...home to roost

LAST week was not a happy one for Lyndon Johnson. It was a time of reckoning for his Vietnam policy, politically in New Hampshire, economically in the London gold pool and on Wall Street. The economy has been distorted and the balance-of-payments deficit exacerbated by the war effort. The Administration can no longer hope to disguise or postpone these problems; it must come to terms with them now, and the terms are bitter.

The international currency system, like any currency system, is grounded in confidence and mutual acceptability; the currency used must be freely convertible into real goods and services, "legal tender for all debts, public and private." The dollar and the pound sterling have served this function between nations since the Bretton Woods Agreement of 1944, which established the International Monetary Fund and the present system of semi-flexible exchange rates.

The various currencies can be exchanged for dollars or for pounds, which are freely convertible into dollars at a rate which is more or less fixed. Dollars can be converted into gold at a fixed rate of $35 an ounce. The system works beautifully--as long as everyone is confident that the price of gold will not rise above $35 and that holding dollars or pounds is equivalent to holding gold.

THAT confidence has been shaken, virtually shattered, by the British devaluation and the prospect of an enlarged U.S. balance-of-payments deficit. Speculators took a look at the vast foreign holdings of dollars and were convinced that the announced dollars price of gold could not be maintained; they wanted to be holding gold if the U.S. devalued.

The two-tiered price for gold announced Sunday afternoon is commonly admitted to be only a stopgap measure. In order to restore confidence in the dollar, the U.S. has to cool its overheated economy and reduce the payments deficit. There are a number of coolants available. The Federal Reserve can raise the discount rate in order to curb investment demand, which it has done, or it can take steps to check the growth of the money supply or even reduce it. But neither of these methods will be adequate; it has become necessary to sharply reduce the federal budget deficit.

This can be done either by increasing taxes or cutting expenditures. A tax increase in an election year is as politically distasteful to Congress as it is to President Johnson, so it is almost certain that the price for the passage of a tax bill will be a substantial reduction in the budget. It takes little imagination to guess where the cuts will be made; the last wisps of the Great Society are about to be blown away.

An even larger share of the war's burden is, thus, about to be shifted onto Negroes. The ghetto will be directly hit by the curtailing of federal programs, but the unemployment resulting from a slowdown of the economy may have an even greater impact. Negroes have always been the first to be laid off as firms react to a decelerating economy, and it is probable that the number laid off will peak sometime during the summer. If the President and Congress were trying to build riot potential, their timing could scarcely have been better.

THE international implications of austerity measures are just as dismal as the domestic ones. The deceleration of the U.S. economy will affect international trade in two ways, both of them adverse.

Since the dollar serves as a substitute for a genuine international currency, expanding international trade requires an expanding supply of dollars to be used in transactions. Dollars are supplied to the international economy only when the U.S. has a balance-of-payments deficit, which means that U.S. deficits must provide the lubricant for international trade. Thus the inherent contradiction in the present system: U.S. deficits are essential to expanding trade, but a chronic deficit causes loss of confidence in the dollar, which must be restored by reducing the deficit--which serves to check expansion of international trade.

If prices were freely flexible downward, international trade could expand with a fixed or even a decreasing supply of dollars; the expansion would merely have to be coupled with international deflation. But there is no reason to believe that international deflation is any more likely today than it was in the thirties. Trade will slacken instead.

However, this effect will probably be overshadowed by the result of reduced U.S. imports. The payments deficit can only be narrowed by expanding exports or restricting imports. A government has control over imports both through tariffs and fiscal policy. But since it is virtually helpless to expand exports rapidly, the latter course is inevitable. Unfortunately, U.S. imports are by definition the exports of other nations, so they must face reduced exports, which will cause them to reduce their imports, which are the exports of still other nations, and so it goes. Because of the complexity of trade relations, it is impossible to predict the magnitude of the eventual impact upon international trade, but it is certain that there is some sort of "multiplier" operating.

THE ripples will finally return to wash the shores of the U.S., reducing its exports and widening the deficit once again. The process is ultimately self-defeating; a small decrease in the deficit is purchased at the cost of decreasing total world trade by a much greater amount.

Still, the U.S. economy will be comparatively untouched by a reduction in international trade; exports comprise only three per cent of the GNP. The developing nations, some of whom rely on exports for seventy per cent of GNP, will be hit hardest. Vietnam will no longer be the only developing nation paying for the war; by impeding international trade we will have managed to increase the cost so that other nations might share too.

This development could have been easily foreseen. That it has not been forestalled is simply one more demonstration of the self-defeating nature of the Administration's policy in Vietnam. Seeking to contain revolution in one nation, the U.S. has been led, economically as well as politically, to increase the likelihood of revolution in many nations.