The LDC debt crisis is usually supposed to involve loans from private banks, especially in the United States, to sovereign governments, especially in Latin America. Yet dur ing the time of massive bank lending, 1971-1982, the United States was a slight net borrower, not a lender abroad. Where did American private investors get the money to lend and invest a net $180 billion abroad?
The answer is that it came largely from the dollar's role as official monetary reserve. The ultimate source of net private U.S. lending was foreign central banks - especially in Europe and Asia - which lent over $150 billion in the 1970s, by expanding their dollar reserves in response to the weak
dollar.If the sovereign debt of Latin America is related to the trade problem, I would suggest that the sovereign debt of the United States - mostly held abroad by central banks, not private investors - has also played an important role.
The demand for reserves puts upward pressure on the dollar that makes U.S. farmers and manufacturers less competitive. This contributes to an upward ratcheting of the trade deficit and pressure for protectionism. When the United States tries to bring the dollar down, foreign central banks step in to buy dollar reserves. In the past year, foreign central banks have purchased over $40 billion through the Federal Reserve alone.
The dollar's special role is also related to the so-called twin deficits. Without reopening old debates over fiscal policy, I would merely point out that, if a budget deficit can cause a trade deficit, then the reverse is also true. To gain dollar reserves the rest of the world needs a balance of payments surplus, which imposes a deficit on the United States. And when the rest of the world's surplus is invested mostly in U.S. Treasury debt, it permits Congress to run a larger budget, which Europeans used to call this the ''deficit without tears."
Milton Friedman once remarked that the only way to get Congress to spend less is to reduce its allowance. But he overlooked the fact that Congress still has a special line of credit - which is what the dollar's official role amounts to.
The question is whether all this is sustainable. We are witnessing a growing conflict between domestic pressures to devalue the dollar or pursue protectionist policies, and the interests of all countries in an open trading system, stable exchange rates, and a reserve asset that holds its value.
I would like to put forward a modest proposal on how we can resolve this conflict, and help solve the Rubik's Cube of trade, debt, budget and monetary problems. My modest proposal is that we should build on the recent Group of Five and Group of Two agreements on exchange rates.
The central banks of the major industrial nations - or perhaps Japan, the United States and the European Monetary System - should not only stabilize their exchange rates, but also agree to settle their accounts in something other than dollars.
I would suggest gold. The central banks are holding over 1 billion ounces of it. At a realistic price, this would provide enough monetary reserves to replace the foreign exchange debt of the major central banks. The United States would negotiate the repayment of outstanding dollar reserves. This could be facilitated if other central banks held their dollar reserves directly with the Federal Reserve.
I believe this approach has a number of advantages.
First, re-liquefying the system would make it easier for foreign and domestic debtors to refinance at low long-term interest rates - a major goal of the Baker and Bradley plans.
Second, "reactivating" gold, as Bob Mundell puts it, would take the
pressure off the dollar without upsetting the whole system. Reducing the burden of the dollar's role would help restore the competitiveness of U.S. farmers and manufacturers. Yet it would also remove the major objection to stabilizing exchange rates, since that would no longer mean tying to the
dollar. Both would reduce pressure for protectionism, so we can reopen markets again.
Finally, this would provide the environment for finally controlling deficit spending - not only more market discipline, but less pressure for trade, farm and bank subsidies.
This proposal is not the last word. I offer the trend of my thinking in the hope of stimulating discussion and action. Nor is it the only thing we need to do. Debt-equity swaps, a larger role for capital-rich nations, tying MDB lending to GATT compliance, reducing subsidies in exchange for debt relief, price rules for domestic monetary policy, and tax reform, can all play a role.
But I believe this is a large piece of the solution that has been missing until now.
I believe we can restore U.S. competitiveness and help less developed nations like Mexico to grow again, move toward freer international trade, and restore worldwide stability.