It's getting familiar to hear on my car radio each morning: ``The US dollar opened lower in Europe today.'' That was the message most days last week. And it also happened that short-term Treasury bill rates were higher last week. As the dollar declines -- if that is what has actually started -- the United States will need to become more concerned about the relationship between the dollar and interest rates.
Two years ago the US had a record budget deficit, some $195 billion. Last year, even with high economic growth, that deficit was still $175 billion. In the current fiscal year, it's estimated to be above $200 billion again -- partly because of the slowdown in the economy over the past 12 months.
During most of the Reagan years, interest rates have stayed unusually high. In real, or inflation-adjusted, terms they are higher still. Back in 1980, interest rates were temporarily around 20 percent, but 13 percent inflation meant the real rate was not as great as it has been much of the time since.
Investors were slow to react to the drubbing they were getting in real terms in fixed-interest-rate investments. Once having reacted, they have been understandably slow to believe inflation is really licked. In any case, an inflation adjustment is usually based not on the current rate but the expected rate over the life of the investment.
Anyhow, this high real rate made US investments particularly attractive to foreigners. Now that rates have finally been declining, one reason for a foreigner to make a dollar-denominated investment has lessened or even disappeared. Still, other reasons for the attractiveness of US investments remain: the political safety of an investment in this country; the liquidity of US financial markets; and the fact that dollars are so widely used elsewhere as the international transaction currency.
This puts the Federal Reserve in the middle of a dilemma. Its chairman, Paul Volcker, indicated the week before last that it was not the Fed's desire to push the dollar lower. Yet, it is clearly also not in the Fed's interest to steer the American economy into the next recession, or even to let it drift into one. To strengthen the economy, it would be convenient if the Fed could push interest rates lower. But pushing them lower might make the dollar even less attractive to foreigners than it has already
started to be.
So what has happened to the US economy in the last five years is that it has become further enmeshed in the economies of the rest of the world. To say that we are hostage to the world's opinion of us would be to overstate the case, but it is only telling the truth to say that the US has less freedom of action in handling its own economy than it did five years ago.
This may have been inevitable. A nation running the world's trading currency is always in a special position -- a position that usually grants it advantages as well as some disadvantages. But the US has been able during most of the postwar period to enjoy first a kind of economic hegemony and then, as that was lost, still a kind of financial freedom which has not required it to be too concerned about the opinions others held of its economic management at home.
That is less the case today, and because of the budget deficits of the 1980s it will become even less so a few years from now.
David D. Hale, chief economist at Kemper Financial Services in Chicago, hints at this in his current economic review: ``When a country is importing capital on as large a scale as the US today,'' he notes, ``there is little difference between perception and reality; one now helps to determine the other.''
All very challenging stuff for a nation that has not had to be too concerned about foreigners' opinions of its economic management.