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Foreign Relations, 1969-1976, Volume III, Foreign Economic Policy, 1969-1972; International Monetary Policy, 1969-1972 Released by the Office of the Historian Documents 41-62 41. Memorandum From Secretary of the Treasury Kennedy/1/
Washington, June 30, 1970.
/1/Source: Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence: FRC 56 74 7, Council of Economic Advisers. Confidential. Forwarded to Kennedy under cover of a June 25 memorandum from Petty.
MEMORANDUM FOR
SUBJECT
Chairman McCracken's memorandum of June 8 suggests that we proceed with the three points outlined by Ambassador Gilbert while setting aside the issue of the basic inequity of GATT rules./2/ I do not believe that approach would relieve either our economic or political difficulties. Of the three points proposed by Ambassador Gilbert, two are clearly of minimal importance and solutions would result in no substantial trade benefits for U.S. producers. The third faces us with the same basic issue of GATT inequity which Chairman McCracken suggests we set aside. Any substantive proposal on changes would require an amendment of GATT provisions concerning the amount of allowable adjustments.
/2/McCracken's June 8 memorandum summarized the results of a June 5 meeting, where agreement was reached on how to proceed at the July GATT meeting. Gilbert outlined three points: "opposition to adjustments for taxes occultes; a requirement for confrontation and justification in the event of changes in a country's tax system involving border adjustments, and international control or surveillance of 'averaging.'" GATT rules allowed Contracting Parties to levy border taxes, sometimes known as border tax adjustments, imposing domestic, indirect taxes (i.e., excise, value added, and turnover taxes) on imports and rebating and/or excusing such taxes on their exports. A number of European nations and Japan, which relied heavily on indirect taxes (such as value added and turnover taxes), imposed significant border taxes, whereas the United States, which relied primarily on direct taxes (particularly income and property taxes), had only very limited scope for making border tax adjustments. In many circles this was viewed as discrimination against U.S. exports and subsidization of imports into the United States, contributing significantly to the U.S. balance-of-payments deficit. A number of papers regarding border taxes are in the Volcker Group records in the Washington National Records Center, Department of the Treasury, Volcker Group Masters: FRC 56 86 30. Border taxes were discussed in the GATT Working Party on Border Tax Adjustments. Documentation is in the National Archives, RG 59, Central Files 1970-72, FN 16 GATT.
The U.S. has talked about taxe occulte/3/ and averaging primarily for tactical purposes--keeping the talks alive while we consider the basic issue. The problems of averaging and border adjustments for taxe occulte have largely passed us by as they do not inherently exist in the value added tax system. As Italy and Belgium will be adopting the TVA within 18 months, only Spain and Austria, among the developed nations, will be left with cascade tax systems/4/--the area of most abuse regarding averaging and taxe occulte. A modification of taxe occulte procedures would limit possible U.S. action while leaving Europeans free to obtain benefits equivalent to adjustment for taxe occulte by simple modifications of their TVA systems. It is clear that there is little economic or political advantage in pursuing a change regarding these points.
/3/The taxe occulte is the "hidden" amount of tax that accrues in the value of a product, depending on the number of transactions that occur during a product's production and distribution. Unlike value added taxes where the rate of application is generally clear, when taxe occulte occurs the effective rate is difficult to gauge, giving rise to the question of what is the appropriate, "average" rate for border tax purposes. See Border Tax Adjustments and Tax Structures in OECD Member Countries (Paris: Organization for Economic Cooperation and Development, 1968), pp. 20-21 and 58-63.
/4/The cascade tax, or the turnover tax, was used in several European countries. Community members were expected to replace their cascade taxes with value added taxes.
As for the third point, I agree that countries should not be allowed unilaterally to disrupt the international trading mechanism by changes in their border adjustments.
Border tax adjustments will continue to be a problem as EC tax harmonization proceeds. Eventually all of Western Europe will be using the TVA and making substantial changes in their border adjustments. These changes, condoned by the bias in the GATT rules, will have serious disruptive effects on both trade and international balance of payments adjustments. Failure to resist this undercutting of our economic strength will badly damage our ability to prevent other similar actions.
In order to argue that changes should be controlled, we must demonstrate that they have trade effects. But in most instances this is true only if direct taxes are, in part or in whole, passed forward to the consumer and/or indirect taxes are partially absorbed by the producer. Either position directly contradicts GATT rules and confronts us with the issue of amending them to correct the bias in favor of indirect tax systems. Unless the rules are amended, countries would argue that their actions are in conformity with GATT and they have no responsibility to offset any trade effects of changes in adjustments.
Thus advocacy by the U.S. of proposals covering the points raised by Ambassador Gilbert would seem to make sense only as part of a package which includes a major change in how nations handle border adjustments for taxes.
Chairman McCracken's thesis that past changes in tax adjustments at the border are washed out by exchange rate changes disturbs me./5/ It seems to me wrong in implying an equilibrium that simply does not exist and cannot practicably be obtained.
/5/McCracken argued that if a country made a 10 percent border tax adjustment for, say, a value added tax, by rebating that amount on exports and levying that amount on imports, any trade impact of that adjustment would be offset by a corresponding 10 percent appreciation in that country's currency, which would render its exports 10 percent more expensive in foreign currencies and its imports 10 percent more expensive in domestic currency.
We have all recognized the absolute necessity of attaining a stronger goods and services position. The present bias in the border tax adjustment rules complicates the achievement of this goal.
The plain fact is that exchange rate changes of the last 10 or 15 years have not and will not eliminate the problem of existing border tax adjustments: our trade balance and balance of payments structure have deteriorated in recent years. The fact that some exchange rate changes might have been different without the border adjustments, if true, provides no answer to the U.S. structural problem. Furthermore, numerous changes in border adjustments have occurred which were not offset even partially by exchange adjustments. Thus, Belgium and Italy have not modified their exchange rates since 1949, the Dutch since 1961, and most of Scandinavia since the immediate post World War II period. Changes in taxes and border adjustments have occurred regularly, with rates and product coverage generally increasing. It is only with respect to the 1960 and 1968 German revaluation and the 1961 Dutch revaluation that we can conceivably say that exchange rate change even went in the right direction in order to offset in part the trade effects of the border adjustment. But even in those cases, it cannot be definitively stated that the trade effects of cumulative border tax adjustments were effectively offset. It seems to me fruitless to argue that remaining disequilibria can simply be offset by further exchange rate changes that in practice are both unlikely in the degree necessary and deeply disturbing to the international monetary climate.
Carried to its logical conclusion, Chairman McCracken's argument implies that the U.S. need not worry about the level of existing U.S. and foreign tariffs, U.S. and foreign subsidies or most U.S. and foreign import barriers as changes in exchange rates have eliminated their economic impact on U.S. and foreign trade interests. If this were so, the trade message submitted by the President need not have called for tariff reducing authority nor provided for retaliatory authority against foreign subsidies in third country markets. Although exchange rate changes may conceivably eliminate balance of payments disequilibrium, in the sense of reserve losses and gains, we must always question whether the process of adjustment is desirable, the new equilibrium is appropriate for the world and for the U.S., and the resulting payment structure and resource allocation are truly efficient. A new equilibrium with the EC in a heavy trade surplus and the U.S. relying on capital inflows would be structurally unsatisfactory for the U.S. and for the entire world.
On a political level, I also do not believe that an argument that exchange adjustments have eliminated the impact of old border adjustments will be persuasive. Certainly these exchange adjustments do not eliminate our countervailing duty problems as the border adjustments continue to exist. In this regard I would point to recent statements by Congressman Mills that he intends to amend the countervailing duty law to require action against all rebates of taxes.
As I mentioned before, any effective mechanism for controlling changes in border adjustments must have as its basis the same arguments already put forward on the amount of adjustment for direct and indirect taxes. To achieve an effective control limiting a country's ability to make such adjustments or changes in them would require a basic amendment to the GATT rules. By limiting our substantive proposals to controlling changes in adjustments we do not reduce the need for achieving a structural change in GATT. We would, however, have thrown out one of our basic arguments, receiving nothing in exchange, and prejudicing our credibility on other U.S. initiatives.
David M. Kennedy/6/
/6/Printed from a copy that indicates Kennedy signed the original.
42. Letter From Secretary of Agriculture Hardin to Secretary of State Rogers/1/
Washington, July 18, 1970.
/1/Source: National Archives, RG 59, S/S Files: Lot 81 D 309, NSC-U/SM 73A. Secret. Dear Mr. Secretary:
I refer to National Security Decision Memorandum (NSDM) 68, of July 3, 1970 which directs U.S. policy toward the European Community, and NSDM 45 of March 2, 1970 which directs U.S. policy toward the Spanish Trade Agreement with the European Community./2/ It is my understanding that NSDM 68 resolves the question which has held up implementation of NSDM 45.
/2/Neither printed. (Ibid., Lot 83 D 305)
NSDM 68 directs the Under Secretaries' Committee to coordinate the implementation of U.S. policy toward the European Community. There is a clear and compelling need for the Committee to move quickly. Action must be taken to restore confidence in the agricultural trading community that this Administration intends to defend U.S. agricultural interests. Accordingly, we propose that the Committee decide without further delay to:
1. Formally notify the parties to the Spanish/EC and Israeli/EC preferential trade agreements that we oppose implementation of these agreements, "in the context of opposition to all preferential arrangements illegal under the international trading rules of GATT" (NSDM 45), and that we intend to inscribe the matter on the agenda of the September Session of the GATT Council under the complaint procedures of Article XXIII:2. The two agreements were signed in Brussels on June 29, 1970. They will enter into force soon, possibly October 1, 1970. They are inconsistent with GATT provisions.
2. Formally notify the parties to the Tunisia/EC and Morocco/EC preferential agreements of our opposition to these agreements also. These agreements violate GATT provisions in the same way as the two agreements mentioned above. We should tell the parties at the same time that we intend to inscribe these agreements also on the September GATT Council agenda under the complaint procedures of Article XXIII:2. These two agreements were signed in Brussels on March 31, 1969. They have been in force since September 1, 1969.
3. Formally notify the EC and the applicant countries that we are able at this time to identify agriculture as a critical area for the United States in the accession negotiations and that within agriculture, grains and soybeans are particularly sensitive. Accordingly, the U.S. expects the present EC duty-free status of soybeans to be extended to the enlarged Community, and the grain prices for the enlarged Community to be reduced by $15 per ton from present EC levels.
It is clear that the European Community's Common Agricultural Policy is already seriously curbing agricultural exports from the United States and the rest of the world. U.S. exports to the EC subject to variable import levies have declined 47 percent since 1967. This decline is largely attributable to the Community's protective system. On grains, for example, the Community's high support prices, variable import levies and export subsidies have reduced Community net imports from 12 million tons to less than 4 million tons in the last three years. If this system is extended unchanged to an enlarged Community, further U.S. agricultural trade losses will be heavy as a result of curtailed market opportunities in Europe and subsidized European competition elsewhere. Losses will be in such critical commodities as grains, fruits, and tobacco.
We suggest that the Committee meet within the next week to take decisions on the matters set out above./3/ Prompt action in these cases is imperative. At an appropriate time, we will wish to make additional proposals to the Committee respecting the legality of the EC's variable levy system and other such matters.
/3/Under Secretary of State U. Alexis Johnson replied to Secretary Hardin's letter on July 25, informing Hardin that Deputy Under Secretary Samuels would chair the Under Secretaries Committee to carry out NSDM 68 and would hold a meeting of the Committee on August 12. (Ibid., NSDM 68) See Document 43.
Sincerely,
Cliff
43. Memorandum From the Deputy Under Secretary of State for Economic Affairs (Samuels) to the President's Assistant for National Security Affairs (Kissinger)/1/
Washington, August 20, 1970.
/1/Source: National Archives, RG 59, S/S Files: Lot 73 D 288, Box 837, USC/NSC. Confidential.
SUBJECT
On August 12 the Under Secretaries Committee held its first meeting on the enlargement of the European Communities pursuant to the directives of NSDM 68./2/ As Chairman of the Committee for this meeting I would like to summarize for you the principal issues discussed:
/2/See Document 42 and footnote 3 thereto. In preparation for the meeting, on August 7 Staff Director Arthur A. Hartman circulated to the Under Secretaries Committee several papers, including "Draft Talking Points To Be Used With Parties in EC Enlargement Negotiations." (National Archives, RG 59, S/S Files: Lot 81 D 309, NSC-U/SM 73A)
1. Consultative Mechanism. I recounted to the Committee my recent talks with Commissioner Dahrendorf to establish a series of regular US-EC consultations. Dahrendorf and I tentatively agreed that these consultations should be held at least semi-annually and more frequently if necessary./3/ An agenda for each consultation would be agreed in advance and there would be maximum continuity and follow-up. The first consultation is tentatively scheduled for mid-October in Washington and we will confirm precise dates shortly. The Under Secretaries Committee agreed to this procedure. It was also noted that to ensure maximum continuity it would be desirable, insofar as possible, for the same people on both sides to participate in each of these meetings.
/3/In his August 5 Evening Report to the President, Secretary Rogers wrote that during the trade policy talks in Geneva, Deputy Under Secretary Samuels and EC Commissioner Dahrendorf had come to a verbal understanding on periodic talks on matters of mutual interest. Rogers thought the initial consultation would be in Washington between mid-October and mid-November, and Dahrendorf would head the EC delegation. He also pointed to a possible visit by Commission President Malfatti in early 1971 for an exchange of views with President Nixon. (Ibid., S/S Files: Lot 74 D 164)
2. Notification to Europeans of US Interests. Discussion on this subject centered on two issues: the substance of our initial notification and the form of notification.
As to the substance, a draft "talking points" paper had been circulated prior to the meeting, and some preliminary comments were made on it at the meeting. Several agencies took the view that the language in NSDM 68 (Para 1) supersedes other statements by the President on European policy--notably the President's February message on foreign policy/4/--while State contended that all of the President's statements to date are consistent and may be drawn upon to express US policy. Specifically the view was expressed that the policy of favoring broadening and strengthening the community has now been watered down to favoring only "expansion" of the membership of the Community. An inter-agency working group was instructed to develop further the substance of the initial communication of US interests to the Community.
/4/U.S. Foreign Policy for the 1970's: A New Strategy for Peace, A Report to Congress, February 19, 1970 (Washington: U.S. Government Printing Office, 1970). Also printed in Public Papers of the Presidents of the United States: Richard M. Nixon, 1970, pp. 116-190.
As to the form of notification to the Commission, there was agreement that it should take place at an early date, probably at the first US-EC consultation in October. Communication would also be made to national governments through our embassies. There was discussion of the pros and cons as to whether the communication should be oral or written, but it was decided to wait until the substance was agreed before deciding this point.
3. Preferential Arrangements. A position paper on EC preferential arrangements with Morocco, Tunisia, Spain, and Israel had been circulated prior to the meeting. The thrust of the paper was:
a. These four arrangements as presently constituted are inconsistent with the GATT.
b. We should identify, as soon as possible, potential damage to specific American exports and try to set up a bilateral meeting with the European Communities to look at possible measures to reduce the anticipated injury.
c. We would not wish to push formal GATT consideration of the preferential agreements while the bilateral talks are in progress.
Several agencies, notably the Department of Agriculture, took issue with this approach. They suggested instead that we promptly notify the EC and (presumably) the four Mediterranean countries that we object to the principle of these arrangements as contrary to the GATT and, unless they have proposals to redress the present situation, we intend to raise this issue at the September 29 GATT Council meeting to reiterate American opposition to the principle of these agreements and to invoke GATT Article 28. This action could lead to requests by us for compensation or failing to get satisfaction, for authority to retaliate.
An inter-agency working group was instructed to look into the details of such a course of action and report back to the Committee.
4. Assessment of Specific Trade Interests. For use throughout the course of the enlargement negotiations, a technical working group was instructed to begin as soon as possible to assemble the detailed tariff and other technical information necessary to assess the effect on US interests of specific proposals as they are put forward at Brussels.
By and large the first Under Secretaries Committee meeting elicited a lively exchange on the above issues. In view of the September 29 GATT meeting and the first US-EC consultation in mid-October, it will likely be necessary to hold another meeting of the Under Secretaries Committee in early September.
Conclusion. In summary, it is clear that there is a deep-seated and widespread hostility toward the Community in several agencies of the Executive Branch. Political considerations are brushed aside as largely irrelevant, and attention is focused on short-term economic considerations in a manner out of proportion to our long-term interests. It would be desirable for US policy toward the Community to be made unmistakably clear to the heads of all the Executive Agencies, with the directive that this be conveyed clearly to their staffs.
NS
44. Editorial Note
The first in a series of bilateral consultations between the United States and the European Community was held October 15-16, 1970, in Washington. For a summary, see Document 47. In preparation for this consultation, the Under Secretaries Committee met on October 12 to discuss the issues. Prior to the meeting, on October 9 Staff Director Arthur Hartman distributed to the Committee an Objectives paper and copies of two papers cabled to USEC October 9 for delivery to the Commission setting forth U.S. positions. (National Archives, RG 59, S/S Files: Lot 81 D 309, NSC-U/SM 73B) On October 10 Hartman distributed to the Committee four additional position papers on EC enlargement, agriculture, preferential arrangements, and the GATT work program. (Ibid., NSC-U/SM 73C)
On October 9 Hartman also sent Under Secretary Irwin a briefing memorandum for an October 10 luncheon with Deputy Under Secretary Samuels and the October 12 Under Secretaries Committee meeting. Hartman wrote in his memorandum: "we can anticipate that the domestic agencies--Commerce, Treasury, Labor, and Interior--and to some extent the Office of the Special Trade Representative (Ambassador Carl Gilbert) will want to take a hard line with the Europeans. In the previous Under Secretaries Committee meeting on this subject in August [see Document 43], State was subjected to a crossfire of criticism from these agencies and received no offsetting support. This time we have alerted the NSC representative (Fred Bergsten) of the need to emphasize the President's support for EC enlargement and our basic policy of not interfering directly in negotiations between the British and the European Communities."
Hartman went on to say that Agriculture would likely be the most difficult issue in the consultation, and Assistant Secretary of Agriculture Palmby would suggest a reduction in the unified grain price. Hartman cautioned that "the important thing from our point of view is that such a request be made in the context of U.S.-EC relations, and not be linked in any way as a condition to our acceptance of U.K. membership in the Community." (National Archives, RG 59, S/S Files: Lot 83 D 305, NSDM 68)
While he was in Washington, EC Commissioner Ralf Dahrendorf met with Henry Kissinger at 6 p.m. on October 15. In his October 14 and 15 briefing memoranda for the meeting, Bergsten told Kissinger that "we are treading on the brink of a trade war" and that Dahrendorf was particularly concerned about the Mills bill, U.S. "unpredictability," and a perception that the United States was turning inward. (Ibid., Nixon Presidential Materials, NSC Files, Subject Files, Box 322, European Common Market, Volume I 1969-1970) According to the October 19 memorandum of the October 15 conversation, Kissinger assured Dahrendorf "that the Administration was in favor of free trade. Textiles were the lone exception, based on the President's campaign commitment to that industry. If the textile issue could be resolved through negotiations, Dr. Kissinger was confident that the threat of trade legislation could definitely be avoided." (Ibid.)
In an October 16 information memorandum to Kissinger summarizing the Dahrendorf visit, Bergsten noted that he agreed with Kissinger's assessment of the trade legislation "for this year," but cautioned that the problem was longer term and U.S. trading partners also needed to take free trade initiatives to help hold protectionism "at bay." Bergsten concluded that the Dahrendorf talks "went well from a procedural standpoint, and the consultative mechanism has been well launched." He cautioned, however, that "our major trade problems with the Community are not politically susceptible to resolution satisfactory to the United States, and I envisage increasing difficulty in overall U.S.-European relations as a result." (Ibid.)
45. Editorial Note
Following negotiation of the 2-year offset agreement with Germany on July 9, 1969 (see Document 24), U.S. and German officials began to explore the prospect of German willingness to consider budgetary support to help defray foreign exchange costs of U.S. troops in Germany for the next offset beginning in July 1971. Deputy Under Secretary Samuels and Ambassador Pauls, for instance, discussed this possibility on January 29, 1970. (Evening Report from Secretary Rogers to the President, January 30; National Archives, RG 59, S/S Files: Lot 74 D 164) Moreover, the Under Secretaries' Committee recommended that during Chancellor Willi Brandt's visit to Washington in early April 1970, the President should discuss with him in general terms "the question of seeking new methods, including budget support, to reduce the financial burden resulting from the stationing of U.S. forces abroad." The Committee recognized that the issue was not an easy one for Brandt who might find it difficult to sell budgetary support for U.S. troops to the German people, particularly when the United States might not be prepared to offer the Germans the kind of troop support they would undoubtedly want in return The Under Secretaries' Committee attached to its recommendations its five-part study (with 11 appendices), "Foreign Exchange Offset and Budget Support for U.S. Forces in Germany and Other NATO Countries," which presented various options for the Nixon administration on these matters. (Memorandum from Richardson to Nixon, March 25; ibid., S/S Files: Lot 73 D 288, NSC-U/DM 30)
President Nixon decided, however, "to defer a judgment at this time on whether the U.S. should seek budget support from Germany in the next offset arrangement, beginning in July 1971." Although he wanted U.S. officials during the Brandt visit to indicate to their German counterparts in a general way "the desirability of improving the methods of easing the financial burden to the U.S. of maintaining our troops in Germany," he did not want them to raise the specific issue of budget support. If the Germans raised it, the U.S. officials could respond that they would certainly "consider it as one possible means of achieving improved methods for easing the U.S. financial problem." (Memorandum from Kissinger to the Secretaries of State, Defense, and the Treasury, April 8; ibid., Nixon Presidential Materials, NSC Files, Agency Files, Box 289, Treasury Volume I)
In June 1970 German Defense Minister Helmut Schmidt told Ambassador Kenneth Rush that the current offset agreement could not be continued in its present form after its expiration, and instead he had proposed to the NATO Defense Ministers a new type of multilateral contribution to help the United States meet its European defense burdens. (Telegram 6764 from Bonn, June 12; ibid., Country Files--Europe, Box 683, Germany, Volume V 4/10/70-7/31/70) Later in the year he told Rush that any future financial burden-sharing contribution would have to come out of the German defense budget, which could not be increased, so he hoped any U.S. request for financial burden-sharing would be small. He stressed that any German contribution would have to be in a multilateral framework. (Telegram 11830 from Bonn, October 13; ibid., Box 684, Germany, Volume III 8/1/70-11/70)
46. Memorandum From Secretary of the Treasury Kennedy to President Nixon/1/
Washington, October 13, 1970.
/1/Source: Washington National Records Center, Department of the Treasury, Secretary's Memos/Correspondence, 1966-1970: FRC 56 74 7, Memo to the President September-December 1970. Confidential. Copies were sent to Secretaries Laird and Rogers.
It is with considerable concern that I view the interpretations being placed upon your remarks concerning NATO made in your briefing aboard the Saratoga and press conferences in Ireland./2/ Numerous classified cables and press reports suggest that we are dropping the broad "burden sharing" concept. Since a satisfactory "burden sharing" arrangement with our NATO Allies would help us and the Alliance politically, militarily, and financially, I believe we should continue to press for a satisfactory solution.
/2/See Public Papers of the Presidents of the United States: Richard M. Nixon, 1970, pp. 782-783 and 804-809.
In my view the domestic political situation, particularly on the Hill, concerning reductions in our NATO forces is serious. This political problem is intimately tied to our critical budgetary and balance of payments condition. At the same time we must be careful that our relations with our European Allies are not upset by any precipitous action either by ourselves or by the Congress. With a proper "burden sharing" mix all of these problems can be met or at least blunted for a sufficient period of time to enable us to adjust to new conditions.
There have been a number of discussions by myself personally and my staff with counterparts from our NATO Allies. It must be recognized that the current initiative in "burden sharing" being undertaken under the leadership of Germany is unprecedented./3/ In addition to whatever benefits may accrue to us it has increased the unity and thereby the strength of our Alliance. This in itself has made the preliminary efforts worthwhile.
/3/See Document 45.
The "burden sharing" mix mentioned above in my opinion is important to consider, for no one element of "burden sharing" will provide the complete solution to our political, military, or financial problems. We have looked at this problem carefully and believe that an appropriate mix would consist of some direct budgetary contribution on a multilateral basis to the U.S.; an offset agreement between the U.S. and the Federal Republic of Germany; a transfer of certain military functions from the U.S. to our NATO Allies; and an improvement and modernization of our Allies' national forces.
The U.S. should also consider for both tactical and substantive reasons a small reduction in our own forces committed to NATO. The Europeans have consistently stated that they are concerned that we do not make "substantial" reductions. A small reduction would be proof to our Allies that we are truly having problems and that their "burden sharing " effort was warranted as the reduction would have been much greater if they had not been forthcoming. Further, I detect a continuing tendency on the part of some of our Allies not to believe that we are having serious difficulties and that we therefore will not take any action. A small reduction would reinforce our verbal statements that they must do more for themselves in addition to helping our budgetary and political problems with the Congress.
In some of the internal cables recently sent on this subject and discussions which have been held within the Executive Branch a particular fallacy has developed. There are those who argue that we urge the Europeans to come up with additional funds with which they either improve their own forces or contribute to the U.S. In my opinion these cannot be equated. The Europeans have consistently made it quite clear that if they come up with additional funds, particularly in the short term, it will be because of the help they can provide the U.S. There is no indication that they plan significantly to increase their own defense budgets in order materially to improve their own national forces. Aside from difference of opinion as to the military need, if the European governments were to increase spending on their own forces, that would tend to be inflationary for them to the extent that they spent the money in their own country. This is an important reason why they are unlikely to do it.
Further, the argument being raised by some that we would be considered mercenaries has no validity. All we are asking in direct budgetary contributions is that the Europeans pay some share of the cost of local supplies and services. The U.S. forces would continue to be paid by us in their entirety.
We have an opportunity to improve the Alliance as well as helping to solve some of our problems. A well-planned negotiating effort with our Allies concerning "burden sharing" around the framework mentioned above will materially help. I must, however, say that the cables issued subsequent to your statements and discussed particularly with the Germans will make the task more difficult. An immediate clarification along the lines of the draft cable prepared by Mel Laird and discussed with you would immeasurably help to rectify the situation./4/ I therefore urge that we take this step and start a dialogue as requested by the EURO group minute as soon as possible.
/4/The draft cable was not found.
David M. Kennedy/5/
/5/Printed from a copy that indicates Kennedy signed the original.
47. Information Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/
Washington, November 13, 1970.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 322, European Common Market, Volume I 1969-1970. Limited Official Use. Forwarded to Kissinger under cover of a November 6 memorandum from Bergsten who recommended it be sent forward to alert the President to the issues between the United States and the Community. Presumably after the memorandum came back from the President with his marginal notes, Kissinger wrote at the top: "Bergsten--keep this note in mind."
SUBJECT
State has forwarded a summary of the recent consultations between the U.S. and the European Community (Tab A), the first in a series which will probably represent a new stage in our relations with the Community. We hope that the consultations will defuse, and perhaps even help solve, the numerous contentious issues that will increasingly be arising between us.
This first meeting was carried out with unusual procedural smoothness. Substantively, there was less harmony. The discussions concentrated on four main topics:
a. U.S. Trade Legislation. Community representatives avoided threats, but made clear that they would probably have to react on the trade and investment fronts in response to shoe quotas and the excessive relaxation of the escape clause contained in the House trade bill. If the U.S. avoids enactment of protectionist legislation, however, the Community has offered to assist in a voluntary U.S.-Japanese textile agreement by not raising its own barriers to protect against diversion of Japanese sales to Europe.
b. Community enlargement. We made it clear that we continued to support enlargement, but that the Community would have to consider the effects on the economic interests of third countries, such as the U.S.
c. Agriculture. We explained our concern over the stiff agricultural protectionism of the Community. The Community said that a reduction of farm support prices (and hence increased imports) was out of the question, but that perhaps it could avoid exacerbating the problem through new price increases./2/
/2/The President partially encircled this paragraph and underscored "explained," next to which he wrote "We should complain."
d. Community preferential arrangements. The U.S. objected to the Community preferential arrangements with a whole range of Mediterranean countries as a violation of the Community's most-favored-nation commitment with injurious effects on our exports. The Community said that they are pursuing the agreements as the only instruments available to the Community as a unit to carry out a "European political responsibility" to the poor countries south of Europe.
This memo represents a reminder of an area of difficulties between our own domestic commercial interests and our European policy, which is now largely confined to the economic area but is likely to intensify and could easily spill over into the political arena./3/
/3/The President wrote at the end of the memorandum: "K--it seems to me that we 'protest' and continue to get the short end of the stick in our dealings with the community. Agriculture is a prime example--The Congress is simply not going to tolerate this too passive attitude on the part of our representatives in such negotiations."
Tab A
Memorandum From Acting Secretary of State Irwin to President Nixon
Washington, October 29, 1970.
SUBJECT
Ralf Dahrendorf, Commissioner of the European Community (EC) in charge of Foreign Relations and Foreign Trade, and a delegation from the EC Commission met with an inter-agency delegation led by Deputy Under Secretary of State Nat Samuels on October 15 and 16 in the first of a series of consultations between the US and the EC pursuant to NSDM 68. The discussions centered largely on (1) US trade legislation, (2) EC enlargement, (3) EC agricultural policy, and (4) EC policy on preferential trading areas.
(1) US Trade Legislation
Dahrendorf expressed the fear that the Trade Bill could lead to an escalation of protective measures throughout the world that could seriously disrupt the international exchange of goods and capital. Although careful to avoid threats and explicitly saying that the Community does not intend to make threats, he said it would be unwise for us to think that the European Community would be unable to take common action in response to grave injury to the economic interests of its member states resulting from the Trade Bill. EC officials also made clear that American protectionist measures would strengthen the hand of those seeking to discriminate against European subsidiaries of American firms.
The Community would be directly and importantly affected by quotas on shoes, Dahrendorf said, and would most certainly react. But it is the modification of the escape clause, including the trigger mechanism in the Trade Bill, which is most troublesome because it has the potential to change the total complexion of world trade. The Community also objected to the Domestic International Sales Corporation as being an export subsidy in violation of GATT.
As a positive contribution to a solution of the textile impasse with Japan, the EC delegation indicated, subject to some qualification, it would not raise textile barriers against Japan if the US and Japan were able to arrive at a reasonable voluntary textile arrangement prior to enactment of US legislation.
(2) EC Enlargement
Nat Samuels assured the EC side that we continue to support the accession of the UK to the Common Market but we expect the parties to the negotiations to take fully into account the trading interests and GATT rights of the US and other third countries. The US side suggested the Community consider the effects of enlargement on third countries and made clear that we regard this bilateral consultative forum as appropriate for raising specific trade problems that might arise in the course of negotiations. Dahrendorf responded with an explanation of the problems and delicacy of dealing with third countries while the negotiations with the British and other applicants were proceeding but offered to consider specific suggestions that the US might make.
(3) Agriculture
Nat Samuels and Assistant Secretary of Agriculture Palmby set forth our concerns over the high level of agricultural protectionism in the Community and stressed the need to reduce grain support prices. This would have an important beneficial effect on our exports and reduce the adverse effects of extending the EC agricultural policy to the UK and other applicants. The EC delegation explained that the Commission is resisting political pressures for an increase in grain prices in the Community but insisted that a reduction in grain prices was politically out of the question. The most that could be hoped for was to continue to keep the grain price stable for several more years. At the current levels of inflation in Europe, stable prices would erode the real return to farmers and thus their stimulus to production, while bringing an improvement to the U.S. exporter in terms of real prices. It was agreed to hold subsequent policy-level discussions between the US and the EC on a variety of agricultural trade items, although the EC is unable to publicize explicitly its willingness to include discussions on grain prices lest this spark a political explosion.
(4) EC Preferential Arrangements
The US side made clear its objection in principle to the EC preferential trading arrangements in the Mediterranean which we believe violate the most-favored-nation principle of GATT. Dahrendorf defended these arrangements on political grounds and pointed out that these arrangements are for the time being the only instrument available to the Common Market to meet its responsibility to the Mediterranean littoral. He claimed the Common Market did not seek the arrangements for commercial advantage, and he insisted that they caused no commercial injury to the US or other third countries. The US side contested this by pointing out that the California-Arizona citrus industry has already complained of injury. It was agreed that without derogation from or compromising the question of principle, the US and the EC would jointly try to determine the damage to us resulting from these agreements.
John N. Irwin II
48. Information Memorandum From C. Fred Bergsten of the National Security Council Staff to the President's Assistant for National Security Affairs (Kissinger)/1/ Washington, December 3, 1970.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 309, Balance of Payments. Secret. At the top of the memorandum, Haig wrote: "Amen!" when he rerouted it to Bergsten. Kissinger wrote: "I agree."
SUBJECT
I was shocked to learn that Paul McCracken and Peter Flanigan had seriously raised with you the possibility of U.S. troop cuts abroad for balance of payments reasons./2/
/2/Not further identified.
I take no stand on whether our overseas troop levels are correct. I do take the firmest possible stand that we should never reduce them for balance of payments reasons.
The last Administration had a major hangup over the balance of payments. It did everything from implementing mandatory capital controls, to proposing a tax on foreign travel by American citizens, to requiring the Defense Department to pay 50% higher prices to purchase U.S. commodities, to bringing down Erhard over the offset issue, to the additionality requirements on foreign aid. Even it, however, never reduced U.S. troops abroad for balance of payments reasons--though it considered the possibility repeatedly throughout its eight-year life.
The arithmetic demonstrates why. It is true that our foreign expenditures for military purposes are high. However, drastic reductions in our military capabilities would be required to produce small net gains for our balance of payments. When our deficit is running in the $3-$5 billion range, as it has for twelve years with temporary aberrations on either side of the range, the saving of a few hundred million dollars gets lost in the shuffle--and even a saving of that relatively small magnitude would require major shifts in troop deployments.
In view of the difficult decisions already made to maintain our troop levels in Europe, Vietnamize as rapidly as possible, and pull out of Korea at a pace which already causes major foreign policy problems, I do not see how we could seriously consider additional withdrawals for balance of payments reasons.
What would be the signal to the Soviets if we were to do so? It could only be that the U.S. had become so pitifully weak on the economic and financial front that we could no longer make any pretense of maintaining our defense posture around the world.
It is bad enough to make overseas troop decisions on budgetary grounds, but this at least involves real resources and alternative uses of money. To do so for balance of payments reasons, in order to juggle the statistics marginally and enable us to tell the European financial officials "that we are doing something about our problem", would be criminal.
The underlying problem, as always, is the failure to properly perceive our balance of payments situation--and I deliberately do not say "balance of payments problem". An effort to clarify perceptions on this issue will be the first task of the new International Economic Policy Committee,/3/ as worked out yesterday at George Shultz's meeting on the subject in which I participated. Hopefully, that exercise will dash any notions of troop cuts or other changes in serious policies for balance of payments purposes.
/3/Reference is to the Council on International Economic Policy (CIEP) established in January 1971; see Document 49.
In addition, however, I urge you to stand firm against any such nonsense. I assume you will need little urging in this direction, but wanted to restate the case to you because of the absurdity of the proposal. 49. Editorial Note
On January 18, 1971, President Nixon sent a memorandum to the Secretaries of State, Treasury, Agriculture, Commerce, and Labor; the Director of the Office of Management and Budget; the Chairman of the Council of Economic Advisers; the President's Assistant for National Security Affairs; the Executive Director of the Domestic Council; and the Special Trade Representative establishing a Council on International Economic Policy (CIEP). The President would chair the Council (in his absence the Secretary of State would chair the meetings), and the addressees of the memorandum were the Council's members. The President's memorandum was released to the public on January 19; see Public Papers of the Presidents of the United States: Richard M. Nixon, 1971, pages 40-41. The memorandum and additional documentation on the establishment of the CIEP are scheduled for publication in a forthcoming Foreign Relations volume on the Organization and Management of Foreign Policy. Peter Peterson was named the first Director of the CIEP.
On February 1 Secretary of Defense Laird requested that the Department of Defense be represented on the CIEP, in part because of the balance-of-payments linkage with burden-sharing and offset negotiations. (Memorandum from Laird to Kissinger, February 1; National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 226, DOD 12/1/70-2/23/71) In a February 19 memorandum to White House Staff Assistant John Campbell, Kissinger noted that Laird's request was reasonable but doubted the CIEP would have sufficient military or security business to warrant a permanent Defense Department member. Kissinger suggested getting Peterson's opinion before making a decision on Laird's request. (Ibid.) At least in part because of concerns about NSC control, Kissinger on July 17 sent a memorandum to Peterson, who had some sympathy with the idea, opposing Defense Department participation in the CIEP. (Ibid., Box 218, CIEP) On August 9, however, Peterson sent a memorandum to the CIEP members, including the Secretary of Defense, stating the President's decision that the Secretary of Defense should be a member of the Council and that the Department of Defense would participate fully in the Council's work. (Ibid.)
50. Editorial Note
Under instructions from Henry Kissinger, in early 1971 the NSC Under Secretaries' Committee completed a six-section study entitled "Report on German Offset Negotiations," which it forwarded to the President under cover of a January 19, 1971, memorandum from Nathaniel Samuels, Acting Chairman of the Under Secretaries' Committee. In his memorandum Samuels made the following recommendations concerning the German offset negotiations:
"1. The Under Secretaries Committee recommends that you authorize the negotiation of a new two-year offset agreement with the Federal Republic of Germany covering the period July 1, 1971 through June 30, 1973.
"2. The Committee recommends that, as an initial negotiation position, we seek both maximum quantity ($850 million) and best quality of components in an agreement. Such an offset agreement, together with the recently agreed European Defense Improvement Program (EDIP) would then yield a total burden-sharing package of $1.0-1.1 billion annually.
"3. The Committee recommends that the U.S. negotiators be authorized if necessary in the course of the negotiations to reduce the quantity goal to achieve better quality. This could involve a fallback to about $700 million in terms of order of magnitude.
"4. It is recommended that, to the extent possible, offset negotiating efforts be directed principally to maximizing those offset components which best contribute to improving German and allied conventional defense capability, preferably through direct military procurement and, possibly, by German underwriting of certain Military Assistance Programs now financed by the United States and German assumption of certain costs now borne by the United States in Germany. These are high-quality components. Other components, such as civilian procurement, loans and sales of Eximbank paper, would be assigned lower negotiating priorities.
"5. Finally, the Under Secretaries Committee recommends your approval of the proposed negotiating scenario outlined in the enclosed report calling for a United States negotiating team to be headed by Deputy Under Secretary Samuels with negotiations concluded, if possible, by June 1." (National Archives, RG 59, S/S Files: Lot 73 D 288, NSC/USC Memos)
In a February 17 memorandum to the Chairman of the Under Secretaries' Committee, Kissinger reported the President's approval of these recommendations. (Ibid., Central Files 1970-73, FN 12 GER W)
The first round of negotiations was held in Bonn March 10-11. An undated Department of State paper summarizing these talks is ibid. The second round took place in Washington April 15-16. An undated Department of State paper summarizing these talks noted in part: "As at the first round of talks in Bonn, the atmosphere was very good. However, the German position had advanced very little and at the conclusion the two sides were still quite far apart." (Ibid.)
Following this impasse intensive behind-the-scenes maneuvering and consultations took place prior to the third round of negotiations in Bonn June 28-29. Telegraphic communications between the Embassy in Bonn and the Department of State on these efforts are ibid. A June 25 memorandum from Ernest Johnston of the National Security Council Staff to Kissinger advised that Kissinger recommend to the President that a State Department position to accept a possible further German compromise be rejected. Johnston pointed out the severe split among the State, Treasury, and Defense Departments on the U.S. position for the upcoming Bonn discussions, the shortness of time, and the uncertainty over whether the Germans were prepared to compromise further. He recommended that U.S. negotiators continue to press the Germans strongly but that no U.S. decision on what to accept be made until after the Bonn meetings. (Ibid., Nixon Presidential Materials, NSC Files, Country Files--Europe, Box 685, Germany Volume IX 4-8/71)
Regarding the final U.S.-German negotiations leading to the initialing of an Agreed Minute on offset in Brussels on December 10, see Document 86. Additional documentation on the German offset negotiations during 1971 is scheduled for publication in a forthcoming Foreign Relations volume on Western European regional issues.
51. Information Memorandum From the President's Assistant for National Security Affairs (Kissinger) to President Nixon/1/
Washington, February 9, 1971.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 323, Foreign Aid, Volume I 7/70-1971. Confidential. At the top of the memorandum, the President wrote: "Be sure this gets to Peterson," and Kissinger wrote: "Send comments to Shultz." The memorandum is attached to a January 28 memorandum from Bergsten recommending that Kissinger forward the report to the President. Bergsten wrote that "responses reflect the usual foreign schizophrenia toward the U.S. economy," especially the European perception of the threat of a continued U.S. slowdown.
SUBJECT
Secretary Rogers has sent you a memorandum summarizing the views of our principal ambassadors on European and Japanese attitudes toward the U.S. economic situation (Tab A)./2/
/2/Dated January 22; not printed.
The Europeans are, of course, very sensitive to the health of the American economy since it greatly influences their own situation. Most of them express strong recognition of a need for a resumption of U.S. economic growth--even the French, who because of their monetary and nationalistic investment concerns, have not generally felt this way in the past. There is great worry, particularly in financial circles, about the other side of the balance--the possibility of a resumed U.S. inflation--but the greater stress by officials with broader concerns is clearly on the need for an up-turn in the American economy.
U.S. inflation or an immoderate resumption of U.S. growth are most worrisome for their international monetary implications, and their exacerbating European domestic inflation. Many worry, for example, that a continued rapid lowering of U.S. interest rates will cause a massive flow of funds to Europe, weakening the international monetary system and their own efforts to restrain inflation. The Europeans are disturbed that our colossal monetary importance, combined with the inflexibility of international exchange rates, drags their interest rates behind ours and vitiates the effect of their monetary measures on their domestic economies or on their balance of payments./3/ (To avoid some of these consequences, and to avoid charges that we don't care about our balance of payments, we have already increased the Export-Import Bank's borrowing abroad and reduced the margin requirements which were to some extent pushing U.S. banks to disgorge their previous foreign borrowings.)
/3/The President drew a line in the left margin next to this paragraph and wrote: "Shultz--An early project for the Peterson Council should be examination of the need for a new Int'l Monetary system. This should be undertaken with the closest consultation with Treasury, C.E.A. and Burns." On March 10 Kissinger sent a memorandum to Shultz and Peterson containing the President's instruction. (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP)
Consequently, the foreigners tend to favor U.S. use of fiscal measures rather than monetary measures as medicine for our current problems. They disagree on the domestic effectiveness of incomes policies, and are therefore ambivalent about how the United States should use such measures. However, they do seem to favor some use of strict Federal Government power to help slow wage and price increases. State did not quiz the ambassadors on U.S. trade policy, but most ambassadors made a strong point about foreign concern over the direction these policies have been taking. Part of their interest in resumed U.S. economic growth stems from the belief that U.S. protectionism has gathered force from our economic slowdown.
52. Editorial Note
John Connally replaced David Kennedy as Secretary of the Treasury on February 11, 1971, and Kennedy was sworn in as Ambassador at Large for Foreign Economic Policy Development. On December 29, 1971, President Nixon announced that he intended to appoint Kennedy as U.S. Permanent Representative to the North Atlantic Treaty Organization, which he did on March 17, 1972. Kennedy continued to serve as Ambassador at Large for Foreign Economic Policy Development and remained in that position until March 8, 1973.
On December 2, 1971, Kennedy, who was in London, sent a back channel message to Kissinger at the White House outlining his understanding of the parameters of his prospective appointment as Permanent Representative to NATO. To realize the President's objective of a strong representation in NATO, Kennedy recommended, among other things, that the President make a "clear and unequivocal" statement emphasizing particularly that Kennedy was being assigned to Brussels as "Ambassador at Large and as a member of the Cabinet to illustrate the importance the President attaches to NATO and our economic relations with Europe in general." Kennedy also requested that the Ambassadors to USEC and USOECD clear with him all important issues to "ensure the President's policies and programs were properly and consistently presented to the Europeans." (Attachment to letter from Kennedy to Connally, December 6; Washington National Records Center, Department of the Treasury, Records of Secretary Shultz: FRC 56 80 1, Miscellaneous)
Kissinger discussed Kennedy's message with the President during an Oval Office meeting at noon on December 2. He reported that Kennedy was prepared to accept the NATO appointment subject to some conditions, which Kissinger explained. As Kissinger concluded, the President said "those are all fine." He wanted "somebody who will be my man, who will play ball. Rogers probably wants him out of his hair at State anyway. Don't tell him about the understanding." (National Archives, Nixon Presidential Materials, White House Tapes, December 2, 1971, 11:35 a.m.-12:13 p.m., Oval Office, Conversation 628-2)
53. Memorandum From the President's Assistant for International Economic Affairs (Peterson) to President Nixon/1/
Washington, February 22, 1971.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP. Confidential. A stamped notation reads: "The President has seen." Attached to a March 1 memorandum from Peterson to Kissinger regarding the CIEP's role. Another copy is attached to a February 24 memorandum from Bergsten to Kissinger, which called Kissinger's attention to item IV on "rethinking" balance of payments and international financial policy, in which Peterson was reflecting Shultz' desire "to rid ourselves completely of the capital controls inherited by the Administration." Bergsten noted that this "could cause serious foreign policy problems and in fact the international monetary scene could become very troublesome before the year is out if our payments position remains in heavy deficit." (Ibid.)
SUBJECT
I summarize below my first week's efforts. I ask for your approval for several initial actions in which Messrs. Ehrlichman, Kissinger, and Shultz concur:/2/
/2/The President initialed his approval of each of the four recommended actions.
I. Immediate Problems (Tab A)/3/--That you give me two weeks for an effort to try to assure that your next decision on shoes and cheese is based on a complete analysis of the issues and the impact of this combination of measures upon our basic trade posture,
/3/None of the tabs is printed. They are sections of an undated and untitled 11-page paper attached to the copy of the memorandum cited in footnote 1 above.
II. A Positive Trade Strategy (Tab B)--Preparation of a Positive Trade Strategy for 1971-72 designed to put the Administration on the offensive in its support of liberal trade policy; principally, with a comprehensive and constructive program for industrial adjustment to foreign competition. Such a program should help minimize the possibility of a Congressional initiative for restrictive legislation.
III. A Tri-Partite Initiative (Tab C)/4/--Planning for a major international initiative on a broad range of international economic problems focusing on the US-EC-Japan relationship.
/4/Section III of the paper was summarized in a January 25 memorandum from Bergsten to Kissinger: "The Bureau of Economic Affairs has recommended that the Secretary of State propose to the President that he call a summit conference of Western leaders on international economic problems for this autumn. I understand the Secretary is interested, and you may recall that he alluded to such a possibility at our meeting with the President on U.K. agricultural policy last Monday (January 18)." Bergsten considered the State Department idea "grandiose" and was skeptical the summit could be organized, but stopped short of "throwing cold water on State's idea" at that time. (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 216, CEA) No documentation on a formal State Department proposal for a summit was found.
IV. Balance of Payments Strategy (Tab D)/5/--A basic rethinking of our approach to balance of payments and international monetary problems.
/5/Section IV of the paper made a recommendation to "review our fundamental policies with those in the Administration having responsibility in this area, and some knowledgeable outsiders as well, in order better to fashion the fundamental approach we should take over the next few years."
54. Memorandum From the Director of the Office of Management and Budget (Shultz) to the Members of the Council on International Economic Policy/1/
Washington, March 2, 1971.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP. No classification marking. Sent through Peterson. The memorandum is the attachment to Document 55.
SUBJECT
Each of these programs imposes costs on U.S. business and financial institutions and, through them, on the economy as a whole.
The programs were enacted and have been maintained despite these costs on the grounds that they achieve a result: an improved balance-of-payments position for the United States.
Some have argued that the costs are such as to suggest relaxation of the programs despite the presumed result. This point of view highlights the importance of the costs.
There are additional arguments against retaining the controls. The ability of these programs to achieve substantial and desirable results is questioned. If this argument is correct, then the balance of payments argument is irrelevant and, in view of the undoubted costs, the programs should be abandoned. Material presented in the attached memorandum leads me to that point of view.
George P. Shultz
Attachment
CAPITAL CONTROLS: QUESTIONABLE RESULTS AND
Controls on capital outflows from the United States were designed as temporary measures to deal with short-term problems in the U.S. balance of payments during the mid-1960s.
Three programs are now in effect:
1. The Interest Equalization Tax, designed to restrict the sale of foreign securities in the United States;
2. The Voluntary Foreign Credit Restraints Program, designed to restrict the availability to foreigners of banking services in the United States; and
3. Foreign Direct Investment Program, designed to restrict U.S. financing of foreign direct investments by U.S. firms.
The President has pledged himself to "bring an end to self-defeating controls on investment at the earliest possible time."
This memorandum reviews the reasons why I believe it is timely to redeem the President's pledge.
Estimates of Effectiveness of Individual Programs
The balance of payments is not necessarily determined by trade and capital flows in the direct and predictable way which casual reasoning suggests.
As a result of the format in which the accounts are conventionally arranged, the flow of reserves happens to be the last item listed in the international financial accounts. The assumption that this residual account will be the one to absorb the impact whenever there is a change in some other account is unwarranted. It is equally plausible that one of the other accounts will respond.
For example, it is by no means clear that a reduction in the outflow of U.S.-owned capital will have any effect on the flow of reserves. A priori, any number of accounts could absorb the change. In particular, economic reasoning suggests that the closest substitute category (foreign capital flows) will take up the slack. To the extent that capital from one source is a close substitute for capital from another, the reduction in U.S. capital outflows should be offset by an equal reduction in foreign capital inflows. There is no reason to expect that capital controls would, in any significant sense, actually reduce the net outflow of reserves.
Compliance with the administrative regulations under the control program appears to have been satisfactory. However, the Office of Foreign Direct Investment believes that the longer the controls are in effect, and as costs of compliance to U.S. business rise, compliance problems will grow more serious. In any case, nominal compliance with regulations is not the major test of effectiveness of the programs. Effectiveness is best measured by:
--The degree to which balance of payments gains are offset by losses resulting from nonregulated transactions induced by the control;
--The relevance of the controls, given the role of the United States in the international monetary system.
I am aware of three direct attempts to estimate the balance-of-payments effects of specific parts of the U.S. capital control programs. These studies are summarized below:
The Interest Equalization Tax
In his study, Cooper/2/ compared movements in controlled and uncontrolled capital flows before and after the inception of the IET. He found that net purchases of taxable securities fell by $500 million between the half year just preceding proposal of the tax and a year later. This effect was completely offset by increases in U.S. direct investment, long-term lending by banks, and short-term lending by banks and others. As it happened, the U.S. balance of payments hardly improved despite a $2.7 billion increase in the surplus on goods and services. Cooper therefore concluded that the IET "failed in its broader objective of improving the U.S. balance of payments."
/2/Richard N. Cooper: "The Interest Equalization Tax: An Experiment in the Separation of Capital Markets," paper # 78, Economic Growth Center, Yale University, 1967. [Footnote in the source text.]
The Voluntary Foreign Credit Restraint Program
Laffer/3/ developed two empirical relationships relating capital flows to economic variables using monthly statistics prior to the inception of the VFCRP. Under test, these two relationships proved to be accurate predictors of both private U.S. short-term capital outflows and foreign private short-term capital inflows.
/3/Arthur B. Laffer: "Short-Term Capital Movements and the Voluntary Foreign Credit Restraint Program," unpublished paper, University of Chicago, 1969. [Footnote in the source text.]
Based on data for the sixteen months following the inception of the VFCRP, the same relationships were then used to estimate the effects of the program on short-term capital flows.
The graph below displays the cumulative balance-of-payments effects reported by Laffer. According to the graph, outflows of U.S. private short-term capital were definitely retarded. These favorable balance-of-payments effects were, however, by early 1966, almost precisely offset by compensating unfavorable movements in private foreign short-term capital flows.
[Omitted here is the graph illustrating the conclusion.]
This led Laffer to conclude that:
. . . The net effects of the VFCRP on the U.S. balance of payments seem to be quite negligible. In fact, for a long time, the VFCRP appears to have cost the United States in terms of foreign exchange, and only after a year or more in operation were the net effects on the U.S. official settlements balance of payments non-negative. Therefore, the ostensible success of this program with respect to U.S. capital flows appears to have been negated by foreign capital flows.
The Foreign Direct Investment Program
The CPR/4/ Study came to the following conclusions:
/4/Center for Political Research: Federal Control of Foreign Direct Investments, research report, May 11, 1970. [Footnote in the source text.]
The available statistics regarding the OFDI program . . . cast doubt on the extent to which the program actually restricts direct foreign investment today. The figures set forth show that U.S. firms have never invested the full amount permitted by OFDI quota. . . .
Of course, not all of these allowables can be utilized by individual firms. However, even after taking this wastage into account, it is clear that generous investment allowables are available in most cases to U.S. firms wishing to expand their investments abroad. . . .
These facts naturally raise questions as to why we need a direct investment control program, costing about $3 million per year to administer, plus much larger amounts in compliance costs incurred by the firms subject to OFDI controls.
The Cost of Capital Controls
Although there is no precise measure of the costs of maintaining capital controls, the type of costs and their significance in the aggregate are evident:
--The prestige costs to our country of unsuccessful attempts to manipulate our balance of payments via controls;
--The administrative costs to the Government in running the program, and to the private sector in complying with it;
--The economic costs resulting from the inefficient reallocation of resources by business and financial institutions as they respond to the program;
--The commercial costs of lost business for U.S. financial institutions as other countries develop their own financial intermediaries;
--The political costs to the Administration of continuing an unpopular program.
An Overall Assessment
1. From an economic point of view, there is no reason to expect the capital control programs to succeed. When Americans are inhibited from transmitting capital abroad, it is logical that foreigners will do the investing in their place. As a consequence, foreigners will reduce their U.S. investments. There is no reason to expect that net capital flows (or reserves) will change one way or the other as a result of these programs.
2. Detailed studies of the capital control programs have uncovered absolutely no evidence of any effect on the balance of payments.
3. The programs impose severe administrative costs on both government and business; they misallocate resources; and they penalize Americans for transacting freely with foreigners. Ironically, they have no demonstrable favorable effects. 4. The common and primary purpose of the capital control programs is to stem the net outflow of U.S. official reserve assets by obstructing American investments and loans to foreigners. All available evidence suggests that these programs cannot and have not accomplished or even worked towards this purpose.
55. CIEP Study Memorandum No. 1/1/
Washington, March 8, 1971.
/1/Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP. Confidential. Initialed by Haig.
MEMORANDUM FOR
SUBJECT
The President has decided that:/2/
/2/See Document 53.
1. The Administration should develop a positive trade and legislative strategy for 1971-1972. This strategy should include a comprehensive and constructive program for industrial adjustment to foreign competition. Such a program should help minimize the possibility of a Congressional initiative for restrictive legislation.
2. In order to assure that the shoe case is considered in this larger context of Administration trade and legislative strategy, the President has directed that I prepare a complete analysis of the issues and the impact of the shoe case within two weeks.
3. We should begin intensive planning for a major international initiative on a broad range of international economic problems focusing on the US-EC-Japan relationship. While the main emphasis shall probably be on trade problems, it should also consider important related issues such as investment, aid, and monetary problems.
4. The Administration should initiate a basic review of its approach to the balance of payments and international monetary problems. One illustration of the many issues that arise in the context of our balance of payments programs is the capital control program. I attach a paper from Mr. Shultz on that particular subject./3/
/3/Document 54.
Action Requested:
1. I would appreciate your preliminary suggestions on subjects to be included in items (1) and (3) by March 15. The purpose of this initial outline of subject areas is to define the possible scope of the effort and to serve as a basis for discussion at the first meeting of the Council to be scheduled shortly.
2. I would appreciate receiving any additional comments you have on the shoe case by March 12, 1971.
3. Your comments by March 30 on the paper submitted by Mr. Shultz would be welcome.
Peter G. Peterson
56. Paper Prepared in the Department of State/1/
Washington, March 16, 1971.
/1/Source: National Archives, RG 59, Central Files 1970-73, E 1. Confidential. Drafted by A. Reifman and J. Renner (E), A. Katz (EUR), and E. Preeg (S/PC) on March 16. Sent to Peterson under cover of a March 16 memorandum from Samuels who indicated it responded to Peterson's request in CIEPSM No. 1 (Document 55).
INTERNATIONAL ECONOMIC STRATEGY FOR THE 1970'S
I. The Problem
The character of our economic relations with Western Europe and Japan have been strained. We are at odds on a variety of problems. Most important, at the moment, are textiles, agriculture and monetary issues. On the horizon are problems of reconciling various national policies which affect the economies of other countries, U.S. investment, and international trade in general. More specifically, some of the most immediate issues facing us are that:
--U.S. industry and labor are demanding import restrictions on a variety of products.
--The U.S. farm bloc is concerned over access to the European Common Market and over prospective losses when Britain enters.
--Despite the economic benefits to the United States of an enlarged European Community, specific sectors of U.S. industry may be adversely affected when the British become part of the Community.
--American labor is concerned about jobs presumably lost as the multinational corporation establishes production abroad.
--American industry wants greater access to the Japanese market for exports and investment.
--Foreigners are concerned about the resurgence of protectionist sentiment in the United States as illustrated by the Mills bill, voluntary textile, steel and meat restrictions and quotas for imports of dairy products.
--Europeans are concerned about our balance of payments deficit, particularly stemming from massive flows of short-term capital, and our attitude toward it.
--Foreigners are uneasy about the growing power of the U.S.-based multinational corporation.
Despite these problems the world economy has been growing rapidly and U.S. international trade and investment are thriving. The fact of our success, however, has produced sharp adjustment problems--domestically and internationally--that require urgent attention.
If these problems are not dealt with, the international institutions for economic cooperation, developed in the postwar period and which serve us well, could be threatened.
Even more important, there would be serious political fall-out if world economic cooperation deteriorated. We cannot expect the same cooperation on political and security issues from our major allies in an atmosphere of increasing acrimony over economic issues. Public support at home for our international security policies would be undermined. And, if the economic climate deteriorates sufficiently, the poor countries will have greater difficulty in standing on their own feet.
What we need is a framework among the industrialized countries--principally the U.S., the EC, and Japan--to deal with these existing concerns as well as the new developments we will be facing in the years ahead. The industrialized countries need to intensify their economic cooperation in all areas, including a better ordering of trade relationships directed toward more liberal access to markets, and a more smoothly functioning monetary relationship. Such a program can be undertaken only in cooperation with other countries. Acting alone, and on each problem separately, governments are under pressure to find narrow solutions to domestic problems at the expense of foreigners.
Such a program will require considerable preparation at home and careful consultation abroad. Until it can be developed, we need an interim program to deal with immediate pressures.
II. An Interim Program
An interim program might have four major components:
--International action on specific problems, particularly textiles and certain agricultural products;
--international consideration of the agenda and schedule for a broad economic initiative;
--domestic discussion of issues with Congress and the public;
--trade legislation.
A. Textiles and Various Agricultural Problems
Concerning textiles, we must first deal with the short run problems of imports from Japan and other Asian suppliers through 1973. We should also, however, take up GATT Director General Long's proposal that a multinational consideration of trade problems for all textiles be undertaken before the expiration of the current arrangement on cotton textiles. In the face of increased imports from low wage countries the textile industries in developed countries constitute a strong force against trade liberalization. If Long's proposal could be acted upon, the textile issue might be isolated.
In addition to an effort to settle the textile problem, we should press forward to resolve several highly politicized agricultural problems with the EC--citrus, tobacco, poultry, and lard--and should seek to avoid an increase in EC corn prices. We should recognize, however, that the probability of success is small. We have been trying to deal with trade problems one by one for years with no positive results. In this context governments find it difficult politically to stand up to particular interests.
B. International Consideration of a Broad Economic Initiative
The possible substance of a broad economic initiative is described in Part III of this memorandum. Such an undertaking will require a period of international consultation, as well as domestic soundings. The prospects for a major initiative can also mitigate domestic concerns and pressures, even though actual negotiations may not begin for some time.
We believe it is important, therefore, to initiate international consideration of a comprehensive economic program at the OECD Ministerial Meeting in June.
The organization is the right one in terms of membership. June is the time when the UK entry negotiations will be reaching a crunch and public interest and concern in this country are expected to be considerable.
No binding commitment to international negotiations can be expected before the basic decision on UK entry is made. However, such a commitment must be prepared by a careful process of international consultation and discussion in the media.
The OECD Ministerial Meeting would lay out the need for an international economic action program for the 1970's, and appoint a special group to prepare the guidelines for such a program. This group should consist of high-level government representatives of the U.S., the EC, the UK, Japan, and Canada. Such a group would begin serious work in the fall of 1971 and outline the content of such an action program.
C. Domestic Discussion
We also need to enter into low-key but extensive consultations with Congress and to make a major effort to raise the level of public consideration of the issues at home. We must show how much we have gained from an open, integrated world economy, what we risk by standing still, and what we lose by moving backward.
While there is no substitute for good policy, such policy cannot grow without public understanding and support. The forthcoming reports of the Williams Commission and the Boggs Congressional Subcommittee could be keystones of a public discussion program. But the enormous prestige and influence of the President will be required to coalesce support for a liberal policy.
D. Interim Trade Legislation
The basic question is whether there is any advantage to be gained by seeking interim trade legislation. Our efforts in 1970 to relax the escape clause led to results that would have been disastrous if the Mills Bill had passed. The relaxation of the escape clause in that Bill would have resulted in an enormous amount of new restrictions that would have set off a trade war. In any case, the Tariff Commission, by interpretation, has already relaxed the escape clause, and particularly adjustment assistance criteria. It would, of course, be highly desirable to eliminate ASP, but given the difficulties attendant upon seeking new legislation now, action could well be deferred until comprehensive new legislation is sought.
The lack of authority to provide tariff concessions for new escape clause actions which might be taken in the next year or so is troublesome, but, if necessary, we can live with it.
There is one measure which we are under an international obligation to present to Congress--the generalized preference scheme for developing countries. The precise timing and tactics of submission of this legislation must be carefully worked out.
If we should decide to seek interim legislation, the most likely elements would be:
1. Relaxing the adjustment assistance and escape clause provisions of the Trade Expansion Act.
2. Minor tariff reduction authority essentially to permit us to grant comprehension [compensation?] for our escape clause actions.
3. Repeal of ASP.
III. A New International Economic Initiative
A major international initiative should cover the whole gamut of economic issues of the 70's, although trade, agriculture, and monetary issues will likely be among the most predominant. The major areas for consideration are: agriculture, non-agricultural trade, foreign investment, international finance and assistance to the developing countries. These are briefly described below.
1. Agriculture
Governments of all countries use a wide range of domestic support programs and trade restrictions to help their farmers. The United States has suffered from agricultural policies of other countries, particularly the Common Market and Japan. We are an efficient agricultural producer. Thus, measures to put agricultural trade on a more liberal basis would be in our interest. We also would have to permit an increase in agricultural imports.
In preparing for negotiations which would likely have to deal with the whole range of domestic agricultural programs as well as agricultural trade policies, we should consider the desirability of pursuing the following topics:
a. Stand-still agreements to prevent further restrictions or changes in support programs pending comprehensive negotiations.
b. Internationally negotiated price support levels.
c. Internationally negotiated production controls.
d. Income support programs for families in lieu of conventional price-production-marketing programs.
e. Measures to stimulate demand for farm products. Surplus disposal policies, including food aid. Export subsidies.
f. Other trade barriers.
Since U.S. agricultural exports would expand more than our imports if more efficient agricultural policies were adopted, reciprocity would likely require U.S. concessions on industrial goods as well as agricultural goods.
2. Industrial Tariffs
We have two main reasons for wanting to bring about the reduction of industrial tariffs:
--The enlargement of the European Community in the short run will likely cause some deterioration in the competitive position of American exports. A lowering of the common external tariff of the European Community would ameliorate this problem,
--Foreign governments, especially Japan, and including Canada, have high barriers against products with a large technological component where the American comparative advantage is unusually great.
The Europeans can be expected to insist that some formula be adopted to bring the tariff structures of the major industrialized countries more in conformity with each other.
We will need to consider a formula that would result in both tariff reduction (to satisfy our demands) and tariff harmonization (to satisfy the Community's demands). We might also consider a virtual phasing out of tariffs in certain sectors or under certain conditions.
3. Quantitative Restrictions (Including Voluntary Restraints)
Japan is the major sinner as far as American exports are concerned. Liberalization of Canadian quotas would also benefit our exports.
Japan, in turn, can be expected to insist on a definite schedule for the elimination of discriminatory measures against Japan and the reduction of other quantitative restrictions, including our voluntary restraints.
4. Other Trade Restrictions
Foreign governments have a multitude of other trade restrictions. Their significance in potential trade terms varies greatly. We need to identify those which are the most significant and on which we could make headway. Government procurement policies form one such area. Japan, with a multiplicity of controls on imports, and Canada, with various practices to encourage investment at the expense of imports, would be our major targets. The Europeans also have a number of restrictions that should be included in the negotiations.
Foreign governments will press the U.S. on a number of our own restrictions--including the absence of an injury clause in our countervailing duty law and our failure to abide by the terms of the anti-dumping code--and we must carefully assess our overall interests in this area at an early date.
5. International Investment
The investment issue among developed countries is a composite of assertions with political and economic content. Possible problem areas include:
--European and Japanese fear of loss of control over the direction of domestic economies when decision-making for large enterprises is in the hands of foreigners.
--The sovereignty issue also arises when the U.S. seeks to assert extraterritorial control, such as in commercial dealings of firms under its control with Communist countries; and in connection with United States anti-trust proceedings as they relate to operations in foreign countries.
--Fear that multinational corporations limit competition.
--Fear that firms go where labor is cheap to the detriment of workers in high wage countries.
--Suspicion that intra-company pricing is based more on tax structures than on market considerations.
There have been persistent suggestions for formulation of a set of rules or a code dealing with foreign investment issues. There is, in fact, in existence the Capital Movements Code of the OECD, as well as various bilateral treaties, which provide for national treatment of foreign investments, with certain escapes. We doubt that an attempt at more precise formulation of a code at this time would improve the present position, and it might well worsen it.
No matter how we decide to deal with the broad issue, we should try to mitigate problems which are unnecessarily abrasive, such as sovereignty issues related to our trade control with Communist countries and specific taxation issues which need settlement among countries. We should also be alert to potential EC restrictions as a common industrial policy is developed.
We need a) to depoliticize the subject, b) to assure that no nation's major goals are seriously eroded by the international mobility of firms, c) to avoid conflicting jurisdictions over multinational firms, and d) to assure equitable treatment for the firms.
The U.S. may not need to press this subject since on most of these issues it is hard to see what we have to gain--but we must be prepared to respond if other countries put foreign investment on the agenda.
6. International Monetary Relations
Various issues in this field are being examined:
--The IMF is continuing (with all deliberate speed) its examination of limited exchange rate flexibility.
--The SDR system is in being, although there may be a problem about a year hence in connection with the appropriate amount to be created in the next basic period beginning in 1973 (and it is probably unwise for us to attempt to raise this issue now).
--The two-tier gold system, despite some increase in the price of commodity gold, is functioning well.
The major problem which now exists relates to the continuing U.S. deficit, stimulated most recently by interest rate disparities between the United States and various European countries, chiefly Germany, and the resulting large short-term capital flows.
In addition, there is substantial European concern stemming from recent articles by U.S. academics advocating a "passive" policy or U.S. "benign neglect" of its balance of payments, which Europeans take as meaning less cooperation with them and an attempt by the U.S. to force them to take the remedial action instead of trying to work out with them an acceptable joint solution.
We will need to achieve four things:
--Creation of an amount of SDR's in 1973 and after that will assure a continuation of the system.
--Stronger programs to control short-term capital flows, preferably through U.S. unilateral action but perhaps on a joint basis with other countries.
--A clear recognition of responsibilities by both surplus and deficit countries, including the relationship of more flexible exchange rates to the adjustment process. --Better coordination of the domestic monetary policies of the major countries.
7. Aid
Development of constructive policies for relations between developed and less-developed countries requires agreement on priorities and actions among the developed countries. To some extent this has been accomplished:
--The developed nations have all agreed to seek a system of generalized preferences to help LDC exports.
--There is general agreement that aid flows through multilateral institutions should be augmented, but with some reservations.
--The United States has not endorsed a specific aid target; however, the President has proposed that the downward trend in U.S. aid appropriations be reversed.
--Insofar as it is beneficial to developing countries, a reciprocal untying of bilateral aid would be desirable. We are attempting to negotiate such an arrangement in the OECD, although France remains a holdout to agreement at this point.
Any initiative for the 1970's should give a prominent place to development issues; and this must build on the major areas of agreement, particularly in the trade field.
8. U.S. Legislation
Any program will require public and Congressional support. The question of when we ask for legislation and what type of legislation is desirable has to be carefully considered as we progress in our international and domestic consultations.
It is particularly important that we keep Congress fully involved in the international discussions. This could be achieved by having Congressional representation on our delegations to various international meetings. Whether we do this or not, frequent and close consultations with Congress is essential.
Clearly, we will need legislation at some stage in the game. The questions of what and when cannot be decided until we get a clearer view of what we want and what foreign governments are prepared to do.
In any case, legislation probably will be needed to provide authority to reduce tariffs and non-tariff barriers, to negotiate about domestic agricultural support programs, and to repeal ASP.
An imaginative new adjustment assistance program is essential if we are to embark on a major trade liberalization initiative, and such a program will also likely require legislation. We have already submitted suggestions to you on the possible form such an adjustment assistance program might take.
57. Memorandum From Secretary of the Treasury Connally to the President's Assistant for International Economic Affairs (Peterson)/1/
Washington, March 29, 1971.
/1/Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, CIEP Study Memoranda. Confidential. This memorandum and Document 58 are attached to a March 12 memorandum from Assistant Secretary Petty to Connally to the effect that the CIEP's effort to get jurisdiction over balance-of-payments and international monetary issues was paralleled by State's effort to be the focus for coordination of all foreign assistance agencies, which would impinge on Treasury's responsibilities for the international financial institutions.
CIEP Study Memorandum #1/2/ rightly focuses on some key issues before the Administration. We will be sending along some suggestions for the first three items shortly.
/2/Document 55.
However, I believe the memorandum raises, by indirection, important organizational issues that need to be resolved. Specifically, paragraph 4, which calls for a basic review of our approach to balance of payments and international monetary problems, seems simply to ignore existing responsibilities of the Treasury and present coordinating machinery.
I have assumed that the deliberations and responsibilities of the Volcker Group were to be continued--this has been the channel for issues such as those posed in paragraph 4. Obviously, as appropriate, the results of the Volcker Group work could be reviewed at sessions of the Council on International Economic Policy. I do not know whether you contemplate some other procedure; if so, we had better clarify this now.
Although not raising the matter directly, your memorandum also brings to mind a second issue--that of the role and function of the National Advisory Council on International Monetary and Financial Policies in coordinating, under Congressional mandate, our international lending activity. We have assumed that the NAC, too, would maintain its responsibilities and that its functions would not be the subject of any jurisdictional grab by others. As you know, the day to day work in this area for the past twenty-five years has been conducted quietly and efficiently at the staff and Assistant Secretary level.
In view of the creation of the CIEP, it may be that matters referred by the NAC Alternates to the Principals in the past would, hereafter, go to the Council. I would be prepared to function on that basis.
John B. Connally/3/
/3/Printed from a copy that indicates Connally signed the original.
58. Memorandum From Secretary of the Treasury Connally to President Nixon/1/
Washington, March 29, 1971.
/1/Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, CIEP Study Memoranda. Confidential. See footnote 1, Document 57.
I understand you should soon have on your desk for decision matters relating to the organization of the Administration for foreign economic policy, filling out the framework established by the Council for International Economic Policy. I believe it is important that this matter be cleared up promptly. It is even more important that the arrangements be effective, workable, and consistent with operating responsibilities.
Internationally, my major concern, as Secretary of the Treasury and your chief financial official, must be with international monetary and balance of payments policy. The Treasury Department, by the nature of its statutory responsibilities and role, necessarily carries the principal burden in this area--it is part and parcel of the daily job, and the Congress, the public, and foreign governments properly look to me as the spokesman. That responsibility carries with it a further responsibility to advise you on these matters.
Equally clearly, there is a need for coordination and consultation--most closely with the Federal Reserve, but also with State, the Council of Economic Advisers, and others. In practice, throughout your Administration, the principal channel for coordination of international monetary policy has been through the Under Secretary of the Treasury for Monetary Affairs--the so-called "Volcker Group," where all relevant agencies are represented. I have found considerable agreement that this channel has worked effectively, and I assume it will remain in place.
Essentially, I believe this Group could and should, under my immediate direction, formally function as a committee of the CIEP, recognizing that some sensitive matters in this area need to be treated in a more restricted forum than the full Council. Indeed, I am at a loss to see in what other way this area can be handled consistent with my present responsibilities and those of the Department, yet assuring the full Administration consultation and coordination you seek through CIEP.
I am also closely concerned with the foreign assistance area./2/
/2/In a March 1 memorandum to Kissinger, Peterson addressed the Council's role on foreign assistance issues; see footnote 1, Document 53.
Your constructive reorganization of our bilateral programs will require some new arrangements. There are special problems in melding the thought of an over-all coordinator for aid, as urged by Rudy Peterson, and the concept of the CIEP. I have sent to George Shultz a more detailed memorandum,/3/ outlining what seems to me a sensible solution, but also wanted you to have the essence of my thinking directly.
/3/Not found.
Essentially, the new bilateral aid agencies could be coordinated through a CIEP subcommittee, chaired either by State, or--to fit the concept of a divorce from short-term foreign policy--by Pete Peterson or one of his assistants. If one man needs to show the flag in Congress, the Secretary of State would seem to remain the logical choice. However, I would stop well short of any concept of a single coordinating "czar" in this area. Inevitably, that would cut across the CIEP arrangements and blur--possibly to the point of extinction--your basic idea of keeping separate the several distinct elements in the foreign assistance program.
We already have the National Advisory Council mechanism, with a Treasury Chairman, for the multilateral programs. Among other things, this provides the Congressionally sanctioned vehicle for the Treasury legislative effort in this area, which has been rather successful through the years. I believe the NAC should continue in practice as a parallel committee of the CIEP.
The big issues--how much money to allocate to the bilateral and multilateral programs, the basic policy guidelines--are certainly matters for the CIEP, itself.
John B. Connally/4/
/4/Printed from a copy that indicates Connally signed the original
59. Memorandum From the President's Assistant for International Economic Affairs (Peterson)/1/
Washington, March 30, 1971.
/1/Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, CIEP Study Memoranda. No classification marking. Copies were sent to Burns, Connally, Kissinger, and McCracken.
MEMORANDUM FOR
As indicated in CIEP Study Memorandum No. 1 of March 8,/2/ the President has directed a basic review of our policy approaches toward the balance of payments and international monetary problems within the framework of the Council on International Economic Policy. He wants this work to proceed on a high priority basis. I have also discussed with the respective heads of your operations the virtue of keeping the initial work group small and restricted, to those with real expertise in the field.
/2/Document 55.
I am, therefore, creating an Ad Hoc Group on the subject, comprised of the addressees of this memorandum. The President has also indicated that we should bring in the best people from outside Government to participate in our efforts as they develop./3/ I am assuming, of course, the "Volcker Group" will continue to coordinate the implementation of U.S. international monetary and balance of payments policy. Everything I've heard is that this is one of the best interagency groups in the Government.
/3/This directive has not been further identified.
As I see it, we first need to lay out an agenda of the policy issues in this area which need to be discussed. I have discussed monetary problems with a number of people both inside and outside of Government during my six weeks here. I'm simply attaching a preliminary list of what some of those areas are that have come up in some of my discussions.
I would hope we could discuss these ideas, and others which you might suggest for our work agenda, at our first meeting on March 31 at 9:00 a.m. in my office./4/ I would also hope we could discuss some ideas on how to go about the work, and what outside inputs we might use.
/4/No record of a meeting has been found.
Attachment
1. What should be the objective of U.S. balance of payments policy, both in the short term and over the long run? Do we need to adopt a balance of payments target at all? If so, how should such a target be formulated? Should our target relate to our overall balance (on what definition?) or to particular components of the U.S. balance of payments?
2. What policy measure should we adopt in pursuing any balance of payment target we might choose? For example, do we want to encourage foreign investments by U.S. firms? How should we finance deficits?
3. What should be our objectives for the future development of the international monetary system? What is our view about the future role of the dollar in the system? The role of SDRs? The role of gold? What changes do we want in the adjustment process, if any, especially toward increasing the flexibility of exchange rates? How do we go about achieving these objectives?
4. Do we want any new approaches to deal with the large movements of short-term capital which now seem to characterize the system?
5. What should be our policy toward monetary integration in the Common Market? Do we favor it or oppose it? How can we influence its substance and its timing so that it will fit into a satisfactory worldwide monetary framework?
I would hope we could discuss these ideas, and others which you might suggest for our work agenda, at our first meeting on March 31 at 9 AM.
60. Memorandum From the Under Secretary of the Treasury for Monetary Affairs (Volcker) to the President's Assistant for International Economic Affairs (Peterson)/1/
Washington, April 1, 1971.
/1/Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, CIEP Study Memoranda. Confidential. A 17-page, March 23 analytical memorandum from Wilson Schmidt to Volcker on the "Effect of Capital Controls Program" is attached but not printed.
SUBJECT
In CIEP Study Memorandum No. 1, you requested comments on a paper by Mr. Shultz which recommended abandonment of the capital control program./2/ Although the Treasury fully concurs in the view that these controls should be removed as soon as the U.S. balance of payments position permits, we believe that it would be a serious mistake to remove them at the present time.
/2/Documents 55 and 54, respectively.
The issue at present is not simply one of the statistical or even economic effectiveness of the controls./3/ It seems to me unavoidable that removing the controls at this time would be interpreted abroad as "malign neglect" of our responsibilities as a key currency country for the stability of our currency and the monetary system and as an overt affront to other countries dealing with what they consider to be highly excessive dollar inflows. Beyond any effort on our part to explain the "ineffectiveness" of the controls, action could not only trigger loss of confidence in the dollar and a major international financial crisis, but, in the eyes of much of the world, cast us in the role of initiating villain. As you know, our official settlements deficit last year, excluding the SDR allocation, was $10.7 billion. In the first three months of 1971, the rate is, unfortunately, much higher. While we do not expect the deficit to continue at anything like this level, there is grave concern among foreign monetary authorities at the present time.
/3/On March 18 Federal Reserve Governor Brimmer sent Assistant Secretary Petty a letter to which he attached the Federal Reserve's preliminary conclusions regarding Shultz' paper. The preliminary conclusions were that the paper was "superficial," failed "altogether to do justice to the analytical complexity of the questions raised by the [capital controls] program," and was "deliberately misleading." (Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, CIEP Meetings)
It is important to note that the Congress accepts the need for retaining the controls at present without a murmur and, in fact, insisted upon giving us more authority to apply controls over our objections. The Interest Equalization Tax extension passed the House without dissent./4/ In the hearings, there was specific recognition of the inadvisability of eliminating the controls, and even directly affected financial houses did not ask for elimination at this time but, rather, accepted the need for continuance.
/4/The vote on HR 5432 was 393 to 5, with 34 members voting. See Congressional Record, March 10, 1971, pp. 5859-5866.
Finally, on the issues raised by Mr. Shultz, we simply do not find the evidence presented persuasive, although I suspect we can all agree there is very considerable "slippage" in controls of this type.
Paul A. Volcker
61. CIEP Decision Memorandum No. 3/1/
Washington, April 8, 1971.
/1/Source: Department of State, S/S Files: Lot 82 D 126, Box 5197, CIEP Decision Memoranda. Confidential. Transmitted to the National Security Council under cover of an April 5 memorandum from Peterson to Kissinger and Shultz, which noted that the paper had been approved by the State Department. Another copy is attached to an April 6 memorandum from Bergsten to Kissinger recommending that Kissinger approve the organizational arrangements in time for the President to approve and announce it at the first CIEP meeting on April 8. Bergsten noted that the Decision Memorandum was the result of long negotiations between Peterson and the State Department, which had concurred even though the memorandum was different from what State had proposed. (National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 218, CIEP)
The President chaired the first meeting of the CIEP on April 8 from 10:40 a.m. to 12:17 p.m. in the Cabinet Room. Rogers, Connally, Hardin, Stans, Hodgson, Shultz, McCracken, Kissinger, Gilbert, Kennedy, Siciliano, Hinton, Webster, Bergsten, and Peterson attended. Franco Mario Malfatti, President of the Commission of the European Communities, joined the meeting at noon. (Ibid., White House Central Files, President's Daily Diary)
MEMORANDUM FOR
SUBJECT
This memorandum supplements my memorandum of January 19, 1971, establishing the Council on International Economic Policy (CIEP)./2/ In order that I shall be provided the most effective assistance in considering international economic issues, I hereby direct that the Council system operate as follows:
/2/See Document 19.
1. Membership
The membership of the CIEP is as set forth in my January 19 memorandum. I shall also invite other agencies to participate in the Council on an ad hoc basis when matters for which they are responsible are to be considered.
I have designated Ambassador Kennedy as a member of the Council.
2. Meetings
The Council shall meet regularly and I shall approve the agenda. I shall chair the Council, but should it be necessary to convene the Council in my absence, the Secretary of State will chair its meetings.
3. Review Group
A Review Group of the Council is hereby established. The Review Group shall:
--Review papers for submission to the Council. Such review will assure that issues are fully and objectively stated, that department and agency views are fairly and adequately set out, that all realistic alternatives are presented, and that the issues require Presidential decision. A paper prepared by the Operations Group, task groups, or one or more which requires Presidential action but which need not be considered by the Council will be forwarded by the Executive Director to members of the Council simultaneously with its submission to the President.
--Assign action, for implementation or study, to the Operations Group.
The membership of the Review Group shall consist of the Assistant to the President for International Economic Affairs who will serve as Chairman of the Group and designated representatives of members of the Council at the senior political appointee level.
4. Operations Group
The Operations Group will carry out those functions described in my January 19 memorandum. The Executive Director, in consultation with the Chairman of the Operations Group, will refer particular issues to the Operations Group.
5. Task Groups
The Executive Director may also appoint Task Groups to work on particular problems, as outlined in my January 19 memorandum. I shall expect that he will call upon the best expertise in and out of the Government for staff work on such Task Groups.
6. Interdepartmental Groups
Whenever issues under consideration by NSC Interdepartmental Groups include significant economic issues, the Assistant to the President for International Economic Affairs shall be represented. Economic matters within the purview of the CIEP, and previously treated by the NSC Interdepartmental Groups, shall henceforth become the responsibility of the CIEP, and may be assigned to interdepartmental groups established within the Operations Group framework, or to Task Groups.
7. Consolidation of Existing Committees
Following due consideration, I shall announce the consolidation within the Council structure, to the extent practical, of existing committees and groups presently dealing with responsibilities that I have now assigned to the Council.
Richard Nixon
62. Memorandum From the Deputy Under Secretary of State for Economic Affairs (Samuels) to the President's Assistant for International Economic Affairs (Peterson)/1/
Washington, April 8, 1971.
/1/Source: National Archives, RG 59, Central Files 1970-73, FN 13. Confidential. Drafted by L.J. Kennon (E/IFD/OMA) on April 2 and cleared by Deputy Assistant Secretary Weintraub.
SUBJECT
I would like to comment briefly on the Capital Control Programs, including Mr. Shultz' memorandum of March 2./2/
/2/Document 54.
Without commenting in detail on the analysis in the Shultz memorandum, I agree basically with the conclusion that we should dismantle the capital controls programs. This should, however, be done progressively and not in one step, for reasons stated in the next paragraph. The controls distort resource allocation and the most efficient development of U.S. and European capital markets, raise the cost of doing business abroad, and give rise to resentments under certain circumstances in foreign countries over the dominating role that U.S. companies play in absorbing capital availabilities in the European capital market. Further, these controls get in the way of attempts to reduce artificial barriers to the flows of capital and resources. Moreover, by now we may have exhausted any short-term balance of payments benefits from the controls, although this conclusion could be debated on a technical level ad infinitum.
In stating the above, however, I believe it important that this unwinding should take place in an orderly fashion and take account of the problems involved. For example, in winding down the FDIP, whether we do it through increasing allowables or collapsing schedules or by some other device, we must bear in mind there exists $10.5 billion of outstanding American borrowing abroad which could readily flow into U.S. hands and greatly exacerbate our dollar outflow problem unless the dismantling is handled carefully. Although much of the massive outflow this and last year is a result of the U.S. and European business cycles and interest rate differentials being out of phase with each other and is probably capable of being better stabilized as interest rates change, abandonment of the structure of controls under present circumstances would be viewed as an affirmation of the current widely-held belief abroad that the fundamental U.S. attitude toward the balance of payments is in fact one of "benign neglect." This would have unfortunate monetary effects, and beyond that would further encourage foreigners to seek ways of insulating themselves from the effects of U.S. economic and monetary policies. I reiterate, therefore, that we should progressively wind down the controls toward elimination, preferably at a substantially accelerated rate over that which has so far prevailed.
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