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Foreign Relations, 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972 Released by the Office of the Historian Documents 1 -20 Foreign Economic Policy 1. Summary of the Report of the Task Force on U.S. Balance of Payments Policies/1/
New York, undated. /1/Source: National Archives, Nixon Presidential Materials, Transitional Task Force Reports 1968-1969, Task Force Summaries (Arthur F. Burns, 1/18/69). No classification marking. Forwarded to the President-elect under cover of a January 18 letter from Arthur F. Burns in his capacity as Chairman of the Program Coordination Committee. Burns' letter is on the stationery of the Office of the President-elect and bears a New York address. The undated, 33-page Report of the Task Force on U.S. Balance of Payments Policies, chaired by Gottfried Haberler, is ibid., Task Force on U.S. Balance of Payments Policies.
The present U.S. balance-of-payments position is very precarious. Serious deterioration in the nation's trade accounts is being temporarily camouflaged by a combination of window-dressing special transactions and an abnormal inflow of foreign capital. Existing balance-of-payments controls should be rapidly eliminated because they are wasteful and inefficient, undermine our free enterprise system, and thus reduce the rate of growth in the economy. Their dismantling is further indicated because whatever short-run payments relief they may have afforded in the past, they are now beginning to have a delayed adverse effect. Diplomatic efforts aimed at inducing other countries to hold more dollars than they normally would also should be terminated.
Given the present underlying weakness of our payments position, severe foreign-exchange pressures against the dollar could develop quickly. A series of protective actions is therefore necessary, involving the pursuit of disinflationary economic policies domestically and simultaneous reform of existing international monetary arrangements. With respect to reform, confidential negotiations with the key industrial countries through the Group of Ten should begin immediately, with the main American objective being to secure quickly a significant realignment of parities of some currencies. To provide continuing flexibility in the international monetary mechanism, this one-time realignment should be accompanied by:
(1) The establishment of wider permissible trading bands for currencies under IMF rules (with fluctuations on either side of par to range up to 2 percent or 3 percent, instead of the present 1 percent maximum). (2) The provision for automatic adjustments in parities by small amounts in instances where a currency remained at the upper or lower end of its band for some specified time period.
Discussion aimed at providing wider bands and self-adjusting pegs should proceed even if significant one-time realignment of Group-of-Ten currencies cannot be successfully negotiated. Such reform in itself would not solve the problem of outstanding dollar balances, and consequently the present de facto inconvertibility of the dollar into gold would continue. Nevertheless, a general increase in the price of gold should not be undertaken because its benefits would be distributed very unevenly and inequitably and because it would tend to fuel international inflationary tendencies. Continuation of de facto inconvertibility of the dollar into gold need not be a crucial problem so long as visible progress is being made by the United States in pursuing domestic policies that promise reduction of new infusions of dollars into the international economy and so long as flexibility is imparted to the international monetary mechanism. Foreigners recognize that any large-scale attempt to convert dollars into gold would disrupt international trade and payments and would lead to an immediate American embargo on gold exports. If for any reason this premise proves false and a "gold rush" develops, the United States should suspend gold convertibility before our gold stock declines very much below its present level. Such suspension would not necessarily lead to a radical depreciation of the dollar on international exchanges. Instead, it is likely that many countries would continue the policy of pegging their currencies at the existing parities to the dollar. In a period of transition during which convertibility was suspended, negotiations aimed at introducing new flexibility into the international monetary mechanism could proceed. 2. Editorial Note
The Nixon administration inherited a macroeconomic international economic environment characterized by declining U.S. merchandise trade and current account surpluses. The trade surplus declined from $6.8 billion in 1964 to $0.6 billion in 1968 and the current account balance had declined from a $5.8 billion surplus to, for the first time since 1959, a $0.5 billion deficit in 1968. The trade surplus remained constant at $0.6 billion in 1969 while the current account deficit mounted to just over $1.0 billion.
With postwar recovery, international capital flows had become an increasingly important part of international transactions in the 1960s. Many of these capital flows were associated with international direct investment on the part of the multinational corporations, and this issue came to a head in the 1970s under the rubric of economic nationalism in developing countries and the quest in UNCTAD and elsewhere for codes of conduct for multinational corporations. Other capital flows were associated with the increasing predilection of companies, financial institutions, and central governments to have portfolio and currency positions in other than their national currencies, in part related to the rise of the Euro-dollar market and the role of the U.S. dollar as a reserve currency. The U.S. balance on current account and long-term capital was in deficit most years from 1960, and increased from a $1.4 billion deficit in 1968 to a $3.0 billion deficit in 1969. The net liquidity balance-of-payments deficit increased from $1.6 billion in 1968 to $6.1 billion in 1969. However, the official reserves transactions balance of payments recorded a $1.6 billion surplus in 1968 and that surplus increased to $2.7 billion in 1969. U.S. monetary gold reserves had declined from $17.8 billion at the end of 1960 to $10.8 billion at the end of 1968, but then increased to $11.9 billion by the end of 1969. (The Economic Report of the President, 1973)
The perception of an increasingly precarious U.S. balance-of-payments position led the Johnson administration to take a number of measures to encourage exports, stem imports, and restrict international capital flows. Regarding these measures, see Foreign Relations, 1964-1968, volume VIII. The new administration in 1969 was faced with the question of whether or not to intensify these measures, roll them back, or adopt a new approach. The aforementioned measures, which were microeconomic in nature, were directed at single items that go into the balance of payments rather than the overall bottom line; as such they tended to be resisted by those who agreed the balance of payments needed correction but who favored a more free market-oriented, macroeconomic approach.
As to how to approach the balance of payments, one view was set out by C. Fred Bergsten in a March 26, 1969 (mistakenly dated April 26, 1969), memorandum to Kissinger commenting on Secretary Rogers' Briefing Book for his March 27 testimony before the Senate Foreign Relations Committee: "There is no U.S. policy to 'eliminate our balance of payments deficit'. The Johnson Administration sought 'a sustainable balance' in our position. This Administration has not yet stated its objective. There is a highly significant difference between the two, and the Secretary of State should definitely not say that 'we are taking every feasible step to eliminate our deficit'. This is a very important point." (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, State, Vol. II, Box 279) In many quarters foreign assistance was viewed as an important source of the problem and there were many members of Congress in 1969 who favored sharp cut-backs in economic and/or security and/or military assistance.
U.S. military expenditures abroad (aside from issues related to Vietnam) were seen by some as an important factor in the balance-of-payments equation. Senator Mike Mansfield would again sponsor legislation to reduce U.S. forces in Europe for balance-of-payments reasons. The Johnson administration had already adopted a policy for the Reduction of Costs in Europe (REDCOSTE) and had negotiated an offset agreement with the Federal Republic of Germany to compensate for the balance-of-payments cost of maintaining a U.S. military presence in Germany. President Nixon soon ordered a 10 percent reduction in official, non-military personnel abroad, Operation Reduction or OPRED, for much the same reasons. The Nixon administration from the outset was faced with next steps in the REDCOSTE program and negotiation of a new offset agreement with the FRG. With time, and the refinement of the Nixon doctrine, military burden-sharing with Europe and Japan became an important aspect of the foreign policy dialogue. In Europe this was part of NATO strategy and policy, but the underlying balance-of-payments problem was central to the debate. An early input on this issue was given by Robert E. Osgood in a March 26, 1969, memorandum to Henry Kissinger on the "Briefs for Secretary of State" before the Senate Foreign Relations Committee on March 27:
"In late 1968 the Secretary of Defense put forward a series of proposals, known as REDCOSTE, which would 'streamline' administrative and logistics and support elements. . . .
"Congressional pressures for reduction of U.S. forces in Europe have been based on the general objection that the U.S. is overcommitted and carrying an inequitable proportion of the collective defense burden in Europe. They have focused on the balance-of-payments difficulties that result from maintaining American forces in Europe. These pressures were manifested in Senator Mansfield's Resolutions of 1966 and 1967, calling for 'substantial' reductions and by the Symington Amendment, which would have denied Executive funds for more than 50,000 troops in Europe beyond December 31, 1968 (vice 405,000 in 1955, down to 320,000 in early 1969). The Soviet invasion of Czechoslovakia has blunted pressures for withdrawal, but they could well revive if projected European defense contributions are not forthcoming and the offset problem is not resolved." (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, State, Vol. II, Box 279)
Regarding the Nixon administration's handling of REDCOSTE and the German offset problem in its first months, see Documents 18 and 22. The U.S. balance-of-payments deficit and the increased foreign holding of dollar-denominated assets was a major source of new international liquidity in the 1960s, but was increasingly seen as a source of instability in the international monetary system as foreign holdings of dollars soon exceeded U.S. official reserve assets, calling the convertibility of dollars to gold into question. To help deal with this problem the Johnson administration had already set the groundwork for the creation of a new international reserve asset, the Special Drawing Rights (SDR) in the International Monetary Fund. Activation of the SDRs was one of the first tasks of the Nixon administration, and was one aspect of the new administration's effort to reform the international monetary system. The concluding paragraphs of the Summary of the Report of the Task Force on the Balance of Payments (Document 1) pointed to greater exchange rate flexibility as central to solving the balance-of-payments problem and recognized that the already de facto inconvertibility of the dollar to gold might have to be replaced with de jure inconvertibility, presaging fundamental reform of the international monetary system.
3. Action Memorandum From Richard Cooper and C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/
Washington, January 28, 1969.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. Confidential; Urgent.
SUBJECT
The President met last Friday with his new Cabinet Committee on Economic Policy./2/ It comprises his domestic economic advisers: Secretary Kennedy, Secretary Stans, Budget Director Mayo, CEA Chairman McCracken, etc. They discussed the removal of present controls over the export of funds by American banks and businesses. The sentiment was very strong for immediate removal of these controls, with little consideration of the consequences of so doing or of the actions to be taken in response to those consequences. It now appears possible that Secretary Stans will announce a change in his part of the program as early as tomorrow (Wednesday)./3/
/2/The meeting on Friday, January 24, was held in the Cabinet Room 4:03-5:40 p.m. (Ibid., White House Central Files, President's Daily Diary) The Diary lists the following attendees: Kennedy, Hardin, Stans, Shultz, Burns, McCracken, Mayo Stein, Houthakker, and Safire. See Document 9 regarding economic committees during the Nixon administration.
/3/Next to this sentence in the left margin someone wrote "not done."
This question has a high foreign policy content. No action should be taken before a thorough review of both the effects on the balance of payments and foreign, especially European, reaction to removal of the controls. Removal of the controls might well result in a substantial increase in the payments deficit, or at least widespread expectations thereof, confronting the Administration with an international monetary crisis. It would evoke a strong negative reaction from high officials in Germany, France, the Netherlands, Switzerland, and possibly other countries-a reaction that would, among many other things, undercut our efforts to work out more satisfactory arrangements for sharing the financial burden of NATO.
The NSC is the natural place to consider the foreign policy implications of our balance of payments program and a meeting is scheduled for February 26 on international monetary arrangements./4/ You should urge the President to avoid making any decision or public commitments on this question until after the NSC review and to instruct his Cabinet Members (especially Secretary Stans) not to do so either. Attached is a draft memorandum to him on the subject./5/
/4/The meeting was canceled. See Document 16 and footnote 4 thereto.
/5/Not found, but see footnote 1, Document 4.
4. Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/
Washington, January 28, 1969.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, BOP. Confidential. A handwritten note on the memorandum reads: "Copy given to Bergsten on 2/4/69." Presumably this memorandum was attached to Document 3.
SUBJECT
I understand that you have discussed with your domestic economic advisers the removal of our present controls on American investment abroad. I heartily agree with the desirability of removing the controls. However, such a move has vitally important foreign policy implications, especially with respect to our relations with Europe.
Removal of the controls must be planned carefully and, to avoid risking an international monetary crisis, probably must be coupled with new and positive U.S. policy initiatives. I therefore urge you to defer any final decision on this matter until you can review the foreign policy aspects with the NSC, and to instruct your Cabinet officers likewise to defer any decision./2/ An NSC meeting on international financial matters is now scheduled for late February./3/
/2/Next to this sentence the President wrote "I agree."
/3/Next to this sentence the President wrote: "I believe Kennedy, et al think we should act sooner-check with McCracken (who is the W.H. man in charge of this area) and set an earlier date for N.S.C. meeting if his check with the principals involved believe it is advisable." McCracken sent more or less weekly reports to President Nixon on balance-of-payments related matters, even after the President said he no longer needed to see them in early 1970; see Document 38. The NSC meeting was canceled; see Document 16 and footnote 4 thereto.
5. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Petty) to Secretary of the Treasury Kennedy/1/
Washington, January 28, 1969.
/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Studies and Reports, Volume 7, 2/68-11/69. Confidential; Limdis. Drafted by Petty on January 28. Copies were sent to Under Secretaries Walker and Volcker. A handwritten notation reads: "(Note: very limited distribution) per [T. Page] Nelson (Jan 31)."
SUBJECT
Weighed against the obvious domestic political advantages of the abrupt removal of controls/2/ are: (1) the adverse foreign reaction it will create and the fallout of this reaction on (a) the SDR ratification and implementation, (b) monetary reform, (c) options available in crises, and (d) speculation for an increase in the official gold price.
/2/In a January 28 memorandum to Secretary Rogers entitled "Abolition of Interest Equalization Tax and Balance of Payments Controls on Direct Investment," Greenwald informed Rogers that at a meeting of the Economic Cabinet, most of the group, including the President, wanted to terminate the controls immediately but that final action had been put off for several days at the request of the Council of Economic Advisers. (National Archives, RG 59, Central Files 1967-69, FN 16 US) Presumably Greenwald was referring to the January 24 meeting (see footnote 3, Document 3), which the full Council of Economic Advisers attended.
A quick removal of controls, as viewed abroad, would not be justified by the U.S. balance of payments statistics, the underlying trend of our position or the state of our domestic economy./3/ It would signal that the new Administration
/3/A January 28 covering memorandum from Petty to Kennedy referred to a January 27 memorandum from Petty to Kennedy (attached) that put the balance-of-payments cost at least $2,100 million if the direct investment program were abandoned for 1969. (Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Studies and Reports, Volume 7, 2/68-11/69)
--has lowered the priority of achieving equilibrium,
None of this would heighten their interest in pushing rapidly forward on the SDRs. In fact, a quick removal of controls could seriously jeopardize our efforts in all monetary areas. It would be regarded as leading to a substantial liquidity deficit in 1969, and possibly result in renewed gold losses to central banks.
Commerce will be announcing tomorrow a trade deficit for December-and this will not reassure anybody.
U.S. leadership in monetary reform is necessary if progress is to be made. Speaking from a position of strength is vital to our capacity to direct the course of events. As a review of the monetary system is high on the priority of this Administration, we must be careful not to inhibit our conduct of this review by appearing to belittle the responsibility of the deficit country in the balance of payments adjustment process.
The high priority we are giving to contingency planning/4/ is a testament to the tenuous state of the international financial system. If a crisis such as that at Bonn,/5/ or worse, occurs in the next few weeks, having done away with our controls would dangerously limit our options and undermine our capacity to control events in such an atmosphere!
/4/Reference is to contingency planning for an international monetary crisis; see Documents 110 ff.
/5/Reference is to a significant increase in holdings of dollars by the Federal Republic of Germany.
We are in the process of preparing proposals to liberalize our controls and these alternatives-together with their costs and benefits-should be available shortly.
6. Volcker Group Paper/1/
VG/LIM/69-50 Washington, February 6, 1969. /1/Source: Washington National Records Center, Department of the Treasury, Volcker Group Masters: FRC 56 86 30, VG/LIM/31-VG/LIM/50. Confidential; Limited Distribution. Circulated to members of the Volcker Group on March 18 under cover of a routing memorandum from Willis that indicated the paper was discussed at a February 28 meeting. ALTERNATIVES FOR A SOMEWHAT RELAXED AND REVISED
Question: What steps toward relaxation of the control programs might be taken and what might this cost?
I. Balance of Payments: Position and Outlook 1969 balance-of-payments projections present a bleak picture. The anticipated gain in the trade balance and the current account in general is more than offset by an anticipated reduction in foreign private capital inflow.
The trade projection assumes continuation of the 10% surtax and of current monetary policy; a GNP growth (current dollars) of 7.1% as compared with 9% last year; and less pressure on productive capacity.
The projected growth of total imports from 1968 to 1969 is only 5.2% (at mid-point of range). But, excluding autos and parts imports from Canada, exceptional food imports in 1968, and strike-induced imports in 1968, the growth is projected at about 8%.
The export projection assumes an 8% increase in industrial production in other advanced countries, compared with an 8.8% increase last year. The projected growth of total exports from 1968 to 1969 is 9.3% (at mid-point of range). But, excluding autos and parts exports to Canada, commercial aircraft, and agricultural products, it is 11.9%.
The capital projections assume no change in the IET, or in the Commerce and Federal Reserve programs beyond the changes already announced. Finally, no substantial change in expenditures in connection with the Vietnam conflict is assumed.
1969 Projected Over-All Balance of Payments
The major items projected for 1969 by an interagency working group are shown in the following table. Most of the 1968 figures are still estimates.
1968 (bils. of $'s) 1969 (proj.) Improve or Exports 33.4 35.7-37.3 Imports 33.3 34.5-35.5 (a) Trade balance (at mid-point of 1969 range) 0.1 1.5 1.4 (b) Services bal. (incl. private remittances and govt. pensions) 0.8 1.1 0.3 of which (Direct investment income, fees & royalties) (6.3) (7.0) (c) Current account bal. 0.9 2.6 1.7 (d) Direct investment (before deduction for funds borrowed abroad) -3.3 -3.6 -0.3 (use of funds bor. abroad) (2.2) (1.5) (-0.7) (Net) (-1.1) (-2.1) (-1.0) (e) Bank claims 0.3 -- -0.3 (f) Other private U.S. capital -1.7 -1.2 0.5 (g) U.S. Gov't. capital (incl. economic grants) -4.3 -4.2 0.1 (h) Foreign private capital inflow: Direct investment in U.S. 0.4 0.2 -0.2 Loans to finance U.S. direct invest. abroad 3.1 1.3 -1.8 Stock purchases (excl. $210 mil. Shell pur. in U.S. sub) 1.7 1.0 -0.7 (i) Errors and omissions/*/ 0.1 -- -0.1 Subtotal -2.8 -3.9 -1.1 (j) Receipts from Foreign Gov'ts: (or internat'l. instit., other than IMF) 2.9 not est. for last two items. Military advance payments(- means run-off). (-0.1) (-) (0.1) Purchases of U.S. agency bonds by internat'l. instit. (0.1) (-) (-0.1) Debt prepayments (0.3) (-) (-0.3) German pur. of special Treasury issues, incl. $125 mil. by German commercial banks in 1968 (0.6) (0.5) (-0.1) Other Gov't. purchases of special Treas. issues (1.4) (not est.) Purchase of medium-term U.S. bank CD's (0.6) (not est.) "Liquidity" Balance 0.1 -$3.9 less total receipts obtained under (j)
/*/During 1960-67, the U.S. had consistent deficits in "errors and omissions," averaging -$600 mil. (-$210 mil. to -$997 mil.). The small estimated surplus in this item for 1968 could turn out to be merely a temporary favorable shift, possibly associated with unusually large capital receipts last year.
Some of the above projections such as foreign stock purchases here this year are obviously not much more than "guesstimates." But the projections clearly indicate that given the assumptions, a major adverse swing in our balance of payments this year is very likely.
With regard to foreign government investment in special Treasury issues and medium-term U.S. bank CD's, it should be noted that $911 million of the former mature in 1969 ($800 million held by Canada and $111 million held by Switzerland). About $2.4 billion of long-term bank CD's held by various foreign governments mature in 1969. Even if all these were rolled-over in the same amount, as assumed in the above projections, there would be a deterioration of that amount in the 1969 position relative to 1968 when such foreign government investments showed a net increase.
While no formal projection of the U.S. balance of payments beyond 1969 has been made, the probability of a continued deficit of a worrisome size is high.
II. Alternatives in Revising the Balance-of-Payments Program
Steps to move away from the restrictive aspect of the present program may need to be commenced promptly. This might involve a relaxation--beginning soon--which would entail some risks and the likelihood of an increased capital outflow. It might also involve the need, for balance-of-payments protection, of a continued tight money policy, even if there is some easing in domestic inflationary pressures. A relaxation of controls would be a clear step in the direction of removing them, without throwing caution to the winds.
A. The Direct Investment Program A revised program involving a relaxation of direct investment controls has three basic alternatives: (1) modification and relaxation of the existing program; (2) shifting to a voluntary program; (3) abandonment of the investment controls.
Options available in each of these general alternatives are discussed below. (It should be noted that an FDIP report to be filed by direct investors by February 28 will give the first complete projection of 1969 direct investment plans, including projected capital outflow, use of foreign borrowing, earnings, and dividends to U.S. parents. Results from this report will not be available until sometime in March.)
1. Modifying and Relaxing the Existing Program
There are four primary areas in which this may be done:
(a) Increase the level of minimum authorized investment. This is presently proposed as $300,000 for 1969, compared with $200,000 in effect in 1968. We would estimate that the balance-of-payments cost of increasing the level to $500,000 would amount to approximately $60 million and would relieve some of the burden of the Foreign Direct Investment Program for approximately 200 companies. Should the level be increased to $1 million, the additional balance-of-payments cost (over the $300,000 level) would amount to $160-200 million, with about 350 companies benefiting.
(b) Increase the elective earnings allowable from its present proposed 20 percent level to 30 percent. (The 20% proposal differs in several respects from the automatic exemption for a certain minimum level of direct investment described in (a) above. It is an optional method of determining a company's allowable direct investment in all cases where the minimum exempt amount is exceeded; hence, it is an alternative to the base-period investment method. This optional method would allow a firm to make direct investment in 1969 not less than 20% of its direct investment earnings in 1968. Data on the latter for the fourth quarter, 1968 are not due from direct investors until February 14 and some time will be required for processing, so that the figures below must be regarded as preliminary estimates.)
The net additional cost of a 30% earnings allowable would be an estimated $220 million, and approximately 85 companies would benefit. Raising the percentage to 40% would cost $530 million over the announced 1969 program cost and 160 companies would benefit. Increasing the percentage to 50% would involve additional payments costs of approximately $1 billion over the announced 1969 Program level, with over 230 companies benefiting.
(c) Exemption from the program of transactions with affiliated foreign nationals solely involved in a selling capacity. We do not have trading company data, but crude estimates based on available information suggest balance-of-payments costs on the order of $100 million. Companies with which this idea was floated expressed no interest in it, presumably because they feel the pressure of the present ceilings much more with respect to investment in their production affiliates than in their trading affiliates abroad. Also, they believed accounting and definitional problems would be unsurmountable. (d) There has been a great deal of discussion about the possibility of collapsing Schedules A, B and C into a single schedule. This would do a great deal to simplify the regulations, reporting requirements, and administration of the program, and would be widely acclaimed by the business world. Data for estimating the payments cost of such a move will not be available until March. However, we would guess that the cost would be substantial--say, $1 billion--for the following reason. Many companies find their present quotas partially unusable because these are locked into area schedules where the companies have no specific investment plans.
The attached tables summarize the effects of the above proposals and provide a rough projection of the direct investment situation./2/
/2/None of the attached tables is printed.
We have not attempted to assess the incidental balance-of-payments costs, or benefits, that might attend a liberalization of the direct investment program-for example, the effects on foreign government and exchange market confidence in the dollar, and on U.S. exports and imports. These effects could, of course, be substantial.
2. Voluntary Program
Shifting to a voluntary program would depend upon the cooperation of a few hundred companies.
Information gathered this past year greatly increases the capacity to choose those companies which would most appropriately be included in a voluntary program. But a 1969 projection of direct investment by U.S. companies and a sources-and-uses-of-funds forecast with respect to their foreign affiliates would be needed to conceive a voluntary program adequately. This material will be gathered, hopefully, by the end of April; and a proposal could be in shape for announcement some weeks later.
Among the basic questions which would have to be covered are:
In case borrowing costs in the U.S. decline relative to Europe, would companies be willing to maintain their existing outstanding indebtedness in Europe rather than refinance it in the U.S.? Would they be willing to do a large portion of new borrowing in Europe, rather than in the U.S. for direct investment purposes? Would they insist on counting exports as an offset to their direct investment outflows?
3. Abandonment of Direct Investment Controls
Abandoning controls would cost $2 billion or more--compared to what it was in 1968--depending upon the extent to which companies would refinance in the U.S. foreign debt created in prior years and where they would raise funds for new direct investment.
B. The Federal Reserve Program
The announced 1969 program left the bank program ceiling at essentially 103 percent and made no significant changes in the Program. The Fed resisted the general preference to exempt medium-term export credits, as did the OFDI, which would be greatly affected by such an exemption. It was felt that no major change should be made before the new Administration had had an opportunity to review the over-all U.S. balance-of-payments program.
It was announced last December that the Fed would review the Program early in 1969, and Governor Brimmer is now in the process of discussing with banks and other financial institutions their experience under the Program. The main considerations of the Program review are the reduction of inequities among financial institutions covered by the Program, and the methods that might be used to resolve any conflict between the need to stem potential dollar outflows and the need to assure that funds necessary to finance U.S. exports are available. In order to stimulate consideration by the banks of various alternatives, he has mentioned the following as examples:
(a) extending the IET to cover foreign credits and investments now covered only by the VFCR, including short-term bank loans;
(b) establish a special reserve requirement against credits to foreigners;
(c) create an auction system related to the total amount of bank lending to foreigners;
(d) make changes within the present program to minimize inequities, especially for the smaller banks;
(e) making special provisions to facilitate exports.
Suggestions (d) and (3) would overlap to the extent that higher ceilings approved for small banks would be concentrated on export credits.
The meetings of Governor Brimmer with institutions covered by the VFCR extend to March 11, and recommendations will then be made by the Governor to the Board. The range of possibilities for some relaxation and simplification is quite large, and judgments of the balance of payments cost will vary depending on the extent to which additional extensions of credit are expected to stimulate exports that otherwise would not occur. Pending completion of the review by the Board no recommendations are made here.
C. Interest Equalization Tax
The IET rate is presently 18.75 percent on purchase of long-term debt (28-1/2 years or more) and equity securities. This is roughly equivalent to an annual cost of 1-1/4 percent.
The IET has operated as nearly an absolute barrier for American lending to foreign borrowers. Virtually no IET collections have been associated with loans to foreigners or purchases of foreign bonds.
Collection data show that well over half the IET payments in over four years were associated with American purchases of South African gold mining shares. Most of the balance came from purchases of outstanding issues of Canadian mining stocks and a few "special situation" issues. U.S. speculators in foreign mining shares have generally been able to resell "tax-paid" shares in the U.S. market at prices equal to or exceeding what they paid the foreign issuer plus IET.
We cannot predict with any precision what rate constitutes the threshold for substantial outflows based upon interest differentials alone. But an example of the potential for such outflows is the large volume of attractive convertible bonds issued abroad by U.S. companies in recent years to finance direct investment. A substantial reduction of the IET would seem very likely to encourage U.S. private purchases of these issues and thus defeat the purpose of the Foreign Direct Investment Program-that is, the encouragement of use of foreign capital for financing U.S. direct investment.
A reduction to one percent per year would not entail a substantial increase in capital outflow under the existing structure of interest rates here and abroad. A reduction to three fourths of 1 percent would be more risky because a sizeable pent-up U.S. demand for foreign issues probably exists, and a sizeable reduction of the IET could trigger it off, not only because of the reduced tax per se but also because of the psychological impact of a substantial liberalization step.
Also, interest differentials between here and Europe could shift by mid-summer sufficiently to make a three fourths percent rate quite costly and even a one percent rate costly.
The attached tables show IET collections and interest rate differentials. (The collections data suggest that from $850 million to $1 billion of foreign stock was purchased by U.S. investors during the period October, 1964, through October, 1968.)
The IET has related effects which must be borne in mind in evaluating changes in the rate:
--it facilitates the pursuit of an autonomous domestic monetary policy;
--it stimulates development of the European capital market;
--it facilitates operation of the Federal Reserve Program by relieving the pressure on U.S. banks of foreign demands for credit;
--it restrains capital outflow to developed countries through channels not covered by other programs.
Since the need for these related effects may continue well beyond the expiration of the IET in July, 1969, continuation of the IET, at least on a standby basis, should be seriously considered.
7. Memorandum of Conversation/1/
Paris, March 2, 1969, 12:41-1:49 p.m.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Presidential/HAK Memcons, Box 1023, De Gaulle 2/28-3/2/69. Secret. The meeting was held at the Elysee Palace; the time is taken from the Daily Diary. (Ibid., White House Central Files, President's Daily Diary) The two Presidents also met on February 28. Their discussion touched on economic issues, and President Nixon told de Gaulle that he thought "it was clear that both the USSR and the US would like to reduce the financial burden [of defense expenditures] on themselves. He wished to make clear that on this matter he would not make the decision in this matter on a financial basis, the US had to be able to afford whatever security required." (Ibid., NSC Files, Presidential/HAK Memcons, Box 1023, De Gaulle 2/28-3/2/69) The two also met on March 1; a record of that meeting is ibid. President Nixon traveled to Belgium, the United Kingdom, the Federal Republic of Germany, Italy, and France February 23-March 2.
PRESENT
[Here follow brief opening remarks.]
The President said that he would like to have an understanding with General De Gaulle that if either of them wished to communicate directly with the other they could do so by private letters and such relations need not necessarily pass through the usual diplomatic channels. For any private matters below the Chief of State level, General De Gaulle could have his people communicate with Dr. Kissinger.
General De Gaulle asked whether Dr. Kissinger himself would bring the letters.
The President said that this would not necessarily be so, but he might find the need at some time to send Dr. Kissinger over. He said that sometimes it was useful to avoid communications that were too formal in nature.
General De Gaulle agreed and said he would bear this in mind.
The President said that, insofar as discussions on monetary matters were concerned, he felt that the suggestion that these could be handled privately and discreetly through a special representative was a good one, and we would be prepared to talk with whoever the General might designate to represent France on such matters.
General De Gaulle said that after the President returned to Washington he would let him know who the French would appoint. This person, of course, would have an unofficial mission and would not be charged with settling matters but rather to take contact with his American counterpart./2/
/2/No record of an appointment of a special representative has been found, although continuing expressions of French interest periodically surfaced. On February 5 Houthakker wrote in a memorandum of a February 4 dinner conversation with the Financial Counselor of the French Embassy, George Plescoff, of the latter's "pitch" for bilateral U.S.-French conversations "on the entire range of international monetary problems." (VG/LIM/69-12; Washington National Records Center, Department of the Treasury, Volcker Group Masters: FRC 56 86 30, VG/LIM/1-VG/LIM/30) During Plescoff's introductory call on Treasury Under Secretary Volcker on February 19, Plescoff said he had not sought to have regular official contact with Treasury in recent years due to policy differences but that he now wished to develop a close and regular working relationship. Volcker thought conveying this message was the main purpose of his call. (Ibid., Files of Under Secretary Volcker: FRC 56 79 15, France) During his March 18 introductory, courtesy call on Treasury Secretary Kennedy, French Ambassador Charles Lucet said that "France hoped the United States would eventually take the initiative to arrange some quiet, unpublicized talks on the problem of international monetary reform." (Ibid.) In an April 19 memorandum to Secretary Rogers, reporting on his April 9 conversation with French Foreign Minister Debre during the April 10-11 NATO Ministerial meeting in Washington, Kissinger reported: "Debre raised the possibility of very confidential US-French conversations, recalling that this idea had been broached previously at the time of the President's visit to Paris." (Ibid.)
The President agreed to this.
General De Gaulle then asked whether the President had made similar arrangements with the British and the Germans.
The President said that this had not been done. We would talk with them in a more formal way. Both the British and the German Finance Ministers would be coming to the US, but he wondered whether the General felt it might be better to handle these matters with them in the same way as the French.
General De Gaulle said that he did not see any reason to do this.
The President then said that it was better if the conversations were conducted somewhat discreetly as formal discussions gave rise to speculation on the price of gold and so forth. The discussions would be initially exploratory.
General De Gaulle then repeated that he would notify the President, after his return to Washington, who the French representative would be and reiterated that this man would be an unofficial representative.
The President said he felt that one could not make much progress when one was working in a goldfish bowl. On other matters of consultation, our Secretary of Commerce, Mr. Stans, would soon be coming to Europe. His discussions would be strictly on matters of trade and in a broad sense. He would not get into matters such as the Common Market and who should belong to it. Rather he would discuss such matters as trade and restrictive practices which we or others might have. His policy would be not to have our Government play as active a role as in the past in attempting to determine the shape and form of Europe. We had ideas which we would submit, but we felt that this was essentially a matter for Europeans.
General De Gaulle said that there was GATT and it was normal for our Ministers to speak of this agreement and its application.
[Omitted here is a lengthy discussion of Vietnam.]
8. Memorandum of Conversation/1/
Washington, March 11, 1969, 10 a.m.
/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Studies and Reports, Volume 7, 2/68-11/69. Confidential. Drafted by Petty on March 13 and approved by Volcker. The meeting was held in Room 4426 of the Treasury Department.
SUBJECT
PARTICIPANTS
Treasury:
State:
Commerce:
Federal Reserve:
CEA:
BOB:
White House:
Under Secretary Volcker introduced the discussion by giving a brief report on the foreign exchange markets which indicated that the pressure on the French franc and the pound sterling was modest and the atmosphere of last Thursday/2/ no longer prevailed. Mr. Volcker referred to the proposed Memorandum to the President/3/ and indicated that the proposed relaxation could cost in balance of payments terms an amount in the neighborhood of $1 billion, depending upon various developments. He reported that the staffs of the various agencies expressed considerable caution at the idea of moving ahead now to relax controls to the degree indicated. The primary concern was about the probable negative reaction abroad to such a relaxation. Foreigners would grumble that this relaxation will finance takeovers by American companies; it would make more difficult the activation of Special Drawing Rights, and it could impede the talks on monetary reform. Finally, Mr. Volcker reported that the IMF Managing Director Schweitzer suggested caution about the idea of relaxing controls and said that the cost could be reduced by not including the Federal Reserve Program in the relaxation.
/2/March 6.
/3/Reference is to a draft memorandum to the President on "Relaxation of Balance-of-Payments Controls," which was circulated by Kennedy to the Secretaries of State and Commerce, the Budget Director, and the Chairmen of the Federal Reserve System and the Council of Economic Advisers on March 7, under cover of a memorandum inviting them to the March 11 meeting to discuss the draft. (Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence, 1966-1970: FRC 56 74 7, Memo to the Secretary, March-April, 1969) An earlier version of the draft memorandum to the President, dated March 3 with the subject line, "Reversing the Trend Toward Restrictions by Beginning the Relaxation of Controls," is ibid., Deputy to the Assistant Secretary for International Affairs: FRC 56 83 26, Current Problems and Contingency Planning 11/68-4/69. See Document 15 for the memorandum that was sent to the President on April 1.
Mr. Volcker closed with the question: Should the Federal Reserve be part of the relaxation? And what should be the timing of the announcement?
Secretary Kennedy pointed out the difficulty of the choice in view of the bad balance of payments numbers which are projected. "If we do nothing now," he said, "we get locked into the ways of the past; on the other hand, we do not want to touch off an adverse market reaction with possible side effects that are unpredictable."
Secretary Stans indicated that he was leaving for Europe on April 11, and he would not want to have the relaxation announced a week before he would go--as he would have to spend most of his time explaining the action. Second, he underscored the importance of an early announcement by pointing out that presently, regulations do not exist for the foreign direct investment program for 1969; and, to be fair to the corporations, they must come out shortly. Finally, he indicated that most of the advantages to the Administration would be attained through the OFDI relaxation, and therefore it is possible that it could be done separately.
Secretary Rogers indicated that President Nixon during his trip agreed to undertake consultations with the Europeans, and he indicated that it would be appropriate to do that on this matter. Mr. Volcker said that the Europeans would be likely to say: "No." Secretary Rogers indicated that this is what consultation is all about. Secretary Kennedy commented that, in view of this, Mr. Volcker should propose to consult in Europe on this matter.
Counsellor Burns doubted that the balance of payments deficit as projected would be increased to the extent indicated. He added that consultations may occasion long delays in the announcement if they are undertaken thoroughly. The Europeans are concerned about the trade policies of the United States, and they do not understand the details of the OFDI. What they are anxious to avoid is a unilateral action in the trade area.
Chairman McCracken commented that there are different dimensions to foreign concern about the U.S. balance of payments. One concern is they would argue that we are taking the wraps off of our companies, permitting them to buy out European corporations. And the second concern is that we get on top of our inflationary problem. He supported the relaxation and pointed out it carried a greater obligation to control inflation at home.
Counsellor Burns said the fact the domestic economy was going too fast and the fact that the relaxation carried a greater obligation to control inflation provided all the more reason to pursue the course of relaxation of controls now. If we can announce our expenditure policy for fiscal 1970, the President's proposed balance of payments statement would be greatly strengthened.
Secretary Rogers doubted if more pressure to control inflation were needed--there is no lack of consciousness or determination in this regard. Secretary Kennedy added that we are not getting the budgetary cuts he would like to see.
Mr. Houthakker suggested that the relaxation could be presented as primarily a technical adjustment. Counsellor Burns said the matter was broader than that, and the announcement should be too: we should add the continued deferment of withholding tax on interest paid on foreign deposits. We must decide now whether we do or do not have a philosophy as a government; we must declare we are moving away from creeping restrictionism. The Europeans are as afraid as we are of the trend toward restrictionism.
While Secretary Stans did not feel there is any need for a ballyhoo statement because American interests would understand the significance of the move, Counsellor Burns felt that the President needed to state his principles now.
Mr. Petty inquired if an announcement of this sort was really of the nature that would require consultations; it is nowhere near the league of NPTs or ABMs. Secretary Rogers replied that the statements on the President's trip did not imply any limits to consultation.
Director Mayo indicated that any announcement would be strongly reinforced with an announcement on expenditure cuts and an extension of the tax surcharge.
Chairman Martin summarized his views and said that it would be appropriate to undertake consultations on this subject, but he emphasized that these consultations should be at the political level and not with the central banks or even with the G-10 Deputies. Mr. Volcker should make it clear that the United States is choosing general restraint over selective controls and we would take whatever steps necessary to control inflation.
Secretary Kennedy summarized: Mr. Volcker would go and make the necessary consultations, he would present this action in a positive manner and indicate that this Administration would seek an extension of the Interest Equalization Tax, an extension of the surtax, and include appropriate expenditure controls, as well./4/
/4/C. Fred Bergsten reported on this March 11 meeting to Kissinger in a March 12 information memorandum. He informed Kissinger that Burns and Stans had resisted Rogers' insistence on consultations and had been overruled by Kennedy. Bergsten wrote: "any decision to relax the present controls has been postponed. . . . Treasury Under Secretary Volcker will thus raise the issue in his upcoming European trip. He will inform them that we plan to reduce our reliance on controls but will seek their views on timing and complementary steps. This approach will stand in marked contrast to that of the previous Administration, which enacted the entire control program-a much more drastic step than the marginal relaxation now envisaged-and then sent teams to Europe and the Far East to inform them of the action. In fact, it could be argued that it is stretching the President's commitment quite far to consult on an issue of this magnitude. However, I supported Rogers on the grounds that any unilateral action should be avoided so shortly after the trip." (National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, BOP) Under Secretary Volcker traveled to Bern, Bonn, Brussels, The Hague, Rome, and Stockholm March 21-26.
John Petty
9. Editorial Note
On March 14, 1969, Cabinet Secretary John C. Whitaker sent a memorandum to all members of the Cabinet asking their opinions on Cabinet Committees established by Executive orders of previous Presidents. Whitaker noted that President Nixon thought there were too many such committees, which duplicated those established by the Nixon administration or no longer served a useful purpose. On the foreign economic policy front Commerce Secretary Stans was given responsibility for making recommendations on the Export Expansion Advisory Committee, which provided guidance to the Export-Import Bank on allocations to promote export expansion, and Treasury Secretary Kennedy was to make recommendations on the National Advisory Council on International Monetary and Financial Policy (NAC), whose functions were to coordinate the activities of the U.S. representatives to International Financial Organizations and the Export-Import Bank. (National Archives, RG 59, S/S Files: Lot 73 D 288, Box 839, NSC/MTS) On April 14 Secretary of State Rogers wrote to Secretaries Stans and Kennedy supporting their committees as presently constituted. (Ibid.) Both committees continued to meet during the Nixon administration.
On June 2 Whitaker sent a memorandum to all members of the Cabinet transmitting a revised list of Cabinet committees and subcommittees, including the following committees that dealt with foreign economic policy:
The Cabinet Committee on Economic Policy, whose members were Vice President Agnew, White House Counselor Burns, Treasury Secretary Kennedy, Agriculture Secretary Hardin, Budget Director Mayo, Labor Secretary Shultz, Commerce Secretary Stans, and Council of Economic Advisers Chairman McCracken, who was responsible for staff support;
The Economic "Troika," which comprised Treasury Secretary Kennedy, Budget Director Mayo, and Chairman McCracken;
The Economic "Quadriad," made up of the Troika plus Federal Reserve Chairman Martin; and
The Committee for Comprehensive Review of Oil Import Controls chaired by Labor Secretary Shultz. Other members were Interior Secretary Hickel, Treasury Secretary Kennedy, Defense Secretary Laird, Secretary of State Rogers, Commerce Secretary Stans, Office of Emergency Preparedness Director Lincoln, and Phillip Areeda who provided staff support. (Ibid.)
The Cabinet Committee on the Balance of Payments, which had played an active role in balance-of-payments policy during the Kennedy and Johnson administrations, was not mentioned in either of Whitaker's memoranda. Deputy Assistant Secretary of the Treasury for International Affairs John C. Colman commented in an April 17 memorandum to Under Secretary Volcker that the committee might be beyond the scope of Whitaker's inquiry because it had been initiated by a June 7, 1962, memorandum from President Kennedy to Treasury Secretary Dillon, not by Executive order. Colman noted that as the balance-of-payments problems became more pressing and the various programs of restraints and incentives became more detailed, the Deming Group, now the Volcker Group (see footnote 1, Document 109) increasingly shaped policy rather than the "unwieldy" Cabinet Committee. The conclusion of Colman's argument was that balance-of-payments issues should be taken up in the Cabinet Committee on Economic Policy and the Volcker Group. (Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 75 101, Cabinet Committee on the Balance of Payments, US/3/106-113, Establishment and Representation) Regarding the establishment of the Cabinet Committee on the Balance of Payments, see Foreign Relations, 1961-1963, volume IX, Document 10.
No formal record of the Cabinet Committee on the Balance of Payments' demise has been found, nor any record that it met during the Nixon administration.
10. Paper Prepared in the Department of the Treasury/1/
Washington, March 17, 1969.
/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Studies and Reports, Volume 7, 2/68-11/69. Confidential. The paper, which bears no indication of a drafter, may have been prepared for the President's meeting with the Economic Quadriad on March 18 (see Document 12) or for Volcker's European consultations (see footnote 4, Document 8).
TALKING PAPER ON REVISED BALANCE OF
The Nixon Administration views with great concern the growing trend toward restrictionism around the world. Restraints on capital flows are now being reinforced by restraints on the trade account and the pressure in this area is mounting. We have not succeeded if a system of reasonable international equilibrium can only be obtained through excessive demand restraints coupled with selective restrictions. We believe that the process by which international payments between nations are adjusted must be improved in order that equilibrium relationships can be maintained without selective controls.
1. The selective controls on Direct Investment of the Johnson Administration were put together hurriedly; of necessity, inequities arose in the base periods selected. We have now had the benefit of statistical runs for 1968, and we consider it desirable and proper to make adjustments in the direct investment program which will have the effect of:
a. Substantially reducing the administrative burden, both to the Government and to the smaller corporations;
b. Providing some relief for those companies which were caught with an inequitable base period;
c. Relaxing somewhat on the restrictions on the amount of earnings retained abroad--which should help the situation on foreign borrowings:
("Help the situation": for us means that those companies which have had to repatriate more than 80-100 percent of earnings because of the formula will only have to repatriate 70 percent; this allowance should also help them repay foreign debt from the proceeds of their operations abroad; the Europeans if they interpret the statement favorably might see it as a slight easing of demand upon their banking resources which would help the debt "overhang" problem of our companies and also help to ease rates; others could interpret a relaxation as providing all the more money for takeovers.)
2. The Interest Equalization Tax, as you know, was created to remove the interest incentive which the lower money rates in New York usually allowed over comparable rates in European markets.
It seems to us that under present circumstances and with the tight money conditions in the U.S. that an adjustment in the IET rate is warranted. Congress gave us flexible authority to vary the rate with money conditions and since this is a unique delegation of authority we must use it when conditions warrant; otherwise, when we go to extend this legislation next year, Congress may withdraw that power.
3. The Federal Reserve Program has hit pretty hard the small and medium-sized banks who were left without a base period, and we may announce some modification or changes designed primarily to make the regional banks be more active in promoting exports.
Any attempt to put a balance of payments price tag on these intended steps would be misleading because the numbers involved in adjusting the targets in these complicated programs are difficult to translate into year-end balance of payments results. Basically, we have had the approach of not making the changes so small that they are unnoticeable; nor so large that they demonstrate a lack of caution.
Conclusion
Increasingly, our main thrust in balance of payments adjustment will be upon general measures rather than selective controls. There is no doubt about the determination of this Administration to recreate a proper balance in our economy. We will employ monetary and fiscal policy to the extent necessary and for as long as necessary to achieve this type of economic order. While we will be reversing the trend toward restrictionism by our intended modest relaxation we know full well that until general restraints have done their task, selective controls cannot be abandoned.
11. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Petty) to Secretary of the Treasury Kennedy/1/
Washington, March 17, 1969.
/1/Source: Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence, 1966-1970: FRC 56 74 7, Memo to the Secretary, March-April, 1969. Limited Official Use. Drafted by J. C. Colman on March 17. Sent through Volcker. A stamped notation indicates that Volcker initialed the memorandum. It is attached to Volcker's March 18 handwritten transmittal note to Kennedy: "My only added thought here is that the 'soundings' should be coordinated with proposed announcement on controls. This extension should be proposed, in general terms, at time of relaxation." Kennedy's handwritten reply on Volcker's note reads: "I agree. After the extension is proposed begin checking in Congress to determine whether any changes should be made."
SUBJECT
The Problem
The IET expires on July 31 of this year. In view of the necessity for Congressional consultations and the likely extensive drafting time, we must plan now for the extension.
Congress has never been favorably disposed toward the IET but rather has supported it because of its necessity. The tax was proposed in 1963 and the Act only passed a year later. The Act has been renewed twice, in 1965 for 18 months and in 1967 for two years. In the most recent extension, the maximum rate of tax was increased (from one percent to 1-1/2 percent per annum) and the President was given discretionary authority to vary the rate of tax. Our problems with the balance of payments are still with us and undoubtedly will continue to be after July 31. Therefore, we will need the IET, at very least on a standby basis, as a means to restrain capital outflows from the United States. The IET has been very useful in effecting such restraint on portfolio outflows and bank lending to foreign borrowers and has supplemented both the Federal Reserve and Commerce Department programs. These are reasons enough to continue the tax.
The IET also will provide a very flexible policy instrument in the future when it may be appropriate to relax our monetary policy at least for domestic purposes. We would not want to be constrained from taking this action in fear of substantial capital outflows. Accordingly, extension of the IET will preserve our ability to carry out a relatively autonomous monetary policy.
In the prospective phasing out of our capital controls, there is the possibility that we may face large capital outflows by U.S. residents. There is undoubtedly substantial latent demand to purchase foreign securities or Euro-dollar convertible debentures issued by American corporations in recent years as well as to lend to major foreign borrowers. Therefore, to permit better phasing out of our capital controls and to mitigate these incipient outflows, we should retain a flexible IET.
Possible Legislation
The IET Act now on the books is a workable and effective instrument. There are a number of technical points, both substantive and non-substantive, which could be clarified in renewal legislation. However, if such amendments were to jeopardize the prospect of renewal, it would be entirely feasible to continue the IET without amendment.
Renewal is strongly recommended for the reasons cited above. If Congressional soundings indicate any substantial opposition or complications from an attempt to introduce amendatory legislation, then we should seek renewal without amendment.
The tax rate may now be varied from zero to 22.5 percent of the value of the security or loan subject to tax (equivalent to a maximum interest rate of 1-1/2 percent per annum). The President has the right to vary the rate by Executive Order. The maximum rate has proved to be effective in restraining almost all outflows for debt securities and loans and most equity securities other than speculative mining stocks. Accordingly, there is no reason to seek a higher statutory maximum rate or any change in the discretionary authority to alter the rate.
The IET rate now must move together for the tax on acquisition of both stocks and debt instruments. In the past, Treasury has always rationalized the IET rate in relation to debt issues. There is very little economic basis for holding that the IET rate should move together on both debt and equity issues. It thus might be preferable to consider having the tax move separately, at the discretion of the President, and possibly to set a higher maximum rate of tax for the purchase of equity securities. However, such a proposal would draw the opposition of the investment community as it has in the past, present substantial drafting and administrative problems and likely complicate renewal legislation. Accordingly, it appears favorable not to introduce any amendment in this area.
An amendment should be considered to give the President discretionary authority to exempt new issues from the application of the tax while retaining the tax on outstanding securities. We have such a precedent established in the present exemption of new Canadian offerings from the tax while the IET barrier still applies for outstanding Canadian securities. The introduction of such discretionary authority on a global basis among the developed countries wherein the IET applies, would give a new degree of flexibility for phasing out our capital controls. In particular, this would give more latitude to permit a limited amount of capital outflows for new financings in the U.S. markets without incurring substantial risk of large portfolio capital outflows to purchase outstanding foreign securities (particularly equities).
There are several other housekeeping and technical improvements that we could make in this legislation. For the most part, the matters are non-substantive, but they would close loopholes and improve administration. There are a number of substantive matters which should be handled by legislation (e.g., the IET status of leases, oil and gas interests and other hybrid ownership interests such as commodity futures; the treatment of captive foreign sales finance companies; and the treatment of foreign stock or debt obligations acquired out of foreign sourced borrowings). Among the substantive matters, it appears that amendments relating to the treatment of leases and captive foreign sales finance companies are the most important. In these two areas we find the greatest number of taxpayer questions and possible inequities in interpretations of the present statute.
The current law is awkward in delineating conditions to grant partial exemption of individual countries from the application of the IET. At present, countries can be exempted only by classification as "less developed" or through the finding by the President that exemption in whole or in part is required in the interest of international monetary stability. Over the years we have had numerous requests (e.g., Bahamas, Iran, Ireland, Spain) for partial or total exemption from the IET. In most cases the requests have been founded more on political grounds than on any economic hardship. Any amendment to give the President greater discretion in granting partial exemption from the IET to particular countries would undoubtedly severely complicate renewal legislation and bring a host of foreign governmental requests for exemption. Accordingly, it is recommended that no amendment of this sort be considered.
Recommendations:/2/
/2/There is no indication of Kennedy's approval or disapproval of the recommendations.
1. That you authorize Messrs. Cohen and Petty to begin immediately soundings on the Hill of a proposal to renew the IET legislation for two years from its expiration on July 31, 1969. Such soundings would especially involve the schedule for public and executive hearings and the relation of such hearings to the schedule for tax reform hearings.
2. That the soundings include discussion of an amendment to give the President authority to exempt new issues while maintaining the tax on outstanding issues from countries to which the tax now applies.
3. That the soundings include discussion of technical amendments, including substantive changes relating to the treatment of leases and captive foreign sales finance companies.
12. Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/
Washington, March 17, 1969. /1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, BOP. Confidential. Drafted by Bergsten who, in his March 17 cover note to Kissinger, wrote: "Pursuant to your instruction, attached is a memo to the President informing him of the major foreign policy implications of the proposed line of action and advising him to adopt a 'go slow approach' in implementing it." There is no indication that the President saw the memorandum; an undated cover note to Colonel Haig reads: "I don't think you want this to go to the President now--it was being provided for his meeting with the Quadriad on 3/18. If the information is still valid for the President, perhaps the reference to the Quadriad meeting should be deleted." Haig wrote on the note "OBE--File."
SUBJECT
Issue
I understand that you will discuss the reductions of our present capital controls with your economic Quadriad tomorrow afternoon./2/ There are major foreign policy implications of our moving in this direction. As a result of the considerations outlined below I recommend that you not commit the Administration irrevocably to the abolition or large scale reduction of the controls until an alternative solution to our international monetary problems is in sight. I have no objection to the limited reduction which is proposed for the near future although I agree fully with Secretary Rogers that it should not be undertaken until after full consultation with our European allies./3/
/2/The President met with McCracken, Kennedy, Martin, Mayo, and Burns in the Cabinet Room from 4:18 to 6:06 p.m. on March 18. (Ibid., White House Central Files, President's Daily Diary)
/3/See footnote 4, Document 8.
Foreign Policy Aspects
Eliminating restraints on private investment abroad has three foreign policy aspects. The first is that the initial effect of easier monetary conditions in the U.S. in the absence of controls would be an enlarged payments deficit, to which most of the countries of continental Europe would object strongly. Foreign disapproval would be expressed relatively quickly, even before the emergence of a large deficit, since foreign officials can look ahead. The move would be interpreted as a disavowal of our earnest intentions to maintain a strong payments position.
Such officials, incidentally, do not share U.S. antipathy to controls over capital movements. Nor does the foreign business community. Except for Germany, all the European countries maintain some form of restraints on international capital movements. Even Switzerland, the citadel of free enterprise, controls the access of foreigners to the Swiss capital market.
The main effect of this reaction would be a setback to our efforts to improve the monetary system through cooperative steps with the Europeans. Thinking that the U.S. no longer cares about its payments position, their propensity to cooperate even in the activation of Special Drawing Rights, let alone more far-reaching reforms such as adoption (or even serious study) of greater exchange rate flexibility, will be sharply reduced. In short, we may be circumscribing our option of a cooperative solution--forcing us inevitably toward the kind of unilateral action described below. (The counter-argument is that a cooperative approach will not work anyway and that unilateral U.S. moves are inevitable. I do not share this pessimism.)
Second, many--probably most--Europeans welcome U.S. controls on direct investment (i.e., investment involving U.S. management control) as providing some slowdown to the takeover of European industry by American firms. This potentially explosive anxiety is by no means confined to government officials. To be sure, Europeans are ambivalent about American investment. Except for those firms feeling the direct competition, they generally welcome the infusion of technology and even new management techniques. But, because of the central position of the U.S. dollar in the international monetary system, we are open to charges of dollar imperialism if American capital is permitted to move to Europe without restraint--at least as long as our balance of payments is in sizable deficit. Some kind of restraint on direct investment-even the pre-1968 voluntary restraints were helpful in this regard--provides the necessary ambiguity on our side, combined with their own ambivalence, to diffuse the issue.
Finally, and most important, the alternative policies which we might be forced to adopt in lieu of capital controls could be much more damaging to U.S. foreign policy. Troop withdrawals, additional pressure on Germany and others for "better" offset arrangements, and further restrictions on the aid program are only the most obvious possibilities--and ones which we should reject for obvious foreign policy reasons. Unilateral U.S. suspension of gold convertibility--essentially adoption of a floating exchange rate of the dollar--would represent a massive display of U.S. power and rupture all our efforts to forge a new partnership with Europe on the basis of greater equality. An increase in the official price of gold--which would represent only a temporary solution anyway--would also be a unilateral act rejected by most official Europeans and would betray $15 billion worth of dollar holders from Germany to Thailand. Adoption of trade controls, such as export subsidies and import surcharges, would be no economic improvement over capital controls and would be much more damaging to our foreign policy, because of the network of international rules which govern trade and which would be broken in the process.
As I understand it, the present proposal of the Secretary of Treasury is for some relaxation in all three of the present control programs but mainly affecting direct investment. The estimated gross cost to the balance of payments is about $400 million. The relaxation would come against an agreed projection of significant deterioration--at least $1 billion and possibly more--in our payments position in 1969. This first step will raise the problems outlined above to only a minor extent, but I recommend that you not commit yourself irrevocably to the abolition of investment restraints until a clear alternative is in sight.
13. Memorandum From C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/
Washington, March 24, 1969.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Country Files--Europe, Box 681, Germany, Volume I, through 4/69. Secret. An attached memorandum from Kissinger to the President, undated, entitled "Preliminary U.S. Position on German Offset Problem," refers to an "attached" memorandum from Secretaries Rogers and Kennedy and Under Secretary Packard (not found) proposing "that you authorize Under Secretary Volcker to take a 'hard' line on the offset question during a visit to Bonn next week for exploratory talks on a wide range of monetary issues." No record has been found that the memorandum went to the President or that he acted on its recommendations.
SUBJECT
Problem
The German offset problem arises because of the effects on the U.S. balance of payments of our military expenditures in Germany, which are approaching $1 billion per year. The Administration must negotiate a "good agreement" or risk: (a) heightened Congressional pressure for troop withdrawals, and (b) an increased balance of payments deficit which under the present international monetary system can cause us serious economic and foreign policy problems. Treasury, with Defense and State not far behind, wants to meet these problems by requiring Germany to spend in the U.S. roughly equivalent amounts of money, linked as closely as possible to military items (purchases of U.S. military equipment, training of German military personnel in the U.S., support costs for U.S. military expenditures in Germany, etc.).
The real issue is what constitutes a "good agreement" and to what end we should use the leverage with the Germans provided by our military position. The German Cabinet has decided to offer a package, for two years, which will offset about 75 percent (about $700 million annually) of our expenditures. It would include $350 million of military procurement, about $70 million of non-military procurement, and about $300 million of loans of various types. It is probable that most of the non-military procurement and some of the loans would occur independent of the offset arrangement, i.e. the U.S. would get no additional balance of payments benefits from them. Some of the military procurement would occur anyway too, but military purchases are conventionally accepted as true offsets and hence meet our domestic political problem.
Background
The previous Administration adopted a progressively tougher line with Germany on the offset. U.S. troop levels in the FRG were linked explicitly to German commitments to fully offset the resultant costs to our balance of payments. Accepted methods for achieving the offset evolved:
--From military purchases which Germany would have made anyway, and which thus provided no additional real help for our balance of payments.
--Through purchases of U.S. Treasury bonds which caused the Germans some pain, though not much because of the huge payments surpluses they were running, and which helped our balance of payments statistically but were criticized by many as only "postponing the problem". --To commencement of efforts to get Germany to pick up a large part (perhaps $400 million annually) of our own expenditures in the FRG, which would clearly help our balance of payments but are seen by the Germans as politically indefensible support costs reminiscent of the occupation.
In addition, in 1967 Germany fully committed itself not to buy gold from the United States. This has no impact on our balance of payments statistics, but is by far the most important part of the "offset" package. It means that Germany, despite its huge and persistent payments surpluses, will put no pressure on U.S. reserves and thus reduces sharply the constraints generated by our payments deficits. There is no evidence of serious German unhappiness with this part of the package.
Our offset talks with Germany have proceeded largely independent of our over-all international monetary policy. In the latter context, we have pressured the Germans to eliminate their surpluses--most recently at the crisis conference in November when we took the unprecedented step of explicitly urging them to upvalue their currency./2/ We have given no indication to Bonn that cooperation on over-all monetary policy would affect our position on the offset.
/2/Reference is to the G-10 meeting in Bonn in November 1968; see Foreign Relations, 1964-1968, vol. VIII, Documents 214-220.
Alternatives:
1. The U.S. could continue to link troop levels to offset expenditures in the U.S.:
(a) Achieved only through "real" devices such as additional military purchases and payment of support costs; or
(b) Achieved in large part through loans, i.e., accept the present German offer, or seek to harden it only marginally.
Pros
--Especially if via (a), would undercut Congressional efforts to use balance of payments arguments to force troop withdrawals.
--Would provide significant help for our balance of payments which is, of course, a continuing problem.
Cons (each much more serious if via (a))
--Could further erode German confidence in our security commitment.
--Could lead to eventual troop withdrawals since FRG unlikely to meet U.S. demands indefinitely.
--Could cause FRG at some point to renege on gold commitment, which could seriously jeopardize U.S. financial position and hence produce, inter alia, massive domestic pressure here for troop withdrawals if Germany actually began to buy U.S. gold.
2. The U.S. could drop completely the link between troop levels and balance of payments effects.
Pros
--Major payoff in relations with Germany (and perhaps some with rest of NATO).
--Major restoration of credibility of U.S. security commitment (included in Soviet perception).
Cons
--Would invite massive Congressional pressure for troop withdrawals.
--Would completely ignore our international monetary problems.
--As a result, and especially if we move toward elimination of our present capital controls, would generate widespread views that U.S. no longer cared about its balance of payments and hence could touch off a major financial crisis.
--Would simply give away a major U.S. negotiating lever.
3. The U.S. could substitute for the explicit link between troop levels and German offset expenditures a request for sharply accelerated over-all German cooperation on international monetary matters, particularly agreement to:
(a) Press actively for early and sizeable activation of SDRs. (b) Initiate meaningful studies of ways to improve the adjustment process including greater flexibility of exchange rates.
(c) Continuation of the gold commitment; and
(d) Possibly upvaluation of the DM after the elections in October.
Pros
--Would increase credibility of our security commitment.
--Should improve our over-all relations with FRG.
--Could produce a major breakthrough in improving the international monetary system.
--Would use our leverage with FRG in most profitable way.
--Would avoid any budgetary requirements of the Germans.
Cons
--Requires educational effort with Congress to avoid renewed pressure for troop pullbacks.
--Risks inadequate German performance on over-all monetary policy and hence possibility of future serious bilateral problems.
Recommendation:
That we:
(a) Accept the German package for one year only;
(b) Indicate to them that for the future we will drop our insistence on military offsets per se if they provide satisfactory cooperation on over-all international monetary matters.
Germany is unlikely to accept "real" offsets to our military expenditures unless we commit ourselves to a fixed level of forces in Germany for several years and/or the President makes it his top priority requirement. If he were to do so, the credibility of our security commitment and political relations with Germany would suffer enormously.
Further loans would neither allay our domestic pressures for the longer run nor really get us very much help on the monetary front.
Complete abandonment of the issue gives away a major U.S. bargaining lever and risks major financial difficulty. We should thus change our offset policy to (a) reduce the political and security problems caused by demands for support costs and (b) to pursue positively our major international monetary objectives. These objectives are (a) assurance of sufficient international liquidity via Special Drawing Rights; (b) improvements in the adjustment process, probably including greater flexibility of exchange rates; and (c) restoration of stability in the exchange markets which will require an upvaluation of the DM. Active cooperation by Germany on each of these issues--on upvaluation after their election in October--is a necessary component of a satisfactory approach. It will be difficult to move the bureaucracy quickly in this direction but the potential gains in both political and economic terms are well worth it.
Because it will take up to a year to monitor German performance and to educate the American public on this approach, we should inform Germany at once of these changes in our position for the future, but accept their package for this year as a transitional device. (If they want to soften their package as a result, we should be willing to consider so doing.)
14. Telegram From the Embassy in Italy to the Department of State/1/ Rome, March 26, 1969, 2010Z.
/1/Source: National Archives, RG 59, Central Files 1967-69, FN 10 IMF. Confidential; Priority; Limdis/Greenback. Other Limdis/Greenback cables from a number of European posts reporting Under Secretary Volcker's conversations with foreign officials are ibid. The Limdis/Greenback series was a specialized series of cables, distribution of which was limited in Washington to the Volcker Group and overseas to the Ambassador, Economic Minister, and the Treasury representative. The Limdis/Greenback caption had been used during the Johnson administration as well. 1803. Pass Treasury for Secretary Kennedy and Petty from Volcker. Subject: Summary of European reaction to relaxation of capital controls.
I have now completed consultations with all countries visited re proposed relaxation of capital controls. At my instruction, McGrew also consulted Larre of French Treasury in Paris./2/ This will summarize reactions and my conclusions:
/2/Donald McGrew was the Treasury Attache at the Embassy in Paris. Volcker did not visit Paris.
1. Major countries (Germany, France, Italy) expressed least concern, all noting desirability in principle of relying on less controls and recognizing value of clear signal to that effect. Italian Treasury Minister Colombo and Blessing nonetheless specifically noted adverse impact on balance of payments would make SDR activation more difficult and weaken U.S. bargaining position in other respects.
2. Swedes expressed their concern most forcibly and openly, against background of full support for basic U.S. position re SDRs and other matters.
3. Dutch, Belgians and Swiss in varying degrees counseled caution and delay pending clear signs of balance of payments improvement, particularly in trade accounts. Impression left was that we will be reminded of "premature" easing during future bargaining on monetary reform if overall balance of payments fails to improve.
4. These reactions were received in context of my presentation that strongly emphasized: (1) value of "concrete" move to signify long-term objective to minimize reliance on controls, (2) "limited" and "prudent" nature of move, (3) decision to retain basic control apparatus for time being and to request renewal of IET authority, and (4) possible value of affirming in this way commitment to liberal trade and payments at a time when protectionist pressures are rising world wide.
5. My conclusion is that we should go ahead on agreed basis against background of strongest possible stance re monetary and fiscal restraint. Announcement should be related to surtax announcement and presidential endorsement of spending restraint. Timing and nature of future moves should be left vague. It seems to me essential that President request renewal of IET authority to avoid any impression of "recklessness" or implication that controls will be entirely dismantled at an early date. Statement should clearly recognize that U.S. accepts, as corollary of relaxation of controls, additional burden on monetary and fiscal policies as basic tools for dealing with balance of payments.
6. Alternative approach would be to forego inclusion of Federal Reserve program in package at this time. This would certainly ease European concerns over possible balance of payments impact. However, I do not feel this compromise approach essential in light of reactions received. European attitudes do confirm, however, that proposed actions, while useful, do carry some risk of weakening our bargaining position.
Ackley
15. Memorandum From Secretary of the Treasury Kennedy to President Nixon/1/
Washington, April 1, 1969.
/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Studies and Reports, Volume 7, 2/68-11/69. Confidential. An earlier draft of the memorandum had been discussed at a meeting on March 11; see Document 8.
SUBJECT
It is important that this Administration signal at an early date and in a concrete way its intention to reverse the trend toward controls and restrictions on international payments. To that end, we propose a limited but significant relaxation of the present controls on capital movements.
This recommendation is being made following a series of consultations just undertaken in Western Europe by my Under Secretary for Monetary Affairs, Paul Volcker. The reactions he received ranged from unenthusiastic to cautionary./2/ It was particularly pointed out that these proposed steps will not make things any easier on an early and sizeable activation of the Special Drawing Rights. This reaction was anticipated, and emphasizes the necessity in European eyes for accompanying relaxation of controls with evidence of restrictive monetary and fiscal policies. European reservations are not, however, a compelling reason for delay.
/2/See Document 14.
I am joined in this recommendation by Secretary Rogers, Secretary Stans, Chairman Martin, Chairman McCracken, and Director Mayo.
In making this recommendation, we are running a risk in terms both of weakening our balance-of-payments position this year and of adverse reactions abroad. In particular, we are proposing this relaxation in face of staff projections of a substantial balance-of-payments deficit in 1969 on the liquidity basis and the absence of evidence that the deterioration in our trade accounts has yet been reversed. In fact, a February trade deficit has just been announced.
The more widely used definition of our balance of payments, the so-called liquidity measure, showed a small surplus of $158 million in 1968. However, this surplus was achieved only by virtue of an unprecedented inflow of private capital stimulated by controls, tight money, and the attraction of our stock market. In addition, there was an element of "statistical window-dressing" (mainly foreign governments' buying medium-term securities at our behest rather than investing in short-term Treasury bills and time deposits). The less familiar official settlements measure (not ordinarily affected by our "window-dressing") showed a substantial surplus of $1,600 million.
The first quarter of 1969 will show a very large deficit on the familiar liquidity basis. The official settlements measure, on the other hand, will show a surplus--still reflecting our tight monetary policy.
Attachment A/3/ tells the story for 1968, and shows the 1969 forecast of a further deficit of around $3 billion on the liquidity measure. The official settlements outcome is more difficult to forecast but it is not likely to be so bad. While balance-of-payments forecasts have particularly wide margins of error, there is good reason to believe that deterioration in the capital accounts will more than offset an anticipated gradual increase in the trade surplus later this year.
/3/Not printed. Attachment A gives the balance-of-payments result for 1968 and the projection for 1969. The projection for the liquidity deficit in 1969 was $3 billion compared to an actual deficit of $1.1 billion in 1968.
These projections make no allowance for the relaxations we are proposing. Potentially, these relaxations could add almost $1 billion to the deficit. However, we would expect the net cost to be considerably less--perhaps no more than $500 to $600 million--if money remains tight in the U.S.
Aggravation of the already difficult balance-of-payments problem carries important economic and political risks. The result could be to intensify pressures for maintenance of restrictive monetary policies to protect the balance of payments, even if that would be less appropriate than at present in terms of the domestic economy.
A further danger is psychological. Some financial officials abroad view the action as premature, and may reduce their willingness to cooperate with the U.S. in other areas. In particular, it will make more difficult our objective of obtaining an early activation, in appropriate size, of SDR's. Moreover, we must guard against any lessening of the sense of urgency in the U.S. about dealing with the balance-of-payments problem, including efforts to economize on net government spending abroad.
On balance, we think these risks are acceptable. The main advantage is to indicate, early in your Administration, a firm intent to reject "creeping restrictionism" as an answer to our problems; also to demonstrate that the philosophy of achieving solutions consistent with market forces should carry over into the trade area.
The potential losses entailed, while significant, may not themselves be the critical margin in the viability of the present monetary system. Properly presented, the moves proposed should suggest confidence and prudence, rather than a willingness to throw caution to the winds.
To maximize the benefits with minimal risk, it is essential that this relaxation be accompanied by an expression of your broad balance-of-payments strategy and objectives. Therefore, we propose an announcement along the lines of Attachment B./4/
/4/Not found. Attached is the actual statement as released on April 4; see footnote 5, Document 16. An attached April 10 memorandum to the files by Philip P. Schaffner, Director of the Office of Balance of Payments Programs, Operations and Statistics, indicates that the April 4 text was drafted in the White House "using Treasury's draft."
This announcement would express your determination to create over time a viable balance-of-payments picture without a mass of controls, reversing the restrictionist trend of the past. But it would also highlight the actions you are taking to strengthen our economy and the dollar, to develop an effective export program, and to work toward monetary reforms.
The question of whether this action now implies that a second installment, and maybe a third installment, is due at a predictable time in the future is one upon which we believe judgment should be reserved. Developments in our domestic economy later on this year, for example, may raise a serious risk of a substantial capital outflow if our Interest Equalization Tax is down too low. We would contemplate that the Interest Equalization Tax could be utilized in a flexible manner in the future. However, any relaxation in the Commerce or Federal Reserve programs should be considered as a decision that would be very difficult to reverse in the future.
A. The Direct Investment Program
A modest relaxation of the mandatory Direct Investment Program can be undertaken and we concur in the proposal of Secretary Stans which would involve raising the ceiling $400 million to $3.35 billion.
Two key features are part of this proposal:
(a) Raise the minimum investment allowable for each company from $300,000 to $1 million
--recommended by industry
(b) Raise the alternative earnings base from 20 to 30 percent (giving the companies a more meaningful option in selecting a reference base)
--strongly recommended by industry
It is important to note that OFDI's chance of not exceeding the $3.35 billion ceiling rests on the companies' carrying forward about $2 billion of unused investment quotas from 1969 to 1970. There is a good chance of this happening only if present tight U.S. monetary policy is continued.
Some thought has been given to raising the ceiling $600 million, rather than $400 million. This would be done by raising the alternative base percentage from 20 to 35 percent. However, this would only benefit about 25 additional companies, and $200 million seems to be too expensive for such a small return.
Beyond this immediate announcement, we are studying additional ways to simplify the Commerce program.
B. The Federal Reserve Program
Chairman Martin advises that the Board of Governors recommends that the Federal Reserve guidelines for restraints on credits to foreigners be modified to reduce the inequities in the position of many of the smaller banks and to give some additional room for export financing. First, the Board would increase the ceiling for bank lending to foreigners by about $400 million. The room for expanding such lending would actually be about double that amount since banks are presently about a half billion dollars below the aggregate ceilings. Virtually all of the increase would be available to the small banks. Second, the Board would also lift the limit on loans by non-bank financial institutions, such as insurance companies, by about $40 million. Banks and non-bank financial institutions would be asked to continue to give top priority to credits to finance U.S. exports.
The Board believes the proposed increase in lending limits takes account of the Commerce direct investment controls, to which the credit restraints are closely related, and would, in fact, lead to no more than a modest outflow of bank credits this year, under prevailing monetary conditions.
C. The Interest Equalization Tax
Reduction of the IET rate by 1/2 percent from its present 1-1/4 percent to 3/4 percent could be undertaken now without risk of a substantial outflow. A smaller reduction would carry the risk of being termed "tokenism." A larger cut would run counter to the philosophy of gradualism, which must be employed in phasing out these controls, and would sharply increase the risk of an accelerated outflow of United States funds to acquire issues previously placed abroad by American corporations. If this occurred, the IET rate would need to be raised again quickly, and this would reflect on our judgment in reducing the rate too far in the first instance.
The IET expires in July and responsible business groups concur that the legislation should be extended. It is important that we have this tax authority available (with the option of increasing the rate) for the time when our domestic situation might call for an easing of monetary policy. The IET also serves to reinforce both the Commerce and the Federal Reserve programs.
Recommendations:/5/
/5/There is no indication of President Nixon's approval or disapproval of the recommendations. See also Document 16.
(1) That you approve the $400 million ceiling increase in the Direct Investment Program.
(2) That you approve lowering the IET 1/2 percent, down to 3/4 percent.
(3) That we seek an extension of the IET, past its July expiry. Particulars of the extension can be considered in the near future.
(4) This announcement should be made on Friday, April 4. It would be desirable for market reasons, if the announcement could occur after the Stock Exchange closes at 2 p.m.
(5) That the announcement of the relaxation be part of a balance-of-payments strategy message.
(6) That the message take the form and strategy of Attachment B (draft message).
David M. Kennedy
16. Action Memorandum From C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/
Washington, April 1, 1969.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, BOP. Confidential.
SUBJECT
The attached memorandum from Secretary Kennedy recommends that the President announce shortly the modest relaxation of all three aspects of our controls over private capital outflows already decided./2/ The recommendation is agreed to by Secretaries Rogers and Stans, Chairman Martin, Paul McCracken, and Bob Mayo.
/2/See Document 15.
I recommend that you support the recommendation, although it carries significant foreign policy (and domestic economic) risks as outlined in the memo itself and conveyed to you in my earlier memos. There are, however, two specific problems of concern to us, one relating specifically to our new emphasis on consultations and one relating to the decision-making process.
This recommendation was delayed for two weeks to permit Treasury Under Secretary Volcker to consult with the Europeans on it./3/ None of the Europeans oppose the move outright, but virtually all of them were highly cautionary. They indicated that any resultant increase in the U.S. payments deficit would weaken our over-all bargaining position, particularly with regard to early and sizeable activation of Special Drawing Rights. The major implication of this conclusion is that our preferred multilateral approach to monetary reform is now less likely to succeed, and we may be forced to take unilateral steps which could be seriously disruptive to the entire Atlantic Alliance.
/3/See Document 14.
Since we do not plan to reduce the pressure on the Europeans to move ahead on SDRs--and on much more "radical" reforms--the question of our sincerity in undertaking consultations will arise at some point in the near future. We gave them a chance to record their views and they did so. Our future action may well imply that we have ignored those views. I flag this as an early case of the obvious problem that the new emphasis on consultation will create.
On decision making, this is a prototype case of unsatisfactory ad hoccery. The President is being asked to enunciate his over-all international monetary policy without ever considering that policy. He has been given no choices, nor even a paper on the over-all subject. In retrospect, the decision to lift the subject from the NSC agenda was a mistake/4/--since the Secretary of Treasury has not exercised the responsibility which he sought and received.
/4/The meeting had been scheduled for February 26. See footnote 4, Document 3.
This factor does not lead me to recommend your opposing the proposed action, since the President has made known his strong desire to begin relaxing the controls as soon as possible. But I suggest that you remind the President that he is being asked to do something without consideration of its context and without systematic exploration of its full implications, and recommend that he instruct the Secretary of Treasury to present an options paper for his consideration in the near future.
Recommendation:
That you sign the attached memorandum to the President, recommending that he:
(1) Approve the proposed relaxation of controls.
/5/April 3-5. The President released a balance-of-payments statement at Key Biscayne, Florida on April 4. See Public Papers of the Presidents of the United States: Richard Nixon, 1969, pp. 265-267.
/6/Possibly a reference to the Treasury Department's Basic Options paper prepared for the meeting with the President on June 26; see Document 130. On April 11 Kissinger sent the President a memorandum entitled "Relaxation of Balance of Payments Controls," repeating his support for the President's limited action despite certain foreign policy risks. Kissinger noted, however, that because of Secretary Kennedy's reluctance to have the matter referred to the NSC the President had, in effect, been asked to make his balance-of-payments strategy statement without an opportunity to address the subject systematically and in context. Kissinger recommended the President ask Secretary Kennedy to prepare a memorandum outlining options in the balance-of-payments and international financial area and attached a memorandum for the President's signature so instructing Secretary Kennedy. The President initialed the memorandum for Secretary Kennedy on April 15 requesting a paper on "what my choices are" with respect to international monetary policy, "a paper which will permit me systematically to look at the available options." (National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, BOP)
17. Memorandum From the Director of the Office of Industrial Nations, Department of the Treasury (Widman) to Secretary of the Treasury Kennedy/1/
Washington, April 3, 1969.
/1/Source: Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence: FRC 56 74 7, Memoranda to the Secretary, March-April, 1969. Secret. Sent through Petty and Volcker. Copies were sent to Volcker, Colman, Jurich, Hirschtritt, and Cross.
SUBJECT
Date and Time: Thursday, April 11, 1969, about noon
Persons Expected to Attend:
Japan:
United States:
I. Background
Your meeting with Minister Fukuda should take place against the background of increasing dissatisfaction with the current status of the U.S.-Japanese partnership arrangement. Japan is demanding the reversion of Okinawa and we in Treasury at least are becoming increasingly concerned with the trade and financial relationships. We had a bilateral balance of payments deficit with Japan last year of more than a billion dollars--including $1.1 billion on trade. The best forecasts that our people can produce show this trade deficit likely to rise to a range of $3 to $3-1/2 billion within five years. Our gross military expenditures in Japan are approaching $600 million and the Japanese spent less than $100 million here. I do not think the American people will tolerate the development of a trade deficit such as now appears to be in the cards nor do I see how the U.S. can approach balance of payments equilibrium with such a deficit with Japan.
The NSC mechanism is currently considering U.S. policy toward Japan. We in Treasury have not been satisfied with the paper which is before the Review Group./2/ There are attached at Tab A: (a) a talking paper prepared for Treasury spokesmen at the Review Group/3/ and (b) a copy of a Treasury comment for dissent attached to the document.
/2/Reference is to NSSM 5; see Document 20.
/3/Not printed.
Your conversation should also be against the background of the strong position taken by Secretary Fowler in meetings with Japanese Minister Mizuta last year. (See Tab B)/4/ We insisted on balance of payments cooperation arrangements in 1968 which were negotiated by Mr. Petty under the direction of a Treasury-State-Defense steering group. These negotiations produced a package with a nominal value approaching $500 million although much of it was little more than window dressing. (See Tab B also.)
/4/Not printed. See Foreign Relations, 1964-1968, vol. VIII, Document 179.
Minister Fukuda will probably not initiate any discussions on this subject but he will be alert to clues as to your attitude toward offset agreements.
Japan's great economic and financial strength is new and the Japanese themselves are not yet accustomed to it. They consistently underestimate their strength. They may even express some worries about their balance of payments position this year, arguing that the expected slowdown in the U.S. will cause a very drastic reduction in their exports. The thinking of Japanese leaders still tends to be very parochial and self-centered. Their concern is with appeasing their political opposition in Japan and neither the government itself nor the Japanese Diet has an adequate appreciation for the influence of economic developments in Japan on the rest of the world. They want to be treated by the U.S. as an equal partner but also to continue to receive the special benefits that a guardian might bestow upon his ward. Anything which appears on the horizon as a possible threat to the Japanese commercial or financial position is likely to bring a highly emotional reaction. Consequently, it is difficult to get the Japanese to assume responsibilities and costs commensurate with their current and prospective economic strength.
II. What Minister Fukuda will Want We might expect Minister Fukuda to ask the following: a. Early Congressional action on ADB special funds--Tab C/5/
/5/Tabs C-J are not printed.
b. A comprehensive report on U.S. discussions with other industrial countries on the various issues involved in improving the international monetary system--SDR's, greater flexibility in exchange rates, realignment of rates, and treatment of South African gold. For political reasons Fukuda must be able to say that Japan is intimately involved in all of these discussions--Tab D c. U.S. support for an increase in Japan's IMF quota--Tab E
d. A reassurance that the U.S. will not increase the price of gold.
e. A substantial purchase of gold from the U.S. in the near future--Tab F
f. Assurances that the U.S. will see to it that Japan gets the right to purchase new gold production for monetary reserves if European central banks are allowed to do so--Tab F
g. A continuation of Japan's IET exemption--Tab G
h. That the U.S. forego restrictions on trade, the imposition of any border tax and make no arrangements to restrain exports of textiles to the U.S.--Tab H
Recommended positions on these questions may be found at the tabs indicated.
III. Areas in which you might wish to take an Initiative
a. Japanese ratification of SDR and support for early activation in a substantial amount--Tab I
b. Japanese leadership in support of the ADB--Tab C
c. Balance of payments cooperation (actions to offset U.S. military expenditures in Japan)--Tab J
d. Increased Japanese efforts toward trade liberalization--Tab H/6/
/6/Under Secretary Volcker added point d by hand.
IV. General Comments You probably will also wish to chat with Minister Fukuda about the forthcoming meeting of the U.S.-Japan Cabinet Committee on Trade and Economic Affairs. We do not as yet have any information on a specific date although the meeting is expected to take place in Japan in July.
Many of the foregoing issues can only be touched upon in your meeting with Minister Fukuda. Mr. Petty hopes to arrange a meeting with Vice Minister Kashiwagi which could go into more detail and cover points omitted.
Tab A/7/
Washington, March 24, 1969.
/7/Confidential.
TREASURY COMMENT
NSSM ON JAPAN
The Treasury believes that this paper does not give adequate attention to the relative sharing of costs and benefits of the U.S.-Japanese partnership and incorrectly assesses the trends as "increasingly valuable" to the United States. It is the Treasury view that Japan is not carrying an equitable share of the financial burden of the partnership, either budgetary or balance of payments. Furthermore, the inequity appears to be growing rather than diminishing. Unless we are able to reverse this trend and demonstrate that Japan is moving promptly and steadily to assume a greater share of these financial responsibilities, we must expect Congressional and public pressures for trade restrictions and the growth of anti-Japanese sentiment within the United States. The ability to reach an accommodation with Japan on the burden sharing question may be crucial to the continuation of the present partnership.
The scheduled meeting between President Nixon and Prime Minister Sato provides an opportunity for substantial progress in bringing about an equitable sharing of costs and benefits./8/ We believe that the United States should not underestimate what Japan is willing to pay for the reversion of Okinawa. We believe, furthermore, that U.S. balance of payments and trade goals should be given a high priority in the quid pro quos we should seek for concessions on Okinawa.
/8/In the opening days of the Nixon administration, arrangements were agreed in principle for Prime Minister Sato to pay a State visit to Washington in November at dates to be agreed on.
The Treasury feels that NSSM-5 does not focus sharply enough on the question of priorities among U.S. goals and that to the extent that it does touch on this question insufficient weight is given to the need for large-scale contributions by Japan toward equilibrium in the U.S. balance of payments. Loss of world confidence in the dollar would be a disastrous blow to the security of the free world as well as to the world's economic health and progress and the prestige of the United States. Preservation of confidence in the dollar requiring the elimination of our balance of payments deficit should be considered in that context, along with the level of forces in Japan or nuclear storage rights in Okinawa or Japanese aid for other countries in Asia.
Throughout the paper there is a tendency to assume that the balance of payments problems will be solved "in a global context" making it unnecessary to look to bilateral actions by Japan as a major contribution to this problem. While the Treasury agrees that a multilateral agreement of some type may be necessary before the U.S. restores a sustainable payments equilibrium, we remain convinced that Japan, along with Germany and other major surplus countries, must bear a very substantial part of the required payments adjustment and that bilateral actions, particularly involving the military accounts, will be necessary.
For two years the U.S. has had overall bilateral payments deficits with Japan of almost $1 billion annually. With no other country have we had deficits which even approach this magnitude. The major deficit elements are our military expenditures, now approaching $600 million annually, and a trade deficit which reached $1.1 billion in 1968. Our latest projections indicate that unless special action is taken, our trade deficit with Japan may climb to $3 billion or more in five years. We cannot tolerate such a development-either politically or in terms of maintaining dollar confidence. We cannot rely on the "hope" (as this document recommends) that the Japanese will assume their fair share of the costs, but should make clear to them at the highest level that a major redistribution is necessary if the partnership is to remain viable. We should, furthermore, assign high priority to this objective in our negotiations with Japan on specific issues.
18. Editorial Note
The National Security Council, in its meeting on April 8, 1969, discussed the North Atlantic Treaty Organization and possible negotiations on the German offset problem. The State Department's position for the NSC meeting was set forth in an April 7 memorandum from Assistant Secretary of State for European Affairs Hillenbrand to Secretary Rogers. (National Archives, RG 59, S/S Files: Lot 71 D 175, April 8 NSC Mtg) National Security Decision Memorandum (NSDM) 12, dated April 14, recorded the President's decisions at the NSC meeting on REDCOSTE and the German offset. Concerning the German offset negotiations, NSDM 12 reads:
"We should proceed with offset negotiations, for this year, taking fully into account their possible impact on the political situation in the Federal Republic of Germany. The subject of support costs should not be raised and we should not seek any substantial increase in the currently anticipated level of German military procurement and should not press the issue to the point of risking a possible row with the FRG. At the same time, we should seek to improve the value to us of other measures to be included in the package. We should indicate to the Germans our willingness to explore a broadening of the discussion in future years to include discussions of monetary cooperation in general.
"As this year's negotiations proceed, the President will wish to re-examine the package being negotiated to determine if we should move the offset negotiations into a broader monetary context in the present round." (Ibid., S/S Files: Lot 83 D 305, NSDM 12)
19. Information Memorandum From C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/
Washington, April 14, 1969.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 215, Council of Economic Advisers. Confidential. SUBJECT
The President expressed a number of interesting foreign policy views at the April 10 meeting with his economic advisers./2/ Foreign economic policy topics dominated the overall discussion.
/2/The Cabinet Committee on Economic Policy met in the Cabinet Room 4:19-6:02 p.m. Attendees were Agnew, Walker, Hardin, Stans, Shultz, Mayo, McCracken, Burns, Safire, Samuels, Moynihan, and Bergsten. (Ibid., White House Central Files, President's Daily Diary)
1. The President linked NATO and soybeans. He said that his support for NATO would be seriously jeopardized if the Europeans took restrictive action against U.S. exports because mid-western Congressmen, whom he can now control on security matters, would shift their views if European trade restrictions hurt them directly.
2. The President also said that the EEC "could forget U.S. political support" if it turned inward economically.
3. The President is prepared to take a hard look at the possibility of a major U.S. initiative regarding U.S.-European agricultural trade. He noted that we could do the Europeans "no greater favor" than to convey our farm policy experience to them in time to head off similar mistakes there. A task force chaired by CEA, of which I am a member, is developing proposals.
4. The President again expressed his great interest in East-West trade, essentially for political reasons. He specifically wants to look at the possibility of agricultural deals with Eastern Europe "in two or three months." The President instructed the CEA to prepare a study on the quantity of U.S. exports which might be involved in a trade liberalization package and to include Eastern Europe in their study of U.S. agricultural trade. I will coordinate these with our NSSM 35 exercise./3/
/3/NSSM 35, dated March 28, 1969, called for a study of "US Trade Policy Toward Communist Countries." (Ibid., RG 59, S/S Files: Lot 80 D 212, NSSM 35) 5. The President suggested that Secretary Hardin might include one or two Eastern European countries on his forthcoming trip. 6. The President indicated that foreign economic policy should be discussed in the NSC for political considerations and the Cabinet Committee on Economic Policy for economic considerations. However he expressed the primacy of the political aspects of most foreign economic problems (reminding Treasury of his approach to the German offset!) and, on East-West trade, referred to "kicking the subject up to the NSC". (Paul McCracken had apparently raised this jurisdictional issue with the President.)
The course of the discussion fully justified my attendance at the meeting and I thanked McCracken for acceding to your request that I be able to attend./4/
/4/Neither the Department of State nor the NSC were members of the Cabinet Committee on Economic Policy.
20. Editorial Note In National Security Study Memorandum (NSSM) 5, dated January 21, 1969, Henry Kissinger informed the Secretaries of State, Defense, and Treasury, the Director of Central Intelligence, and the Chairman of the Joint Chiefs of Staff that the President had directed the NSC Interdepartmental Group for East Asia to prepare a study of alternative U.S. policies with regard to the full range of U.S.-Japanese issues. A Treasury representative was specifically designated to sit on the NSC Group for this study. (National Archives, RG 59, S/S Files: Lot 80 D 212, NSSM 5) In response to NSSM 5, an undated paper prepared by the Interdepartmental Review Group for East Asia was transmitted under cover of an April 28 memorandum from Jeanne W. Davis of the NSC Secretariat to the Office of the Vice President, the Office of the Secretary of State, the Office of the Secretary of Defense, and the Office of the Director of Emergency Preparedness, with copies to the Under Secretary of State, the Chairman of the Joint Chiefs of Staff, and the Director of Central Intelligence. Davis' memorandum noted that revisions had been made pursuant to a discussion in the Review Group on April 25. Part V (pages 35-43) of the paper covered U.S.-Japan economic issues and identified key policy matters for the United States as "(1) trade, and (2) US balance of payments considerations, particularly the implication of US military expenditures in Japan." The NSSM 5 response paper and an "agreed summary paper" that Davis circulated to the same addressees on April 29 were intended for discussion at an April 30 NSC meeting. (Ibid.) The summary paper noted that the NSC meeting would "concentrate on Okinawa and other security issues" but it was recognized that trade, balance of payments, and aid policy issues were "an integral part of Japan policy and that they should be considered, particularly in developing a negotiating position on Okinawa." (Ibid.) See Document 17 for the Department of the Treasury's dissent from the economic approach being taken by the NSC Interdepartmental Group. That dissent was repeated in an April 25 memorandum from John C. Colman, Acting Assistant Secretary of the Treasury for International Affairs, and Anthony J. Jurich, Special Assistant to the Secretary of the Treasury, to the NSC Review Group on NSSM 5. (Attached to memorandum from Petty to Kennedy, May 5; Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence: FRC 56 74 7, Memos to the Secretary, May-June 1969)
The National Security Council took up the NSSM 5 response paper during a 10:30 a.m.-12:11 p.m. meeting in the Cabinet Room on April 30. (National Archives, Nixon Presidential Materials, White House Central Files, President's Daily Diary) Pursuant to the NSC meeting, on May 28 Kissinger sent National Security Decision Memorandum (NSDM) 13 to the Secretaries of State, Defense, and the Treasury and the Director of Central Intelligence setting out the President's decisions on U.S. policy toward Japan. NSDM 13 dealt primarily with defense/security/Okinawa matters, but the first decision related to economic issues: "We shall basically pursue our current relationship with Japan as our major partner in Asia, seeking ways to improve this relationship from the viewpoint of U.S. national interests and to seek an increasingly larger Japanese role in Asia." (Ibid., RG 59, S/S Files: Lot 83 D 305, NSDM 13)
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