAL RESERVE BANK PUSHED UP INTEREST RATES. TODAY THESE SAME HIGH INTEREST RATES, COUPLED WITH THE POSSIBILITY OF ATTRACTIVE CAPITAL APPRECIATION AND POLITICAL STABILITY CONTRIBUTE TO ASTRONOMICAL EXCHANGE RATES.

THE STRENGTH OF THE AMERICAN ECONOMY IS SUCH THAT WHATEVER THE VALUE OF THE DOLLAR IT ENABLES THE UNITED STATES TO TAKE AWAY WITH ONE HAND WHAT IT GIVES WITH THE OTHER. TODAY THE GROWTH IN IMPORTS WHICH IS THE CONSEQUENCE OF A HIGH DOLLAR IS BALANCED BY HIGHER DEBT SERVICE COSTS AND LOWER COMMODITY PRICES FOR DEVELOPING COUNTRIES. TOMORROW A FALLING DOLLAR COULD PRODUCE EXACTLY OPPOSITE RESULTS. A SHARP AND SUSTAINED DROP IN THE VALUE OF THE DOLLAR COULD--AS IT DID IN THE SEVENTIES--HAVE MAJOR DISRUPTIVE EFFECTS ON INTERNATIONAL TRADE AND FINANCE.

BY REDUCING SHARPLY THE EXPORTS OF DEVELOPING COUNTRIES
AND INCREASING OUR EXPORTS.

NOT THE POLICY QUESTION--UNANSWERABLE IN THE ABSTRACT--IS
WHETHER A DESIRABLE ONE-TIME DROP IN THE DOLLAR IS CONCEIVABLE,
OR. WHETHER IT WILL BE DIFFICULT (ONCE THE DOLLAR STARTS
WEAKENING) TO REESTABLISH CONFIDENCE IN THE DOLLAR. IN
ECONOMICS AS IN OTHER FIELDS THE GODS SOMETIMES PUNISH
HUMANITY BY FULFILLING ITS WISHES TOO COMPLETELY.

THREE POLITICAL CONSEQUENCES SEEM TO ME TO FLOW NECESSARILY
FROM EXISTING ARRANGEMENTS:

-- ONE OF THE PRINCIPAL VIRTUES OF FLOATING EXCHANGE
RATES--ECONOMIC POLICY FLEXIBILITY--TOO OFTEN HAS BEEN TURNED
INTO A VICE. COUNTRIES HAVE BEEN ABLE TO SUPPORT OVERVALUED

28

EXCHANGE RATES BY BORROWING, OR TO ENCOURAGE UNDERVALUED
RATES TO FOSTER EXPORTS. IN PRACTICE, THE SYSTEM HAS
ALLOWED TOO MUCH FLEXIBILITY.

-- EXCHANGE RATE ARRANGEMENTS HAVE BEEN A PROFOUND SOURCE OF POLITICAL CONTROVERSY AMONG THE INDUSTRIAL DEMOCRACIES FOR OVER A DECADE. THE POLITICAL IMPACT OF UNILATERAL ECONOMIC DECISIONS MORTAGES OTHER RELATIONSHIPS.

-- DISAGREEMENT OVER EXCHANGE RATES IS THE WAY UNDERLYING DISAGREEMENTS OVER BROAD ECONOMIC POLICY GOALS AND METHODS ARE MADE EXPLICIT. THE EXCHANGE RATE REGIME NOW IN PLACE TENDS TO MAGNIFY THESE DIFFERENCES BUT IT DOES NOT CAUSE THEM.

THE FUNDAMENTAL ISSUE IS THAT THE INTERNATIONAL ECONOMIC SYSTEM CANNOT BE SUSTAINED INDEFINITELY BY UNILATERAL AMERICAN

DECISIONS, HOWEVER ADVANTAGEOUS THESE MIGHT BE TO US IN
THE SHORT RUN. LEADERS CONCERNED WITH COOPERATIVE INTERNATIONAL
FOREIGN AND ECONOMIC POLICIES MUST UNDERTAKE A SYSTEMATIC
REVIEW IN ORDER TO FIND THE BASIS FOR NEW, MORE EQUITABLE AND
LESS VOLATILE EXCHANGE ARRANGEMENTS. ITS TEST WILL BE WHETHER
THE INDUSTRIAL DEMOCRACIES ARE ABLE TO AGREE ON COORDINATED
ECONOMIC POLICIES. NO INTERNATIONAL SYSTEM CAN MEET EVERYBODY'S
MAXIMUM DEMANDS; BUT IT MUST RESPOND TO ENOUGH COMMON
ASPIRATIONS SO THAT MAINTAINING THE SYSTEM SEEMS MORE IMPORTANT
TO ITS MEMBERS THAN INSISTING ON ANY SPECIFIC DISSATISFACTION.
A SYSTEM THAT DOES NOT MEET THIS TEST--AND THE PRESENT SYSTEM
DOES NOT--IS CONGENITALLY VOLATILE.

INTERNATIONAL DEBT The Politics of International Debt

I HAVE EXPRESSED MYSELF ON OTHER OCCASIONS ON THE
INTERNATIONAL DEBT PROBLEM--NOT ALWAYS TO THE ENTIRE SATISFACTION
OF BANKING AUDIENCES. LET ME BEGIN BY STATING TWO PROPOSITIONS:

-- IN THE SEVENTIES NEITHER GOVERNMENTS NOR THE IMF
INTERVENED SERIOUSLY IN THE PROCESS FOR RECYCLING THE HUGE
ACCUMULATED EARNINGS OF THE OIL PRODUCERS. THE COMMERCIAL
BANKS THUS PLAYED AN INDISPENSABLE ROLE IN CUSHIONING THE
FINANCIAL CONSEQUENCES OF THE SUDDEN AND DRAMATIC RISE IN OIL
PRICES. HAD THEY NOT DONE SO A FINANCIAL CRISIS WOULD HAVE
OCCURRED MUCH EARLIER AND UNDER MUCH WORSE CIRCUMSTANCES.
NOR DID THE BANKS GO BEYOND CONVENTIONAL WISDOM WHEN THEY

31

GEARED THEIR LENDING POLICIES TO THE EXPECTATION OF A

CONTINUED RISE IN OIL PRICES AND HENCE CONTINUED INFLATION.

-- THE FUNDAMENTAL CAUSE OF WHAT HAS BEEN CALLED THE

DEBT CRISIS HAS BEEN POLITICAL. THE GOVERNMENTS OF THE

INDUSTRIAL DEMOCRACIES (FAILED TO COORDINATE POLICIES AND STOOD

ALOOF FROM THE CONSEQUENCES EVEN THOUGH THESE WILL DETERMINE

THE FUTURE OF NORTH-SOUTH RELATIONS AND THE STABILITY OF THE

INTERNATIONAL SYSTEM FOR A LONG TIME TO COME. THIS OSTRICH-LIKE

POLICY HAS COME TO THE END OF ITS POSSIBILITIES. DEBT

MANAGEMENT BASED ON PURELY FINANCIAL CRITERIA AND NEGOTIATED

BY FINANCIAL INSTITUTIONS INVOLVES THE POLITICAL SURVIVAL OF

TOO MANY GOVERNMENTS IN DEVELOPING COUNTRIES; IT IS NOT A

PURELY ECONOMIC PROBLEM. IN A CONFLICT BETWEEN BANKS AND

32

GOVERNMENTS IT IS FOOLHARDY TO ASSUME THAT GOVERNMENTS WILL NEVER FOLLOW THE POPULIST DEMAND TO RESTRICT FOREIGN FINANCIAL INSTITUTIONS OR TO DECLARE SOME FORM OF UNILATERAL

relevering, to the writing of a debt negotiation, is to rely on such a system indefinitely.

IS TO PLAY RUSSIAN ROULETTE.

NO DOUBT MANY DEVELOPING COUNTRIES GRIEVOUSLY MISMANAGED THEIR ECONOMIC POLICIES, THE TOTALITY OF THEIR ERRORS SPELLS THE DEBT CRISIS. WITHOUT REFORM OF THE ECONOMIC POLICIES OF MOST DEBTORS NO AMOUNT OF HELP FROM BANKS OR GOVERNMENTS CAN POSSIBLY BE EFFECTIVE. BUT THIS REFORM REQUIRES A SUBTLE AND SENSITIVE JUDGMENT OF WHAT, ESPECIALLY IN FLEDGLING DEMOCRACIES, THE TRAFFIC WILL BEAR. THE OBJECTIVE IS OR SHOULD BE TO ENCOURAGE DEMOCRATIC, MARKET-ORIENTED, RESPONSIBLE

GOVERNMENTS. WE MUST NOT IN THE NAME OF DEBT SETTLEMENT
BRING INTO POWER GOVERNMENTS THAT CHALLENGE THE WHOLE CONCEPT
OF FREE ECONOMIES AND FREE PEOPLES. THAT IS NOT A ROLE IN
WHICH BANKS (EVEN CENTRAL BANKS) OR INTERNATIONAL INSTITUTIONS
ARE EITHER COMFORTABLE OR SECURE.

THE CONVENTIONAL ANALYSIS--PARTICULARLY IN THE UNITED
STATES--HOLDS THAT THE WORST IS OVER, THAT THE MOST HEAVILY
INDEBTED COUNTRIES ARE ON THE WAY TO RECOVERY.

THE PAST TWO YEARS HAVE INDEED WITNESSED CONSIDERABLE
PROGRESS. THE EXTERNAL DEFICIT OF SEVERAL KEY DEBTOR COUNTRIES
HAS CONTRACTED MARKEDLY, AT FIRST THROUGH AUSTERITY PRODUCED
BY THE REDUCTION OF IMPORTS; MORE RECENTLY THROUGH AN EXPANSION
OF EXPORTS. THE INCREASE IN DEBT HAS SLOWED. MASSIVE AMOUNTS
OF PUBLIC AND PRIVATE DEBT HAVE BEEN RESCHEDULED. SOME
CORRECTIVE ECONOMIC POLICIES HAVE BEEN PUT IN PLACE IN MOST

(M)

STILL, I BELIEVE THAT THE CURRENT SYSTEM OF DEBT MANAGEMENT IS REACHING ITS INHERENT LIMIT. THE ISSUE IS NOT WHETHER THE FINANCIAL TERMS WHICH NOW SEEM TO BE EMERGING FROM COMMERCIAL BANK DEBT RENEGOTIATIONS ARE INAPPROPRIATE. THE BANKS HAVE MADE A MAXIMUM EFFORT TO TAKE INTO ACCOUNT THE ECONOMIC PRESSURES ON DEBTOR COUNTRIES. MY CONCERN IS THAT THE POLITICAL DYNAMICS OF THE PROCESS ARE NOW BEYOND WHAT EVEN THE WISEST AND MOST FARSIGHTED FINANCIAL INSTITUTIONS CAN REASONABLY BE EXPECTED TO HANDLE BY THEMSELVES. THE RECORD OF THE LAST FEW YEARS ARGUES AGAINST THE HOPEFUL VIEW THAT ANY ONE SETTLEMENT WILL BE FINAL. IN EACH ROUND OF A UNENDING NEGOTIATION CREDITORS HAVE FELT OBLIGED TO YIELD A

LITTLE MORE GROUND. RESCHEDULING AGREEMENTS ARE REOPENED;
TERMS NEGOTIATED IN GOOD FAITH YESTERDAY ARE RENEGOTIATED
TODAY. INEVITABLY, THEY MAY BE VIEWED AS ADJUSTABLE TOMORROW
AS WELL. SUCH A PROCESS INVOLVES A HIGH RISK, AT SOME POINT,
OF RUNNING OUT OF CONTROL.

IT IS THIS UNCERTAINTY--COUPLED WITH WORRIES ABOUT
WHAT FUTURE INTERNATIONAL ECONOMIC AND FINANCIAL CONDITIONS
MIGHT BE--WHICH IN MY VIEW IS AT THE HEART OF THE APPARENT
FRAGILITY OF CONTEMPORARY INTERNATIONAL FINANCIAL MARKETS.

THE VERY FLEXIBILITY OF RECENT TERMS MEANS THAT THE
BANKS HAVE CONCEDED ALMOST THE LIMIT OF WHAT A PROFIT-MAKING
INSTITUTION CAN SUSTAIN. THIS WOULD NOT MATTER HAD WE REACHED
THE END OF THE PROCESS. I DOUBT SERIOUSLY THAT WE HAVE FOR

TWO REASONS. THE HISTORY OF THE THIRTIES SUGGESTS THAT THE
CRISIS IN DEBT PROBLEMS OCCURS NOT AT THE HEIGHT OF THE CRISIS
BUT WHEN MATTERS ARE IMPROVING. AS THE ADJUSTMENT PROCESS BEGINS
TO WORK THE POLITICAL INCENTIVE TO SUSTAIN IT WILL WEAKEN--EVEN
THOUGH IN MANY CASES THE UNDERLYING ECONOMIC IMBALANCES
WILL CONTINUE FOR A LONG TIME. REFLATION TEMPTS, HOWEVER
ILL-FATED AND SHORTLIVED THOSE EFFORTS MIGHT PROVE IN THE
ABSENCE OF FUNDAMENTAL REFORM. JUST AS THE U.S. AND OTHER
MAJOR INDUSTRIAL DEMOCRACIES SEEM UNABLE TO DIVORCE ECONOMIC
POLICY FROM SHORT-RUN POLITICAL CONCERNS, DEVELOPING COUNTRIES--
MANY OF WHOM, ESPECIALLY IN LATIN AMERICA, ARE THEMSELVES
MOVING TOWARD DEMOCRACY--COULD BECOME CAUGHT IN A DILEMMA
THAT BAD ECONOMICS SEEM TO MAKE GOOD POLITICS, AT LEAST IN

THE SHORT RUN. AND THE BANKS HAVE LITTLE LEVERAGE LEFT ONCE
THE REPAYMENT OF PRINCIPAL HAS BEEN STRETCHED OUT INTO THE
INDEFINITE FUTURE.

FUTURE DEBT DISCUSSIONS WILL TAKE PLACE IN AN
INCREASINGLY DIFFICULT POLITICAL CLIMATE IF THE PRESENT
FRAMEWORK IS NOT CHANGED. MANY GOVERNMENTS, MOST POLITICIANS,
POLITICAL PARTIES AND MEDIA IN THE DEBTOR COUNTRIES ARE
ADOPTING HARSHLY NATIONALISTIC, ANTI-IMF, ANTI-BANK RHETORIC.

ONE CAN TRY TO CONSOLE ONESELF THAT THIS RHETORIC IS FOR
DOMESTIC CONSUMPTION, THAT SERIOUS LEADERS KNOW BETTER, ABOVE-
ALL THAT UNILATERAL RESCHEDULING WILL MAKE FINANCIAL MATTERS
WORSE. THIS ARGUMENT HAS UNDOUBTED MERIT. BUT IN OUR WORLD
RHETORIC TENDS TO CREATE ITS OWN REALITY. AND IF ONLY ONE
MAJOR COUNTRY KICKS OVER THE TRACES IT WILL BE DIFFICULT

FOR THE REST TO SUSTAIN THE CURRENT COURSE--UNLESS THE VIOLATOR IS MADE TO PAY A HUGE PRICE WHICH IN TURN COULD START A POLITICAL CRISIS THWARTING THE OBJECTIVE OF SUSTAINING MODERATE, DEMOCRATIC, PRO-MARKET GOVERNMENTS.

THE ADJUSTMENT PROGRAMS DEMANDED BY THE IMF ARE NOT TECHNICALLY UNREASONABLE; WHAT THEY LACK IS A POLITICAL CONTEXT BEYOND THE POWER OR RESPONSIBILITY OF THE IMF OR BANKS AND WHICH THESE INSTITUTIONS HAVE HAD TO IMPROVISE BECAUSE OF THE ABDICATION OF GOVERNMENTS.

SOONER RATHER THAN LATER THE TERMS OF REFERENCE OF THE DEBT DEBATE MUST BE CHANGED. THE CURRENT AD HOC DEBT STRATEGY LED BY PRIVATE INSTITUTIONS AND THE IMF HAS GIVEN BOTH CREDITORS AND DEBTORS SOME MUCH NEEDED BREATHING SPACE. THE

TIME SHOULD BE USED TO CHANGE THE FRAMEWORK OF THE DIALOGUE.

DEBT SERVICE IS AFTER ALL NOT AN END IN ITSELF. TAKEN ALONE
can even
IT ACTS AGAINST THE LONG TERM INTERESTS OF THE CREDITORS
THEMSELVES FOR IT RESULTS IN THE DRAIN OF CAPITAL FROM THE

POOR TO THE RICH. WITH THE BEST INTENTIONS, THE CREDITORS
AND DEBTORS VIEWED ONLY FROM THE NARROW PERSPECTIVE OF

DEBT SERVICE HAVE SOMEWHAT CONFLICTING OBJECTIVES. ON THE
- without a paid debt service is primarily
an anachrony melange-
OTHER HAND GLOBAL GROWTH IS A GOAL WHICH FARSIGHTED LEADERS

FROM BOTH NORTH AND SOUTH SHOULD SHARE. SUCH AN APPROACH
SHOULD TAKE ACCOUNT OF TWO REALITIES:

-- WITHOUT IMPROVEMENT OF THE ECONOMIC POLICIES OF
THE DEBTOR COUNTRIES NO OUTSIDE PROGRAM OF ASSISTANCE PRIVATE
OR PUBLIC CAN HAVE ANY LONG-TERM IMPACT. ECONOMIC REFORM

(ND)

41

IS NEEDED IN MOST DEBTOR COUNTRIES NOT FOR THE SAKE OF
THE BANKS OR OF THE IMF BUT FOR THEIR OWN WELFARE.

-- THE DEBTORS SHOULD NOT BE EXPECTED TO EXTRICATE
THEMSELVES FROM THEIR DIFFICULTIES BY REFORM AND AUSTERITY
ALONE. THE CREDITOR COUNTRIES MUST RECOGNIZE THAT THE

ACCUMULATION OF EXCESSIVE INDEBTEDNESS REFLECTED IN MOST
GASES—FUNDAMENTAL ECONOMIC IMBALANCES CAUSED BY FORCES

OUTSIDE THE DEBTORS' CONTROL THE EXPLOSION OF OIL PRICES

CAN ONLY BE RESOLVED BY A STRATEGY OF GLOBAL GROWTH. A
COOPERATIVE EFFORT BETWEEN THE INDUSTRIAL DEMOCRACIES AND
THE PRINCIPAL DEBTOR COUNTRIES ON THE POLITICAL LEVEL IS
THEREFORE ESSENTIAL.

42

THE ESSENTIAL CHALLENGE IS TO RECOGNIZE THAT THE

DEVELOPING COUNTRIES CANNOT GROW WITHOUT LARGE AMOUNTS OF

(TYPICALLY BORROWED) FOREIGN SAVINGS IN A WORLD WHICH SEEMS

LESS AND LESS PREPARED TO INVEST ITS SAVINGS IN DEVELOPING

COUNTRIES. THE ADJUSTMENT PROGRAMS OF THE DEBTORS SHOULD

THEREFORE INCLUDE A POLITICAL COMPACT WITH THE INDUSTRIAL

DEMOCRACIES WHICH IN TURN COMMIT THEMSELVES TO ASSIST

THE ECONOMIC DEVELOPMENT OF THE DEBTOR NATIONS.

SEEN FROM THIS PERSPECTIVE, THE ECONOMIC AND POLITICAL

ELEMENTS OF THE STRATEGY WOULD CHANGE DRAMATICALLY. SO WOULD

THE ROLE OF THE BANKS, WHO THROUGHOUT THE SEVENTIES WERE
ASKED TO PLAY A ROLE--THAT OF DEVELOPMENT FINANCIERS--FOR
WHICH THEY WERE NOT DESIGNED. LONG-TERM DEVELOPMENT FINANCE,
WHICH IS WHAT MOST OF THE HIGHLY INDEBTED COUNTRIES NEED
TODAY, INVOLVES A MAJOR GOVERNMENTAL RESPONSIBILITY--HOWEVER
UNPOPULAR SUCH A VIEW IS IN MOST INDUSTRIAL DEMOCRACIES,
INCLUDING OUR OWN. THE ECONOMIC COST OF SUCH A PROGRAM WOULD
BE MINOR COMPARED TO THE CONSEQUENCES OF A GLOBAL FINANCIAL
AND POLITICAL CRISIS. IF BOTH CREDITORS AND DEBTORS LIFT
THEIR SIGHTS THERE IS HERE THE PROSPECT OF A COMPACT THAT
COULD PUT THE RELATIONSHIP BETWEEN THE INDUSTRIAL DEMOCRACIES
AND THE DEVELOPING WORLD ON AN ENTIRELY NEW BASIS.

CONCLUSION

WE MEET AT A PERIOD OF SUBSTANTIAL AMERICAN RECOVERY.

THE ECONOMIES OF MOST OTHER INDUSTRIAL DEMOCRACIES ARE IMPROVING AS WELL, IF MORE SLOWLY. THERE SEEMS TO BE AT LEAST SOME MANEUVERING ROOM WITH RESPECT TO THE DEBT PROBLEM.

ALL THIS CREATES AN OPPORTUNITY TO POINT THE WORLD ECONOMY TOWARDS GREATER COHERENCE AND BRIGHTER VISTAS.

ONE OBSTACLE TO THIS GOAL IS THE TENDENCY OF ALL DEMOCRACIES TO MAKE ECONOMIC POLICY ALMOST EXCLUSIVELY IN A DOMESTIC CONTEXT. BECAUSE OF OUR VAST ECONOMIC POWER THIS IS A PARTICULAR PROBLEM FOR UNITED STATES POLICYMAKERS AND THEIR CONSTITUENTS. MOST OF THE AMERICAN PUBLIC STILL VIEW THIS COUNTRY AS BEING RELATIVELY UNAFFECTED BY INTERNATIONAL

ECONOMIC DEVELOPMENTS. OUR POLITICAL PROCESS HAS NOT YET ADJUSTED TO THE REALITY THAT THE US IS STEADILY BECOMING MORE INTEGRATED INTO AN INTERNATIONAL ECONOMY THAT IS BECOMING MORE GLOBAL. WE MUST RESOLVE THE DILEMMA IF WE ARE TO OVERCOME CHRONIC INTERNATIONAL ECONOMIC INSTABILITY.

FOR OUR TIME AND OUR OPPORTUNITY REQUIRE DRAMATIC U.S. LEADERSHIP.

IN 1944 THE UNITED STATES THREW ITS ENORMOUS POWER INFLUENCE BEHIND BUILDING INTERNATIONAL INSTITUTIONS. A NEW AND DYNAMIC ECONOMIC SYSTEM GAVE IMPETUS TO AN EXTRAORDINARY GLOBAL RECOVERY. TODAY THE NEED IS THE SAME AND THE STAKES ARE EVEN HIGHER FOR MANY MORE COUNTRIES ARE NOW PRINCIPAL PARTICIPANTS IN INTERNATIONAL ECONOMIC AFFAIRS.

46

THE SPIRIT THAT PRODUCED BRETTON WOODS REFLECTED THE REALIZATION THAT IN THE LONG RUN THE NATIONAL WELFARE CAN ONLY BE SAFEGUARDED IN THE FRAMEWORK OF THE GENERAL WELFARE.

ALL GREAT ACHIEVEMENTS WERE A VISION BEFORE THEY WERE, A REALITY. THERE ARE MANY IN THIS ROOM BETTER QUALIFIED TO FILL IN THE MANY BLANKS FOR AN OVERALL DESIGN. MY MAJOR POINT IS THAT THE WORLD NEEDS NEW ARRANGEMENTS. A NEW BURST OF CREATIVITY IS NEEDED TO ELIMINATE OUR DANGERS AND FULFILL OUR PROMISE.

DISCUSSION ON KISSINGER'S GOLD TALK (LEISCHING, MODIANO, PETERFFY, JARECKI)

JM: Some of the focus on unemployment is excessive because unemployment is (1) unreal and (2) political. I personally prefer to look at employment. In the last fifteen years we have had a very large rise in employment in North America but a decline in employment in Europe. Now should that not indicate that Europe's economy is diverging from that of the United States?

RL: Well, I think they are getting more and more diverse in trend and I think you are right in the long run because the market is just getting so much more powerful. In other words, how can you set one price in end-markets? How can you just fix one gold price with the price of people floating in all the other markets?

HJ, you suggested a $4,000 price at which to fix gold. How did you come up with that number? Just to wipe out the debt?

HJ: Not entirely but in part. The debt is after all the reality. If I am the sovereign and owe this much money and have a bunch of physical assets, the only way I can get rid of my debt is by making these assets available. This is the only way I can avoid mortgaging my future.

TP: The same thing as if you had gone through bankruptcy in a bankruptcy court.

HJ: Yes. That is why I think that is where truth lies. All the creditors come and pick up the pieces. I am not, it is true, offering you my people's houses, buildings and farmlands; but I am trying to give you (or make available for you if you come to pick it up) the thing you and I have always called money.

RL: Sure. But why should the foreigners accept this? Suppose there was another country the same as the U.S. which had a different ratio that worked for it? Wouldn't that give you a political problem?

HJ: You've got some measure of a political problem in it but it seems to me that the owner of the most gold and the most dollars can do more or less what he wants in this regard.

RL: That raises, then, the question of how large the U.S. is in this market vis-a-vis the others? Once you establish such a gold for dollars exchange rate, all of the Eurodollars will be as good as gold, yes? I mean that's a mammoth amount to take around and present to the U.S. Treasury. And besides, you are only looking at the onshore dollar indebtedness of the government. The moment you monetize gold you've made all the offshore dollar indebtedness good as gold. So they can all come in, troop in, you know a trillion dollars worth.

HJ: Why so? The Eurodollars are all paper obligations from one bank to another. Only the dollars owed by the U.S. government are eligible for bringing to the Treasury or Mint for redemption; all the others shake out into debts and demands before they are presented. In the second place, the Treasury has, by my definition, enough gold to meet all these debts. And in the third place, you can't have it both ways: the debt is so big that folks will take away all our gold and the price is so high they'll flood us with gold and take away all our paper dollars.

RL: Is it good that this stops inflation? You've got to have a lot of inflation to wipe out the South American indebtedness.

DISCUSSION ON KISSINGER'S GOLD TALK -2-

HJ: But this gives you some of that inflation.

RL: What I find dangerous about the $4,000 gold monetization scheme is that it's such a leap of faith, that you set the number right and ...

TP: I don't believe that it's possible to do this so that the gold price can still fluctuate.

HJ: Why should it? If it did, nobody would believe in the paper. You have to do something so that for the next 30 or 40 years people will believe in the paper.

JM: But nobody really believed in the paper for 30 or 40 years.

TP: The problem is that you can only fix the price of gold if you also fix the supply.

HJ: Why?

TP: Because otherwise the supply may increase and you will have to keep buying it; soon enough you will be full of gold and there won't be any dollars.

JM: At a high enough price the amount of gold will certainly be rising and that will be inflationary to a certain extent.

HJ: We will never find a long-term perfect solution but a $4,000 price could be a solution for 25 or 35 years.

RL: What about the alternative of bringing the price up slowly?

HJ: How?

TP: Put more and more gold into the SDR every year.

HJ: Until it is almost fully gold?

RL: Yes, and get the U.S. government to issue SDR debt not dollar debt. Move gradually but steadily in that direction.

TP: Every year put in 10% more gold for the next ten years.

RL: But, you see you're saying that America is the biggest and strongest economy with the most dollars and the most gold and that it therefore has the right to mandate the gold/dollar exchange rate. That could, however, be the wrong gold price for everyone else vis-a-vis their dollars and cost of living index generally. So it will make some people happy and some sad and is thus not politically neutral. Some people will be very sad indeed because they may have no dollars; they may in the past have decided to invest in other things and so their economies will be severely deflated.

HJ: So let's go back to gold. Let's pretend one of us is Kissinger and he says, "Guys, I barely know anything about gold, I do not want to talk about the economics of gold, I want to talk about the politics of gold. That's the thing I am good at, I know political matters and I am willing to talk about that question." What elements would we talk to him about so we help him think about what he could say. Let's start by defining the elements without going into their details.

SL?

DISCUSSION ON KISSINGER'S GOLD TALK -3-

RL: Clearly one thing is the South African and Russian supply. If gold is to have any place in the world, you have to address the problem of the potential control of the gold supply by these two less favored nations and any scheme that you work out either has to prevent them from cornering the market and dominating western policy-making or it has to state what your future relationship with these two are.

HJ: All right, what else?

RL: Again, from Kissinger's perspective, I think it has to involve this co-ordinated view. I don't know how he sees the development of coordinated policies worldwide. Even with your system of monetization at $4,000 or mine or alternatively a crisis in which case gold just naturally emerges, any way the use of gold re-establishes itself has major political implications because certain governments will lose political power and in particular the power to control their monetary policy.

HJ: You're saying there are at least three roads to re-monetization.

1. A fiat price

2. Gradual golding of the SDR, and

3. A crisis which leads gold to emerge from the marketplace itself.

And the fiat market price is, you think, impossible, yes?

RL: M-hm.

SL: HJ: Even though we agree that the only price that makes it possible at all is one at which the U.S. knows all of its gold can't be taken away, which is how I got to the number. (shows chart).

ttm

RL: Yes. But that road is problematic because it is not neutral in terms of its political implications. And so it would cause people to resent the U.S. even more. One of the major features of the past five years has of course been the increasing dominance of the world by the dollar. That certainly is something Kissinger could mention. I used to try to annoy the Fed by accusing them of "dollar-imperialism". Even if it's not dollar-imperialism that we've got at the moment, it's certainly dollar-hegemony. Particularly in '81 the sum level of dollar interest rates would put you out of business no matter what you're doing anyway, and the U.S. has basically done this which is why you've got counter-trade exploding, Euro-yen exploding, everything exploding.

TP: Yes, but why do we have an ever-increasing trade imbalance? That cannot go on forever unless the dollar became a worldwide currency.

RL: No, no, the possibility of the dollar becoming a worldwide currency is in fact lower than in the past. Basically what's happening is that we're having a fantastic standard of living here because we're living on the seigniorage rights of the dollar. In other words, the only reason the dollar isn't affected by the imbalance is because everyone thinks that the U.S. is a wonderful place to invest their money. If they ever had some real serious alternatives they would take them. That's what happened to us in the UK.

DISCUSSION ON KISSINGER'S GOLD TALK -4-

Whenever we felt our standard of living declining we'd print a few more sterling bank notes, ship them out to the colonies, and they would ship us in the food or whatever. This went on until suddenly people had a really serious alternative, the dollar. So they dumped sterling and the UK really got shafted. And exactly the same thing is happening here.

HJ: The seigniorage point is very good. Partly because it's based on a fantasy. The foreigners believe that if they own a farm in Iowa, it forces the U.S. government to give them a passport in case the Russians march into Switzerland. That is causing people to invest in America. There is in fact no logical reason to invest here.

RL: Yes, there is: convenience. Convenience in the political sense as well as the economic one. I'm giving a little talk at one of the conferences at the end of the week, I'll send you a copy of it. The only country that can get away with this enormously stimulative policy is the U.S. In other words, if the French give a 30% wage increase, what happens is that all the money leaves the country. The only reason the U.S. can get away with it is because they are printing dollars. But you can only get away with it for a certain period of time.

SL: 
ttm

HJ: Now how is this related to gold?

RL: Because the abuse of the seigniorage on the world's currency really increases the interest in diversifying out of U.S. debt. I mean, how many South American countries, if they survive this cycle, will want to take five-year or ten-year dollar borrowing. Wouldn't they rather do five or ten-year yen borrowing or even, for that matter, ten-year gold borrowing? I mean, if you're in Chile and someone comes in and says I can lend you five-year dollars, five-year gold, or five-year yen, which would you take? I mean, I would go for the five-year gold frankly.

HJ: Only if you were mining gold. What if you weren't?

RL: Well then I'd probably say the yen, because you know the Japanese won't screw you.

HJ: Do you think the Americans are screwing people?

RL: Well, if you are the reserve currency country you have the white man's burden in the sense that the monetary policy that is optimal for your own country may not be the same as the monetary policy that's optimal for the world. Given the politics of the U.S. you can only really run your monetary policy or domestic objectives until a crisis develops, then you are forced to address the world monetary policy.

HJ: I'm not sure I agree with your yen or gold borrowing idea. I would rather borrow the world's reserve currency. I have a lower risk. It's less likely to be squeezed in some odd way. That is, if I had to choose between funding myself in molybdenum or gold I would choose gold.

RL: Sure. But the yen and lots of these other currencies are emerging so rapidly that they can become very substitutable alternatives. I mean, suppose you could convert molybdenum to gold just like that (snap) with a guaranteed narrow spread. Then, the currency becomes much more substitutable. What's happened in the past five years is that the substitutability between currencies has greatly increased.

DISCUSSION ON KISSINGER'S GOLD TALK -5-

HJ: I don't see how you can have it both ways. How can the dollar command such seigniorage if everything can be substituted?

RL: Ah. The seigniorage right comes from the transactions. In other words, it is the dominant clearing currency. You can invest your assets in anything else but if you want to actually pay for something, you need dollars.

HJ: Well, we keep shifting to our views about dollars instead of addressing the question of what can be said about gold.

RL: Well, I think they fit together in the sense that it's the problems of the unstable dollar monetary policy which lead to the need for an alternative and one of the best alternatives is gold.

HJ: When you say unstable monetary policy, what do you mean?

RL: I mean, I think our policies are inherently unstable because dollar monetary policies must either be run to benefit people in the United States or to benefit people in other parts of the world. Those two rarely if ever coincide and, given the nature of the U.S. (this of course will appeal to Kissinger), the Americans always view their policies from the domestic perspective rather than looking at the global implications. So the fact that you have this dichotomy and that the U.S. is very strongly biased towards domestic goals forces the dollar monetary policies to be enormously unstable in the global context.

HJ: Did you see the recently published study called *Closing the Gold Window* in which Ms. Gova analyzed the political issues around the closing of the gold window in 1971 and concluded that it was due to domestic politics and that it's unsafe to think that America's big decisions around monetary affairs are made on international grounds.

RL: Well, that insight should appeal to Kissinger given his orientation towards setting a sort of global-international policy.

HJ: Well he was quite involved in it; the book says he was trying to direct the U.S. Treasury's policy to take the international standpoint into consideration but ultimately couldn't and as a result one of his assistants resigned.

JM: When the price of gold went from $20 to $35 an ounce in January, '34, was there a large jump in Russian production?

SL: HJ: I don't know the answer but it could be worth checking into.

ttm
RL: Some time ago I wrote a little article on remonetization of gold, which took the view that the markets are in a way starting to do it by all these sort of clever swap deals that are being done. I think this is another alternative to the out of the blue fiat which has, I think, too enormous consequences. How, in any case would the U.S. do it? Just by itself? Suddenly announce it? I mean, how would that be coordinated with people overseas?

HJ: Why not do it at a Committee of Ten meeting or something? If you're going to do it, do it.

[L.C.]

DISCUSSION ON KISSINGER'S GOLD TALK -6-

RL: But, I mean if word got out at all, the gold price would just take off.

HJ: That risk always exists but not more than with other policies.

RL: I think that the real difficulty is how do you set the price? I mean if you set the price you're accepting the freedom that will be given in the volume so you've got to be prepared to take or to give.

HJ: That's my point with my $4,000 proposal. The only way to do it safely is in a way that covers your outstanding debt.

JM: At $4,000 you will take, you won't give. That's what happens if you have a quantum change in anything. People's minds will not be accustomed to it yet and so the price will seem high and they will sell.

HJ: What about $2,000?

JM: It's like the silver spoons at the Hunts time. The housewife did not think of a ladle as a $300 dollar ladle because she is not accustomed to thinking in these terms. It's a quantum jump. It's a function not of the price but of the derivative of the price ...

HJ: Okay, so you will have some inflation. Of course you will. But it won't happen on a quiet Tuesday morning anyway. That's not how it's done because everybody will say: "What the hell did he do that for?" Right? So, you do it in the midst of some drama, maybe you wait until Black Thursday to end a drama. Certainly if you've got a massive depression in which stocks are falling out of bed and people are falling out of the windows, and you do it ten to one, it would probably stop the depression because, if people bring you gold as Joe says they will, you start printing money by the galore.

JM: Yes, you give 15 to 20...

RL: You can't really talk about the gold price, you have to consider really what else will be done in terms of policy. How you then are going to ______ because I think this really will enforce the U.S. monetary policy on the world. In other words ...

SL?

HJ: Well there wouldn't be a monetary policy would there?

RL: Well there would be a new supply of gold coming in.

JM: That's not a policy of the government of the United States, however, that's just brought about by the gold miners.

RL: And is that optimal?

JM: The money supply would be a function of what the mining companies do.

RL: Isn't this making your policy a hostage to the Spanish galleons? The Spanish galleons arrive and you get inflation every time they do? Doesn't this give enormous power to the Russians and South Africans? What if you're being nasty to them and they decide to delay shipping gold to you in order to deflate your economy a bit?

DISCUSSION ON KISSINGER'S GOLD TALK -7-

HJ: I don't think their delay would have any effect: the amount of above-ground gold is two and a half billion ounces and all they've got is 40 million ounces a year. They have, then, no great influence.

JM: Where, in a scheme like that, where do you see interest rates: 2-1/2% per annum?

HJ: Sure, you'd be back at 1 or 1-1/2% per annum. This would be good for the South Americans, no, and for the U.S. banks with South American and LDC problems?

RL: But this is going to explode, the problem is that an awful lot of investments which are made on other bases.

RL: Yeah.

HJ: They can pay off their debt. They can borrow at 1-1/2% to pay off their debt and would not have to pay the ridiculous punitive rates that we're unfortunately forced to charge them.

HJ: They like it.

RL: If they are winners, someone else must be a loser.

SL:

HJ: Certainly. The pensioners and bond holders are the losers. As the French finance minister who was being berated for a ten to one devaluation said, "we will not leave them the handkerchiefs with which to wipe their eyes". That's what my chart says: If you want to find a price that wipes out our 213 billion of Foreign debt you can do that for $808; to wipe out our domestic debt of ______ you have to go to $980; and you can do them both at $4,519. You have to add a little to monetize the currency in circulation: $5,042; and if you want to cover the federal agency debt as well you how to raise the price to $5,788.

RL: But this is merely looking at U.S. dollar debt?

HJ: That is correct.

RL: And you see ...

HJ: Federal debt.

RL: In that sense its arbitrary.

HJ: That's true. But I'm telling you I owe you the money and show you my treasury and that this is all I've got. Well, you could say, "how about your house?" and "could I have three concubines as well?". But, I don't know whether I am obliged to do that.

RL: But how about another country that says, "Well, I reckon I can pay off my debt with $2,000 or $1,000.

HJ: Lucky you. Lucky you. Now who's in bad shape?

DISCUSSION ON KISSINGER'S GOLD TALK -8-

RL: Obviously the guy on the other side.

HJ: Right. Whoever was a borrower of gold. And whoever was a lender of paper money. The lenders are always disadvantaged in every scheme. When they can't do it with the rule against perpetuities in the law, they do it with repeated devaluation.

RL: Sure, sure.

JM: Now the truth of interest is at 2% or whatever it might be is the probability that gold will double again in 20 years.

HJ: No. It is the improbability that the word "risk-free" means what it says.

JM: Yes. We are saying the same thing.

HJ: There could, of course, also be a denunciation of debt. There is a little bit of that risk. And it certainly would take interest rates down to 1% or 2%. I don't know why not 1% really. Why wouldn't it be 1%. It would take it to below 1% because it would take it to the gold borrowing price at which we are today lending gold, namely at 1% or so.

JM: Yes, but it will still be 3%.

HJ: Why?

JM: I don't know why but the sovereign was 3% in 19th century and so was the french franc.

RL: It depends on the real marginal ______ product to capital, I mean how much you can actually get. If you are really going to undertake some real activities, that ultimately is going to determine the real interest rates. In other words, if the world is not making more than a certain amount, then if you are paying an interest rate that's higher or lower than that, either you are expanding financial ______ or you're contracting them.

SL:

HJ: What advice do you have for me in trying to describe to Dr. Kissinger how he should focus himself? It may very well be that we go there and shoot the breeze, but we ought to have a framework for him. I fear we have been too fuzzy and lost today.

RL: Sure. I think you have to give him some sort of framework within which to speak and I think you have start with a little bit of history, you know, as to why you want to talk about gold anyway. And then, given his global orientation, perhaps to talk about to start with the issue of global monetary responsibility, you know, ______ defects.

SL:

HJ: Well, let's start here. Why talk on gold?

1. Mocatta reasons

2. Relevant for certain contemporary problems, especially LDCs, monetary and thus political coordination, yes?

RL: Exactly. And then you could also say structural changes that are in process like because it is an idea whose time has gone.

[L.C.]

DISCUSSION ON KISSINGER'S GOLD TALK -9-

RL: So, clearly, this is a time in which there is going to be a very large
change in world political power and that puts an enormous onus on U.S.
monetary policy. The U.S. really has a responsibility for world monetary
policy in this incredible transition period.

HJ: All right, what are the routes by which gold comes to play a role in this?

RL: I think we've outlined 3 or 4.

HJ: We've talked about

1. Fiat change of price to a very high price and fiat change to a price a bit above the market;

2. Adding more and more gold to the SDRs;

3. A popular rejection of paper i.e., one that develops out of the marketplace and without government input; and

4. Crisis,

5. Implications, by which we mean such political implications as South African-Soviet power and the stocks to flows ratio argument against that risk being real.

HJ: Feasible currency area discussion. How does gold relate to that?

RL: I think it does because if you go to a gold standard, then, it makes much clearer where relative benefit lies. If the world were on a gold standard, I think you'd get a much more rapid loss of employment in Europe, vis-a-vis Southeast Asia.

HJ: So, what it does is, it disturbs domestic controls, yes?

RL: Oh, yes.

HJ: And brings European employment down more rapidly and Southeast Asian employment up more rapidly.

RL: Because it is very apparent that your point on risk is crucial. If you don't have the uncertainty on the currency then it is going to make relative returns equal real returns. But when no one knows what their real return will be (because of the uncertainty on the currency), investments tend to be equal. But once the world is on a gold standard, everything becomes clear and investors go for the highest marginal real return.

HJ: Okay. He may also want to talk about the perceived unfairness of the U.S. activities relative to certain contemporary problems, and about the perceived unfairness of the U.S. monetary policy; about the seignorage question; about seignorage abuse and about what I call the Iowa farm fantasy. What else did we say about the perceived unfairness?

RL: Part of the unfairness within the seignorage right questions stems from the fact that the Americans either don't care about what's happening overseas or have a crisis on their hands in which case they lean over backward to accommodate one particular aspect which just exacerbates a normal, political problem. This is what I called the white man's burden problem. Whoever is being the world's policeman ...

HJ: Are you saying this is a kind of stop-go character?

DISCUSSION ON KISSINGER'S GOLD TALK -10-

RL: Yes, it's built-in, because it goes with the job. This is true both politically and economically. If you're running the world's monetary policy and being the world's policeman, you're always forced into acts that are inconsistent and morally reprehensible. Both in monetary policy and political terms. I don't know whether you would accept that. In political terms you're supporting one group of guerrillas and putting down another. In economic policy terms, you are beating up on one group for having too high a debt level and then you are subsidizing another group for too high a debt level. The dichotomy and its inevitability would I think make an interesting theme for him.

HJ: Tell me that one again, please.

RL: Basically the idea that if you are running the world's monetary policy and being the world's policeman, there is an inherent dichotomy in that role and therefore you are always forced into inconsistent and reprehensible acts.

JM: You've got to watch China, because you are not elected by the citizens of China.

RL: And so that you're attacking one set of guerillas and supporting another.

HJ: How are doing that? How is that related?

RL: That's in political terms. In monetary policy terms you're attacking one set of debtors and you are supporting another. The same thing. I mean, if you are trying to optimize or you are acting in the role of the world's monetary police-man and world political policeman. It is the dichotomy that goes with the job. If you don't accept the dichotomy, it is exacerbated. That's why Kissinger should like this. The typical American attitude is, "I don't care about the rest of the world. The rest of the world is where all the problems start. Screw the rest of the world. If anything really goes wrong, I'll close my borders and stop the lot of them." And that can work politically, but it cannot work in the monetary policy sense because the world is so integrated that if you screw the rest of the world in the monetary policy sense you are going to screw yourself. So you are forced to have international monetary responsibility. And, if you don't accept that, then you will have a crisis. And the crisis will either be international or domestic but you can't avoid it.

JM: When you talk about ______ the interest of the world at large, you can say clearly, "All I care ______ under the United States". Now when we talk

SL:
ask
JMod
to
fill
out

about the world at large, you still are introducing the weighting factor because in respect of that gross national product of every country, it doesn't go by individual, I mean, China ______ because they have a billion people there isn't going to be three times the weight of the United States. So there are three problems.

RL: Yes. And one could use that as a sort of a theme to link it. That the U.S. has responsibility for the world's monetary system being the biggest economy and running the world's money, it goes with the job.

HJ: Monetary policy is biased towards ______ to gold but more international policy goes with the job.

DISCUSSION ON KISSINGER'S GOLD TALK -11-

RL: Yes. And one could of course mention the Bretton Woods agreement and its critics. In fact however, we have had over 25 years of the best economy we have ever had.

HJ: Well, that's about as long as you can expect. In any case, I'm going to put all this onto a piece of paper with Joe's assistance and pass it through us and maybe we can make some more notes on it and then pass that on to Dr.

SL:

Kissinger. Thank you very much.

6(A16-26)ii:nv
061584

Ladies and Gentlemen:

It was with great pleasure that I accepted the invitation of the Mocatta Metals Corporation to deliver the first of what I am told will be annual Mocatta Lectures on international monetary affairs. The Mocatta Company has a long history -- more than three hundred years, I am told, depending on one's reading of 17th century British financial history -- of practical involvement in the international financial system. I doubt if these lectures will have anything like the same longevity, but they can make important contributions to the international monetary debate.

More than ten years ago the Bretton Woods system collapsed under the weight of large-scale speculation against the dollar, reflecting broad international lack of confidence in the U.S. and U.S. economic policy. Through the seventies the value of the dollar declined -- sometimes gradually, occasionally precipitously -- as governments, corporations and individuals chose to switch from dollar assets to yen or marks or gold. Inflation, a measure of our inability to sustain economically prudent policies, accelerated steadily.

The conventional wisdom of the time was that the dollar-based system was evolving into a multiple reserve currency system; some even hoped the SDE could become the centerpiece of the new international financial system. Supposedly this evolution reflected

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the relative and absolute decline of the power of the United
States and a levelling of its stature in world affairs. Many
analysts -- wrongly as it has turned out -- assumed this was
a secular trend which would continue into the eighties.

However, today the circumstances are dramatically
different. The dollar has more than recovered its underlying
dominance, reflecting new found economic dynamism, as well as
attractive financial and real investment opportunities. And
our ability and willingness to assert ourselves politically
has also been rejuvenated.

The dramatic shift has had equally dramatic consequences
for the rest of the world and for the world economy. Today
I will talk about some of those consequences, about how they
have affected the fabric of the international monetary system,
and about the changes which I think are essential to solidify
and internationalize the U.S. economy.

The Global Economy

It is necessary to start with first principles. For the
first time in history, the world economy is truly global in
scope. When the great European powers dominated international
economic and political relations, major parts of the globe
were either excluded from participation in international
trade and finance or were engaged only peripherally. China
and Japan, despite political importance in Asia, did
not play significant roles in world commerce.

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In the twentieth century this has changed. Today no geographic region is excluded from international commerce. The major economic actors are not only spread around the world, but are closely linked by commercial and financial ties. Markets for financial assets, commodities, and even information increasingly bind the desparate parts of the world economy more closely together. Although sharp political difference obviously exist between the East Bloc and the West, even these are in some respects transcended by economics.

In short, the rhetoric of global economic interdependence - which has long been a mainstay of speeches to audiences such as this one - is more a reality in the mid-1980s than could have been expected only ten or twenty years ago.

## Democracy

At the same time, all of the major Western economies, which account for the great bulk of global economic activity are mass democracies. Even in the developing

countries which are s. x. Cannot follow purely economic criteria especially if these take a long time. democracies or rapidly participate. For example, this is the case throughout Latin America.

This means that economic policy is produced through a fundamentally political process which necessarily must be responsive to short-term political pressures. Governments are

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## Democracy

At the same time, all of the major Western economies, which account for the great bulk of global economic activity are mass democracies. Even in the developing world, many of the countries which are significant economic players are either democracies or rapidly moving towards systems of mass political participation. For example, this is the case throughout Latin America.

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voted into or out of office because of their performance,
including their ability to maximize real economic
growth. Usually this performance is measured over a very
short time frame - until the next election - and, certainly
in recent years, few excuses are tolerated. The political
landscape of the last ten years is littered with the remains
of politicians and governments who have failed to produce
acceptable economic results.

These two facts - the globalization of economic relations
and the movement toward mass democracy throughout the indus-
trialized world - in effect determine the economic and
political parameters which must be drawn together by the
international monetary system. And the system--in effect,
the linkages between national economies--has changed. However,
(and here I risk getting my conclusion ahead of my arguments)
not enough in ways likely to assure what economic systems
are supposed to produce: sustained economic growth.

2 approaches: automatic =
economic

In the nineteenth century governments, including
that of the United States, were willing and able to accept the
discipline of the gold standard which tied domestic economic
management to fluctuations in the demand and supply of gold.
For the United States, which was a developing country at
the time, the results were spectacular. For example, the US
was officially on the gold standard for most of the years

from 1879 to 1914. D
increased more than f
rose more than 140%.

Two approaches: automatic economic i.e.
gold standard specific discussion involving
pol. act

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These two facts - the globalization of economic relations and the movement toward mass democracy throughout the industrialized world - in effect determine the economic and political parameters which must be drawn together by the international monetary system. And the system--in effect, the linkages between national economies--has changed. However, (and here I risk getting my conclusion ahead of my arguments) not enough in ways likely to assure what economic systems are supposed to produce: sustained economic growth.

In the nineteenth century governments, including that of the United States, were willing and able to accept the discipline of the gold standard which tied domestic economic management to fluctuations in the demand and supply of gold. For the United States, which was a developing country at the time, the results were spectacular. For example, the US was officially on the gold standard for most of the years from 1879 to 1914. During that period industrial production increased more than five times; employment in manufacturing rose more than 140%. Other countries had similar results.

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Economic historians will argue endlessly about cause and effect, about the relationship between the discipline of gold and the mix of economic policies, and about the supposedly deflationary effects of gold. But today I want to focus on the political aspects of the system. The gold standard forced automatic policy adjustments; politicians had the option to be on or off gold, but once they adopted gold, they were forced to conform spending, taxing, and monetary policies to its discipline.

However, the political reality of the late twentieth century is that an international monetary system in which economic adjustment is highly automatic is not compatible with our political preference for mass democracy. Politicians who live with the discipline of the ballot box, refuse to accept the automatic policy discipline of gold or some other commodity. Unlike earlier politicians, office holders today are not willing to limit themselves to "on or off" decisions; they want to control the economic policy levers directly to conform to immediate political goals.

## The International Monetary Fund

Architects of international monetary arrangements have tried to overcome this tendency by having the one hand, recognizing the US economy and, on the other hand, recognizing

its own disadvantages:

1. short term approaches

2. shift one problem to other countries.

Monetary Fund as the disciplinary force. The 1976 amendment to the

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Architects of international monetary arrangements have tried to overcome this tendency by creating a system which, on the one hand, recognizes the dominance of the dollar and the US economy and, on the other, establishes the International Monetary Fund as the disciplinary force. The 1976 amendment to the

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Articles of Agreements, which grew out of discussions at the Rambouillet Summit, was supposed to provide enhanced authority for the IMF to play this role.

This attempt to introduce a kind of "technicians' automaticity" into the system seems to be no more acceptable politically than a gold or silver or other commodity standard. Put another way, the US and other major industrial democracies are generally unwilling to accept IMF restrictions on their economic policies. Ironically, this has not changed even as IMF discipline for developing countries has emerged as an integral component of the strategy for dealing with international debt.

In short, the political realities of the post Bretton Woods era have discouraged any effective degree of automaticity from being reintroduced into the system. Instead we have the discipline of the market. In theory, this should be an even more incorruptible judge of the appropriateness of economic policies than the Fund or gold. In practice, moreover, the dominance of the United States and the dollar in economic affairs and the ability of countries to delay adjustment through borrowing from public and private sources has meant that, unlike Mother Nature, the market can be fooled at least for a while. And this has led to wide fluctuations in exchange rates, interest rates, and prices. Unfortunately, it has also contributed to uneven and inadequate domestic and international economic growth.

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This poor economic record, along with the debt problem, growing protectionist pressures and practices, and the apparently overvalued (at least by traditional measures) dollar, raise doubts about the adequacy of the present international financial system. The key question, then, is how to develop international monetary rules which are compatible with democratic forms of government and which promote sustained economic growth.

This must begin with an examination of the key present day international economic problems. Decisions about the evolution of the system will inevitably be made in reference to these issues. Moreover, one of these issues, if mismanaged or misunderstood, could provoke an international crisis which would become the catalyst for systemic change.

There are two issues which pose the greatest threats to the system: debt and trade. In addition, the continuing debate over whether more or less freely floating exchange rates encourage or discourage stable economic and political relations among countries remains of great concern, especially to Europeans. It has been made more urgent by the high level of interest rates and, partly as a result, of the dollar, despite the very large domestic and foreign deficits of the United States. But only five years ago, when the IMF and Yugoslavia, a similar weakness. So the concern should not be whether the dollar is too strong or too weak - market conditions can change

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This poor economic record, along with the debt problem, growing protectionist pressures and practices, and the apparently overvalued (at least by traditional measures) dollar, raise doubts about the adequacy of the present international financial system. The key question, then, is how to develop international monetary rules which *are* compatible with democratic forms of government and which promote sustained economic growth.

There are two issues which pose the greatest threats to the system: debt and trade. In addition, the continuing debate over whether more or less freely floating exchange rates encourage or discourage stable economic and political relations among countries remains of great concern, especially to Europeans. It has been made more urgent by the high level of interest rates and, partly as a result, of the dollar, despite the very large domestic and foreign deficits of the United States. But only five years ago, when the IMF and World Bank Annual Meetings were in Yugoslavia, a similar degree of urgency emanated from dollar weakness. So the concern should not be whether the dollar is too strong or too weak - market conditions can change

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dramatically - but whether the exchange rate system itself
is appropriate.

## International Debt

I know that increasingly the conventional analysis
of the debt problem - particularly in the United States -
is that the worst is over, that the most heavily indebted
countries are on the way to recovery.

Of course, there has been considerable progress over the past two years. Most importantly, the deficit of the developing countries' has contracted markedly - largely through import reduction but now due to export expansion as well - and the growth in debt has slowed. Massive amounts of public and private debt have been rescheduled. Corrective economic policies have been put in place in most of the debtor countries largely stopping the hemorrhage of financially motivated capital flight. There are even some faint signs of economic growth in countries like Mexico and Brazil.

Many of the bankers in this room would also add, I am sure,
that no significant debtor has defaulted or unilaterally
rescheduled on non-market terms. Commercial bank balance
sheets and income statements have, on net, not been hurt by the
debt crisis.

But these "successes" do not make the international
debt problem last year's story. Consider some facts:

- This year the major Latin American debtors

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will spend at least $40 billion on interest, some 35% to 40% of their export earnings.

-- During 1985-87 these same countries are supposed to repay more than $100 billion. These payments inevitably will have to be rescheduled; that process is already beginning.

-- Inflation remains excessive in many of the debtor countries; in some cases it is even higher than when the debt crisis began.

-- Real per capita Gross National Product in Latin America--one measure of average living standards--has dropped by at least 12% since 1980. Even the most optimistic projections indicate the per capita decline has continued in 1984 and that by the end of the decade per capita incomes will still be below 1980 levels.

-- Investment, and the import of capital goods, seem to have fallen disproportionately. Combined with the economic mismanagement of the late 1970s, this will continue to mortgage the developing country's future growth prospects.

-- Although the debt problem is most generalized in Latin America, similar financial and economic conditions exist in Asia and Africa. Many small countries have entirely lost access to private

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capital flows and the bulk of available official
capital is largely being absorbed by the largest
debtors.

-- The social and political fall-out is severe and increasing. Although the Catogena consensus was remarkably moderate in tone and substance, more governments, politicians, and political parties are adopting harshly nationalistic, anti-IMF, anti-bank rhetoric. The political will to continue with the current strategy seems to be rapidly eroding.

-- Finally, the leverage in debt negotiations seems to be shifting from creditors to debtors as the former behave increasingly like they have more to lose than do their borrowers. Thus bankers are today making concessions which six or twelve months ago would have been unthinkable. Where will they be in six or twelve months more?

I do not want to argue that the financial terms which now seem to be emerging from commercial bank debt renegotiations are inappropriate. As a non-professional, they actually seem to me to be more appropriate to debtor country circumstances than those negotiated during 1982-83.

But I am concerned at a process in which the commercial bank creditors seem to give - grudgingly - a little more in each round of negotiation. Rescheduling agreements are reopened; terms negotiated in good faith yesterday are

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renegotiated today. Inevitably, it seems to me, they will
be adjustable tomorrow as well.

My sense is this uncertainty - coupled with worries
about what future international economic and financial
conditions might be - has much to do with the apparent
fragility of international capital markets.

The basic worry - I would almost call it the
Achilles heel of the current technical approach - is the
interest question. Commercial banks appropriately negotiate
only about the spread over the cost of their funds. Debtor
countries, however, negotiate from a different perspective:
they have to pay the whole interest charge. And if interest
rates go higher, or perhaps even stay as high as they are,
it is difficult to imagine that full interest payments will
be maintained.

There may be an analogy to the oil company -- OPEC
negotiations a decade ago. During 1971-73, the oil companies
lost a little bit more in each round of negotiations, not
only on price, but--more importantly--on control of oil
supplies. Price increases were small in nominal terms but
large in percentage terms. And leverage was gradually shift-
ing to the producers. Because small dollar changes had limited
economic impact, most policymakers did not pay much attention--
until too late. The sharp price escalation may have been
inevitable in light of the underlying demand and supply
balance, but I suspect the process had something to do with

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the final outcome. And policymakers, with greater crises
commanding immediate attention and conforted by small
changes in prices as well as an apparently smoothly function-
ing negotiating process, did not really notice.

Is there an analogy in the debt negotiations? I do
not know and do not want to predict that there is. But
I believe we should be as aware of the possibility and should
reassess both the conclusion that the debt problem is
largely behind us, and the basic tenets of the current debt
strategy.

What is needed--and it may already be too late--
is an entirely different frame of analysis: one which
recognizes that the accumulation of excessive indebtedness
in most cases was only a symptom of more fundamental
economic imbalances. The real problem is growth or rather
the inability to grow without large amounts of (typically
borrowed) foreign savings in a world which apparently wants
to invest less and less of its available savings in devel-
oping countries.

To many, especially in the debtor countries themselves,
the present approach to the debt problem makes austerity
and debt service ends in themselves. But no country will
be able to sustain a long-term adjustment program--
however necessary--in the name of paying interest to foreign
commercial banks. Moreover, at the first sign of improvement
in the balance of payments, regardless of how achieved,
there will tend to be a political perception that the debt

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problem is solved. This seems already to be happening
in some Latin countries which have achieved significant
shifts in their external trade balances. This will
further undermine the political dynamic behind the adjust-
ment effort--even though in many cases the real under-
lying economic imbalances remain. Adjustment programs
might be abandoned for reflation programs, however ill-
fated those efforts would be in the absence of improved
economic policies. Industrial countries do this all the
time; why should developing countries be expected to be
more prudent?

In short, the present framework of debt management
may not be viable politically--which means it may not be
viable. Just as the U.S. and other major industrial
democracies seem unable to divorce economic policy from
short-run political concerns, developing countries--many
of whom, especially in Latin America, are themselves
moving toward mass democracy--could become caught in a
dilemma that bad economics seem to make good politics, at
least in the short run. Ultimately, that could threaten the
stability of the international banks and the fabric of the
international system--as well as the long run recovery of
the debtor countries themselves.

Foreign Trade


The trade problem is clearly related: the standard
prescription for rebuilding economic vitality today is
to export more and import less. This has two major

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flaws. First, when too many countries do it simultaneously it is either self-limiting-there is not enough demand to go around - or it results in the accumulation of large trade imbalances in a very few countries, which itself is probably unstable. At present, the United States is playing this role: the trade deficit is officially forecast to exceed $120 billion.

Second, such a basically mercantilist strategy inevitably gives rise to increased protectionist pressures in the developed countries. This is especially the case in the low and medium technology sectors which are most vulnerable to competition from developing countries and which tend already to be in decline. Of course, industrial country unemployment problems which are particularly severe in Europe, make politicians even more willing to grant relief than normal.

Growing protectionist sentiment--and, increasingly, the reality of protectionist barriers--is another example of the conflict between the globalization of the world economy and the seemingly unavoidable political tendency to pursue economic policies which are responsive to near-term political pressures.

This problem of protectionism is not only a U.S. phenomenon-where the list of trade actions and legislative proposals before the President and Congress is long and potentially serious-but a world-wide one. Free trade has certainly been a myth for some time, but the risks of

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a significant deterioration in the global trading environ-
ment (after several years of virtual stagnation and then
modest recovery) seem greater than they have been in
years. In turn, the costs of such deterioration could
also be great. The existing debt strategy, however flawed,
is potentially at risk: in volatile and increasingly hostile
domestic political circumstances the political and business
leaders of debtor countries view new protectionist
impediments to their exports as acts of economic aggression.
This could threaten not only commercial and financial ties,
but political ones as well.

Exchange Rates

Finally, the adequacy of the exchange system itself
needs to be reviewed. The rise of the dollar this year
reflects the attraction of high interest rates as well
as the opportunity to invest in an economic expansion
of almost unprecedented strength. This has helped to keep
US inflation low and to boost US imports which,
in the short run, is crucial to the debt strategy. But
high interest rates and the very strong dollar have also
had some adverse international consequences: higher debt
service, higher energy costs in local currency terms,
lower commodity prices and earnings and, maybe, lower
economic growth.

Also increases
sweeps
earnings
from oil exports

There is yet another potential consequence which
could also affect international economic stability.

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If confidence in the dollar, US economic policies and
the economic outlook erodes, a sharp and sustained
drop in the dollar would - as it did in the seventies -
have disruptive effects on international trade and
finance, exchange rate arrangements in Europe, and -
probably - global economic prospects.

I will not repeat the economic arguments for and against
floating exchange rates (or, rather, the post
1973 exchange rate system). Whether exchange rate
fluctuations encourage or retard investment, trade and
growth is wrapped in too much ideology and the actual
experience has been affected by too many extraneous cir-
cumstances for a clear cut answer. Moreover, I want to focus
again on the political consequences of existing arrangements.

Thus, I will make two observations which seem clear
to me:

- One of the principal virtues of floating exchange rates - economic policy flexibility - too often has been turned into a vice. The system has often encouraged the tendency for political imperatives to outweigh economic ones. Large countries have been able to avoid the "discipline of the market" at least long enough to create economic disturbances with significant internal and external consequences. This was true of the United States in 1978-79 and

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and of France in 1982.

-- Exchange rate arrangements have been a profound source of political tension among the industrial democracies. This is almost as true today as it was five years ago. Admittedly, this probably reflects more fundamental disagreements over broad economic policy goals and methods, but the exchange rate regime now in place tends to magnify these differences.

Neither of these have made the achievement of political stability and dynamic international growth - elusive goals under the best of circumstances - any easier to achieve.

## Political Consequences

Ultimately, the international economic system - in its financial, commercial and monetary dimensions - needs to be judged from the perspective of whether it promotes sustainable economic growth better than alternatives. In my view, the present system, reflecting the interaction between an increasingly global economy and national democratic political institutions, reinforces political tendencies which complicate achieving the growth objective. For example, today there is a tendency to delay action until a problem becomes a crisis, which inevitably reduces the range of options and often the quality of the ultimate solution. Similarly, the present arrangements reinforce the inclination of political leaders and institutions to deal with each aspect of related

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problems as unique (eg, trade and debt), to operate
with relatively short time horizons, and to discourage
the consideration of international consequences in the
formulation of domestic policies.

Of course, these problems are not unique to the
economic policies area, nor to the United States. But
in combination they seem to discourage rather than to
promote the achievement of long-run sustained economic
growth. Certainly when future historians chronicle our
accomplishments, a dynamic, expanding world economy is
unlikely to be among them.

However, since both globalized economic relations and
mass participatory democracy are far preferable to the
alternatives, the dilemma can only be eased, not
resolved.

The system also needs to be reviewed from the
perspective of the U.S. economy as it exists today. The
current mix of economic policies, which were adopted
as a remedy to the
economic deterioration of the late 1970s, at least
temporarily has made the U.S. a user of the world
capital stock (instead of its traditional role
as supplier) and the U.S. government a major consumer
of domestic savings.

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The consequence for the United States has been a
very strong economic recovery, job creation, and low
inflation. But there is a growing perception - shared
by both political parties-- that neither the budget
nor the trade and current account deficits are sustainable
at present levels. Internationally, the dramatic re-
orientation of US economic policy brought the debt crisis
to a head (although it was probably an inevitable
consequence of the economic shocks and policy responses
of the 70s) and has complicated its resolution (through
to the effects of continued high interest rates).

In short, our present circumstances again demonstrate
the proclivity of the United States to pursue economic
policies which at various times produce *international*
(balance of payments) or *domestic* (inflation) imbalances.
Inevitably, the system eventually requires that these
policy imbalances be corrected. Unfortunately, the
consequences for the international economy are often
severe.

Part of the problem is that U.S. policymakers and
their constituents prefer to make economic policy almost
exclusively in a domestic context. The reality is that
most of the American public still view this country as being
relatively unaffected by international economic developments,
at least in the sense that they can be safely ignored in
domestic policy debates. The current election campaign is
a good example: despite the urgency with which many of you
attending

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the Annual Meetings view some of the economic issues
I have discussed today, they are barely being
mentioned by the major candidates.

This overwhelming domestic orientation, of course, is
yet another consequence of the dichotomy between the
workings of the democratic political processes in the late
twentieth century and the reality of a truly global
economy. For the rest of the world this produces accepta-
ble results only if U.S. economic policy is consistently
aimed at achieving stable, long-run growth. However, as I
have said, our political process does not encourage this.

The Future

There are two broad alternatives for improving the
international monetary system. Either one would necessarily
impose more external constraints on the formulation of
national economic policies. This is always
difficult politically - look at the problems which
the Europeans have in trying to manage a common market that
has clear economic and political benefits, but which requires
some reduction in national independence.

But if an alternative helped to create political
conditions which encouraged the maintenance of growth
oriented economic policies and which helped to reduce
political tensions among developed countries as well
as between developed and developing, then the tradeoff would

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be justified. It would still require strong leadership, political courage and foresight from the leaders of the industrial democracies. But under such conditions there would be a greater chance of those rare qualities being found in adequate supply.

The first alternative is a system based on gold or some other commodity standard. Even John Maynard Keynes, whose characterization of gold as a "barbarous relic" is well remembered, admitted there were circumstances when a gold standard would be preferable to alternatives. Such a system ties economic policy to market determined supply and demand of the standard base commodity. By definition, this reduces the flexibility of the key currency country; this, of course, is both virtue and vice.

However, the historical association of periods of strong economic growth with maintenance of a gold standard is well documented. Economists and historians argue endlessly about causes, but the US economy clearly had one of its longest and most rapid expansionary periods in its history (the thrifty-five years prior to the first world war) when its currency was freely convertible into gold. Germany, which eventually suffered from the greatest recorded hyperinflation in 1922-23, also enjoyed a period of considerable prosperity under a gold standard in the years prior to the war. The history of earlier periods has produced many similar examples.

The major alternative is policy harmonization among major industrial countries. This would require a political

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commitment to adjust economic imbalances promptly
and to make domestic policy in an international
context. This is intrinsically easier for small,
open economies than for large countries with relatively
small foreign sectors because of the small political
constituency for adjusting to international pressures
in the latter. This, of course, is the case in the
United States.

True policy harmonization is largely untried,
certainly on a global scale. But the history would not
be very telling in any event since the political and
economic circumstances which have been my theme today
are unique to the present. In the present context, a
commitment to better integrate economic policies of
major economic actors - policy harmonization--
would considerably raise the likelihood of producing
a healthier and more stable international economy.

However, the historical record inevitably demands an answer
to the question, why *not* gold? There are two answers.
First, it is not compatible with our political systems.
Politicians in a mass democracy will not permanently
surrender their authority to an automatic adjustment
process. Nor should they.

Second, from the perspective of the United States, a
dollar based system maximizes our advantages, unless we
abuse it. It gives us the greatest flexibility and allows

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us to reap the considerable benefits of controlling
the printing presses.

Ironically, however, the inevitable consequence
of a dollar system is to encourage the further economic
integration of the United States into the global economy.
If this process proceeds faster in fact, then does the
domestic political awareness of it, then we run the
risk of not only wasting the advantages but also
letting loose political forces which could adversely affect
long-term U.S. interests. The present debt situation
may be an example: high interest costs--in the context of
the existing debt management process--could contribute
to an economic <u>and</u> political confrontation with debtor
countries harmful not only to our banks but to our long
term relationships in Latin America and elsewhere in the
developing world.

This is the underlying dilemma. The US is steadily
becoming <u>more</u> integrated into an international economy that
is becoming <u>more</u> global. But our political process seems
to work against the development and maintenance of sound,
internationally consistent economic policies. If we do
not resolve the dilemma--and the only resolution possible
requires dramatic US leadership, domestically and inter-
nationally--then we are condemned to international economic
instability. Over the long-run this cannot be consistent
with the kind of a strongly expanding world economy which
is integral to US economic and political interests.

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Unfortunately, there are few practical proposals to achieve the policy harmonization objective. We could devise additional policy co-ordination machinery within the IMF or OECD or Economic Summit frameworks. But this would just be another technical solution to what is fundamentally a political problem. The leaders of the US and the other industrial democracies have to understand the importance of economic policy harmonization and its benefits. And they have to understand that its benefits, economic and political, outweigh the costs.

For the United States, especially, the benefits are clear: if poorly understood. "Internationalization" of our economic policies is the best way to preserve the advantages of the dollar-based system. It is also the best way to achieve what any economic system is supposed to achieve: sustained, strong economic growth.

There are undoubtedly many different views in this room on some of the issues which I have discussed today. Some may conclude there is no international crisis which requires rethinking basic concepts. Others probably think the crisis already here and may conclude that some degree of automaticity, perhaps a gold standard, is the only viable solution. Others may wish to debate whether or not there is still debt crisis: the perspective

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seems to vary dramatically if one is an official or banker
from the developed or developing world.

However, it is virtually undeniable that we have
an intellectual crisis when it comes to thinking about
international economic and monetary issues. We lack ideas
or, rather, we are pre-occupied with so-called "political
realties" which preclude creative thinking and most
potential solutions. Unless we break out of these
restrictions unless we overcome the self-fulfilling
prophecies that too often start "Congress (or Parliament)
will never..., we will eventually be overwhelmed by
these problems.

In my judgement we are not at that point yet,
although we are certainly closer than is often acknowledged.
We will avoid it only if we begin working now not on
politically acceptable palatives, but on real solutions.

And that will require real leadership from all of
you who, as bankers, traders or government officials, make
up the international monetary system. With such leadership
the international economic problems we face can be turned
into opportunities from which all can benefit.

Thank you.

23

to maximize national advantage--in short a mercantilistic
world.

The Japanese seem to have come to this conclusion.

They make no pretense that their foreign economic policy
is guided by a commitment to the free play of market
forces. It is instead more or less explicitly geared
to manipulate the trade system as it really operates
to the national advantage. Japan is therefore widely
criticized for acting counter to existing economic theory.
In fact, it is possible to argue that it is simply playing
the de facto game more systematically and with greater
coherence than anyone else.

But however reluctantly we can play the same game
if we are driven to it and enhance our competitive position
in a world of unilateral trade practices and bilateral
agreements. We need not fear such a world; its chief
peril is if we fail to recognize its emergence. At some

-- Disagreement over exchange rates are the way underlying disagreements over broad economic policy goals and methods are made explicit. The exchange rate regime now in place tends to magnify these differences but it does not cause them.

The fundamental issue is that an international economic system cannot be sustained indefinitely by unilateral American decisions, however advantageous these might be to us in the short run. Leaders concerned with cooperative international foreign and economic policies must undertake a systematic review of the international economic system in order to find the basis for new, more equitable and less volatile exchange arrangements. Its test will not be its technical operation but whether the industrial democracies are able to agree on coordinated economic policies. No international system can meet everybody's maximum emands; but it must respond to enough common

35

Still, I believe that the current system of debt
management is reaching the limit of what can reasonably
be asked of it. This year the major Latin American

36

debtors will spend at least $40 billion on interest, some 35% to 40% of their export earnings; they are supposed to repay more than $100 billion before 1988. This even with the principal scheduled, all of the principal will, of course, be rescheduled.

But the interest alone will continue to represent a heavy drag on economic recovery, at least as long as interest rates remain so high.

The financial approach to the debt problem has produced considerable improvement in balance of payments accounts. It has had less success in restoring dynamic economic growth. Even optimistic projections see little prospect that by 1990 real per capita incomes in Latin America will reach 1980 levels. Partly as a result, social and political pressures have been severe. Many governments, especially those in the debtor countries and media are adopting harshly nationalistic, anti-IMF, anti-bank rhetoric. One can console oneself that this rhetoric