THE 1988 FEDERAL BUDGET : Link to Budget Shortfall Unclear : Ballooning Trade Deficit May Ensnare U.S. in Debt

WASHINGTON —  The specter of budget deficits in the hundreds of billions of dollars, once a yearly nightmare, has become commonplace and perhaps even manageable.

But now a new and equally frightening vision is looming: an ever-growing trade deficit, also in the hundreds of billions a year, that eventually traps the nation’s economy in an escape-proof prison of debt, eventually to be measured in trillions of dollars owed to foreigners.

Economists, including Lester Thurow of Massachusetts Institute of Technology, warn of a “black hole” of debt swallowing up U.S. economic growth for decades to come. And to Jerry J. Jasinowski of the National Assn. of Manufacturers, the bill for today’s excessive buying from abroad in money borrowed from abroad must be future austerity: a reduced standard of living expressed in less consumption, enforced saving and dwindling investment.

Parallel Numbers

Underlying these fears is the common belief that the ominous trade deficit is a direct consequence of the huge pileup of budget debt incurred during President Reagan’s Administration.

Indeed, the huge numbers seem to parallel one another, with the $221-billion budget deficit of fiscal 1986 nearly matched by a merchandise trade deficit for the calendar year that is on course toward more than $170 billion.

“The relationship is close and it’s critically important,” said C. Fred Bergsten, head of the Institute for International Economics. But he said the trend in 1987 should be a healthy decline of as much as $40 billion in both deficits, thus easing fears that the two are out of control.

Higher Interest Rates

But whether there is a cause-and-effect link between the budget and trade deficits is not entirely clear.

Under the most familiar theory, the gargantuan budget deficit would force record government borrowing, and the extraordinary demand for money would cause the price of money--namely, interest rates--to rise. Foreigners would begin to buy dollars at unprecedented rates to take advantage of the high interest rates.

That in turn, according to this theory, would cause the dollar to rise in value on international currency markets. The mighty U.S. dollar would make foreign goods cheap in the United States and American products expensive abroad. Imports then would soar, exports would stagnate and the trade deficit would explode.

Events have cast doubts on this theory. Although interest rates have declined and the dollar has lost value, the trade deficit has continued to mount.

Edward M. Bernstein, a senior economist at the Brookings Institution, concluded that the old theory, however plausible, “is misleading, if not entirely wrong. . . .”

Some economists have developed a more sophisticated explanation of the link between the budget and trade deficits. The government is pumping about $200 billion more into the economy in the form of spending than it takes out in taxes. With that infusion of money, U.S. consumers are able to buy more and more goods and services.

Limited Uses for Dollars

Those consumers are turning overseas to find what they want, sending enormous payments of U.S. dollars abroad. The recipients of those dollars can put them to only a limited number of uses.

They can buy a few commodities, notably oil, for which the dollar has become the international currency. Or they can buy Eurobonds--denominated in dollars and sold anywhere outside the United States.

Otherwise, they generally can spend the dollars only where they are legal tender--the United States--so they return them to their country of origin by buying U.S. products or investing in U.S. securities, real estate or other items. Alternatively, they can exchange the dollars at a bank for local currency.

The inflow of capital from abroad in turn helps finance the U.S. budget deficit. In effect, instead of soaking up money that would otherwise be invested privately, the government is running on foreign funds.

“In a direct sense,” Bergsten said, “the rise in the budget deficit generated the external imbalances.”

Bernstein is equally unimpressed by this chain of logic. The trade deficit, he pointed out, has mushroomed even though domestic productive resources are nowhere near maximum. Unemployment is stuck at 7%, and more than 20% of manufacturing capacity is idle.

Bernstein concluded that large U.S. trade deficits seem likely for the foreseeable future, no matter what the size of the budget deficit. And that, he warns, is likely to aggravate future budget deficits.

The 1986 trade deficit, he estimated, means the U.S. gross national product was 3.3% less than it would have been if all goods and services consumed here had been produced here. That in turn means the U.S. tax base was smaller and the budget deficit larger than it otherwise would have been.