Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distiling their frenzy from some academic scribbler of a few years back.
- John Maynard KeynesKeynes has been that influential defunct scribbler for the past generation. But who would ever have thought that the politician hearing Keynes' voice in the air might be Ronald Reagan?
- Martin Feldstein, former chairman, President's Council of Economic Advisers
Only a week remains until Election Day. It is time for the nation to focus on issues that plainly have been on the back burner: The massive deficits in the budget and foreign trade, the burgeoning foreign debt, the risk of resurgent inflation and the threat of a dollar crisis that could force U.S. interest rates sharply higher.
True, the political dialogue this fall has been desultory, but the election promises to be far from routine. It will surely set the tone, not only for the twilight years of the Reagan administration, but also for the upcoming presidential bout in 1988.
The White House has been able to deflect attention from the economy in part because, as Professor Feldstein noted, for the time being the Keynesian formula appears to be working. The short-run outlook for business is really quite good - far better than the current headlines about sluggish activity would suggest.
For example, the Commerce Department's initial estimate for the gross national product during the summer months was a growth rate of 2.4 percent. This was better than the increase of only 0.6 percent in the second quarter. But manufacturing activity has been weak, and the growth of the overall economy has admittedly been sluggish.
But even a glance beneath the surface of the GNP estimates reveals that the central core of the domestic U.S. economy (real final sales, GNP less changes in business inventories and the trade deficit) has been strong. The core economy increased at an annual rate of 5.6 percent this summer - far in excess of the average growth during the postwar period of 3.5 percent.
Several indicators support the impression of solid strength. A record 61 percent of the population over age 16 is at work. Skilled workers are in short supply. New orders for durable goods rose sharply in September. The demand for credit is strong.
Two sectors that have represented a major drag on expansion over the past six months: business inventories and foreign trade are now poised for an upturn. Rather than reduce GNP by $83 billion, which was the case in the second and third quarters, these sectors should to add to output in the months ahead.
International trade is most critical for the near-term economic outlook. The Federal Reserve's easy money policy has driven down the value of the dollar in world financial markets. In turn, this has set the stage for a major turnaround in U.S. foreign trade. During 1987, a surge in U.S. exports is likely to be the principal factor behind a strong, albeit probably ephemeral, expansion in the economy.
The Federal Reserve Bank of Dallas recently published an index of the
dollar's value, which raised doubts about this conclusion. The Dallas index indicates that the currency has dropped only 6 percent from its peak. If this result were meaningful (it is probably not), then the U.S. trade balance might continue to deteriorate and the economy would not improve.
More traditional measures - say, the indexes compiled by the Federal Reserve Board or the International Monetary Fund - show much sharper declines in the dollar's value, generally in excess of 30 percent. But there is no single correct answer. As Federal Reserve Vice Chairman Manuel H. Johnson remarked the other day, it all depends on what question you are asking about the dollar, what you are trying to measure.
The Federal Reserve Board's index, for example, includes 10 countries (Germany, Japan, France, United Kingdom, Canada, Italy, Netherlands, Belgium, Sweden, Switzerland), with the weight of each currency equal to that country's share of total world trade in 1972-76.
As such, the Fed board's measure is a multilateral trade-weighted index. To cite one example, the combined weight the Fed assigns to Belgium and the Netherlands (which trade heavily between each other) exceeds that of Canada, which is the United States' largest trading partner.
By contrast, the Dallas index is based on the bilateral pattern of U.S. trade with 131 nations. As a result, this yardstick is heavily influenced by currencies of countries in the Middle East and/or Southeast Asia that either peg their currencies to the dollar or conduct their trade largely in dollars. It also shows a marked impact from the declines in the currencies of the high- inflation nations in Latin America.
Changes in the relation of the dollar to minor currencies convey considerable information about economic conditions in those countries. However, they tell very little about the competitiveness of U.S. exports. In the real world, what counts most is the drop in thevalue of dollar in relation to the main U.S. competitors in Europe and Japan.
The delay in the response of U.S. foreign trade to the devaluation of the dollar still seems to be within normal parameters. A significant temporary improvement in the U.S. trade deficit is probable. Lord Keynes, who died in 1946, seems to be roaming corridors of power in Washington - whether to haunt the administration, or to protect it, remains to be seen.