Sometimes when people introduce me as having been economic Deputy to Henry Kissinger a while back, they note that's a bit like being military advisor to the pope which unfortunately is the case after I left a working for Henry in that capacity. I let a decent interval pass and I then wrote an op-ed piece in the New York Times which rather took him sharply to task. He was by then Secretary of State took him rather sharply to task for not being concerned with the economic dimension of foreign policy suggesting that was rather anachronistic in the 1970s, but I have to admit in retrospect. I made a mistake.Because it turned out there was one thing worse than Henry Kissinger not getting involved in u.s. International Economic Policy those of you who follow it. No when he did get involved that was even worse. So I should have left well enough alone. What I want to talk about today is a dramatic reversal in the whole International position of the United States our trade position of international investment position. Our financial role in the world is undergoing. What is truly an historic change.No less important for not being too widely recognized either in the United States or around the world yet. But its effects are going to come home very very sharply very very soon. And I want to talk about that suggest some ways to again get out of the problem and then see what you would like to talk about in more detail as I go beyond that it's first critical to understand as I'm sure most of you do how the international economic situation is absolutely crucial to the US domestic economy. Most of you here are undoubtedly familiar with some of the structural numbers how the u.s. Now depends on export markets for almost 25 percent of our industrial output over 40% of our agricultural output how almost one out of every three dollars in US corporate profit derived from the international activities of our firms their Investments as well as their tradeBut what is even more impressive than those structural numbers is how changes in our International position literally over the last six or seven years have dominated the course of our whole economy from 1978 to 80 the last period until last year when we had any decent economic growth in this country literally three quarters of the total increase in our GNP came from the improvement in our trade balance. That was a period only a few years ago when US exports were growing twice as fast as world trade our current account position our balance and goods and services improved by 60 billion dollars in two years, excluding the run-up in the oil price and when us manufacturers regained a share of world markets in almost every sector higher than we had had since the late 1960s so much for the argument that the u.s. Cannot compete needs new government intervention industrial policies, whatever the u.s. Clearly can compete and compete effectively in the world economy, but then the story changed and in the recession of 191 1982 it may surprise you to learn that the deterioration in the trade balance was by far the biggest single cause of element the deterioration of the trade balance was more than twice as great as the housing slump far bigger and the deterioration of the Auto industry indeed a counter for about three-quarters of the total decline in our GNP from early 81 through the end of 82 the recession period had we not had that deteriorating trade balance. We wouldn't have even talked much about a recession because it would have been so modest one wouldn't have even noticed it and even in the last year and a quarter as the economy has again been roaring in in Broad terms the continued deterioration of our external position has taken a lot off that last year. The growth rate was about 30% lower than it would otherwise have been because of continued deterioration of our trade balance. And in the first quarter of this year when recorded GNP growth was at the already booming rate of about eight point three percent in annual terms, it would have been ten and a half percent had it not been for the further deterioration in the trade balance.Now the fact that the trade balance kept it down a little bit may have been for a short run a good thing and I'll get back to that later. But the fact is that at the margin over the last six or seven years changes in our International position actually dominated the course of our whole economy in terms of jobs, even in terms of price levels of point out. So I turned back to in a moment, but the question today is why that turn occurred why the external sector was such a support to our economy back in the late 70s and through 1980 and then as turned around with such a Vengeance since that time turned around with such a Vengeance, in fact that the trade deficit the merchandise trade deficit this year. We'll probably hit the unheard-of number of a hundred and twenty billion dollars and in 1985 on my projection will probably hit at least 150 billion dollars. These are numbers that had not even been contemplated or even imagined as recently as a year or two ago and therefore represent an enormous deterioration.Of the u.s. Position vis-à-vis the rest of the trading world and as I'll note the moment in terms of its International financial position as well. Now, how could that happen? How could the u.s. Becomes such a massive deficit country in this very short period of time. They're really three causes one is the fact that our economy has been growing faster than that of the other major countries in the world. That's obviously a healthy thing from our standpoint one would prefer to see the Japanese and Europeans growing more rapidly. But the fact that there is a growth Gap that the US and 83 and 84 for the first time in the post-war period is growing faster than every other major industrial country, of course sucks in more Imports compared with the export expansion that we can enjoy with the slow growth in those other countries a second factor is the debt crisis the shortcut back in import opportunities in the developing country as they have had to conserve foreign exchange to put their houses in order has met a sharp loss and exports to us particularly to Mexico, but the third factor is by far the dominantThat is the huge overvaluation of the dollar in the exchange markets compared with the underlying competitive relationship between the United States and its major trading partners or competitors International financial matters and exchange rates often seem esoteric and hard to relate to trade and jobs and real world affairs. But I think it's very simple to understand almost any analyst who's looked at. This issue would conclude that the dollar is overvalued relative to underlying competitive Relationships by about 25% and what that means is that we are effectively taxing at the rate of 25 percent. All Goods that are producers are trying to exploitLikewise we are paying a subsidy on the order of 25% to All Imports coming into the country. That's great. If you want to import television sets or cars if you want to take a trip on the Riviera, it is very difficult for American industry and workers to compete when they have 25% price disadvantage brought not by any effect of their own Industries activities, but rather by the position of the dollar in the exchange markets as a whole and that is the primary reason why there's been this enormous deterioration in our trade balance even back when our own economy was in recession and with a Vengeance now as we come out of it, so the dollar has been overvalued it works like a tax and a subsidy there is one positive effect of that overvalued dollar namely it has helped to fight inflation when the dollar has been strong it obviously goes further to by Imports and other products. It keeps competitive pressure on American industry, but my own view is that's temporary and bound to be reversed and indeed may even love us intoThinking that we've conquered inflation more effectively than we really have the main and Lasting effect in my judgment is this enormous competitive loss that we have suffered as a result now because of this huge deterioration in the trade balance as many as 3 million Americans will be unemployed at the end of next year as a result of the decline in our trade position. That's a growing number. It's probably now 2 million. It's rising very sharply. It's going to mean enormous problems for major sectors and major regions of this country unless it is turned around quickly moreover as the dollar stays at these overvalued levels and as many forecasters suggest that it will stay there for some time to come despite the trade deficits themselves more and more American firms are beginning to ask themselves whether their next Investments should be made in the United States or should be made abroad already. We can see many multinational firms who have a wide array of Affiliates and subsidiaries in other countries.Shifting their servicing of World Markets from the u.s. To the rest of the world that indeed is one of the reasons for the deterioration in our trade balance one major company Ingersoll Rand has indicated that it normally Services 60% of its World Markets from the US 40 percent abroad but given the dollars position in the last three years. It has reversed that ratio. If you generalize that shift to the whole universe of American voter National firms, you would have explained almost the whole of the hundred billion dollar deterioration in our trade position and is continuing to rise so far the issue has been mainly for those firms where to serve as foreign markets out of the US or abroad and as I say, they're shifting to existing foreign Affiliates now as we're economic growth picks up some and its capacity utilization begins to be moving toward higher levels the firms that have to ask themselves. Where do I put my new plan? Can I take the risk of putting it here in the US when I'm priced out so substantially to start with if that's going to continue. I better put the plant abroad and to the extent.That there's any risk of deindustrialization of the United States. I think it has very little to do with Japan Incorporated unfair Trade Practices abroad the lack of an industrial policy in this country. There are things to do on all those fronts but those aren't the major problems. The major problems are that we're pricing ourselves out of World Markets by dint of our own hand now, how could that happen? The main reasons for the overvaluation of the dollar or two one is the so-called safe-haven appeal of the dollar in The Exchange Market in an uncertain World both in economic and political terms. Obviously people in both industrial and developing countries have wanted to move into the dollar and they have done. So that's clearly something we can be proud of we wouldn't want to change it. We're not going to undermine our safe haven status in order to fend off Capital inflows. Well that occurs and there's not much policy can do about it in this country at least other countries can get their situations improved and try to correct it from their side, but not much we can do. However, the second major reason is one we can do a great deal about and have not and that is of course the enormously High rate of interest rates in this country the level of real interest rates much higher than the rest of the world Rising again now sucking in billions, maybe trillions of dollars of capital from around the world into the dollar because of financial flows there for pushing the dollar to Holes way out of line with the underlying competitive position of not just our manufacturing sector, but our agriculture our services the whole of our producing economy and those High interest rates in turn, of course relate directly to the massive and growing deficits in our federal budget. You see projections of those deficits at 200 billion dollars that tells it much better than it's likely to be under current policy without changes in policy. Those budget deficits will be rising to at least 300 billion dollars toward the end of the decade and if there's a recession somewhere along the way it's more likely to hit 400 billion dollars. So even if the current so-called down payment is enacted by the Congress as well as might be only a marginal Dent will be made in the budget deficits and therefore the prospect for high interest rates recall that the so-called hundred fifty billion dollar package is only 30 billion this year and then maybe 60 or 70 next year and then maybe a little more the third year but those are cumulative three-year numbers not one year numbers and so they only begin to make a modest dent. In the huge and growing structural deficit which in turn crowds out the private markets drives up interest rates. And in addition to the direct domestic effect, which I'm afraid we'll begin to feel now within the next six months as interest rates rise again, the in international effect is devastating along the lines that I mentioned. So that is in large part the cause of the problem now its implications are numerous. I've already mentioned a couple a substantial drag on the economy a risk of deindustrialization is American firms feel forced to invest abroad a loss of jobs directly through the deterioration of our trade balance. Unfortunately, that is not the end of the story. There are more consequences one is the truly breathtaking reversal of the International Investment position of the United States from 1917. Literally the end of the first world war through 1982. The United States was a net foreign investor. We were building up our assets abroad are multinational firms investing abroad Are banks. Lending abroad sometimes too much I come back to that in a moment, but there was an enormous buildup in the foreign asset position of the United States as a country to the tune of about 200 billion dollars all that will be thrown away and indeed reversed in three years given these massive deficits in our trade balance that I mentioned recall that when you have a trade deficit you have to finance it by importing capital from abroad and so when you run a hundred billion dollar deficit in the current account trade in goods and services and I think we will this year 425 next you have to bring in that much Capital net to finance it and that builds up your International debt because you've got to pay back and literally in just two years with a hundred billion dollar deficits this and next. We will have offset in two years the build-up of international Investments. We had accumulated in 65 and since it can't turn around on a dime even if a number of the changes I suggest to implemented quickly. We will be moving in 86 87 to an unheard of Position as a debtor country by some time in 1986 on current Reckoning. We will have a foreign debt bigger than that of Mexico or Brazil who now leave the league obviously that's not quite as serious for us. It's for Mexico and Brazil. We have a much bigger economic base export base to support it nevertheless. If it continues for a few more years 300 400 billion dollars, it becomes very serious. We've always told ourselves at least some people have told her told ourselves that our national debt didn't make much difference because we owe it to ourselves increasingly. We don't owe it to ourselves and we will therefore have an increasing vulnerability to events in the rest of the world even going what beyond what I suggested at the outset as that debt builds up in some sense. It's the international counterpart of the massive buildup in domestic debt in the budget deficits. I think the figure is well known that in the current five-year period 81 through 85 the accumulation of total debt budget deficit and debt in the United States will equal the amount that was built. in the first 206 years of Our National History The international counterpart is what I mentioning that in two or three years. We will reverse the build-up of 65 years worth of International Investment position. Now, what's the matter with that? Why is it bad to be an international debtor? Well, it does seem rather strange for the richest country in the world, which we still are on most counts to be importing capital from the rest of the world one normally thinks of a wealthy country being a net exporter as the United States was since the first world war, but they're very practical effects. Every time you build up a hundred billion dollars worth of debt with interest rates at 10% or so, you've got to pay out another 10 billion of Interest a year as recently as 1982. We were earning 30 to 40 billion dollars a year on our net foreign investments an average rate of return higher than 10% that meant we could run a deficit on our merchandise trade of an equal amount and still have a balance in goods and services and being roughly balanced shape, but now instead of earning 30 to 40 a year. We're going to be paying 10 20 30 a year as our investment position deteriorates. That means we have to earn that much more on merchandise trade to balance the accounts. That means the dollar is going to have to be that much weaker to give us a competitive position to do it. And that means all of us will be poor. There's a real price to pay no free lunch for these huge deficits that are now being run including because of their International Dimensions, finally one more major effect of this enormous swing in our position. And that is the impetus. It gives to protectionist trade policies. The United States, of course is the largest country in the world economy is the center country in the world trading system and indeed has led the battle Harlan Cleveland's been involved in that in many occasions in the past has led the battle literally since the disasters of the 1930s the trade Wars of that period which helped bring on the second world war. The US has led the world since that time in opening up the world economy promoting maximally free trade for our economic benefit, but also for broad foreign policy concerns reasons of international stability and Amity among nations. A study of the history shows. However, that the most reliable leading indicator of an outbreak of protectionist pressures and protectionism here in the United States perhaps surprisingly is not the unemployment rate at all. But rather is an overvalued exchange rate for the dollar when we have had previous bouts of dollar imbalance the late 60s early 70s, which required the to bigd evaluations and 71 and 73 a more modest overvaluation in 76 and 77 that required the runoff of the dollar in 78 that I'm all too familiar with having sat there at the treasury at the time. It went too far. We had to take bold action to turn it around and stop it and now again it all those episodes when the dollar gets too strong to support the underlying competitive position of our country the natural reaction of labor unions firms that are beleaguered is to look for immediate remedies and trade protection. It's totally understandable. The Coalition of firms looking for trade controls is then not just the Really vulnerable industry steel textiles Etc, but it becomes a much broader group. All of whom do have a legitimate complaint because as I said before their import competition is being subsidized to the rate of 25% on current node analysis by the exchange rate and the underlying interest rate and budget situation. So it's a real problem and out of it comes a real set of proposals to respond through trade controls import relief now at the same time the United States, of course is the only country in the world, which is growing rapidly as I suggested before bringing unemployment down substantially. So if the United States at this time went further in a protectionist direction, it would tend to bring immediate retaliation from other major countries certainly in Europe certainly in the developing world and could risk disrupting the entire trading system on which so much of post-war prosperity and amicable for the whole international relations have been based. This is not pure theory if you look at the last three years. The current Administration despite. I think it's a sincere Devotion to open markets free trade and the like has taken more protectionist actions in eight or nine major industries than any us Administration since the 1930s. I don't say that to castigate them though. I think they could have done better in some of those but rather to show the enormity the pressures look at 1983 unemployment dropped sharply dramatically protectionism Rose dramatically. It wasn't fended off by unemployment it in fact continue to rise and so the situation is perilous as this trade deficit continues to deteriorate as the dollar stays overvalued and as unemployment inevitably at some point, we'll turn back up as the domestic demand growth slows down and perhaps even stalls out later this year or sometime in 1985. So the threat on the trade side is enormous in addition to disrupting the trade system our own export markets international relations in the like it would have a very dramatic effect on the debt crisis. I'm not going to speak in detail about the debt crisis if you want to ask questions about it. I'd be delighted to Respond, but the only fundamental answer to the debt problem of the developing and other debtor countries is to be able to expand their foreign exchange earnings through export increases adequately to again be servicing their debt on a more or less market-oriented basis. They can only do that. If there is rapid growth in world trade that requires sustained economic expansion in the industrial world. And also it requires open markets if barriers are raised to their exports, they can't do it and indeed will begin to throw up their hands one. Therefore has to be enormously disquieted when the US government on one same day last winter as indicated in two side-by-side columns on the front page of the New York Times puts out a billion and a half dollars of credit relief for Brazil but slaps import quotas on Brazilian steel shipments on the exact same day. We should have learned from the famous German reparations problem in the 1920s that you can't get paid on your debt unless Take their goods. And unless we learn that lesson we're all going to be in very very deep water. Now. I've enumerated a number of problems a number of implications of what is going on and seems continuing to go on at least well into next year no matter what happens what to do about the critical issue. As I mentioned is to get the exchange rate between the dollar and other major currencies the Yen the Deutsche Mark other European currencies corrected to a level where it will accurately reflect the underlying competitive relationship between our economies in turn the most promising indeed. The only essential way to do it is to get our interest rates down and that in turn requires getting our budget deficits down obviously things are moving in the opposite direction right now, but they can be turned around if if both the Congress and the administration recognized the urgency and magnitude of what needs to be done down payments of thirty billion or even 50 or 60 billion a year won't do it. It's got to be much larger. Roger I hope we can last until after the election to see it done in early 1985. I'm afraid however that for both political and economic reasons. This was the best year to take action on the budget deficit and it may be harder next year. If the economy is slowing down if President Reagan is re-elected and feels Vindicated as a result of his election and sticks with his policies against tax rises again slow down in the defense build-up if the Democrats come in and are reluctant in their first few months in office to proposed tax increases of hundred billion dollars, which is about what's necessary to do it to enunciate those possibilities is to indicate how difficult it is. It's going to have to be done. If this International problem is not to continue to disintegrate now beyond the budget deficit what else could be done if one doesn't attack that in a frontal way other countries could help the Germans the Japanese could stimulate their economies more rapidly. For reasons that are understandable but run counter to what one needs in the short run those countries are tightening their budget deficits despite their very slow economic growth that keeps among other effects that keeps their interest rates low and pushes their money out the same way our high interest rates pull money in what we actually need is a new kind of swap agreements where we swap our mix of fiscal and monetary policy for there's that would have a greatly beneficial effect on exchange rate relationships. We're not going to get that perhaps they could take some steps in that direction. There are measures that can be taken directly in the exchange markets. I'm not a great fan of direct intervention, but it is true that when as always happens for temporary periods, the exchange rate start moving in the correct direction in this case the dollar coming down and the mark and Yen going up the central banks could come in go with the market Trend and I think have good prospects for pushing the adjustment much further much faster than the markets themselves would take it. However, there's a ideological rejection of any Of intervention policy in the current Administration in Washington and that has made it impossible to even experiment with measures of that type most drastically one might have to interfere directly with the capital flows. That is I said are swapping the trade flows and causing the exchange rates to get way out of line. The Japanese. In fact could do that rather easily and when President Reagan visited Tokyo and prime minister nakasone last November they indeed pledged to do so, they indicated they would borrow heavily abroad borrow dollars convert them into Yen. And that would increase the rate of the end. Of course in the exchange markets very substantially. Unfortunately as frequently happened the Japanese have not fulfilled their pledge likewise the Japanese could carry out what I call the 30 phone call approach as we all know the Japanese government agencies have a great deal of moral suasion of Power with the private sectors that deficit under their guidance that is sometimes overstated incidentally that guidance that the Japanese Ministries give but in the financial sector it is true and as recently as 1980 after the And will shock the Japanese finance ministry called up the leading Japanese insurance companies Pension funds Banks and told them to avoid any capital outflow for a few quarters because of the huge deficit that Japan was then running in its trade account. They did it capital outflow went to zero and Japan was magically Back in Balance. Now when they faced the problem of a huge Trade Surplus, but nevertheless a weak currency. They should be doing the same thing making those 30 phone calls stopping the capital outflow, which is running about three billion dollars a month and that's what's depressing the yen exchange rate in order to push it up in combination with the foreign borrowing the Europeans might do the same thing. So there are a number of steps that are possible some more desirable and more fundamental than others but none is being carried out at the moment. Unfortunately, therefore the trade balance continues to deteriorate the u.s. Moves much further into net debtor position protection is pressures continue to grow. Unfortunately, I'm afraid I can't have much optimism that any of these things are going to be dealt with in any significant degree in the near future. There's coming in just three weeks the London economic Summit a natural place and one used in some past years to try to put together package deals of the type that are necessary to address a complex problem like this. It may be in London. There will be modest movement toward getting a new trade negotiation going which I think is wholly a good thing in order to add one more device for resisting trade protectionism, but no sign of any action to deal with these fundamental questions. The foreigners May complain again bitterly about how us interest rates the overvalue dollar pulling money out of their countries forcing their interest rates up making it more difficult for them to carry out the kind of economic policies, they would like but so far those calls for Action by the us but in tandem with others has not really gotten through and so therefore in closing I'm afraid I have to have Very pessimistic message that the United States is undergoing in an incredibly short period of time a massive unprecedented and I'm afraid disastrous swing in its international trade and currency position at some point at some point. If constructive actions of the type I mentioned are not taken there will be a collapse the dollar itself, even as us interest rates rise higher will at some point when the trade deficit hits a hundred and fifty two hundred billion or more will collapse foreign Capital will lose confidence in the continued strength of our economy and or of his continued value of the dollar in which its assets are held money will flow out even faster than a float in the dollar will decline precipitately that will push up inflation enormously cause enormous pressure on interest rates to go up further because here's all this money being pulled out which is now financing about 50% of our budget deficit and we will be in a stabilization crisis or in short in the soup in a massive way his mind. I hope that there will still be time and be action to head that off, but at the moment, I'm not optimistic. Thank you very much. Many of the debtor nations in a developing world are being pressured by the international monetary fund to adopt austerity programs, which means in a lot of cases cutting back on their Imports. Do you see any political significance to this? Some writers have are quite concerned that they may default on their debts or have a revolution or something in these countries. Well, there's a great deal of significance both political socio-economic any way you want to look at it. The root of the problem of course is twofold the world economy itself went bad the world recession of 81 and 82 that I mentioned another context sharply truncated the export markets for those countries interest rates Rose, and so literally overnight during the course of 1982 their interest payments came to sharply exceed the rise in their export earnings. And so Moved into a basically untenable position that was compounded by the second issue some of their own policies Mexico. For example with its oil boom in the late seventies was growing in real terms nine ten percent a year right through the first half of 1982 when the rest of the world was in recession in short overspending could not possibly keep up with that whatever the course of the world economy. So two things have to happen to resolve. The problem one is those countries have to put their own houses in order as you mentioned. The IMF is often blamed for that. But the imf's only the messenger the problem is the policy requirements of those countries. They have to tighten their belts given the world the situation and indeed IMF involvement usually cushions the adjustment blow to some extent by providing more Finance giving confidence to commercial lenders that adjustment is being undertaken. So the IMF Surplus not a negative but the question as to whether the whole thing is viable really depends on how rapidly the world economy. Returns to a basis that permits them with decent domestic policies to make it to get back not to repay the debt. They're not going to repay the debt for a long time but to service the debt on a reasonably market-oriented basis and that is right now the Six hundred billion dollar question because it's a race there is a pickup obviously in the US economy. It's spreading slowly to the rest of the world not very much. But at least it's coming a little bit until recently interest rates were behaving themselves, but there's some worrisome signs interest rates now jumping back up. The recovery is could stall out protectionism as I mentioned could very easily pick up Bank lending which has continued although on an involuntary basis at least at a sufficient level to keep financing the lower deficits. They're running it could dry up even further. So there are a lot of big ifs out there. You've been reading in the press the last few weeks about the impact of higher interest rates the reaction that's leading to in the developing countries. And it's you know, it's totally understandable Brazil has gone through a major belt-tightening program to cut a billion dollars or so off its Imports. Most of that is offset in two weeks when the prime rate Rises to percent because that adds a billion and a half dollars a year to the Brazilian Debt Service requirement. So There is I think a very perilous Point coming attended that conference at the New York Federal Reserve Bank week ago today, I guess I was the only non banker there bring some of these Dimensions to their attention and I think the effort that's going on is to see whether techniques can be discovered that would stretch out at least the impact of interest rate Rises on the debtor countries interest capitalisation variable maturity loans their various techniques for doing that and if the interest rate rise continues without the world economy booming so much is to offset it in growth terms, then probably some of those techniques are going to be required but it's sort of the race can the underlying economics which I mentioned earlier on giving them the opportunity to earn their way back into a reasonable position. Well that happened before the social and political fabric breaking these countries in most of the countries. In fact in all the countries so far. There's been enormous resilience. To the austerity programs some predicted that within a year or two things would go bust Brazil is now in its fourth year of recession and is in fact showing a bit now a sign of turning out of it. It's therefore no surprise that they've had the most riots domestic UPS Etc. If they hadn't been democratizing their domestic political system, which is what some down there called the Roman circus effect. It may have been that the attention of the people to the economics would have been more and they might have had more upset so they may have been lucky but it's a race and at the moment whereas I would still think on balance, we're not going to have a crisis. It's by no means assured. I'm John Holland. I've got two questions. I've been my Economist friends, especially on the president ministration argue against the strict relationship between us deficits and interest rates. I've never been able to understand that can you clarify that no and say so there's no easy way with the sections. I don't think there's any way and what timeframe do you think there will be a return to high interest of higher inflation. Well, that's of course another one of the big questions at the moment the inflation numbers continue to behave very well, but I'll elaborate on a point that I made in passing in my remarks my judgment and that I think of most macroeconomist is that the underlying US inflation rate now is somewhere about five or six percent the underlying inflation rate now if that's true, how can it be that the recorded inflation rate has been running a two or three for the last couple of years. Well part of it simply the recession back a couple of years depressing demand and holding down the rate of inflation. But even since the economy has been booming the last year year and a half. The inflation rate has stayed down one big part of the answer is a strength of the dollar in The Exchange Market as I mentioned when the dollar Rises it holds down import prices is a competitive spur to American industry to keep their import prices down as long as they're not protected by quotas like the Auto industry and therefore you get an anti-inflation effect. Unfortunately, when the dollar corrects as it inevitably will and must you will not only lose the game from say 6 to 3. You will take a loss from 629 and the inflation rate simply because of the weakening of the dollar will shoot up enormously. Well, when it hits a new equilibrium level again, you'll drop back to the underlying rate of 6, but in the meanwhile people could Panic the markets could Panic the FED would have to react with higher interest rates as I mentioned and one could get a very very messy outcome simply from the decline in the dollar in the exchange markets. That's one element which if it occurred and if occurred precipitately particularly could have an enormous effect in bringing on inflation. Now when that's going to happen had a debate with my good friend and board member Alan Greenspan before the joint economic committee yesterday. We testified on the London Summit and Alan said he agreed with everything. I said except my forecast on the trade numbers because he thought the dollar might collapse very soon. He may be right no one has ever predicted any of the turning points in the big swings and currencies we've had in the last 10 years under flexible rates. I think it's more likely the dollars going to stay strong for a while because interest rates are moving back up. Germany doesn't look very good. Japan doesn't look all that booming either. So the alternatives to the dollar don't look terribly impressive, but that's a guess Alan could be right if he is then he inflation run-up will start very soon and it could affect wage negotiations the whole range of commodity prices and have a pervasive effect on the economy as a whole. My guess is it's going to come a little later but it's inevitable that it's going to come and so again the urgency to take constructive action to try to get a soft landing and rather than a hard one. A moment ago you and looted to various policy options are being considered. So to speak to immunize the debt problem from domestic Financial conditions as I understand it one of the most seriously considered proposals having been Advanced by the president of the New York Federal Reserve Bank and also endorsed by the chairman of the Federal Reserve. The other day is to somehow arrange to put some kind of a cap on rates to on in on rates in loans to some of these debtor countries in thus to insulate them from any further interest rate increases. Well considering that so much of the daddy is after all bank yet and considering we've just had a situation last few days with the major internationally International Bank unable to Found himself this naturally raises the question. Well, if we proceed this way to deal with Brazil, Argentina Mexico and so forth. Where do we next proceeded to do with continental and whoever comes after Continental? Well, your question is very apt. What we are seeing is a heat real erosion of the traditional lending process the fiduciary nature of the international credit process in reaction, however to an over lending spree earlier and this an unanticipated decline in the world economy. The question of course is compared with what if by letting it go one really thought he would trigger serious defaults or unilateral moratoria or some other disruption. I think not Castro type repudiation but something fairly extreme then of course, that's worse yet. Not just for the banks, but for the International Financial system and our own domestic Financial system. So the policy call has got to be whether one requires some further further loosening of the traditional approach. Via some type of interest rate cap. I mentioned a couple of technical options a moment ago or whether to let it go and hope it works out including putting new money in and some sense for the banks what's been done since the debt crisis broke 20 months ago has been to put in new money to permit the old interest to be paid. And that remains one option they can increase their exposure further and put in more money so that the interest servicing continues the debtor countries actually are not too keen on that because it simply does mean a bigger build up in debt. They prefer a course to avoid the interest rate Rises and earn their way out but that is one option. However, many banks particularly in Europe particularly smaller banks in this country. I suspect some here in this city are rather fed up with expanding their exposure in terms of new loans and would rather take some hits on existing portfolios. Now, there is one way out of the Dilemma of course, and that is if the regulatory authorities would see fit or be instructed to see fit to go easy in their treatment of various techniques for interest rate caps. I mean after all variable maturity loans are commonplace British mortgages have been financed that way for a century interest capitalisation is not a new phenomenon lots of real estate loans in the mid 70s were handled that way. So these are not new Natural phenomena and if the Judgment were valid that taking one of those routes would add to the stability and likely repayment of the portfolio as compared with doing nothing then one could reasonably say wow. It's a why step maybe it makes the loan substandard but you don't have to deduct from earnings go to non-accrual in the light those very technical issues accounting issues. Regulatory. SEC issues are in fact, very critical at the heart of the matter because they determine how the effectivity of this would have to be reported by the Banks Etc. So in that sense the gimmick King doesn't matter. Maybe it's just, you know admit what astute Market observers already believed to be the case, but I think that's the area in which these accommodations probably are going to be made an answer your question with a very good one. It's a critical policy question as always an economist will tell you it's compared with what We keep reading about the huge amounts of money. They're being Borrowed by one company to buy out. Another is this a complicating factor in relation to the problem is you outline and if so, is there anything we should be done about it? Well, it's a complicating factor in the sense of being one more Demand on funds and therefore pushing up interest rates. Now whether you think it's a good or a bad thing depends on your basic view about mergers whether you think that's a natural component of a market economy that over time does add to efficiency Etc. I don't have a dogmatic view want it myself. I think in some cases it does in some cases doesn't it's hard to generalize but certainly the monetary effect as you suggest is further Demand on the flow of funds further increases in interest rates and that complicates both the dollar exchange rate problem our own trade problem and it certainly complicates the debt problem further as well. One mean if one felt a new wave we're coming that was going to be an enormous factor in that direction one might declare a moratorium some of the Congressional bills aimed. The oil industry a few months ago aim to do that as I say, I wouldn't Advocate that approach myself. I don't think a blanket prohibition or moratorium is is desirable on Broad policy grounds. But if you're worried about it and saw a massive new borrowing surge coming from that Source, you could legislate or declare a temporary moratorium to try to avoid more deleterious effects and let me ask you one final question. We're in an election year and we can't let you just be an economist. You got to be a political Economist. What would you say of the of the level of understanding of candidates and the people around them in this period so far and prospectively of the of the very serious issues that you've been explaining to us today. Well as I suggested, I think the understanding on the part of the incumbent is not overwhelming. So that's a view on one of the candidates. I should say. Actually it's a mixed picture. I think on some issues like debt and in the effort to fight protection Bill Brock, for example, I think they've done quite well, they've tried hard I've certainly worked with them supported their efforts, but on these big issues the budget interest rates exchange rates, there's been a obtuseness. I'm afraid which has been very unfavorable for the national interest and and that's underlying one candidate among the Democratic candidates. I think it is a mixed bag. I think your native son here. The former vice president is probably more sophisticated in this area than any high-level politician we've had in this country since the war. That may surprise you that I say that because he's been branded in some quarters of protectionist for supporting the local content bill as those of you who know him. However know he led the fight along with Senator Javits and the Senate the early 1970s to stop the Burkhart key bill which was the biggest protectionist effort we've ever had in this country since the war. He authored many of the amendments to the trade Act of 1974 that liberalized trade substantially in the in the Tokyo round. He's been one of the leaders in that area more importantly for what I've been talking about. If you look at any speech or statement he has made in this area. He has started by describing the exchange rate problem as the core of the difficulty you think back to I think it was the Dartmouth debate when both Senator Hart and Governor asked you was in a race hit him about being protectionist and his Auto content position. He backed away from his Auto content position and stress the fact that we are taxing all exports 25% subsidizing oil imports. And in that framework, it's very tough. I think he understands these problems probably better than any politician we've had and so I would be modestly encourage frankly. I made a raised a question in my remarks whether a democratic Administration coming in would would have the courage to do the right things on the budget the vice president former vice president. I think has campaigned fairly honestly on that and he has said that to get the economy, right and including this International Dimension. There's going to have to be a tremendous diminution of these budget deficits. It is going to require a tax increases spending cuts and like a like most politicians. He hasn't spelled out line by line what he's going to do, but I think he has made that a priority and I frankly think if elected he would recognize that there was going to have to be a recession in his term us and going to go six or seven years without a recession better to take it early and more importantly you will get it in a milder form if you move sooner than if you wait for these collapse scenarios, and I mentioned to build up further so paradoxically just as we've had a Conservative Republican president launched the massive the most massive Keynesian stimulus and most massive budget deficits in the history of the world. I would foresee a new Democratic Administration more likely to take conservative steps to reduce the budget deficit get the dollar under control and get the economy back on track. I don't say it's a hundred percent probability that would happen. But I think it is more likely and so on balance if it came out that way and a former vice president was a candidate. I think there'd be at least some reasonable chance that some of these issues would get back on track. Thank you very much. We very much appreciate your coming and very much appreciate to your capacity to talk about these. Sometimes very complicated matters in understandable English. Thanks very much.