Dancing to a Foreign Tune Time's

By John Greenwald

When it comes to the thorny topic of international economics, generations of Americans have long enjoyed blissful ignorance. Phrases like "terms of trade" were more likely to suggest a baseball-player swap than something that could gravely affect people's jobs or incomes. Those innocent days, though, are past. When TIME's Board of Economists met last week in Manhattan to assess the business outlook, the animated session was dominated by issues ranging from the colossal U.S. foreign trade deficit to the financial crisis in South Africa. Said Alan Greenspan, a New York City-based economic consultant: "We are looking at an unprecedented period in American history. What's going on internationally is dominating our domestic economy and our policies."

Foreign matters are striking home because a flood of high-quality and attractively priced imports continues to wash over the U.S., crippling entire industries and putting millions of Americans out of work. The clearest sign of distress is the burgeoning trade deficit, which measures the gap between America's exports and its imports. TIME's board estimated that the shortfall, which is expected to reach a record $150 billion this year, cut in half the growth in the U.S. gross national product during the first six months of 1985. Without that trade deficit, the U.S. would perhaps have had growth at an annual rate of more than 2%, rather than an anemic 1.1%.

But the tidal wave of imports has brought benefits as well. The foreign challenge, Greenspan said, could even help keep the U.S. from slipping into a recession. He argued that fierce competition from abroad has spurred American companies to invest heavily in cost-saving equipment, and the outlays mean that business will continue growing. Capital spending is a significant driving force behind the economy.

The board noted further that the large volume of dollars that the Federal Reserve continues to pump into the economy makes a slump unlikely during the next twelve months. But should the Fed suddenly tighten the money supply, the action could raise the chances of a downturn sometime next year. Board members expect the GNP to expand somewhat more rapidly in the second half of this year than it did in the first, growing 2.8% from July to December. That remains well below the Reagan Administration's optimistic forecast of 5% growth over the same period. Said Charles Schultze, a senior fellow at the Brookings Institution: "We will continue to muddle through."

A spate of economic reports last week tended to support that view. Buoyed by a 7.1% jump in August purchases of U.S.-made cars, retail sales rose a strong 1.9% for the month. Much of the big auto gain reflected the low-cost financing that car- makers used to help clear dealers' lots. The Government also disclosed that industrial production rose a modest .3% in August, after remaining unchanged in July. The small increase showed that imports continue to cut deeply into American factory output.

In predicting moderately faster growth for the second half of 1985, board members counted on a continued downward drift in the foreign exchange value of the U.S. dollar. The sky-high price of the dollar has been the chief cause of the trade deficit, because it has made American exports expensive and goods from abroad alluringly cheap. A weakening of the dollar would slow down the pace of imports and thus encourage consumption of domestic goods. Although the dollar has risen a bit in recent weeks, it now stands some 9% lower against major foreign currencies than it did when it peaked last February after a record four-year climb.

The TIME board cautioned, however, that the bloated trade deficit cannot be completely closed in the foreseeable future, so imports will continue to dampen growth. "The pillars of our export strength are badly eroded," said Rimmer de Vries, chief international economist for Morgan Guaranty Trust. He noted that the U.S. is losing some of its foreign farm sales because output abroad is up sharply. Concurred Robert Hormats, a vice president of the investment banking firm Goldman Sachs and a guest at last week's meeting: "Europe is exporting poultry, beef and all the things we sold them in the '50s, '60s and '70s." Hormats, who had been Assistant Secretary of State for Economic and Business Affairs in the first Reagan term, said that even India, a traditionally hungry giant, may start exporting agricultural goods.

While a falling dollar could boost U.S. inflation by raising import prices, the economists were confident that any increases will remain mild. They noted that labor costs, which make up some 65% of the retail value of most products, are continuing to rise at a modest pace. Raw material prices are also stable. The Labor Department reported last week that in August the Producer Price Index fell .3%, the sharpest decline in more than two years. Said Greenspan: "Overall, there is just no evidence of any acceleration of inflation."

Board members were mostly unimpressed with the drop in the unemployment rate to 7% last month, its lowest level since mid-1980. They pointed out that the decrease reflected such statistical quirks as a one-time bulge in the number of self-employed people, and a decline in the size of the work force. Nonetheless, the economists saw the dip in joblessness as an encouraging sign. Said Schultze: "The August employment numbers by themselves don't mean a lot, but they are at least consistent with the view that the economy is still growing, albeit slowly." The board expects the unemployment rate to inch up to 7.2% by the end of the year, and to be at that level in 1986.

The economists were less certain about the direction of interest rates. The outlook is clouded by the other huge deficit that has been bedeviling the economy: the $200 billion federal budget shortfall. Although that ominous gap tends to push interest rates higher, the relatively weak economy has resulted in less demand for credit. The board was divided over which way rates are headed in the next six months. Some members felt they are likely to fall slightly, while others expected them to edge up.

TIME's panel was deeply worried by the mountain of bills now before Congress that would attempt to solve U.S. trade problems by restricting imports. More than 300 measures have been introduced. Said Hormats: "This is the high-water mark for protectionist legislation. There is more pressure for protectionism than at any other time since World War II." Hormats believes that President Reagan's refusal last month to place limits on shoe imports has stiffened congressional resolve to take action. One likely candidate for passage: a bill to limit textile imports. The Administration last week began working with congressional leaders to head off a wholesale protectionist bill.

Hormats said that "free trade is more a myth than a reality," noting that many governments have long subsidized exports while creating a host of regulatory barriers to imports. He said the U.S. should counter these restrictions by applying current legal sanctions that are permitted under the General Agreement on Tariffs and Trade, an international body devoted to furthering global commerce.

Board Member Lester Thurow, an M.I.T. economist, called for more aggressive moves to narrow the U.S. trade gap. Noting that the U.S. will pass Brazil as the world's biggest foreign debtor next year, Thurow urged Washington to intervene in currency markets to help reduce the value of the dollar. He also expressed support for a bill that would tax imports from countries with big trade surpluses. Said he: "I am not in favor of protection. I think active measures to reduce the American balance of payments deficit should not be described as protectionist."

Other board members disagreed with that approach, arguing that it is not the right way to help industries hit by imports. Said Schultze: "You couldn't have a worse industrial policy than one that tried on a large scale to deal with present problems by putting on measures to restrict imports."

The economists agreed that the erection of trade barriers could worsen the financial condition of heavily indebted Third World countries, which depend on exports to repay their loans. De Vries noted that while Brazil, Mexico and other Latin American nations have eased their debt problems, they remain beset by economic woes. Said he: "The debt crisis has been substantially defused. What has not changed is their poor earnings from exports." Unless those countries can dramatically boost their exports, he said, they will have to continue borrowing just to pay the interest on their existing loans.

TIME's board saw little chance that South Africa's political and economic agony would put added pressure on the hard-pressed international financial system. South Africa this month halted repayment of principal on most of its $21 billion of foreign debt after imposing temporary controls to keep money from fleeing the racially embattled country. De Vries noted that South Africa's foreign obligations were small in comparison with the $103 billion that Brazil owes and Mexico's $96 billion of international loans. Said he: "I feel that South Africa is a very separate problem." He added, however, that Pretoria "is going to have a very hard time getting money from the financial markets for a long time to come."

Turning to domestic issues, the TIME economists offered a mixed assessment of the Reagan Administration's tax-reform proposals. Harvard Economist Martin Feldstein, who served from 1982 to 1984 as chairman of the Council of Economic Advisers, said parts of the measure amounted to "standing Reaganomics on its head." In contrast to the President's 1981 tax cuts, which were designed to encourage savings and investment, the reform package would remove the investment tax credit and other advantages that companies now enjoy. Feldstein argued that such measures made the legislation "an antisaving, antiinvestment bill."

Other board members disagreed. Greenspan said the changes in business taxes would discourage wasteful investments like those that have created a current nationwide glut of office space. Schultze praised the proposed reduction of corporate taxes from 46% to 33%, and the dropping of the top personal rate from 50% to 35%.

The economists, though, saw little Congressional or public support for the ambitious tax proposals. Feldstein, who had just attended a weekend meeting of the House Ways and Means Committee, reported that apart from Chairman Dan Rostenkowski, "hardly any member present was enthusiastic about the bill." He said the legislators also found during August that tax reform was "a big yawn at home." Nonetheless, Feldstein predicted that the House would pass a tax-reform measure this year out of fear that Reagan will otherwise "come down very hard on the Democrats." Getting a reform bill through the more conservative Senate, Feldstein added, will be far more difficult and is probably impossible this year.

Though the TIME panel remains troubled by the huge budget deficit, members praised lawmakers for moving this summer to stanch the red ink. "Congress ought to get a pat on the back," said Alice Rivlin, director of economic studies for the Brookings Institution. She noted that a Congressional Budget Office study showed that the spending cuts would lower the deficit to $143 billion by 1988, or about $100 billion less than previously forecast. More than a third of the reduction, Rivlin said, will come from defense outlays, which have become unpopular because of military procurement scandals.

Despite the substantial cutbacks, board members cautioned that the budget shortfall remains menacingly large. Rivlin noted that the projected reductions look good only by comparison with the $200 billion deficits of recent years. Last week the White House asked Congress to raise the federal & debt ceiling to $2.1 trillion, more than twice the level it stood at when Reagan took office.

The economists were worried, moreover, that congressional efforts to lower the deficit have come to an end. "I think it's all over now," Feldstein said. The White House has already ruled that two major ways of closing the budget gap, cuts in Social Security or tax increases, are off limits. And since spending on nondefense programs has already been slashed, little progress can be expected there.

The budget deficit is thus likely to remain a major obstacle to economic health for years to come. By pushing up interest rates, it leads to an overly strong dollar and the large trade gap. It also threatens to raise borrowing costs to levels that could choke off vital spending on new plant and equipment. The Administration and Congress can run away from the budget deficit problem, but they cannot hide.

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