Washington, May 13, 1969.

/1/Source: Washington National Records Center, Department of the Treasury, Deputy to the Assistant Secretary for International Affairs: FRC 56 83 26, Contingency Planning 1969. Confidential. A May 14 cover note from Petty's office to Willis indicates that distribution in the Treasury Department was limited to the Secretary, Under Secretaries Walker and Volcker, Petty, and Willis. There is no indication that this memorandum was forwarded to the President's attention, but the President was subsequently informed of the balance-of-payments results by McCracken; see Document 129.

SUBJECT
The First Quarter Balance of Payments Results and Announcement

Later this week (probably on Thursday),/2/ the regular announcement will be made of the balance of payments results for the first quarter. This will not be happy reading.

/2/May 15.

The measure most widely used by the press--the so-called "liquidity" balance--will be in deficit, seasonally adjusted, by $1.8 billion, or an annual rate of $7.2 billion. While the informed public and foreign officials are already aware that we had a sizeable deficit on this basis, the actual near-record figure will nonetheless be startling. It can only add to the already uncertain atmosphere in international financial markets.

Actually, the immediate situation is not nearly so bad as the "liquidity deficit" makes it look; moreover, the alternate measure of results ("official settlements") shows a very substantial surplus of $1.1 billion for the first quarter. This surplus reflects the strong performance of the dollar in the exchange markets and the fact that official dollar holdings of many European central banks got uncomfortably low-even before the recent exchange crisis.

Nevertheless, the liquidity deficit will make the headlines. The heavy dependence of the official settlements surplus upon short-term capital inflows related to the tight money conditions in the United States renders this performance more suspect.

Only technicians will fully unravel the confusions inherent in the different measures of our balance of payments. However, all sophisticated observers will recognize that the structure of our balance of payments is in poor shape. The major culprit is the long period of domestic inflation and excess demand, which has dwindled away our historic large trade surplus-averaging $4 to $6 billion in the first half of the 1960's--to a small deficit. Consequently, earnings on the trade account are simply not available to pay for the balance of payments costs of our aid and military commitments overseas, or for private foreign investment.

For the time being, the adverse impact of the shrinking trade balance has been largely offset by extraordinary capital inflows--long and short term. But we must recognize that certain capital inflows are quite subject to reflow. In looking ahead, we should be under no illusions about our ability to achieve and maintain a sustainable payments position without a sizeable positive trade balance.

Special Factors in the First Quarter

Two important factors contributed to the deterioration in the first quarter.

--U.S. corporations apparently placed an exceptionally large volume of funds abroad, either directly or through their foreign subsidiaries. This reversed the artificial pull-back of funds to the United States last December, when companies made sure they got under their direct investment quotas.

--In addition, the first quarter was almost free of so-called "special" official transactions, which also contributed heavily to the statistical liquidity surplus recorded in the fourth quarter of 1968. As a matter of policy, we have not pressed foreign countries to alter the form of their dollar holdings simply to "dress up" our statistics.

For these reasons, it is logical to average the last two quarters to arrive at a fairer estimate of the trend in the payments, as shown in the table attached./3/ While the six-month average shows a sizeable deficit on the liquidity basis, it does not show a basic deterioration. Moreover, the official settlements basis shows an improving trend--a fact that deserves more emphasis, even though we cannot forget it is highly subject to variation.

/3/Not printed. This short table gave balance-of-payments results for 6-month periods ending in March 1969, September 1969, March 1968, and September 1968.

Outlook

A new Government staff review of the balance of payments outlook for this year points to a near-record deficit of about $4 billion on the liquidity basis, before allowing for any "Special Transactions". Estimates on the official settlements basis might show approximate balance for the year as a whole but it could also give way to a sizeable deficit.

While these projections point up the structural weaknesses in our balance of payments, our position could well be sustainable for some time, provided:

(1) Tight money in the United States retains the short-term capital inflow, and

(2) Progress in curbing inflation offers a firm prospect of future improvement in our trade balance. But neither the financial community nor foreign officials are likely to maintain optimism for long, unless progress is visible on the "fundamentals."

Meanwhile, we must live with the fact that the weakness in our balance of payments compromises our negotiating posture in the economic and the financial field generally. It does not provide a firm base for leadership in pushing for international monetary reform; in this sense, our payments performance is our own worst enemy.

Implications

The potentially unsettling consequences on the international exchange markets of our own balance of payments performance is further complicated by the release this week of poor trade figures by both the U.K. and France. The other side of the coin is the very strong performance by Germany, Japan, and Italy. (It is not entirely a coincidence that these countries carry relatively light defense burdens.) The refusal of the Germans to revalue in the face of the strongest kinds of market pressures--and the refusal of the Italians or Japanese to even consider revaluation--only points up the difficulty of redressing these basic imbalances in an orderly way.

Three implications seem to me perfectly clear:

(1) Progress on the side of controlling inflation and eliminating excess demand is as essential to maintain the strength of the dollar abroad as it is domestically. We cannot expect dramatic or quick results in terms of the trade balance, but signs of progress are essential to maintain confidence that we have the will and the ability to achieve eventual equilibrium.

(2) We must continue to work toward some revaluation of exchange rates by chronic surplus countries (at least by Germany). This would be a necessary prelude to more thoroughgoing monetary reform. It would also be "preventive therapy" against the possibility of one-way devaluation by the French and British that would simply leave us and the monetary system worse off.

(3) At this stage, we are in no position to seek further important relaxation of our balance of payments measures, including defense offsets, investment controls, and aid tying.

Meanwhile, we will continue to work with other leading countries on "evolutionary" reforms--pushing the Special Drawing Rights in the IMF, actively exploring the feasibility of agreed changes toward more flexibility in exchange rates, and (subsequently and for the more distant future) considering the possibility of consolidating all reserve assets in the IMF.

However, we must also recognize that the events of recent weeks and our own balance of payments difficulties point out the political and economic roadblocks to orderly agreed change. We can anticipate the probability of further currency crises. Conceivably, such a crisis could be turned to a constructive purpose, and help accelerate the process of desired change. But a crisis atmosphere could also defeat the process of orderly change and cooperation by giving rise to uncoordinated, independent actions detrimental to our basic objectives in this area.

I am reviewing again our main alternatives in this difficult situation and will report to you shortly.

David M. Kennedy/4/

/4/Printed from a copy that indicates Kennedy signed the original.

22. Memorandum From the Chairman of the National Security Council Under Secretaries Committee (Richardson) to President Nixon/1/

Washington, May 26, 1969.

/1/Source: National Archives, RG 59, S/S Files: Lot 83 D 305, NSDM 12. Secret. Drafted by Colonel G. D. Overbey (EUR/RPM) on May 21 and concurred in by U. Alexis Johnson, Brigadier General Hampton (OSD/ISA), Major General Orwat (JCS), Springsteen (EUR), and Hartman (U). An earlier draft, prepared by the Interagency Working Group chaired by Under Secretary Johnson, was sent on May 14 by Staff Director Arthur A. Hartman to the Deputy Secretary of Defense, Kissinger, the Director of Central Intelligence, and the Chairman of the Joint Chiefs of Staff informing them it would be discussed at the Under Secretaries Committee meeting on Thursday, May 15. (Ibid.) On June 5 Kissinger sent Richardson a memorandum stating "the President has reviewed your memorandum and approves the recommendations." (Ibid., Lot 83 D 276, NSC-U/DM 9) A handwritten note at the top of the memorandum printed here indicates that the President approved.

SUBJECT
Report of the Under Secretaries Committee on REDCOSTE

The Under Secretaries Committee has completed its examination of the REDCOSTE proposals, which you directed (NSDM-12)/2/ be examined by it, taking into account our desire not to undercut our efforts to get our Allies to increase their defense efforts and our desire not to reduce our combat capability.

/2/See Document 18.

The Committee concentrated on those items on which no agreement to proceed had been reached previously, as well as those items where agreement in principle existed but proceeding was dependent upon discussion with host countries (i.e., Turkey and Spain).

In addition, the Committee reaffirmed those REDCOSTE proposals previously agreed and approved the proposed implementing schedule.

On those proposals upon which inter-agency agreement was pending, the Committee agreed that we should proceed with some degree or form of implementation of all but one of the proposals examined. However, implementation of several of the proposals is conditional and subject to responses and reactions of our European Allies.

On the basis of our tentative conclusions, it is anticipated that those REDCOSTE proposals previously agreed, together with those recommended herein for approval, should permit a possible reduction of about 27,400 military, 1,800 US civilians, and 7,100 Foreign National personnel. It is expected that there will be annual budget savings (after FY 1972) of about $355 million and a saving of $128 million in the balance of payments.

However, these figures are dependent upon Allied agreement to take over certain tactical missions, (Hawk and Nike Battalions in Germany and Sergeant Missiles in Italy) as well as Turkish assumption of certain facilities. If agreement is not obtained, the above figures will be reduced by about one-third.

Therefore, if fully implemented, we could achieve about 80% of the estimated 45,000 personnel reductions (32,000 military) and $429 million and $158 million savings in budget and balance of payments which the Secretary of Defense originally hoped to achieve. To have fully realized these projected savings would have meant a highly visible reduction of our forces in Europe, withdrawal of some NATO committed units (beyond those being offered to our Allies), and some degradation of combat capability, which might have been taken as a signal by our Allies of a lessened US interest in NATO.

With regard to the effect on the combat capability of US forces, it is our view that the cumulative impact of the REDCOSTE adjustments which the Committee agreed to make will not be significant. It is, of course, obvious that any reduction of this magnitude will have some impact upon military operations. However, the reductions have been effected essentially in the non-combat areas and every attempt will be made to minimize the impact upon combat capability. In this regard, General Goodpaster has been briefed, for his cognizance when he becomes SACEUR, on our conclusions and the magnitude and nature of the REDCOSTE proposals as well as the manner in which we propose to handle implementation with our NATO Allies.

In our scenario at Tab A/3/ it will be noted that we intend to handle each measure as an individual and independent action. Consistent with this approach, we have agreed that the Government will not make an announcement, as has been the practice in the past, concerning the totality of the reduction to be made. In consonance with the guidance in NSDM-12 that the proposals not be handled as a package, we do not intend to make public nor inform our Allies about the total personnel to be eliminated or the total savings anticipated. However, we would tell NATO, at the Military Committee level, and the respective host countries concerned, about certain significant measures. Our approach would be in terms of the kinds of things we are doing to streamline and tighten up our military establishment in Europe, rather than in terms of the quantitative savings or reductions we expect to achieve.

/3/Entitled "Scenario for Implementation"; not printed.

Following are the REDCOSTE proposals examined by the Committee and its conclusions. (The summary sheets at Tab B,/4/ describe the individual proposals and discuss the factors considered and anticipated savings and personnel reductions):

/4/Not printed.

1. Proposal: Reductions in US personnel and facilities in Spain.

Conclusion: Implementation should be contingent upon and be in context of the outcome of base negotiations with Spain.

2. Proposal: 60% reduction of US military personnel and dependents and facilities in Turkey.

Conclusion: We should continue to negotiate takeover of the facilities with the Turks, awaiting Turkish reactions before proceeding with implementation of the planned reductions or considering other options. (Other unilateral reduction proposals not related to or contingent upon the on-going negotiations could proceed.)

3. Proposal: Reduce US element of NATO staffs (19 headquarters) by 15%.

Conclusion: Any reduction in the manning of NATO staffs should be the result of normal personnel surveys and reviews rather than a unilateral decision to reduce the US element by 15%; this should be handled within the context of our efforts to share the defense burden with our Allies. However, the question of the level of US participation should be considered again in the context of Presidential decisions about the future level of US forces in Europe and attitude, in the long-term, toward NATO.

4. Proposal: Reduce Aviano Air Base, Italy, and relocate tactical unit in Italy.

Conclusion: Aviano should be retained in a fully operational status and the Quick Reaction Alert detachment not be relocated as proposed.

5. Proposal: Offer of 8 Air Defense Battalions (Hawk and Nike) to the Federal Republic of Germany; if they refuse offer, two Hawk Battalions would be withdrawn.

Conclusion: We should propose to the Federal Republic of Germany that they take over the 8 Air Defense Missile Battalions (4 Hawk and 4 Nike); the decision on whether to withdraw 2 Hawk Battalions if the Germans refuse to take them over would await German reaction and be re-examined again this summer in the context of the US response to the NATO Defense Planning Questionnaire (DPQ) for 1970 force commitments.

6. Proposal: Reduce activities at Athens International Airport and place facilities on stand-by basis.

Conclusion: The facility and support contingent at Athens should be retained in an operational status; an initial reduction should be made to a 1,100 personnel level; and a Department of Defense study should be made to ascertain whether further reductions should be undertaken while retaining the facility in an operative status.

7. Proposal: Reduce and relocate USAFE Headquarters, Germany; reduce two air bases.

Conclusion: (a) USAFE should be retained at Wiesbaden but reduced by 1,250 personnel; (b) the United States Air Force should attempt further Air Force reductions in the Wiesbaden area and elsewhere in Europe at once; (c) the question of retention at Wiesbaden should be considered again by the Department of Defense within the context of Presidential decisions to be made later this year concerning our long-term attitude toward NATO and the future level of our military presence in Europe; and (d) the matter of increase and acquisition of other air bases in Germany, previously included in this REDCOSTE proposal, should be examined in the context of the overall US European air base posture.

8. Proposal: Reduce SETAF (Southern European Task Force), withdrawing Army Sergeant Missile Unit from Italy; reduce Camp Darby Army Depot complex.

Conclusion: (a) SETAF/Sergeant Missile Unit: We should request the Italians to take over the Sergeant Missile Battalion; however, the decision on whether to withdraw the unit would be made in the light of the Italian reaction. In any event, substantial reductions, about 1,300 US and 600 Foreign National personnel, should be made by the Department of Defense by streamlining and consolidating SETAF Headquarters and support functions while continuing the essential peacetime functions. (b) Camp Darby Army Depot Complex: The Camp Darby Army Depot complex should remain operative and its essential functions continued, but it should be reduced by about 400 US and 900 Foreign National personnel to a level of about 800 personnel, by streamlining and consolidation, including modification, of support functions.

A scenario for implementation of REDCOSTE, covering proposals previously agreed and the foregoing proposals examined by the Committee, is at Tab A.

Individual summary sheets, describing in detail the REDCOSTE proposals which were considered on a case-by-case basis, issues involved and recommendations, are at Tab B.

ELR

23. Editorial Note

Beginning in late April 1969 exchanges of visits and messages between Washington and Tokyo set the stage for the Okinawa reversion negotiations and Japanese Prime Minister Sato's November 19-21 visit to Washington. U.S. policymakers were determined to keep economic issues on the agenda, but no formal linkage to the Okinawa negotiation and its related nuclear issues was stated.

On April 26 the Embassy in Tokyo transmitted the text of a paper that Fumihiko Togo, Director of the America Bureau in the Foreign Ministry, would use in Washington during his consultations scheduled to begin April 28. On the economic issues Togo's paper stated: "The current duty of the Japanese government is to . . . aim at a rational approach to bilateral economic issues . . . and in keeping with the increase in Japan's national strength, to fulfill international obligations commensurate with Japan's status as the leading Asian developed country. . . . [Japan's] role should be to progressively assume international political responsibilities, and to contribute actively in the field of economic development." (Telegram 3311 from Tokyo; National Archives, Nixon Presidential Materials, NSC Files, Country Files--Far East, Box 533, Japan, Volume)

Regarding Foreign Minister Kiichi Aichi's visit to Washington in early June, the Embassy in Tokyo on May 22 reported that Aichi would be prepared to discuss economic aid and bilateral economic problems in the context of Togo's paper, which had no formal status but was an authoritative reflection of Prime Minister Sato's views. The Embassy further noted that Aichi and others were of the view that Secretary Stans (who had visited Japan in May) had seemed more interested in liberalization of capital and trade than in the textile problem. Aichi, Togo, and others agreed Japan should move ahead faster on liberalization but would have great difficulty in appearing to move away from liberalization with regard to textiles. Charge Osborn reported that he told the Japanese officials that "Secretary Stans had not given us in the Embassy any impression of being anything but extremely earnest on textiles and quite serious in warning that alternative might be unilateral restrictive action." (Telegram 4060 from Tokyo; ibid.)

Further to Aichi's forthcoming visit, the Embassy on May 30 sent a cable reporting Aichi's plans to adhere to the approach in Togo's paper, but also indicating that Aichi would say "that Japan intends to assume greater share of own defense burden and to increase economic assistance to other Asian countries." Aichi reportedly would give Secretary Rogers separate papers outlining Japanese intentions on these two issues. The thrust of the economic paper was said to express "Japanese willingness to increase its overseas aid programs over the next ten years in proportion to the rate of increase in Japan's national income . . . [and] to operate through both multilateral (Asian Development Bank, Mekong Development Plan, ASEAN, Consortia, etc.) agencies and bilateral means to assist key countries in Asia (Korea, Taiwan, Cambodia, Laos, Viet-Nam, Indonesia and Thailand)." (Telegram 4325 from Tokyo; ibid.)

At the conclusion of his meeting with Foreign Minister Aichi on June 2, President Nixon noted they had been discussing Okinawa and trade and investment problems in a preliminary way and "asked Aichi to inform Sato that it would be in our interest to try to resolve these when he came to Washington." The President added that agreement would require additional, preliminary, hard work and that he looked to continuing discussions in Tokyo with U.S. Ambassador to Japan Armin Meyer, in whom the President had earlier told Aichi he had "every confidence;" with Secretary Rogers, who was to travel to Tokyo at the end of July; and with Japanese Ambassador Shimoda in Washington. A copy of the memorandum of conversation is ibid.

Secretaries Rogers and Stans traveled to Tokyo for the seventh meeting of the Joint Japan-U.S. Committee on Trade and Economic Affairs July 29-31. Secretary Rogers had separate meetings with Prime Minister Sato and Foreign Minister Aichi concerning Okinawa. He carried with him a July 22 letter from Nixon to Prime Minister Sato that read in part: "We consider the meetings of Cabinet representatives of our two governments to be a valuable means of reviewing the broad range of our economic activities and seeking ways in which to overcome obstacles to expansion of our large and growing trade and economic relations. . . . I look forward to seeing you in Washington later this year when we can review problem areas between us and decide how we can achieve further progress toward our common goals." (Ibid., RG 59, S/S Files: Lot 72 D 320, Japan: Nixon to Sato)

During the economic meetings the Japanese side declared its intention to expand substantially economic assistance, particularly for Asia, and to liberalize a considerable part of its remaining import quota restrictions by the end of 1971. The two sides exchanged views on the textile problem and Japan agreed to continue the discussion in September, without committing to any particular course of action. (Ibid., E/CBA/REP Files: Lot 70 D 467, Current Economic Developments, No. 837, August 5, 1969, pages 8-14)

On textiles President Nixon had approved, pursuant to a July 21 Decision Memorandum from Arthur Burns, a policy of attempting to limit growth of textile imports by negotiating comprehensive bilateral agreements with Japan, Korea, Taiwan, and Hong Kong (in order to avoid having to enlist European cooperation). (Ibid., Nixon Presidential Materials, NSC Files, Subject Files, Box 399, Textiles, Volume I) By contrast, in his cable to the Embassy in Tokyo reporting on his August 8 luncheon meeting with Japanese Ambassador Shimoda upon the latter's return from the July economic conference, Under Secretary U. Alexis Johnson reported that Shimoda said it would be easier for Japan to do something on textiles within the GATT framework than bilaterally. Responding to Shimoda's question about a connection between economic issues and Okinawa, Johnson said "that while matters were, of course, separate and we would continue to deal with them separately there was no getting around fact that Japan's 'image' here, and especially in the Congress, was much affected by Japan's posture on economic matters and, accordingly, this influenced attitudes in Congress on Okinawa." (Telegram 133630 to Tokyo, August 9; ibid., Country Files--Far East, Box 533, Japan, Volume I)

In drafting the joint communique for the November 19-21 meetings between President Nixon and Prime Minister Sato in Washington, the Japanese side sought to have it deal only with Okinawa while the U.S. side thought other items on the agenda, including trade, foreign assistance, and textiles, should be included. An exchange of cables between the Department of State and the Embassy in Tokyo regarding the communique language is ibid., Box 534, Japan, Volume II, 10/69-6/70. The joint statement issued on November 21 has Okinawa as its primary focus, but also dealt with other matters, including trade liberalization and foreign assistance. For text, see Public Papers of the Presidents of the United States: Richard M. Nixon, 1969, pages 953-957. The communique did not mention textiles, however, despite Japan's agreement to hold secret bilateral talks as a precursor to efforts to negotiate a multilateral agreement. Prime Minister Sato had "stressed it would put his government in a very difficult position if it became public knowledge that bilateral talks had been going on between U.S. and Japan before multilateral talks got underway." (Telegram 9407 from Tokyo, November 12; National Archives, Nixon Presidential Materials, NSC Files, Country Files--Far East, Box 534, Japan, Volume II 10/69-6/70)

24. Editorial Note

In the Spring of 1969 the NSC Under Secretaries Committee, pursuant to NSDM 12, coordinated and monitored the Nixon administration's preparations for negotiations with Germany on the offset question. Meetings of U.S. and German experts were held in Washington on May 13 and 14 and in Bonn on May 20 and 21. Concerning the earlier meetings, Helmut Sonnenfeldt sent Henry Kissinger a May 20 memorandum reporting on his luncheon meeting with German Ambassador Pauls that day. According to Sonnenfeldt, Pauls said "the Germans had been baffled" by some U.S. positions which seemed to be related to German performance on currency matters and a possible link between Mark revaluation and an offset settlement. (National Archives, Nixon Presidential Materials, NSC Files, Country Files--Europe, Box 681, Germany, Volume II, 4-6/69) In a May 22 memorandum, Kissinger asked Bergsten and Sonnenfeldt to look further into matter, saying "one thing we must avoid is any arm-twisting of the Germans." (Ibid.)

In preparation for the next round of negotiations in Bonn on June 2 and 3, on May 23 Assistant Secretary of State for European Affairs Hillenbrand sent Deputy Under Secretary Samuels, chairman of the U.S. offset negotiating team, a memorandum for a May 26 meeting of the Under Secretaries Committee on the offset negotiations. Hillenbrand said the principal issue for the meeting was approval of a memorandum to the President and he attached a State draft and a Treasury counter-draft  that "unfortunately differs in tone and negotiating content." The State draft was silent on monetary linkage, but the Treasury draft said: "We see no advantage in explicitly bargaining with the Germans on Special Drawing Rights or other monetary cooperation questions in connection with the offset agreement. We do believe the discussions during the course of the offset would show the need for discussing broader monetary questions. Further, it is our opinion that a firm negotiation could be an inducement toward discussing these broader and longer range questions." (Ibid., RG 59, S/S Files: Lot 83 D 305, NSDM 12)

A May 29 memorandum from Elliot Richardson to President Nixon summarized the negotiations thus far and presented the Under Secretaries' recommendations for the upcoming talks. Regarding the question of linkage, the last paragraph of Richardson's memorandum reads:

"We have not raised with the Germans the question of using the offset issue as part of the bargain on broad monetary compensation. There are no indications of fruitful possibilities along that line at the moment. However, we will remain alert to this possibility, if it at any time seems promising, in the course of the agreement period. Also in accordance with the NSDM 12, we would in our discussions avoid any commitment on U.S. force levels." (Ibid., Nixon Presidential Materials, NSC Files, Country Files--Europe, Box 681, Germany, Volume II 4-6/69)

Attached to Richardson's memorandum is an undated memorandum to the President, signed but probably not sent, in which Kissinger argued somewhat differently: "On the merits, the Germans should make every concession we ask. After their failure to revalue or take any alternative measures, they should do everything possible to offset their huge balance of payment surplus." Crossed out language in the conclusion reads:

"The merits are all on our side. And I told the Germans that you would take into account on the offset their overall monetary performance, which has been completely unforthcoming on revaluation or any alternatives. The Under Secretaries' Committee does not think that including the broader monetary issues in the offset talks would be fruitful at this time. There are major international monetary decisions to be made in the next few months, however, and the offset is one of our few levers with Germany. I therefore think we should leave the door open for awhile."

At the June 2-3 discussions in Bonn, the U.S. side presented its positions, and the Germans made several comments. The status of the negotiations in June and July was summarized in a July 7 memorandum from Richardson to President Nixon (ibid., RG 59, S/S Files: Lot 83 D 305, NSDM 12) and a July 7 memorandum from Bergsten to Kissinger. (National Archives, Nixon Presidential Materials, NSC Files, Country Files-Europe, Box 682, Germany, Volume III 7-11/69) A 2-year agreement for $1.52 billion by categories of FRG expenditures was finally signed on July 9. The joint statement summarizing the terms is in Department of State Bulletin, August 4, 1969, page 92. Bergsten's evaluation of the agreement is in a July 9 memorandum to Kissinger. (National Archives, Nixon Presidential Materials, NSC Files, Country Files-Europe, Box 682, Germany, Volume III 7-11/69)

25. Memorandum From the President's Assistant for National Security Affairs (Kissinger) to the Under Secretary of State (Richardson)/1/

Washington, July 21, 1969.

/1/Source: National Archives, RG 59, S/S Files: Lot 73 D 288, Box 838, NSC/USC Memos. Secret.

The President has ordered a ten per cent reduction in all American overseas civilians directly hired by the U.S. Government and certain American military personnel overseas. Each agency with personnel overseas will be required to meet the ten per cent quota, and reductions will be made on a country-by-country basis, insofar as practicable. The reduction should take account of national security priorities and special local problems, without prejudice to the objective of ten per cent for each agency. Attention should be given to the political problems raised by cuts in U.S. personnel in Thailand. Civilian personnel in South Vietnam will be cut by more than ten per cent./2/

/2/This memorandum launched Operation Reduction, OPRED, a military and civilian counterpart to the balance-of-payments/budgetary REDCOSTE exercise already underway in Europe. For a statement regarding the OPRED objectives and the Department of State's November 24 announcement of post closings to comply with the July 21 directive, see Department of State Bulletin, December 22, 1969, p. 591.

The President has directed the Under Secretaries Committee to report by September 30 its plans to carry out this directive, and actions already undertaken. Monitoring will thereafter be the responsibility of the Bureau of the Budget, which should make quarterly reports to the Under Secretaries Committee.

It is anticipated that the reductions will approximate 14,900 military and 5,100 civilian personnel.

The reductions will be based on the actual strengths as of June 30, 1969, as determined by the Bureau of the Budget for the Under Secretaries Committee, minus outstanding BALPA cuts and other programs of reductions which have been approved.

The reductions do not apply to U.S. military forces committed to NATO or in Berlin or essential to their support, to forces stationed in Korea or in Vietnam, or to units stationed elsewhere in Southeast Asia that are directly engaged in related military operations. The exception in these areas does not, however, apply to direct-hire or contract U.S. civilian personnel working with our military commands there.

Peace Corps Volunteers, but not administrative personnel, are also exempted.

The reductions should commence as soon as possible, and must be completed during FY 1970.

The Committee should also consider means of reducing the number of foreign personnel hired locally by U.S. agencies abroad. Special study should be given to means of reducing U.S. contract personnel whose contracts are not directly with the U.S. Government.

Defense and CIA will together prepare plans for the reduction in Intelligence Community personnel, submitting these plans for review by the Under Secretaries Committee working group. Recommendations will be made in consonance with the priorities for intelligence coverage established by the United States Intelligence Board, and the objective of a reduction of ten per cent in overseas personnel will be accomplished in such a way as to cause the least possible loss of access to intelligence needed for national security purposes.

Henry A. Kissinger

26. Paper Prepared by Consultants/1/

Washington, undated.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 397, A Strategic Overview. Secret. Printed here is section VIII, pp. 66-71, of the 78-page, undated paper entitled "The United States Position in the World: An Overview," forwarded to Kissinger under cover of a memorandum from Robert Osgood on August 20. Osgood noted that the paper was his synthesis of three "sets of books" prepared by the Department of Defense, CIA, and the Department of State in response to NSSM 9 and other NSSMs and analyses, and he credited Richard N. Cooper with preparation of section VIII of the study. There is no indication of how the study was distributed or used. A copy of NSSM 9, "Review of the International Situation," issued on January 23, is ibid., RG 59, S/S Files: Lot 80 D 212.

VIII. FOREIGN ECONOMIC TRENDS

The Separation Between Foreign Economic and Political Policy

Broadly speaking, the United States during the last two decades has preserved a rather sharp distinction between foreign economic policy and the main lines of foreign policy. This distinction arose partly because of an internal division of labor between economic and political issues within the U.S. Government--and within other governments--but partly also because of an underlying assumption that the most felicitous economic environment for the achievement of broad U.S. foreign policy objectives is a thriving, open, and non-discriminatory world economy. Trade is so essential to most countries of the world that successful trade performance becomes a precondition for peaceful and cooperative actions in other areas. Thus, given general guidance for the achievement of a liberal trading environment, it was felt that foreign economic policy should be left alone, free from interference by shorter-term political considerations.

There have, of course, been exceptions to this separation between economics and politics in foreign affairs. In the realm of East-West trade the United States has maintained tight and discriminatory controls for political reasons. The United States lent strong support to the formation of the European Economic Community, a discriminatory trading bloc, on grounds that were fundamentally political. Foreign aid has always been treated more as an arm of general foreign policy toward the Third World than as an aspect of foreign economic policy. But by and large, international trade negotiations and international monetary discussions have proceeded in their own way and at their own pace, aimed at the broadly political objective of freedom of trade and other economic transactions on a multilateral and non-discriminatory basis.

It may be more difficult to preserve this semi-separation between economic and political relations with other countries in the next decade than it has been in the past two decades. Two developments, in particular, introduce new complications: (1) the increasingly complex interaction between foreign trade, international investment, and domestic economic policy, and (2) the growing movement toward preferential trading arrangements. A slightly countervailing tendency is the increasing multilateralization of foreign aid, whereby bilateral political considerations tend to be removed from the donor-recipient relationship.

Trade and Investment

Economic relations among industrial countries have broadened considerably, providing today many more points of contact than the mere exchange of merchandise and occasional travelers. Liquid funds move in large volume between major financial centers. Bond markets are tied more closely together. There has been a vast increase in private American investment abroad, involving managerial control. As a result, a growing amount of international trade is intra-firm trade. All of these developments have profound implications for such traditional national economic policies as monetary policy, tax policy, and business regulation.

Pressure on national monetary policy has already become acute and has evoked such economically "disintegrative" reactions as the interest equalization tax and other restraints on capital outflows from the United States, a German tax on foreign holdings of German bonds, prohibition of foreign mutual funds in Italy, and a host of similar devices in most other industrial countries--all designed to preserve some insulation between domestic and foreign monetary conditions. Pressure on national business regulations is still moderate, but it has given rise to international attention and to foreign concern over the "extra-territorial" extension of U.S. laws and regulations, mainly to U.S.-owned firms abroad. With high international mobility giving rise to easy escape from national regulations and restrictions, the problem will grow more serious.

The increasing attention being given to "non-tariff barriers" to trade also reflects the more numerous points of contact between domestic and foreign economic policies. With tariffs and other explicit barriers to trade sharply reduced among industrial countries, the temptation will be strong to use more subtle techniques for protective purposes. And measures motivated by health, safety, or revenue considerations rather than by protectionism will nevertheless appear as irritating, and hence suspect, obstacles to actual and prospective foreign exporters.

All these developments will compel a searching re-examination, jointly with major countries, of heretofore strictly domestic policy, and this re-examination will create corresponding tension within countries between those segments of the population with a primarily domestic orientation and those whose orientations are increasingly transitional.

Preference Areas

The late 1950s and early 1960s were marked by the successful formation of a number of trade preference areas, notably the European Economic Community, but also the European Free Trading Association, the Central American Common Market, and the Latin America Free Trade Area. Countries that for economic or political reasons do not want full association have frequently pressed for partial affiliation to these various trading blocs. Such affiliation is most advanced in the case of the European Economic Community, where to various degrees Greece, Turkey, the French African countries, Nigeria, and East Africa have achieved some sort of special trading status.

These arrangements point to a substantial erosion of the U.S. objective of an open, non-discriminatory world trading economy. In combination with the factors noted above, they have led to increased pleas for direct U.S. involvement in special trading arrangements, to which the U.S. yielded in the case of the Canadian automotive pact. As these developments progress, foreign political and foreign economic policies will merge, since bilateral trade pacts not only confer favors, but also presuppose political harmony and mutual goodwill--or tutelage--for their effective operation. The United States may expect to be put under increasing pressure to acquiesce in such discriminatory trade arrangements and even to participate in them, especially to grant preferential access to Latin American products coming into the U.S. market.

For political reasons, the United States has encouraged Britain to join the European Economic Community. British membership would inevitably involve several smaller European countries as well and would create a large and formidable trading area entailing some economic costs to the United States. Consequently, British membership would give rise to internal and international frictions with considerable influence on American foreign policy.

In response to pressure from the less developed countries for special trading arrangements, the U.S. has become involved in discussions of a system of world-wide tariff preferences granted by all developed countries to all less developed countries. Certain leaders in the less developed world have laid high hopes on such a scheme. They greatly exaggerate the economic benefits it would bring to their countries, but they consider preferential trading privileges symbolic of the true intentions of the wealthy nations toward the poor ones.

The pressure for preferences reflects a very real problem that will become increasingly acute in the next decade--the need for foreign markets for the rapidly growing output of light manufacturers in the less developed countries. As the LDC's develop efficiently, the output of some products will exceed the home demand for them, giving rise to exportable surpluses; and in any case the LDC's will need to earn foreign exchange to keep their economies both operating and growing. The manufactured products they can export competitively are of the "low-wage" type and hence are politically sensitive in virtually all developed countries. Yet successful economic development in the Third World requires a changing structure of world trade and output which the developed countries can ignore only by closing their markets to the very products that the LDC's, in the course of development, are able to produce efficiently. Assurance of foreign markets is a corollary of U.S. encouragement to development efforts, and in the absence of such markets many otherwise promising development prospects will fail.

International Monetary System

There are likely to be important changes in the international monetary system over the next decade. The reasons lie in the structure of the present system rather than in the purposes and actions of particular governments. Two principal deficiencies in the present system have become evident in recent years. Our method for generating international liquidity, necessary to provide the monetary base for growing foreign trade, is inadequate; and our methods for controlling imbalances in international payments are defective. The U.S. balance of payments deficit, a persistent problem for the United States that will continue for at least several years into the future, reflects these more general deficiencies.

The traditional form for international liquidity has been gold. Gold was accorded a central although unprominent role in the present payments system, laid down by American and British planners a quarter of a century ago. There is clearly not enough new gold at its present price to serve both the growing monetary needs of the world economy and the enlarged private demands for industrial and artistic uses.

The latent shortage of gold would have become evident years ago had not the U.S. dollar served as a kind of surrogate gold in providing international liquidity to nations around the world. (Indeed, one of the problems in framing a sensible policy for the U.S. balance of payments is that U.S. deficits have supplied needed liquidity to the rest of the world.) But this expanded role of the U.S. dollar has left other countries, especially in Europe, uneasy about the capacity implicit in present arrangements for the United States to pursue its international political and economic objectives without regard to the wishes of its allies, while they are nonetheless expected to finance these objectives by accepting and holding dollars in unlimited amounts. Most other advanced nations share broad U.S. objectives, but the very sharp increase in U.S. direct investment in Europe in the early 1960's and the subsequent escalation of our military expenditures in Vietnam brought home the possibility that they might be called upon to finance very large expenditures, public or private, on which they were not consulted and to which they might even object. For this reason, there is a general unwillingness among major countries to acknowledge the reserve currency role of the dollar as a continuing and permanent feature of the payments system.

A solution to the international liquidity problem is near at hand, following five years of negotiation among major countries, in the creation of Special Drawing Rights (SDR's). These will offer a new, manmade form of surrogate gold unrelated to any particular national currency. Creation of SDR's will represent a far reaching step in international monetary cooperation, and with continuing goodwill it will solve the problem of a shortage of monetary gold.

The second deficiency in the payments system concerns the correction of imbalances in international payments. Countries pursue separate policies and they are subject to separate pressures and disturbances. They have divergent rates of growth, and the impact of economic growth on the balance of payments varies from country to country. Their choices between inflation and unemployment and with respect to foreign policy will differ. For all these reasons, countries are bound from time to time to experience imbalances in their international payments. The Vietnam war provides a recent dramatic example, where for reasons of national security, overseas expenditures for the United States were increased sharply.

Under the present rules, laid down twenty-five years ago, temporary imbalances in payments are to be financed out of international reserves and by borrowing directly and indirectly from creditor nations. Where an imbalance persists, it is to be corrected by a change in the value of the country's currency with respect to other currencies; that is, a change in its exchange rate. This mode of adjustment has been difficult to apply in practice, however, and has become increasingly disruptive of international financial order. Countries in payments surplus are not under the same kinds of pressure as countries in deficit to adjust their exchange rate in response to a persistent imbalance. Considerations of international prestige dictate postponement of exchange rate changes, for a change in the value of the currency is (sometimes wrongly) taken as an acknowledgment of poor economic policies. Finally, public anticipation of changes in exchange rates give rise to large and disruptive movements of speculative funds, out of currencies expected to be devalued, into currencies expected to be revalued. With the growing international mobility of capital, these speculative movements have grown dramatically in size.

The currency crises during 1967-1969 reflect this deficiency in the present payment system. In late 1967 large movements of funds preceded devaluation of the British pound--indeed partly forced it as Britain exhausted its reserves--and large amounts of funds have been moved out of France and into Germany during the subsequent period, all in anticipation of changes in exchange rates.

The absence of an effective adjustment process will induce countries in periods of financial strain either (a) to deflate their domestic economies beyond what is desirable on domestic grounds or, more likely, (b) to impose tight controls on their economic transactions with the rest of the world, thereby violating the basic open and non-discriminatory world trading economy which the United States has strived to achieve. Such controls have been used with increasing frequency, after a long period of gradual relaxation of the restraints on international transactions imposed during and immediately following the Second World War. If these violations are not to become increasingly severe and more widespread, the balance-of-payments adjustment process must be markedly improved in the coming years; for example, by improving the methods by which exchange rate changes can be utilized as part of the process.

The weakness of the structure of the U.S. balance of payments has been masked during the past year by large inflows of short-term funds attracted by high interest rates in the American economy. A change in domestic economic conditions should lead to substantial improvements in the trade balance but probably not enough to correct the basic imbalance. This is an additional reason for the United States to be interested in more general improvements in the process of balance-of-payment adjustments.

27. Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/

Washington, September 15, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. No classification marking. Bergsten sent this memorandum to Kissinger under cover of an August 26 memorandum indicating it had been revised (from an August 13 version) pursuant to Kissinger's instructions and comments from McCracken and Burns. Bergsten recommended Kissinger sign the memorandum to the President. (Ibid.)

SUBJECT
Payments Effects of U.S. Government Transactions, FY 1968-70

Attached at Tab A is Bob Mayo's report on the balance-of-payments effects of recent and current U.S. Government international transactions. Comments by Arthur Burns and Paul McCracken are at Tabs B and C./2/

/2/None of the attachments is printed. Mayo's memorandum is dated August 8, Burns' is dated August 11, and McCracken's is dated August 15.

The key elements of the reports are:

1. The payments effects of all government transactions leveled off during the past two years at about $2 billion net deficit.

2. This figure, however, includes window-dressing receipts of about $1.5 billion.

3. The deficit on regular transactions has thus been about $3.5 billion, although it has shown steady improvement and is expected to diminish by 12% to about $3 billion in FY 1970.

4. Because this Administration has decided to eschew window-dressing statistical gimmickery, however, the total net payments effect of government transactions will deteriorate this year.

5. The Defense Department accounts for over two-thirds of the gross payments--almost $5 billion annually--and is responsible for the total net deficit on regular transactions plus offsetting the effect of the special transactions.

6. Non-defense agency transactions now produce a slight favorable balance on their regular transactions, which should grow somewhat in 1970. Much of the inflow is return on previous loans.

7. AID, which is often labeled as a major source of the U.S. payments deficit, has steadily reduced its foreign payments to the relatively small figure of $145 million in 1970. This is a good bit less than half its receipts and less than the combined payments of Interior, NASA and the Panama Canal. The AID receipts are mainly repayments on past loans.

Analytically, this report is useful but cannot be simply compared with our overall payments position--as many people do to conclude that "the deficit is caused by the government spending." This is because there are large offsetting feedbacks to the government expenditures which show up in the private accounts.

For example, Korea and Thailand would not buy as many U.S. exports if they earned no dollars from DoD programs. Even Japan and major countries in Europe adopt easier economic policies because of our military expenditures there, of which some share comes back to us. This is not to say that government expenditures are not a major factor in our payments deficit--but simply to flag the error in simplistic comparisons.

Paul McCracken comments that we should carefully consider the domestic economic effects of the policies, which we inherited from the previous Administration, to minimize foreign expenditures for government programs. He is referring to such practices as the 50 percent preference extended by DoD to domestic suppliers and AID's tying policies, which create some balance of payments savings but are quite costly in budgetary terms. (Reductions in the level of our overseas programs, as per your recent directive on personnel and the Vietnam troop withdrawals, of course help our balance of payments. McCracken is here referring to the foreign exchange costs of a fixed level of government programs.)

Arthur Burns, on the other hand, suggests that you ask the Treasury Department to make recommendations on steps to reduce further the balance of payments costs of overseas government expenditures. Any such steps would probably carry the increased budgetary costs mentioned by McCracken and have small payments effects, unless they represented major program changes./3/

/3/In the margin next to this paragraph the President wrote "no" and someone added the date 9-24-69. In a September 25 covering memorandum to Kissinger Bergsten interpreted the President's "no" as pertaining to Burns' suggestion, in the first sentence of the paragraph, rather than to the analytical point in the second sentence, which he said would put the President in error. Bergsten wrote: "I am sure that Burns did not feel very strongly about his suggestion, which was made August 11, and I see no reasons to pursue the matter any further, since no action is called for under either interpretation. Inaction is particularly appropriate because of the uncertainty over the 'no' meaning and in view of Burns' sensitivity over his memos going to the President through you." On September 29 Kissinger approved Bergsten's recommendation to take no action on the "no" written in the margin.

An interagency committee, chaired by Treasury, is in fact already reviewing present policy and will be making recommendations soon on possible changes. I therefore think that you do not need to take any action now. One change--the elimination of the "additionality" requirements under our AID programs--has of course already been made.

28. Memorandum From Secretary of the Treasury Kennedy to the President's Assistant for National Security Affairs (Kissinger)/1/

Washington, October 10, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Country Files--Europe, Box 682, Germany, Volume III, 7-11/69. Confidential.

SUBJECT
Taxation of U.S. Firms Doing Business in Berlin

This is in reply to your memorandum of September 15, 1969, asking for views and suggestions on the German request that the United States forego its share of tax on income derived from U.S. corporate investment in Berlin to the extent that such income is accorded preferential tax treatment under German law./2/ The Germans raised this issue in NATO in 1968, and have raised it through our Embassy in Bonn on several other occasions. In essence, they seek a "tax-sparing" concession under which the United States would give a foreign tax credit for an amount of German tax which has not in fact been paid--for a tax which has been spared by virtue of the German tax subsidy. Treasury's policy in the past has been to oppose any tax--sparing provision with respect to Berlin.

/2/The memorandum was not found.

Such a provision would require legislation, or a treaty amendment approved by a two-thirds quorum vote of the Senate, and there is reason to believe that we would have great difficulty in selling this idea on the Hill, particularly in view of the fact that the Senate has previously refused to go along with tax-sparing proposals, or even with the extension of the investment tax credit-a more modest incentive than tax-sparing-to stimulate U.S. investment abroad in the context of our tax treaties with less-developed countries.

There are several factors which we feel militate against the German request. First, we believe the Federal Republic of Germany is in a sufficiently strong economic position to enable it to subsidize the Berlin economy in ways which would not, in order to be completely effective, require the United States to give up the tax normally due. The United States is being asked to make a questionable departure from established practice and policy which is not necessary to achieve the German objectives for the Berlin economy. In any case, given the U.S. balance of payments position vis-a-vis Germany, any special provision to encourage the outflow of U.S. capital to that country seems unwarranted. Second, the incentive effect of the lower corporate tax in Berlin is not necessarily nullified by our system of taxation, since under current law the U.S. tax is only applicable (except in certain abuse situations) to repatriated profits from U.S. subsidiaries in Berlin. Therefore, if profits are retained abroad, the Berlin corporate tax incentive remains viable. Third, where there are U.S. corporations doing business in Berlin with excess foreign tax credits generated through their other German operations (or, in the case of U.S. taxpayers using the "overall" foreign tax credit limitation, their worldwide operations) such excess credits can be applied to reduce the U.S. tax on income from investments in Berlin.

There are other considerations which reinforce the above arguments, including how we could justify this exception to countries such as Jamaica and Ireland that have already requested similar treatment. Our balance of payments program has generally distinguished between industrialized countries and LDC's, with the latter receiving special consideration; if we willingly discriminate in favor of a strong industrialized country, we can certainly expect complaints from other countries and, based on past experience, perhaps from such international organizations as the OECD.

David M. Kennedy

29. Letter From the Chairman of the Board of Governors of the Federal Reserve System (Martin) to Secretary of the Treasury Kennedy/1/

Washington, October 21, 1969.

/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, BOP Improvement Measures, Volume 4, 66-69. No classification marking. A handwritten notation on the letter reads: "Copy for Mr. Volcker 10/21 6:45 pm copies to Messrs. Petty and Schaffner."

Dear Dave:

I regret that I shall have to miss tomorrow's meeting on the 1970 balance of payments measures./2/

/2/The meeting has not been identified, but on October 29 Paul H. Boeker sent a memorandum to Assistant Secretary of State for Economic Affairs Trezise informing him that "interested USG agencies are having second thoughts about the Fed's proposed revisions in the VFCR Program announced at last week's meeting of the Cabinet Committee on Economic Policy." Boeker explained that the Fed had consistently opposed increased export credit extension because of its adverse short-term balance-of-payments impact but that "all member agencies of the Cabinet Committee on Export Expansion except the Fed expressed support for the exemption of all export credit from VFCR guidelines." Boeker recommended Trezise contact Governor Brimmer to support further interagency study of the practical consequences of the proposed revision of the VFCR program (before any announcement of new guidelines was made). Trezise's handwritten note on Boeker's memorandum reads: "Call to Brimmer not necessary now. PHT." (National Archives, RG 59, Central Files 1967-69, FN 6 XMB)

Enclosed with this letter is a statement on the balance of payments problem, which provides strong reasons for minimizing any relaxation in the programs and for pressing toward equilibrium in the U.S. balance of payments.

I am sending copies of this letter and the enclosed statement to the other participants in tomorrow's meeting.

Sincerely,

Bill

Enclosure

1. For almost two years foreign monetary authorities as a group have experienced a drain on their dollar holdings. Despite the worsening in the structure of the U.S. balance of payments, the inflow of short-term funds through U.S. banks has kept the dollar strong in exchange markets by making the holding of dollars attractive to private individuals, business and financial institutions abroad.

a. In 1968 the deficit on the liquidity basis improved substantially as a result of the January 1 balance of payments program, and the surge of foreign purchases in the U.S. stock market, despite a fall-off in the trade surplus. But the official settlements position improved even more, as a result of the Eurodollar inflow.

b. In the first half of 1969, the liquidity balance deteriorated sharply for a variety of reasons: a further fall in the trade surplus, a drop-off in stock purchases by foreigners, an increase in direct investment outflows, and the attraction of American funds to the Eurodollar market. But the official settlements balance was in sizable surplus, again because of the Eurodollar inflow.

c. The U.S. payments position has thus been protected in the past two years by short-term borrowing--in an amount exceeding $10 billion.

2. This protection has come to an end. A mere cessation of the Eurodollar inflow is enough to throw the official settlements balance into deficit (as has happened in the past two months). If, as seems likely, U.S. banks begin to repay Eurodollar borrowings, the official settlements deficit will probably exceed the liquidity deficit.

3. Thus foreign monetary authorities will very likely be accumulating large amounts of dollars next year and beyond.

a. No doubt, there is some appetite abroad for additional dollars at the moment. Some countries--notably the United Kingdom and France--have debts to repay. Others would be pleased to rebuild their dollar holdings, which have been depleted in the past two years.

b. But the appetite is limited. A large official settlements deficit is very likely to lead, rather soon, to a large drawdown of U.S. reserves (gold, our IMF position, SDR's).

c. The attitudes of foreign monetary authorities toward the accumulation of dollars, in counterpart of our large official settlements deficit, will no doubt be influenced by whether they regard the large deficit as temporary or permanent. Some reversal of the surplus of 1968-69 will be regarded as normal.

d. But if the U.S. authorities are seen to be dismantling the programs to restrain capital outflows in the face of a large deficit, foreign monetary authorities are likely to be disturbed and to conclude that the United States deficit is here to stay. This in turn is likely to lead them to ask for conversion of greater amounts of dollar accruals into gold, Fund positions, or SDR's.

e. Beyond this, many officials abroad, particularly in the Group of Ten countries, might well regard a significant relaxation of balance of payments restraint programs in the face of a large deficit as somewhat of a breach of faith. They were willing to go along with SDR activation on the grounds that it would help the balance of payments adjustment process. Thus they overlooked the unsatisfactory U.S. payments position in agreeing to SDR activation. A significant relaxation of restraint programs now would embarrass those European officials who were so cooperative regarding SDR activation in substantial amounts. It would also very likely jeopardize future negotiations regarding SDR's.

4. Beyond these considerations, there is the basic question of where the United States is heading with its balance of payments policy.

a. The initiative of Secretary Kennedy regarding a study of limited exchange rate flexibility is unlikely to lead to sizable revaluations of other currencies against the dollar, over and above the present upward move of the DM.

b. Apart from stopping inflation in the United States and bringing about a gradual improvement in the trade balance, there is little else the United States can point to as a policy to improve the payments position.

c. In these circumstances, a sizable relaxation of capital restraint programs can only be seen by close observers as leading to some sort of crisis--presumably a suspension of convertibility of the dollar into gold.

d. While this possibility has been in the minds of many officials abroad, it has been regarded as a last resort in circumstances of unavoidable crisis. In such circumstances, suspension would be understood and accepted in relatively good grace abroad.

e. But if avoidable U.S. actions themselves precipitate the process that leads to suspension, the financial and political repercussions abroad are likely to be grave.

5. All these considerations point to the desirability not only of minimizing the extent to which the Commerce and Federal Reserve programs are relaxed for 1970 but also of continuing to press toward equilibrium in the U.S. balance of payments.

30. Editorial Note

Japanese Prime Minister Sato made a State visit to Washington November 19-21, 1969. Six memoranda of his conversations with President Nixon are in the National Archives, Nixon Presidential Materials, NSC Files, VIP Visits, Box 924, Sato 11/19-21/69. During two of those conversations, on November 20 in the Oval Office from 10:18 a.m. to 12:30 p.m., and again on November 21 from 10:21 to 11:10 a.m., the President and the Prime Minister discussed an accommodation on textiles. The Prime Minister said he was bound by a unanimous resolution in the Diet against a bilateral agreement with the United States on textiles. The President suggested that before the United States "at an appropriate time" took the issue to GATT he and the Prime Minister attempt to work out a common position in order to avoid a confrontation in Geneva. Documentation on the bilateral textile negotiations is scheduled for publication in a forthcoming Foreign Relations volume covering Japan.

At the November 20 meeting the President and Prime Minister also discussed trade and capital liberalization and Japan's economic role in Asia. Regarding liberalization, the President said that if Sato could make a good statement on liberalization it would help him hold protectionism at bay domestically: "if Japan, which currently enjoyed such a favorable balance of trade, did not relax its restrictions people here would question why we should." The Prime Minister "agreed completely" with the President that apart from textiles they should broadly move toward freer trade.

The President noted that "Japan was now at a point where it could play a greater role . . . not just in Asia but on the world scene . . . that Japan should move to a 'higher posture' in the area of trade, investment, political development of Asia and, to the extent we can agree between us even in security . . . the world would be healthier if Japan could be added 'as a fifth finger' to the four existing areas of great power, the United States, Western Europe, the Soviet Union and China." Prime Minister Sato replied that he hoped the Japanese people understood how much they were indebted to the United States for its assistance and cooperation after World War II, and how it had been "quite a shock to Japan" to learn that the Allied Powers had been preparing postwar Japan policy during the height of the war. In that context, and without making any firm commitments, he and the President exchanged views on how Japan might cooperate in Asian development during the post-Vietnam period.

31. Action Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/

Washington, November 28, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. Confidential. Attached to Document 32.

SUBJECT
Balance of Payments Program for 1970

At Tab A are recommendations from Secretary Kennedy for next year's balance of payments control programs on foreign investment by U.S. companies and banks./2/ An early announcement is needed to permit the companies and banks to develop their own plans in light of the new program. I have checked this memorandum with Arthur Burns./3/

/2/Secretary Kennedy's November 19 memorandum and its attachments, including an undated memorandum from Secretary Stans, are not printed. An earlier version of Secretary Kennedy's memorandum, dated November 5, did not go forward to the President. (National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments)

/3/An earlier version of this memorandum was forwarded to Kissinger under cover of a November 20 memorandum from Bergsten, in which Bergsten noted that he had discussed the memorandum to the President "at length" with Burns and had "cleared" it with him. (Ibid.)

Level of Restraint

Secretary Kennedy, with the concurrence or acquiescence of all relevant parties, recommends a modest liberalization of the present controls on foreign investment by U.S. firms:

1. An increase in the level of foreign investment for each firm exempted from the controls, from $1 million to $3 million.

2. Exemption from control of an additional $2 million per firm for investment in LDCs.

These steps represent a compromise between the preferences of some for more liberalization and the preferences of others for less. They would:

--Be a next move toward implementing your April 4 call for "ultimate dismantling of the network of direct controls."/4/

/4/See footnote 5, Document 16.

--Eliminate about 350 companies from coverage by the Commerce program, which would be popular politically.

--Risk an increase in capital outflows of up to $600 million. (The net effect on our balance of payments would be decidedly smaller because any additional capital outflows would generate additional U.S. exports.)

--Risk foreign policy problems, if our balance of payments turns sour enough next year to require us to take tough unilateral actions--such as suspension of the gold convertibility of the dollar--since we might be blamed for creating the problem ourselves by relaxing our defensive measures.

Five other options were considered:

1. Tightening of the controls. (This would signal a new policy direction for the Administration, contrary to our basic philosophy of freer trade and payments.)

2. No change from 1969. [This would disappoint some businessmen but would reduce the risks cited above. It was initially preferred by the Budget Bureau and the Federal Reserve. It is strongly opposed by CEA (Tab B).]/5/

/5/Brackets in the source text. Tab B, McCracken's November 11 memorandum for the President, is not printed. He noted that "maintaining the momentum towards our goal of a more free and open economy . . . should be a primary objective of economic policy . . . [but] the outlook for our balance of payments is not rosy enough to permit complete abandonment of these programs, but neither is it so bad that we cannot do anything at all." McCracken's recommendation was to "urge . . . that a further modest step be taken soon."

3. Liberalization on investment in LDCs only. (This is strongly supported by Arthur Burns, who would increase the level of investment exempt from control to $5 million for LDCs only.)

4. Slightly greater liberalization than finally proposed by Secretary Kennedy, by eliminating the present program's preferential treatment from LDCs in addition to the two steps proposed by Secretary Kennedy. (Its gross payments effect of up to $900 million would run greater real and psychological risks but would be better received by some businessmen. It is preferred by Secretary Stans.)

5. A large reduction or complete elimination of the controls. (This was deemed by all as too risky in view of next year's unfavorable balance of payments outlook.)

Treatment of LDCs, including Latin America

In your speech on Latin America, you said that, "We are examining ways to modify our direct investment controls in order to help meet the investment requirements of developing nations in Latin America and elsewhere."/6/

/6/For text of the October 31 address, see Public Papers of the Presidents of the United States: Richard M. Nixon, 1969, pp. 893-901.

Secretary Kennedy's proposal would redeem that pledge by the increase in the overall restraint level and the preferential "minimum allowance" for investment in LDCs. Arthur Burns' proposal would do so to an even greater extent, by providing a greater degree of LDC preference and less cumbersome rules to implement it.

Tightening of the controls or the "no change" option would clearly not redeem your pledge. Neither would Commerce's proposal, which would eliminate the favored treatment for LDCs under the present program.

Recommendation:

That you approve the proposal of Secretary Kennedy, agreed or acquiesced in by Arthur Burns, Secretary Stans, and all other relevant parties, for modest liberalization in 1970 of our controls on capital outflows by U.S. corporations and banks.

Approve/7/

/7/The President initialed his approval of the first and second options.

Prefer liberalization for investment in LDCs only, as preferred by Arthur Burns. (I would find this fully acceptable.)

Prefer no liberalization, as initially proposed by the Federal Reserve and the Budget Bureau.

Prefer slightly greater liberalization as initially proposed by Commerce.

32. Memorandum From the President's Assistant (Flanigan) to the Staff Secretary of the National Security Council/1/

Washington, December 3, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. Confidential. Document 31 and its tabs are attached.

RE
Log 2310

Our balance of payments has been in deficit for a decade. During the recent election campaign the President strongly criticized the Democratic administration for not having taken steps to cure this serious problem. Since we have been in office we have already had a modest relaxation of foreign investment control. In the first year of this Administration the balance of payments deficit has risen dramatically to a $10 billion deficit on a liquidity basis, two and one-half times the previous peak figure. The outlook for 1970 is not encouraging.

Our apparent unwillingness to take strong action in this area as opposed to the strong action taken in other areas, such as monetary and fiscal policy, raises questions in the US and abroad as to the seriousness with which we regard this problem.

Based on the above, I strongly recommend liberalization for investment in LDCs only (set forth as No. 3 on page 2 of Dr. Kissinger's memo)./2/

/2/An attached December 12 handwritten note from John Brown to Haig notes that this memorandum was received after the President had taken an action on the recommendations in Kissinger's memorandum (Document 31), but that since the President had approved two different courses of action, "this issue may still be alive. Flanigan wants you to know that he feels strongly on his recommendations."

33. Action Memorandum From C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/

Washington, December 9, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. No classification marking.

SUBJECT
Urgent Need for Presidential Decision on Balance of Payments Program for 1970

Issue

The President approved two contradictory options for the 1970 investment control program (Tab A)./2/ The issue is now quite urgent because the hundreds of companies covered by the program are already making their plans for next year; Commerce and Treasury are both agitating daily for a decision. I urge you to take up the matter orally with the President as soon as possible to reconcile the inconsistencies.

/2/See Document 31 and footnote 7 thereto.

Option 1 (your recommendation in Tab A)

1. Increase level of foreign investment exempted from control for each firm from $1 million to $3 million.

2. Exempt from control up to an additional $2 million per firm for investment in LDCs, on a case-by-case basis. (This would meet the President's pledge to modify the controls to facilitate private investment in the LDCs, which he made in the Latin America speech.)

3. Recommended by Secretary Kennedy, with the concurrence or acquiescence of all relevant parties. The Secretary worked this out as a compromise between Secretary Stans' desire for greater liberalization and Arthur Burns' desire for no liberalization at this time.

Option 2 (cited as "fully acceptable" to you in Tab A).

1. Increase level of foreign investment exempted from control from $1 million to $5 million for investment in LDCs only, as a general rule (not case-by-case).

2. Pros:

--Would redeem President's pledge to promote investment in LDCs more than Option 1.
--Would hurt U.S. balance of payments less.

3. Con: less popular with U.S. business community, which expects liberalization of investment to all areas.

4. Strongly supported by Arthur Burns and Peter Flanigan. (Tab B)/3/

/3/Not printed. On December 4 Flanigan sent Kissinger a memorandum noting the President's conflicting decisions, recalling his December 3 memorandum to the Staff Secretary (Document 32), and strongly urging that when Kissinger asked the President for clarification he guide him toward the Burns proposal.

Evaluation

Either approach is fully acceptable from a foreign policy standpoint. Option 2 is more clearly directed toward the LDCs. It also runs less risk of later problems with the Europeans, if our balance of payments turns sour and requires drastic U.S. actions, because it will hurt our balance of payments less; we would then be less susceptible to charges of having induced a crisis ourselves.

The main virtue of Option 1 is bureaucratic: Secretary Kennedy worked it out in a series of lengthy sessions with Stans and Burns. You favored it in your earlier memo. And Stans will be even more unhappy if Option 2 is chosen.

Recommendation:

That you recommend to the President that he choose Option 2--the Burns proposal, strongly supported by Flanigan, that we liberalize for investment in LDCs only./4/

/4/At the top of the first page of this memorandum, Kissinger wrote: "OK--Let's take Burns option." The date of December 11 is stamped below Kissinger's note. Another note by Haig indicates he routed the memorandum back to Bergsten for action.

34. Memorandum From Secretary of the Treasury Kennedy to President Nixon/1/

Washington, December 15, 1969.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 289, Treasury, Volume I. Confidential. Attached to a December 19 memorandum from Kissinger to the President that summarizes Kennedy's report on his European trip. Stamped on Kissinger's memorandum is "The President has seen" with a December 22 date. In a December 18 memorandum to Kissinger, Bergsten recommended that he sign the memorandum for the President and noted that "continued U.S.-French differences on international monetary policy and the threat posed by EC preferential trade arrangements to our support of the Common Market" would be of particular interest to Kissinger. (Ibid.)

SUBJECT
Conversations with European Officials

In connection with my participation in the NATO Ministerial meeting in Brussels, I visited the Netherlands, the United Kingdom, Germany and France between December 2 and 10, calling on the following officials:/2/

/2/Memoranda of these conversations are in the Washington National Records Center, Department of the Treasury, Secretary's Memos: FRC 56 74 17, Memcons 1969.

In Brussels--President Rey and Vice President Barre of the Commission of the European Communities and Minister Snoy and Governor Ansiaux of Belgium;

In The Hague--Minister Witteveen and Governor Zijlstra;

In London--Prime Minster Wilson and Chancellor Jenkins;

In Germany--Minister Schiller and Bundesbank President Blessing (I was a luncheon guest of Finance Minister Moeller);

In Paris--Minister Giscard d'Estaing and Governor Wormser.

In order to be in Washington for the conference on the tax bill, I had to cancel my plan to visit Minister Colombo and Governor Carli in Rome. However, Under Secretary Volcker is keeping those appointments.

On each call, I stressed the Administration's determination to control inflation in the United States and outlined the policies being employed and our current expectations.

I found great concern over the effect which our tight money and high interest rates were having on European economies. Yet, Giscard d'Estaing told me privately that the Common Market Finance Ministers were afraid that we would not or could not control our inflation and would continue to experience such serious balance of payments deficits as to imperil world confidence in the dollar and threaten the international monetary system.

The hope was expressed that we could achieve more restraint through the budget and the reports which I had to give them on the tax bill were very discouraging. Schiller suggested an "interest rate disarmament" conference among a few major countries with the objective of lowering interest rates about 2 percentage points without precipitating disruptive international capital flows. I asked him to give us a little more time to break the back of inflation, but we may want to do this in the spring.

I found Schiller ready to move ahead on the studies of limited exchange rate flexibility as a means of strengthening the international monetary system. He feels that the achievement of common economic policies and uniform price movements within the Common Market is at least a decade away and agrees that in the meantime we must be able to use exchange rate changes as a means of adjustment within the Common Market as well as with other countries. Witteveen and Zijlstra also agree that a common central bank for the EC is a final step which is many years away. Rey and Barre, on the other hand, want to eliminate the possibility of exchange rate change by individual Common Market countries as soon as possible and hope to get agreement within the next year that any such changes would require unanimous consent. If we are to avoid recurrent financial crises, I believe we must make it easier, not harder, for countries to appreciate their currencies against the dollar and I am convinced that it will be necessary to preserve this option for individual Common Market countries for many years to come.

I told my hosts that in striving to improve our balance of payments we were concentrating on fundamentals--first and foremost on the control of inflation. But I also referred to our efforts to negotiate the reduction of barriers against U.S. exports, our desire to remove the disadvantage to our trade resulting from the employment of the value added tax system in Europe, and our concern over the prospective proliferation of preferential trading arrangements between the Common Market and its neighboring countries in Europe which are not prospective members. Rey made it quite clear that the Communities expect to conclude a network of such arrangements (Spain, Israel, Switzerland, Sweden, etc.). Our trade will be adversely affected and our support of the Common Market may be called into question politically at home.

While I was in Europe, the free market price of gold dropped to $35.00 and many of the Europeans were anxious to find a way to ensure that it did not drop significantly below that level. It seems apparent that if it did--at least by any substantial amount and for any significant period of time--a number of European central banks would step in to support the market, either through the Bank for International Settlements or directly. I left Under Secretary Volcker in Europe to negotiate with the South Africans on this issue, and I am hopeful that we can reach an agreement which will keep the price from falling further and thus make this issue moot./3/ The French pointedly reminded me, however, that they have never adhered to the Washington agreement of last year and consider themselves free to buy or sell on the free market at any time.

/3/See Document 145.

My conversations touched briefly on a few other points. There was support for the view that the question of a possible link between Special Drawing Rights and aid to less developed countries ought not to be considered until the world has had experience with the SDR and it has been accepted. Initiating studies of this question now would be most inadvisable.

Finally, Giscard d'Estaing suggested that we might consider jointly how our two countries could deal with the enforcement problems presented by the Swiss banking secrecy laws. I plan to follow through on this suggestion.

It is evident that we and the French still have some troublesome differences of approach to the problems of the monetary system. Giscard showed a personal interest in discussing these differences and I plan to invite him to the U.S. for a further exchange.

Giscard, as well as Ambassador Shriver, indicated that Pompidou will want to discuss with you financial and economic matters./4/ We will prepare a briefing paper for this visit. They also indicated that Pompidou is planning to go to Chicago and suggested that, if possible, I should plan to make a trip to Chicago.

/4/President Pompidou was scheduled to visit the United States February-March 1970; see Document 36.

My conversations on this trip have left me more firmly convinced than ever that the major countries of the world have become so interdependent economically and financially that not even the large European countries can achieve their economic objectives in the absence of U.S. price stability. Our responsibility to stop inflation and use our leadership wisely is not limited to the citizens of our own country but is a responsibility to the world.

David M. Kennedy

35. Memorandum From the Assistant Secretary of the Treasury for International Affairs (Petty) to Secretary of the Treasury Kennedy/1/

Washington, February 11, 1970.

/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, US/3/501, Tied Aid Procurement, Volume 2 1966-70. Limited Official Use. Sent through Volcker.

What Should Be our Policy Toward Aid Tying?

1. U.S. foreign economic assistance was "tied" to U.S. procurement beginning in 1959, originally as a method of offsetting lagging Congressional support of the program. Presentationally, it was argued that tying almost totally eliminated the balance of payments costs of foreign aid: by providing real resources rather than financial resources. In addition we benefited our exporters while accomplishing the development task and the procedure made our aid funds only marginally less efficient--but this was a cost deemed necessary to assure sustained adequate levels of aid appropriations.

2. Both inside and outside the Executive branch question arose on the validity of the claim that tying aid virtually removed the balance of payments costs of the program. This generated pressures to ensure "additionality," i.e. that aid financed exports were additional to goods that aid recipient countries would have purchased from the U.S. commercially in any event. The techniques to bring about "additionality" varied from country to country but they rapidly led to resentment and the development of political problems with developing countries.

3. President Nixon's decision last June to eliminate the "additionality" requirements under our foreign aid program was prompted by a desire to eliminate this political lightning rod from attracting anti-U.S. sentiment in the aid countries. This had the effect of reducing the effectiveness of aid tying. Since that time the tying rules have been further relaxed in the case of Latin America. Henceforth U.S. aid dollars lent to finance imports may be used to procure commodities in either the United States or in Latin American countries. The latter is being given a further advantage of qualifying for such procurement even when the imported component of the item being sold amounts to fifty percent (for U.S. suppliers, only ten percent imported component is normally allowed). The President also decided that tying restrictions be lifted completely for U.S. aid dollars going to Latin America to finance local costs. He decided a similar liberalization on tying of local cost financing by the Inter-American Development Bank's Fund for Special Operations.

4. What does all this add up to?

--With the end of additionality the effectiveness of tying is questionable.

--Removal of the Special Letter of Credit in connection with local cost financing in Latin America by AID and the FSO has the effect of untying for "world-wide" procurement since recipient countries will now be receiving U.S. dollars unrestricted as to subsequent use.

--While the measure is now a regional preference for Latin America, experience with the elimination of "additionality" and evidence of already mounting pressures for partial or full untying elsewhere in the less developed world suggest that restricting the new policy to Latin America alone is not likely to be sustainable.

--There would be a further balance of payments cost to untying in Asia and Africa. Aid constitutes a higher percentage of imports in such countries as India and Pakistan and our share of commercial trade is lower than in Latin America.

5. Determining the "true" balance of payments effects of aid tying has been and continues to be a statistical playground. Past estimates within the Executive Branch of the "cost" of a given tying (or untying) measure have varied widely, with State/AID generally on the low or "de minimis" side, Commerce generally on the high side and Treasury generally in a tentative middle posture. As evidence of this, in calculations last year of the "benefits" from the additionality program, State/AID estimated $35 million world-wide, Commerce estimated upwards of $350 million and Treasury estimated something in excess of $125 million. For Latin America hemispheric untying, Treasury estimated $200 million balance of payments costs. The NSC used a $50 million estimate. From there on, the costs were "nibbled" away by arguments about de minimis effects.

6. Perhaps a better way of looking at the costs of untying is in the context of what we are doing relative to other aid giving countries. If, for example, other donor countries untied their aid simultaneously with the untying of U.S. aid, we would presumably pick up some additional procurement under their programs. However, other programs in the aggregate amount to less than the U.S. program. Nevertheless, their aggregate share of exports to the LDCs greatly exceeds that of the U.S. Consequently, what the U.S. balance of payments would gain from untying by other donors would fall far short of what would be lost through the untying of the U.S. program. Specifically, with the U.S. providing roughly 50 percent of total aid to LDCs and providing only 25 percent of total exports to LDCs, with complete worldwide untying we would stand to incur a balance of payments loss in the aggregate, of at least one half of the total amount of our aid program.

7. It is clear to me that the tying of aid is on the way out, and I think it is desirable that this is the case. This is a form of selective control that is not in keeping with our philosophy, and it is certainly not the most efficient form of economic assistance. However, many countries tie, and it is in keeping with our leadership role that if we go to untying beyond Latin America that we do it in a "burden sharing" manner in which all other donor countries also untie. However, further unilateral untying by the United States would jeopardize our negotiating position in getting other donors to join us. Consequently, I would recommend that the National Advisory Council recommend to the President an initiative to be taken by the United States at the OECD Ministerial Meeting in May whereby the United States would propose that we negotiate--probably through DAC, the Development Assistance Committee--the multilateral untying of bilateral assistance by donor countries. The NAC would also consider how far a multilateral proposal would go toward complete aid untying. Many countries are as attached to aid tying as we have been. They will not quickly accede to this suggestion; but by making this gesture, the U.S. would get the immediate political benefits with the LDCs; and we will move the developed countries along toward this desirable objective. It would permit us in the meantime to discontinue further unilateral untying--so that the time framework would be more in pace with our removal of selective controls over direct investment and banks. Right now we run the danger of removing most government balance of payments controls and still being left with the Commerce and Fed controls.

Recommendation: That we be authorized to commence with an NAC Alternates Meeting whereby a specific proposal to the President is developed to negotiate multi-laterally the untying of bi-lateral (and conceivably multi-lateral) aid, which would be submitted to an NAC Principals' Meeting as soon as possible. This timing would provide adequate preparation for the May ministerial conference.

Approve/2
Disapprove
Other

/2/Secretary Kennedy initialed this option on February 20.

36. Memorandum of Conversation/1/

Washington, February 26, 1970, 10:30 a.m.

/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Presidential/HAK Memcons, Box 1023, President/Pompidou February 24 and 26, 1970. Top Secret; Sensitive; Nodis. Presidents Nixon and Pompidou met in the Oval Office from 10:40 a.m. to 12:37 p.m. (Ibid., White House Central Files, President's Daily Diary) President Pompidou visited the United States February 23-March 3. He met with President Nixon in the Oval Office on February 24 and 26; a memorandum of the February 24 conversation is ibid., NSC Files, Presidential/HAK Memcons, Box 1023, President/Pompidou February 24 and 26, 1970. Following his Washington program President Pompidou traveled to Cape Kennedy, San Francisco, Chicago, and New York.

[Omitted here is a discussion of unrelated matters.]

Economic Situation

President Nixon said that he did not wish to impose on the President's time but he would like to say a few words about the international monetary situation. He was not an expert in this field as President Pompidou was. As he had told him the previous evening,/2/ he would hope that there would be close communication between our finance ministers and central bankers on a confidential basis to work out a more stable situation than the one we presently have. On his part he could assure President Pompidou that through an austerity budget we were doing everything we could to cool the U.S. economy so that our inflation would not be a factor of instability which it is at present.

/2/President Nixon gave a dinner at the White House in honor of President Pompidou on February 24, and in turn attended a dinner hosted by the French on February 25. (Ibid., White House Central Files, President's Daily Diary)

President Pompidou said that he and Secretary Kennedy had talked about this./3/

/3/President Pompidou met with Secretary Kennedy at Blair House at 10 a.m. on February 25; see Document 37.

President Nixon said that he had great respect for Mr. Volcker, the Under Secretary, but the man with the most influence in this matter would be Mr. Burns who thinks in more imaginative terms regarding the need for new approaches. He did not know what these approaches should be but Burns had new ideas.

President Pompidou said that if Burns were in Paris in the next few months he would like to see him alone. He had not wished the previous day to speak before all of the Treasury people.

President Nixon said that one must know Burns to appreciate him. He talks slowly but thinks fast. President Pompidou could talk frankly to him as Burns was most discreet. President Pompidou knew that a bureaucracy does not engender new ideas. They generally defend the status quo and try and patch it up. Burns as a top economic and financial expert thinks in innovative terms now although in a few years he will be part of the bureaucracy and therefore we should take advantage of this opportunity.

Europe

President Pompidou said he would like to ask the President to say a few words about Europe. He wanted to know what importance he should give to the statements by Ambassador Schaetzel concerning the fears and even opposition to the European Common Market by the United States./4/

/4/Not further identified.

President Nixon replied, "None." In his view it was very important for the European Common Market to develop in its own way. It will be increasingly competitive with the U.S. as the U.K. comes in and it may become a rather serious problem for us in an economic sense. But the President said he took the long view that a strong productive European Community including the United Kingdom is in the interest of world peace and stability. The U.S. would have to pay some costs for achieving this bigger goal and the President did not agree with those who rejected this point.

President Pompidou said he had spoken about this to the Congressional leaders he had received the previous day./4/ It was certain that as the European Community developed it may cause economic rivalry. The French would do all they could to insure that it would be open and as liberal as possible so that economic tensions would not become awkward. One should not be too impressed by political figures in France and in the U.S. who are sensitive to the worries of their constituents. Many protested against the French agricultural system which did have many faults, but he could say that the sales of U.S. agricultural surpluses to Europe had doubled since 1958.

President Nixon said that as President Pompidou had said at dinner, if we could only get agricultural subsidies off our books we would be able to give all sorts of assistance to the underdeveloped countries, and added, "some day we must bite that bullet."

[Omitted here is discussion of Vietnam, military matters, and miscellaneous subjects (scientific and technical cooperation).]

37. Memorandum From Secretary of the Treasury Kennedy to President Nixon/1/

Washington, March 2, 1970.

/1/Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, France. Confidential. Drafted by F. Lisle Widman on February 27 and revised by Volcker. The memorandum was forwarded to the President under cover of a March 5 memorandum from Kissinger. (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 289, Treasury Volume I)

SUBJECT
Meeting with President Pompidou

I believe that my meeting with President Pompidou served a most useful purpose./2/ President Pompidou questioned me closely on the possibility of a recession in the United States and on the probable course of interest rates. However, his basic concern for the longer run appeared to be that the United States might not persevere in its effort to control inflation and the balance of payments. Dr. Burns and I tried--successfully I think--to reassure him on this point./3/

/2/The February 26 memorandum of the February 25 conversation, also drafted by Widman, is ibid.

/3/Burns is not listed as a participant in the memorandum of conversation, but a February 18 briefing memorandum from Assistant Secretary of State Hillenbrand to Secretary Rogers indicates that Burns, Budget Director Mayo, and Herbert Stein were to join the group at Blair House at 10:30 a.m. (National Archives and Records Administration, RG 59, S/S Files: Lot 71 D 175, Box 130, NSC Meeting February 23, 1970--France)

President Pompidou emphasized the fact that the U.S. dollar is the pivot or the reference point on which the international monetary system rests. He feels that the system can only function well if the dollar maintains a stable value. Failure of the United States to preserve price stability forces all other countries either to accept inflation in their own countries or to revalue their currencies--an action which, he said, was politically extremely difficult.

Dr. Burns and I assured the President that we were very conscious of this responsibility to the world and were determined to bring inflation under control. Restoration of general price stability was a primary objective of our policy. Given the extent of pent-up demand for investment, we did not feel that there was a great danger of recession.

President Pompidou also said that a perpetual U.S. balance of payments deficit would lead to a dollar crisis which would become a general world economic crisis.

My answer was that we were attacking the fundamentals of the payments problem through our attack on inflation. I had Under Secretary Volcker describe the other elements in our balance of payments program.

President Pompidou feels that international payments problems should be dealt with--not by setting up a mechanism for greater flexibility of exchange rates--but by stopping inflation and thus obviating the need for exchange rate changes. He noted the trend in the Common Market toward freezing of rates.

I assured President Pompidou that we did not look upon increased flexibility of exchange rates as a means of escaping the responsibility of achieving and preserving general price stability in the United States. We did feel, however, that the possibility of employing techniques for limited exchange rate flexibility to strengthen the monetary system ought to be carefully examined.

I stressed the importance of continuing consultations and close cooperation in the financial sphere among the major countries and mentioned specifically the forthcoming visit of French Minister of Finance Giscard d'Estaing, who has accepted my invitation for a meeting at Camp David in early May.

David M. Kennedy/4/

/4/Printed from a copy that indicates Kennedy signed the original.

38. Editorial Note

On March 2, 1970, President Nixon sent a memorandum to Haldeman, Ehrlichman, and Kissinger, "for discussion with the group and implementation," reflecting on his and their use of time during the first year of the administration. The President concluded that "the greatest weakness was in spreading my time too thin--not emphasizing priorities enough." He wanted new rules that applied to his time to apply to Ehrlichman's and Kissinger's time as well, and lower priority issues to be handled by the Executive agencies and White House staff.

The foreign policy issues the President wanted brought to his attention were East-West relations, policy toward the Soviet Union, policy toward Communist China, policy toward Eastern Europe to the extent it affected East-West relations at the highest level, and policy toward Western Europe where NATO and the major countries (Britain, Germany, and France) were involved. At the "next level out" was policy toward the Middle East, followed by policy toward Vietnam and anything related to Vietnam, Laos, and Cambodia. For the rest of Asia and most of Africa and Latin America, the President did not want matters submitted to him unless they required a decision that could only be handled at the Presidential level.

The President turned to specific economic matters under the domestic affairs rubric, where he would take personal responsibility where the decisions affected recession or inflation. In his memorandum the President wrote:

"I do not want to be bothered with international monetary matters. This, incidentally, Kissinger should note also, and I will not need to see the reports on international monetary matters in the future. Problems should be farmed out, I would hope to Arthur Burns if he is willing to assume it on a confidential basis, and if not Burns to Houthakker who is very capable in this field. I have no confidence in the Treasury people since they will be acting in a routine way. International monetary matters, incidentally, are a case in point in making the difficult decision as to priorities. I feel we need a new international monetary system and I have so indicated in several meetings. Very little progress has been made in this direction because of the opposition of Treasury. I shall expect someone from the White House staff who will be designated who will keep the pressure on in this area. The man, however, who could really be the lead man is Arthur Burns because he feels exactly as I do and it might be that he could exert some influence on the others. . . . Where an item like foreign aid is concerned I do not want to be bothered unless it directly affects East-West relations. . . . A lot of miscellaneous items are not covered in this memorandum but I think you will be able to apply the rules . . . trade policy is a case in point. This is something where it just isn't going to make a lot of difference whether we move one way or another on the glass tariff. Oil import is also a case in point. While it has some political consequences it is not something I should become deeply involved in." (National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 341, HAK/RN Memos 69-70)

39. Paper Prepared in the Department of the Treasury/1/

Washington, undated.

/1/Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, Commentaries and Reports, Volume 2 1966-71. Confidential. Attached to an April 3 memorandum from George H. Willis to Assistant Secretary of the Treasury Petty, which indicated that the paper originated with Widman. The text printed here is Willis' suggested revision of that paper.

SUGGESTED REVISION

U.S. BALANCE OF PAYMENTS OBJECTIVES

The United States seeks over time a pattern of international trade and payments which will serve the basic objective of expanding the multilateral system under which national economies achieve greater efficiency in an atmosphere of fewer and fewer restrictions on the exchange of goods, capital and services. When and if the United States payments position is strong, this type of multilateral system allows our basic foreign policy of peace through partnership to be pursued with less strain on the dollar and the international monetary system.

We require the composition of our international transactions to be such as will preserve world confidence in the U.S. dollar as (a) a vehicle for international transactions; (b) a preferred form in which to hold national reserves and a satisfactory standard for an international payments system conducive to sound economic growth throughout the world. We require a record in our international trade and payments which leaves us free to pursue full employment, a satisfactory rate of economic growth, reasonable price stability and an equitable distribution of income at home, without causing excessive strain on our net liquidity position.

The balance in our goods and services transactions should show a substantial surplus./2/ A surplus on merchandise trade and services will in itself be an important factor in preserving confidence in the dollar. To contribute to confidence, however, this surplus would probably need to compare favorably, as a proportion of GNP, with that of other major industrial nations. We can expect income from direct investment to continue to rise, but we must also anticipate that the increase will tend to be offset by rising net tourist outflows and such other invisibles.

/2/According to Willis' memorandum to Petty, Widman and Willis seemed to be favoring a balance of trade surplus of about 1/2 of 1 percent of GNP or a trade surplus of $5 billion in a trillion dollar GNP, and a goods and services surplus, excluding government grant transfers, of $6.5 to $7 billion.

Only by such a surplus can we afford our military and political postures abroad and supply real capital to less developed countries and to other nations requiring foreign capital for the development of their resources. Should we fail to restore and then maintain such a surplus, we would progressively erode the dollar's role--itself the fulcrum to the monetary system. With a reduction of world confidence in the dollar, public and Congressional support for a liberal trading and investment policy would further diminish, along with support for our military commitments overseas.

40. Memorandum From the Deputy Assistant Secretary of State for European Affairs (Springsteen) to the Deputy Under Secretary of State for Economic Affairs (Samuels)/1/

Washington, May 7, 1970.

/1/Source: National Archives, RG 59, S/S Files: Lot 80 D 212, NSSM 79. Confidential. Drafted by A. Katz (EUR/RPE) and cleared by Camps (S/PC), Gold (E), and Higginson (E/OT). Also addressed to Pedersen (C) and Cargo (S/PC).

SUBJECT
Review Group Meeting May 7 on NSSM 79 and 91/2/

/2/The Review Group meeting was held on May 13. NSSM 79, dated October 13, 1969, is entitled "UK Accession to the European Community." NSSM 91, dated March 27, 1970, expanded the scope of NSSM 79 to cover preferential trading arrangements of the European Community with countries not applying for full membership. (National Archives, RG 59, S/S Files: Lot 80 D 212)

The NSSM 79 exercise has pointed up differences among Government agencies concerning the future development of the European Communities. The agencies dissenting from the Department's view would not agree to state the differences in the framework of a single paper and submitted separate written statements./3/ It is possible to summarize the issues and differences as follows:

/3/On April 23 Hillenbrand, in his capacity as Chairman of the NSC Ad Hoc Group (established pursuant to NSSM 79), sent Kissinger, in his capacity as Chairman of the NSC Review Group, a memorandum entitled "Enlargement of the European Community, NSSM's 79 and 91." Hillenbrand noted that it had not been possible to reach agreement in the Ad Hoc Group on either substance or presentation and he attached a State Department paper, a joint Treasury-Commerce-Agriculture paper, and an STR paper. (Ibid.)

Appraisal--On the transitional tariff effects, the Department's study shows practically no adverse effects to our industrial exports if the Community is enlarged to ten, and moderate (up to $300 million maximum damage) if complete free trade arrangements are extended to all the EFTA neutrals.

The Department's study estimates damage to our agricultural trade of $100 million if CAP prices remain unchanged.

The dissenting agencies do not quarrel directly with these studies, although they play up the imprecision of any quantitative projections. Agriculture's estimates of damage to the world grain market are more moderate than the Department's and about the same for damage to U.S. exports. USDA does, however, express concern that U.S. soybean sales may somehow be threatened. The Department sees no reason why enlargement should in any way reinforce or renew the threat to soybeans which has been successfully warded off. Our GATT rights for soybeans in both the EC and the UK are strong and uncontested. USDA also anticipates sharp losses (unquantified and unexplained) for US exports of tobacco, lard, and canned fruits. The Department's studies do not bear out this concern. Both the Department and USDA agree that other suppliers of beef products, dairy products and sugar would be hurt. The U.S. has quotas on these commodities, but we may be under some pressure to enlarge or alter them.

All agencies agree that the longer term dynamic effects will be more important. The Department's study points out that the income growth will lead to increased European imports, but that the enhanced competitive position of Europe, and some of its common policies may have an adverse effect on U.S. economic interests. The Department's conclusions are that the Common Market has been a boon to our industrial exports and investments. British accession, the Department feels, will reinforce the basically liberal outlook of the Commission, the FRG, The Netherlands and others.

The dissenting agencies are more pessimistic concerning the future. They see our competitive position eroding and they believe that enlargement and further deepening of the Community will result in a number of autarkic measures aimed at the U.S. in both trade and investment. In particular they express concern that preferential industrial and procurement policies would adversely affect nearly $4 billion of high technology items or over 35 percent of total U.S. exports to Europe.

The Department sees no basis in fact or discernible trends to warrant such a pessimistic conclusion.

Strategy and Recommendations

While no one suggests questioning the basic policy of support for the Community and its enlargement, the differences in appraisal are reflected in different overall strategies and recommendations.

All agencies appear to agree on both continuing support for European unity and enlargement of the Community, as well as on the need to influence developments in the Community in such a way as to maximize our economic benefits and minimize our losses.

All agree that we should, in connection with the negotiations, exercise fully our GATT rights augmented by bilateral and multilateral diplomacy. All would agree that we should continue to follow internal developments in the Community and influence them in our best interest.

The dissenting agencies, however, adopt a harder and more interventionist tone. They would invoke the U.S. troop presence in Europe and other elements of leverage. They would make the participants in the enlargement negotiations see that the ability of any U.S. administration to maintain its military relationship with Europe could be jeopardized if there was serious damage to our economic interests. They would want us "promptly and firmly" to demonstrate by our statements and our actions an intent to protect our basic economic and financial interests. We would "make clear without delay" or "stress at the outset" a number of U.S. desiderata and "that we are prepared to use such leverage as is available to us as a world power."

It is clear from the discussions in the ad hoc group and the drafting group that what these words are meant to convey is a major and clear-cut effort to put the Europeans on notice. The Department does not believe that such a diplomatic campaign is required by the facts. We believe it would be interpreted in Europe as a clear reversal of the President's position on European unity and on nonintervention in the process of unification. It would be read as a signal that henceforth we will put our economic and commercial interests above our political objectives. The agencies, at least on the working level, wish the U.S. to give such a signal, and in the paper submitted by Treasury, Commerce and Agriculture, have come close to saying so explicitly.

In addition, the agencies would pose specific conditions to enlargement--the toughest being in agriculture where they would insist that there be a reduction in agricultural protection. USDA would have us stress that a midpoint between present EC and UK grain prices "would be acceptable."

The Department agrees with the other agencies that we should use what leverage we can to effect a lowering of CAP grain prices. The problem is that this is likely to be the most intractable aspect of the negotiations. We believe we may be able to influence or reinforce a trend in the EC towards more sensible prices, but we are unlikely to get very much in the course of the enlargement negotiation and for the U.S. to pose hard conditions may well jeopardize the negotiations. There is no disagreement and no apparent problem on maintaining UK and EC zero bindings for soybeans.

The agencies would also make clear in connection with the accession negotiation our opposition to what are only distant dangers in connection with the ongoing development of the Community. Specifically, they mention nontariff barriers such as a "buy European" policy. STR wants us to make clear we would expect compensation for trade and investment barriers not the inevitable result of a customs union.

The Department feels it would be diplomatically inappropriate to intervene in the negotiations by "making clear" in connection with the enlargement negotiation a number of positions which relate to the internal work of the EC and which will not arise as part of the enlargement negotiation. To do so would only be interpreted as a major diplomatic campaign reversing U.S. policy on the Community. We have other ways of defending our interests on the Community's internal development and have a pretty good record so far.

Furthermore, the points the agencies would have us make would be interpreted as challenging the right of the EC to develop an economic union as opposed to a mere customs union. If we want the European countries to become more united economically and politically, we cannot object to their adopting a collective procurement policy or a common investment policy. We can try to influence the content of such policies in a liberal outward looking direction. But it would be contrary to our policy of encouragement of unity if we were to seek to block the development of common policies.

The dissenting agencies would also have the U.S. actively seek to establish a continuing consultative mechanism through which we could be kept informed of the negotiations and register our concerns. The Department feels that we should be prepared to respond positively to a European initiative for a US-EC consultative mechanism, but we doubt that the French will permit the EC to set up such a mechanism at this time. Furthermore, to request such a mechanism in connection with the negotiation would be interpreted as intervention and resented by the parties. Such a request would also encourage other affected countries less interested in the success of the negotiations to seek to read themselves into negotiations. The Department believes that we can rely on normal diplomatic channels and informal high level visits, as well as existing international forums such as the OECD to keep ourselves informed and to make our views known.

Finally, the Department's strategy, besides trying to influence the accession negotiations and the continuing internal development of the Community, also contemplates engaging the Community in multilateral negotiations. Some of the agencies during our discussions expressed doubts about the feasibility or desirability of a major new round of trade negotiations in the near term. The dissenting agencies do not view such a negotiation "as an acceptable substitute" to getting what we want during the negotiation.

The Department clearly does not see a trade negotiation as a substitute for appropriate action to protect our interests during the accession negotiation. But in the last analysis only by lowering the Community's barriers through reciprocal action will we reduce the incidence of discrimination which is inherent and inevitable in a customs union. Perhaps more important, the Department's study points out that the Community will be engaged for the better part of the decade in the complex task of digesting the new members while moving towards an economic and monetary union. A major negotiation will be useful in maintaining the outward looking orientation of the Community and to cement the Alliance in the economic field. We are aware that this decision will be made only after the President's Commission on Trade and Investment makes its report. However, we should be gearing up now for such an effort by developing viable negotiating approaches on NTBs including preferential government procurement and agriculture.

EFTA neutrals and EC preferences

Only STR has included dissent on these issues although some of the other agencies are known to have strong views on the issues.

On the EFTA neutrals, STR wants us to make clear our policy from the outset. The Department feels that this situation is so fluid and delicate that we should adopt a low profile and a holding position until the issues between the EC and the EFTA neutrals are clarified, and we have suggested such a response to queries that holds open all our options. We do not want to adopt positions that tend to force the neutrals and the EC into agreeing on full membership of the neutrals, which might undermine the political development of the community. Furthermore, we must take into account the peculiar problems of Austria and Finland.

On EC preferential arrangements, STR has provided its recommendations. The Department's paper merely sets out the problems in all their complexity./4/ In general, we find STR's recommendations a bit too detailed and tactical for Review Group consideration at this stage.

/4/Reference is to an undated memorandum on "EC Preferential Trade Arrangements" which Richardson gave Kissinger on February 26. The memorandum explained how the preferential trade agreements were contrary to GATT MFN obligations and U.S. trade interests. The memorandum is attached to the memorandum printed here.

Although the Department has not yet developed its position on the options, STR's recommendations as presently worded would give us too rigid a framework for diplomatic maneuver. We believe the NSC should only give general guidelines and leave it to the bureaucracy to work out the detailed positions in each case.