LEBHEKJBUMEsnEIntereSt RatCS During a Vear of Wild Gyrations
An international economist or investor will claim that the international sentiment toward currencies, trade and the economic outlook in the United States, as seen through the eyes of investors in Frankfurt, Tokyo and London, was the principal determinant of interest rates in 1987.</br></br>Our heavy dependence on capital from foreign investors to finance both the federal budget deficit and the current account deficit (of which the trade deficit is the largest component) were the underlying factors.</br></br>The international investor considers opportunity costs in evaluating investment prospects in terms of the premium on U.S. rates over domestic rates. Consequently, faced with larger investment risks in dollar-denominated securities, foreign investors demanded larger-than-usual yields to entice them into owning U.S. bonds.</br></br>In the United States, the main problems were what to do about the dollarÛÓwhether to defend it or allow it to move lower in hopes of reversing the trade deficitÛÓand how to attract foreign capital in order to finance the trade and budget deficits.</br></br>Initially, the TreasuryÛªs dollar policy was anchored in the Louvre Accord, in which the Group of Seven industrialized nationsÛÓthe United States, Japan, West Germany, Britain, France, Canada and ItalyÛÓagreed to support the dollar while the United States made efforts to reduce the budget deficit.