CABINET COUNCIL ON ECONOMIC AFFAIRS OCTOBER 4 1983 8:45 A.M. ROOSEVELT ROOM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85-01156R000100140002-0
• Release Decision: RIPPUB
• Original Classification: K
• Document Page Count: 17
• Document Creation Date: December 21, 2016
• Document Release Date: August 20, 2008
• Sequence Number: 2
• Publication Date: October 4, 1983
• Content Type: REPORT

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CABINET AFFAIRS STAFFING MEMORANDUM ~:
Date: 9/30/83 Number:
Subject: Cabinet Council on Economic Affairs: Tuesday, October 4, 1983
8:45 a.m.in the Roosevelt Room .
ALL CABINET MEMBERS
Vice President
State
Treasury
Defense
Attorney General
Interior
Agriculture
Commerce
Labor
HHS
HUD
Transportation
Energy
Education
=GM1
EPA
UA
168795CA Due By:
13
11
^.
0
0
1-1
CEA
CEQ
OSTP
Baker
Deaver
Clark
Darman (For WH Staffing)
Harper
Jenkins.
CCCT/Gunn
CCEA/Porter
CCFA/
CCH R/Carl eson
CCLP/Uhlmann
CCMA/Bledsoe
CCNRE/
REMARKS:
The Cabinet Council on Economic Affairs will meet on Tuesday,
October 4, 1983 at 8:45 a.m. in the Roosevelt Room. The agenda
and background paper is attached.
RETURN TO: ^ Craig L. Fuller ^ Katherine Anderson ^ Don Clarey
Assistant to the President MI-Orn Gibson ^ Larry Herbolsheimer
for Cabinet Affairs Occnriatp Dirprtnr
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October 4, 1983
8:45 A.M.
Roosevelt Room
AGENDA
1. Report of the Working Group on the Economic Impact of
International Trade (CM#409)
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CABINET COUNCIL ON ECONOMIC AFFAIRS
October 4, 1983
PARTICIPANTS
The Vice President
Secretary Regan, Chairman Pro Tempore
Secretary Block
Secretary Baldrige
Secretary Pierce
Chairman Feldstein
Jack Svahn, Assistant to the President for Policy Development
Under Secretary Ford
(Representing Secretary Donovan)
Acting Deputy Secretary Burnley
(Representing Secretary Dole)
Deputy Director Wright
(Representing Director Stockman)
Deputy Trade Representative Lighthizer
(Representing Ambassador Brock)
Roger Porter, Executive Secretary
Thomas Gibson, Associate Director
For Presentation:
Robert G. Dederick, Former Under Secretary for Economics,
Department of Commerce
Additional Attendees:
Jim Cicconi, Special Assistant to the President and Special
Assistant to the Chief of Staff
Pam Bailey, Special Assistant to the President and Deputy
Director of Public Affairs
Mary Jo Jacobi, Special Assistant to the President for
Business and Commerce
Doug McMinn, NSC
Eugene McAllister, OPD
David Platt, Office of the Vice President
Alan Wallis, Under Secretary for Economic Affairs, DOS
Manuel Johnson, Assistant Secretary of the Treasury for
Economic Policy
Jonathan Rose, Assistant Attorney General, DOJ
John Knapp, General Counsel, HUD
Alton Keel, Associate Director, OMB
CIA
STAT
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Deficits-Actual and Prospective
Years Immediately
1981 1982 1984 Beyond
Trade (BOP) -28 -36 -80 to -100 Little
Improvement
Current Account +4 -11 -50 to -70
Explanation for TOTAL Trade Deficit
Structural surplus on services - over 30
Faster and stronger recovery in U.S. Minor
Economic weakness in LDC's - less than 10
Decline in oil prices + less than'10
High value of dollar - over 50
a. Reduction of inflation here, which has increased
attractiveness of U.S. assets
b. Tensions elsewhere, which have increased ) Minor
attractiveness of U.S. as safe haven
c. High real returns on U.S. physical
investment due to tax incentives 0
d. High real interest rates resulting from:
1. Uneven implementation of monetary
policy 0
2. Anti-inflationary monetary policy ) Major
3. Federal budget deficits
e. Deliberate undervaluation by other countries 0
Effects of Deficits
Everything else held equal:
The capital inflows which are the counterpart of the current account
deficits keep U.S. interest rates lower than otherwise and, hence,
capital formation higher than otherwise.
Deficits benefit LDC's and their creditors
Deficits add to foreign claims on U.S. future income
Adjustment problems are created for specific sectors, i.e., export
and import-competing industries.
Appropriate Remedial Actions
Reduce Federal budget deficit
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TREASURY
Deficits-Actual and Prospective
Years Immediately
1981 1982 1984 Beyond
Trade (SOP) -28 -36 -90 to -100 Little
Improvement
Current Account +4 -11 -60 to -70
Explanation for CHANGE in Trade Deficit
Between 1982 and 1984
Faster and stronger recovery in U.S.
Economic weakness in LDC's
Decline in oil price
High Value of dollar
a. Reduction of inflation here, which has increased
attractiveness of U.S. assets
b. Tensions elsewhere, which have increased
attractiveness of U.S. as safe haven
c. High real return on U.S. physical investment due to) -30
tax incentives
d. High real interest rates resulting from:
1. Uneven implementation of monetary policy
2. Anti-inflationary monetary policy 0
3. Federal budget deficits 0
e. Deliberate undervaluation by other countries 0
Effects
Everything else held equal:
The capital inflows which are the counterpart of the current
account deficit keep U.S. interest rates lower than otherwise
and, hence, capital formation higher than otherwise
Deficits benefit LDC's and their creditors
Deficits add to foreign claims on U.S. future income
Adjustment problems are created for specific sectors, i.e., export
and import-competing industries
Appropriate Remedial Actions
Reduce Federal spending
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September 30, 1983
MEMORANDUM FOR THE CABINET COUNCIL ON ECONOMIC AFFAIRS
FROM: ROGER B. PORTER ,e~
SUBJECT: Agenda and Papers for the October 4 Meeting
The agenda and papers for the October 4 meeting of the
Cabinet Council on Economic Affairs are attached. The meet-
ing is scheduled for 8:45 a.m. in the Roosevelt Room.
The Council will consider the report of the Working
Group on the Economic Impact of International Trade. This
is Economic Policy Study 9 of those commissioned by the
Council on June 30.
The Working Group, under the direction of Under Secre-
tary of Commerce Robert Dederick, has developed papers on:
1. The U.S. Trade Deficit: Causes, Prospects, and
Consequences
2. The Effects of Foreign Capital Inflows on Interest
Rates and Investment Funds in the United States
3. U.S. Agricultural Exports
4. Are U.S. International Transactions Statistics
Adequate?
5. Impact of 1980-1982 Changes in Trade Ratios on
Output and Employment in Selected Industries
These papers, and a carefully drafted eight page summary
of them, are attached.
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October 4, 1983
8:45 a.m.
Roosevelt Room
1. Report of the Working Group on the Economic Impact of
International Trade (CM#409)
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The Under Secretary for Economic Affairs
Washington, D. C. 20230
UNITED ~TATES DEPARTMENT OF COMMERCE
September 26, 1983
FROM: Robert G. Dederick ~-/ .(\
tinder Secretary for:; }
Economic Affairs
SUBJECT: Report of the CCEA Working Group on the
Economic Impact of International Trade
On June 30, the CCEA requested a series of 13 economic studies
on current economic problems. This is the report on Economic
Policy Study Number 9.
The Working Group divided its study into 5 papers to be
prepared by individual agencies. The first, done by the CEA,
analyzes the U.S. trade deficit, its causes, prospects, and
consequences. The second paper, prepared by the Treasury
Department, considers the effects of foreign capital inflows on
interest rates and investment funds in the United States. The
third paper, prepared by the Department of Agriculture,
discusses the importance of U.S. exports to the U.S.
agricultural sector, to the U.S. economy in general, and to the
stability of world agricultural markets. The final two papers,
prepared by the Department of Commerce, focus on (a) the
effects of the weakness in U.S. manufactured exports on
manufacturing output and employment in the U.S., and (b) the
adequacy of U.S. international transactions statistics. Each
or the papers is attached.
In addition, the Treasury Department presented an alternative
view of the causes, prospects, and consequences of the U.S.
trade deficit. Because of the fundamental differences of
opinion that were revealed in the Treasury alternative, the
Working Group was not able to reach a consensus on this issue.
Thus, the Treasury paper is also attached.
THE TRADE DEFICIT: CAUSES, PROSPECTS AND CONSEQUENCES
The U.S. merchandise trade deficit, which was $36 billion in
1982, is expected to widen to roughly $60 billion or more in
1983 and to $90 billion or more in 1984. As has been the case
for many years, the balance on current account is stronger than
the trade balance, because it includes services, in which we
run a surplus, This is even more true now than in past
decades, apparently because there has been a long-run trend in
U.S. comparative advantage away from merchandise and toward
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services. However, the trade deficit was sufficiently large in
1982 that the current account went into deficit that year, and
the current account deficit is expected to widen along with the
trade deficit in 1983-84.
According to the CEA, the most important reason for the
deficits is the high value of the dollar. A secondary reason
at present is the drop in exports to financially endangered
countries in Latin America. Still another depressant both this
year and next will be the faster business recovery in the U.S.
than among almost all of our trading partners.
The Treasury argues that three-quarters of a projected $40
billion slippage in the deficit between 1982 and 1984 is
attributable to two factors: first, the faster business
recovery in the U.S. than among other industrial
countries--accounting for $10 billion; and second, a drop in
exports to financially endangered LDCs--accounting for $20
billion. To the extent that the strong dollar is contributing
to the increase in the trade deficit, it is only partly
attributable to high real interest rates. Treasury argues that
the strong dollar is the result of the slowing of inflation in
the U.S. (which makes the dollar a more at'trac't?ive_sto.re>af
value to other countries), uncertainties abroad (which make the
dollar more attractive as a safe haven), and high real returns
on investment (which result1from the Administration's
investment incentives).
Commerce and OMB recognize that both the CEA and Treasury
arguments have validity, but do not believe that there is
sufficient evidence to quantify precisely the effect of each of
the factors. Clearly, high real interest rates are acting as a
strong magnet for capital. It is equally clear that the
problems of the LDC's and the quicker business turnaround here
than abroad are contributing to the U.S. trade deficits. In
general, however, DOC, OMB, and the CEA believe that the effect
of high real interest rates is likely to become increasingly
dominant. ----?
To the extent that the high value of the dollar is the most
important reason for the deficits, what is the most important
reason for the high value of the dollar? The generally
agreed-upon answer begins with the observation that real
interest rates have been generally higher in the U.S. than in
other industrial nations. High real interest rates raise the
demand for dollar assets relative to foreign assets, attract a
capital inflow, and thus raise the price of the dollar. In
addition to the differential in real interest rates, a second
reason sometimes given for the increase in demand for U.S.
assets and resulting dollar appreciation is the "safe haven"
argument: uncertainty in Latin America and elsewhere causes
capital to flow to the United States.
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Moving back still further, why are real interest rates so high
in the U.S? Investment must by definition equal total saving
(private saving less government deficits). Real interest rates
can rise either because investment shifts up, or because saving
shifts down. At issue is the relative importance of these two
factors. The Treasury emphasizes the first alternative. Other
members of the Working Group emphasize the second. As
evidence, they point to the sharp drop in saving and investment
during recent years, even as a share of GNP. The decline in
saving is divided between a fall in private saving and a fall
in public saving, i.e., the large increase in the budget
deficit.
Treasury agrees that the hoped-for increase in investment has
not yet materialized. But, Treasury argues that incentives to
capital formation which were enacted as part of the President'
program in 1981 will raise investment in the future, and that
today's high real interest rates and capital inflow are a
manifestation of that expectation on the tart--o-f--the-.market.
Treasury also asserts that the U.S. real interest rate has be
raised by increased variability and uncertainty in monetary
policy. The market is said to view the return on bonds as
riskier than in the past. Thus, a higher "risk premium" must
be added on to the expected rate of return in order to induce
people to hold bonds. Other Working Group members believe that
this argument is inconsistent with the capital inflow and
appreciated dollar. Any increase in U.S. monetary uncertainty
should lead to a fall in the demand for U.S. assets (with the
rise in U.S. real interest rates as a result), rather than to
the observed rise in the demand for U.S. assets (with the rise
in U.S. real interest rates as a cause). Foreign investors
presumably are as sensitive to uncertainty in the U.S. as
Americans.
Despite some disagreement on the causes of the deficits, the
full Working Group agrees on the effects. Output and
employment are adversely affected in those U.S. industries that
export, or that compete with imports. But, if we assume that
the dollar level of aggregate economic activity is basically
determined by monetary policy, then it follows that the loss in
income suffered by the export and import-competing industries
is offset by gains in other industries. Such an assumption
appears to be appropriate at present, since the Federal Reserve
is committed to a monetary policy consistent with a recovery
pace that avoids a resurgence of inflation.
If improvement in the trade sector were accomplished through an
increase in taxes or a reduction in transfer payments, the
offsetting cutback would show up in the consumer sector. If
improvement were accomplished through a decrease in government
ILLEGIB
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spending on goods and services, it would show up in the
corresponding sectors, e.g. military goods. And finally, if
improvement were accomplished through renewed monetary
tightening and further increases in real interest rates, the
offsets would be declines in construction, consumer durables,
and business investment in plant and equipment.
It is useful to view these points in terms of the capital
inflow from abroad that is the counterpart of our current
account deficit. Real interest rates have been driven up by an
imbalance between saving and investment (in the form of a
decline in domestic private and public saving in the majority
view, in the form of an increase in investment in the Treasury
view). The capital inflow from-abroad serves to make up the
gap between domestic saving and investment. It dampens the
increase in the real interest rate and, thus, allows more
investment than would otherwise take place.
Changing the mix between monetary and fiscal policy could
reduce the widening trade deficit real interest rates and,, in
turn, the value of the dollar. But, if one takes monetary and
fiscal policies as given, then the capital inflows which
generate the trade deficit have the favorable effect of
allowing more spending on domestic investment than otherwise
would be possible.
THE EFFECTS OF FOREIGN CAPITAL INFLOW ON INTEREST RATES
AND INVESTMENT FUNDS IN THE UNITED STATES
Traditionally, the current account was thought to drive
international transactions. A net export deficit was
interpreted as reflecting dwindling U.S. competitiveness in
foreign markets, forcing the United States to borrow abroad to
finance imports, and weakening the exchange rate. Currently,
however, there are reasons to believe that the capital account
is the driving force, as foreigners seek to invest in the
United States. As they exchange their own currencies for ours,
the value of the dollar is pushed upward, making U.S. exports
more expensive and imports cheaper and contributing to the
increase in the current account deficit.
If it is true that the rest of the world is intentionally
seeking out the United States as a capital investment location,
there could be a beneficial impact on U.S. credit and equity
markets and a valuable supplement to domestic savings, with the
current account deficit rising as a more or less inevitable
consequence.
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The following can be said about the capital inflows:
0 They are small compared with gross domestic saving and
total funds raised in credit and equity markets, and,
therefore, their impact on investment and interest rates so
far has probably been fairly limited.
0 Still,.because of very low total net saving recently in our
economy (and negative saving in the fourth quarter of
1982), these funds may have provided a significant
supplement.
o Overall, foreign inflows have probably had a beneficial
impact on interest rates, although the full impact is
difficult to quantify.
o Much larger inflows forecast for the next several years
could have a more demonstrable influence on investment and
interest rates.
o To the extent that foreign inflows may have resulted in
some potential increase in the money supply, such a rise
has been offset as much as necessary through the Federal
Reserve's open market operations with little difficulty.
o Economic theory suggests that the marked reduction of
inflation in this country over the past two and one-half
years would tend to increase the worldwide demand for
dollars as an unofficial (or official) reserve asset. To
the extent that this demand resulted in inflows which
settled into elements of M1 or M2, it may have contributed
somewhat to the recent drop in velocity. Further, to this
extent, the rapid growth of monetary aggregates over the
past year or so has been less inflationary than otherwise
and has represented a shift in the dollar demand function,
which presumably should not be offset by open market
operations.
While, on balance, the effect of foreign capital inflows is
probably favorable for the investment outlook in this country,
some caution may be warranted in viewing foreign capital
markets as a long-term source of funds. Gross or social
returns may be higher abroad, but on a tax- and risk- adjusted
basis, they are the same at the margin as in the U.S. Our tax
cuts have in fact shifted the balance, and imply a new
equilibrium point. To the extent that the United States is
being temporarily viewed as a safe haven due to its political
stability and the superior liquidity of funds invested in its
capital markets, resources could be withdrawn in the future if
prospects for other countries improve.
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Finally,. in assessing any policy implications of the current
international flow of funds, it should be noted that the U.S.
financial market is the largest and-most liquid in the world,
providing an efficiency unparalleled elsewhere. This is one
source of our economic strength and also provides this Nation
with substantial service earnings. There may be appeals,
particularly by countries suffering losses of capital, that we
take temporary regulatory measures to stem this flow. Such
measures could only detract from the attractiveness of the U.S.
market and reduce its long-run earnings potential.
U.S. AGRICULTURAL EXPORTS
Since the early 1970's, U.S. agriculture has devoted more of
its resources to, and generated a greater share of income from,
the export market. Today, production from two out of every
five acres goes overseas, compared with one out of five in
1970. The value of farm exports as a share of marketings has
doubled in the past 10 years and currently represents about 25
percent of farmers' cash receipts. It is becoming more
apparent that domestic demand alone cannot support the U.S.
farm sector when it is operating at full capacity. Exports are
crucial to the economic health and well-being of American
agriculture.
Every dollar of agricultural export earnings generates just
over a dollar in related activity throughout the rest of the
economy. Approximately 3 percent of the Gross National
Product is derived from farm exports. On the employment side,
agricultural exports. generate over 1.0 million jobs, of which
nearly 60 percent are related to processing, handling and
distribution of products for export.
In the 1970's economic growth, expanded liquidity, and policy
changes abroad led to rising exports, which bolstered farm
prices and income, reduced government program expenditures, and
helped reduce our overall trade deficit. During the decade,
U.S. wheat, soybean and meal exports doubled while feedgrain
exports tripled. The USSR and China became our major grain
markets and the European Community our major soybean market.
The recent decline in U.S. agricultural exports has been caused
by the world-wide economic recession, appreciation of the
dollar, the indebtedness problems of many importing countries,
strong competition from other suppliers, and policy changes in
the USSR. These factors reduced foreign demand for U.S. foods,
feeds, and fibers.
Agricultural export prospects are brighter, however, for the
next year. At the same time, though expected world economic
recovery, recent policy agreements on grains with the Soviet
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Union and on textiles with China, and reduced competitor
supplies in some commodities will be acting to booster sales.
In addition, higher prices should boost the dollar value of
agricultural exports. To be sure, the strong dollar and
still-weak demand for livestock products could temper the
exports of foods, feeds and fiber. In the mid-to-date-1980's,
U.S. exports are expected to rise with population and income
growth abroad. However, the annual expansion in U.S. exports
for the decade of the 1980's is expected to be at less than
half the rate of the 1970's.
"Are U.S. International Transactions Adequate?"
U.S. international transactions statistics can be characterized
as "adequate" but certainly with room for significant
improvement. The emergence of large statistical discrepancies
(errors and omissions) in the past few years, particularly for
1982, has generated increased questioning of the adequacy of
the accounts and the allocation of the discrepancy between the
current account (goods, services, and unilateral transfers) and
the capital account.
Most informed observers conclude that the statistical
discrepancy is largely accounted for by unrecorded private
capital flows, particularly during periods of political,
economic and financial, and military uncertainties in many
areas. This view is supported by the extreme quarterly
volatility of the discrepancy. It also squares with the fact
that the dollar has appreciated steadily in foreign exchange
markets at a time when the current account was moving toward
deficit. Without any doubt, better reporting of a number of
current account items is needed, but there is no reason to
assume that the net effect of improved data would be to
increase receipts, rather than payments.
Efforts are underway by BEA to strengthen estimates for a
number of the service accounts. Also, rather wide
discrepancies between U.S. and Japanese current account data
indicate that plans for a bilateral U.S.-Japanese current
account reconciliation might be initiated, if resources could
be committed and if both partners agree, with the successful
U.S.-Canadian reconciliation serving as the model.
To the extent that there is a strong desire on the part of some
foreign investors not to reveal their identity,efforts to
improve the private capital accounts will be severely
hampered. Among the gaps in capital flow data, the most
important probably is associated with portfolio investment
flows. Reports to the Treasury, particularly by U.S. non-bank
firms, and to a lesser extent by banks, although required by
existing regulations, may be subject to uncertainties as to
whether requirements apply to some transactions, including
those involving new financial market practices and instruments.
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International transactions data for the first half of 1983
indicate that the record 1982 discrepancy will not be repeated
this year. But, the discrepancy may remain rather large, on
average, until prospects improve for a more stable and
prosperous world economy.
IMPACT OF 1980-82 CHANGES IN TRADE RATIOS ON OUTPUT AND
EMPLOYMENT IN SELECTED INDUSTRIES
What would have happened to shipments and employment in
selected manufacturing industries and in manufacturing as a
whole in 1982, if exports/shipments and impor penetration 1/
ratios had remained the same that year as in 1980? An
admittedly over simplified answer to this question is given in
the accompanying table on industrial effects.
For all manufacturing industries, actual shipments in 1982 were
lower than computed hypothetical shipments by $22.7 billion, or
by about one percent. This implies roughly a quarter million
fewer manufacturing jobs.
The aircraft, steel, motor vehicles and parts, and electronic
computing equipment industries exhibited the most pronounced
adverse effects. In all of these industries the
exports/shipments ratios declined between 1980 and 1982, while
the import penetration ratios increased. Only aircraft
equipment, n.e.c. (not elsewhere classified), farm machinery,
and construction machinery had modest increases in output and
employment as a result of changes in the trade ratios between
1980 and 1982.
The analyses found that even high technology sectors are not
immune to the internal and external forces that have caused
U.S. trade balances to deteriorate in recent years.
1/
Shipments are calculated as the value of domestic
output plus or minus
inventory changes. The import penetration ratio is
defined as imports divided by apparent consumption which,
in turn, equals shipments plus imports minus exports.
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Effects of Changes in Trade Ratios Between 1980 and 1982
on Domestic Industry Shipments and Employment in 1982
Difference Between Actual and Computed
Direct and Indirect
1982 Product Shipments
1982 Employment Effects 1/
Difference
Product Group
(millions)
Total,
Motor vehicles (3711) 2/
$-1,223
-22,904
Motor vehicle parts (3714) 2/
-260
-7,247
Aircraft (3721)
-3,458
-75,642
Aircraft equipment, n.e.c. (3728)
300
8,479
Construction machinery (3531)
63
1,585 ?
Farm machinery (3523)
530
13,931
Oil field machinery (3533)
-221
-3, 703
Steel mill products (3312,5,6,7)
-3,212
-58,389
Industrial organic chemicals, n.e.c.
(2869)
-129
-1,227
Electronic computing equip. (3573)
-2,359
-55,583
Semiconductors (3674)
-650
-17,296
Radio and TV communication equipment
(3662)
-730
-23,733
Radio and TV receiving sets (3651)
-1,075
-26,120
Photographic equipment and supplies
(3861)
-556
-8,341
Paper & paperboard (2621,31,61)
-224
-3,654
Totals
$-13,204
-279,844
All Manufacturing
$-22,722
?
1/ Employment effects represent the estimated number of jobs lost or gained in 1982 because of the changes in
trade ratios between 1980 and 1982.
2/ Trade between the United States and Canada is excluded from these calculations.
Source: U.S. Department of Commerce, Bureau of Economic Economics.
Approved For Release 2008/08/20: CIA-RDP85-01156R000100140002-0