Reagan's policies give Europeans little hope of lower US interest rates

Overseas investors and European leaders who met with President Reagan at Williamsburg, Va., last weekend share a common conviction. Neither group appears to believe that the President's economic policies contain a formula designed to substantially reduce interest rates in the United States.

The dollar's surge to record heights against the French, Italian, and Spanish currencies reflects an assessment that American interest rates are likely to remain high in real terms, when measured against inflation.

This assessment is based on several factors:

* The basic US money supply, a senior Reagan administration official said, is growing so fast that the Federal Reserve Board might be forced to tighten up on the monetary reins.

Such a move would put upward pressure on interest rates. At the very least, analysts agree, the money supply situation does not give the Fed leeway to nudge interest rates down by loosening credit.

* Financial leaders in the US and abroad strongly believe that reappointment of Paul A. Volcker to another term as chairman of the Fed would signal Washington's determination to guard against renewed inflation.

Signs that President Reagan may look elsewhere for a new chairman send tremors through the markets and impel lenders to keep long-term interest rates high.

* Reading between the lines of the Williamsburg summit declaration, money managers find little hope that the White House plans decisive steps to control burgeoning US budget deficits.

Both in the summit statement and in other discussions at Williamsburg, US officials stressed that deficits would be brought down primarily by reducing government spending.

Such reductions, many experts insist, will not affect what is called the structural deficit developing in the US government's budget, a deficit that forecasters say could reach $200 billion a year in time, if current policies aren't changed.

The structural shortfall stems primarily from the growing gap between government income and spending, the latter spurred by huge increases in defense outlays and a rising interest bill on the national debt.

Taxes, under the President's program enacted into law, will decline to about 19 percent of gross national product by 1987, compared with 23 percent for spending. Spending in the current fiscal year is above that figure.

Both House and Senate have passed versions of the 1984 budget that contain tax increases larger than Mr. Reagan says he can accept.

In this stalemate, the signal goes out to the markets that the deficits are unlikely to shrink significantly in future years.

At Williamsburg, the President and Treasury Secretary Donald T. Regan stressed the US view that there is no direct correlation between budget deficits and high interest rates. This view was disputed by West German Chancellor Helmut Kohl, among others.

Those disagreeing with Mr. Reagan contend that the prospect of continuing massive deficits does indeed prop up long-term interest rates.

Their reasoning runs as follows:

* Huge deficits beyond 1985 would force the US Treasury to compete with the private sector to borrow money from a national savings pool inadequate to satisfy all demands.

* The Fed, to prevent the recovery from being stifled by lack of capital, might choose to allow the money supply to expand. This, in Wall Street's view, would reignite inflation.

* Or the Federal Reserve Board, fearful of inflation, could tighten the money supply, thus sharpening competition among borrowers and driving up interest rates.

White House officials argue that economic recovery itself will enlarge tax receipts, shrinking even the structural deficit.

Skeptical lenders, unwilling to gamble that this will happen, keep long-term interest rates high to protect themselves over the life of their loans.

Foreign investors, meanwhile, rush into dollar investments to reap a high return. The market assigns a higher value to the dollar than it does to other currencies.

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