326. Memorandum from Kaysen to Bundy, May 201

[Facsimile Page 1]


  • Status Report on the DOD and the Balance of Payments

1. Attached at Tabs 1 and 2 are two tables showing the proposals now being discussed within the DOD to achieve Secretary McNamara’s target of reducing the annual rate of DOD expenditures on foreign account by $300–$400 million. Table I presents the information by country, to the extent possible. It is based on Table II, which lists in detail the actions now under consideration in the DOD. The Comptroller has asked the services to examine these actions and he is discussing them with the Secretary of Defense.

2. As Table I shows, if all the actions listed were taken, the resulting saving would be $400 million in FY 64 and the annual rate of saving would rise to almost $500 million in FY 65. Of these savings, $300 million in FY 64 and nearly $400 million in FY 65 would be achieved through reduction of forces overseas, of which $185 million and $250 million, respectively, would be made in NATO. The other $100 million would come from changes in procurement actions. The whole list of proposals would result in the withdrawal from overseas stations of 137,000 military personnel and 145,000 dependents and civilian personnel; 72,000 military personnel, and 111,000 civilian personnel and dependents from NATO countries.

3. Paul Nitze, in a memorandum to the Secretary of Defense dated April 18, 1963, transmits to him the comments of GPM in State as [Typeset Page 1444] shown in the attached memorandum from Jeffrey Kitchen to Bill Bundy dated April 12 (Tab 3). Nitze’s memorandum, a copy of which is not now available to me, repeats the Kitchen comments, although somewhat more selectively. The reductions in MAP (B 2, Table I; Item 7, Table II) are described by Nitze as simply impossible. The reductions in overseas petroleum procurement (B 2, Table I; Item 10, Table II) are characterized in virtually the same way. The cancellation of further Caribou procurement is described as creating great political difficulty [Facsimile Page 2] and of dubious value in making real savings. (This second judgment is probably not correct.)

Nitze’s strongest condemnations, however, are reserved for the proposals to reduce Far Eastern forces (Item A 3, Table I) and to reduce our commitments in Germany (A 1, Table I). The reductions in forces in the Far East would make it necessary for us to commit ourselves in advance to an immediate nuclear response in the event of any serious threat in Korea and probably elsewhere in the Far East. Further, it would reverse the progress we have made in bringing Japan to face up to its defense problems, as well as having serious adverse consequences in NATO. We could not make it clear, especially to the Germans, why we are willing to make an immediate nuclear response in the Far East and not in Europe, even though there is a militarily plausible argument for differentiating the two situations. This argument, of course, is that the Soviets do, and the Chinese do not, have nuclear weapons themselves. However, before accepting this argument, it is necessary to ask whether our use of nuclear weapons against China or Chinese forces would invite a Soviet response.

In Nitze’s view, the reductions of NATO forces would have equally or more undesirable effects. The most serious effects would arise from redeployments in Germany, the least serious from redeployments in the UK.

4. At Tab 4 is a memorandum from the Director of the Joint Staff commenting on a CINCEUR message discussing possible redeployments of NATO forces. Item b. in the memo corresponds to Item 2 b. in Table II; Item C 1, in the memo correspondences to Item 3 in Table II, but involves a somewhat lesser force reduction.

5. There is also a separate discussion of reducing the Berlin augmentation underway, independently of the balance of payments problem. As presently conceived it will result in the reduction of the present Berlin garrison by some 700 men, the difference between a battle group and a battalion. The change will arise from the Army-wide reorganization of divisions during June and July of 1963. The two battle groups in the regular Berlin brigade will disappear, to be substituted for by three battalions with the same number of men. However, the augmentation force of one battle group will be reduced to one battalion. The [Typeset Page 1445] addition of another battalion to this force would lead to the increase of a few dozens in present Berlin strength, instead of the reduction of 700 now planned. This should be possible, if it is considered desirable.

[Facsimile Page 3]

6. Secretary McNamara discussed the problem of troop withdrawals in NATO with the Secretary of State on Friday. As reported (by George Ball) Rusk was firm in his unwillingness to accept any major force reductions in Europe.

Further discussions (on Saturday) between McNamara and Hitch suggest that McNamara himself is withdrawing somewhat from the notion of troop cuts of the magnitude proposed in Table I. It is not clear what change in these quantities he now contemplates. However, to achieve his savings targets, McNamara apparently is now considering much deeper cuts in dependents or the total elimination of dependents from nearly all overseas activities. It is Hitch’s judgment that the services would consider this entirely unacceptable. Further, the political consequences of this move would be impossible for the Secretary to face. From the point of view of both Army and Air Force, the elimination of dependents for troops in Europe would be a mortal blow to recruiting and would be viewed as the last unbearable step in the subordination of military to civilian needs, with predictable consequences in Congressional outrage.

7. A cursory glance at Table I, suggests that the most bearable items—reductions in France, the UK, Spain and Morocco, plus some reductions in overseas procurement—might save $100 million to $150 million without too much political pain. To go further would clearly pose political problems of the first order of difficulty. The discouraging results of this examination suggest that it is necessary to look again at the financial side of the picture.

8. In his memorandum to the Cabinet Committee on April 20, the President accepted the Committee’s Report and Recommendations of April 8, after discussions on 9 and 18 April. Defense was directed to produce a program with a goal of reducing gross claims against foreign exchange by some $300 to $400 million below the FY 63 level. Only some $100 million of this appears to be achievable at small political cost. This leaves a “gap” of about $200 million in terms of the financial plan recommended by the Cabinet Committee (see Table IV of the Cabinet Committee Report reproduced at Tab 5). [This figure reflects the fact that the programmed savings could not be achieved all at once in any event.] Secretary Dillon made it perfectly clear in the course of the two discussions with the President that estimates of what can be financed by various methods are necessarily rough, and that the figures presented are conservative. The present plan relies on five methods of financing (see Table II of the Cabinet Committee Report reproduced at Tab 6): pre-payment of debt; borrowings denominated in foreign [Typeset Page 1446] currency; [Facsimile Page 4] increased holdings of dollars by foreign central banks and private holders under exchange-value guarantees provided by swaps and forward operations (covered dollars); increased holdings of dollars without exchange value guarantees (uncovered dollars); and gold sales.

In the course of the 18 April discussion, Secretary Dillon gave his judgment that the financing figures shown were not maxima. It would appear possible to increase special borrowings and dollar holdings under forward cover, and to sell somewhat more gold, in such a way as to provide enough extra over the two-year period to eliminate the need for a drastic reduction in Defense expenditures.

It is clear that this policy would expose us to a somewhat greater financial risk, essentially the possibility that present holders of outstanding claims against the dollar (which are larger than our total gold stock) would seek to convert them into gold; this, in turn, would stimulate an outflow of U.S. liquid assets abroad and finally force us to devaluation. We have, however, two well prepared lines of defense should this threat begin to materialize: the regular resources of the IMF, and the special additional resources provided by the Paris Agreement. It was the clear and unanimous opinion of the Cabinet Committee that these resources, plus what other central banks would feel constrained to do in their own interests, are more than adequate to defend us against the dangers of a run.

If we were forced to draw heavily on these resources in the situation of an imminent run, we would have to undergo a critical review of our economic and financial situation at the hands of the Fund, and the Finance Ministers of the Paris Club. It is likely that this review would lead to a request that we tighten domestic credit by raising interest rates. Depending on just when such an event were to occur, its effect on the level of domestic economic activity might be adverse. But even if we resisted the demand for tighter money, we would get the resources we needed. Neither the Directors of the Fund nor the Finance Ministers Vienna Club would have any real alternative to giving us the help we request. Otherwise, they would be destroying the present international payments system and the Fund itself. Nonetheless, there might well be some domestic support for this demand, which would welcome the occasion for pressing it, and we might find that this was the price we did pay, whether or not we had to.

[Facsimile Page 5]

A more modest use of IMF resources would be available on essentially automatic basis whenever the Treasury decided it was useful to ask for it.

The problem, therefore, is to balance the political risks inherent in the suggested reductions of overseas military deployments and the financial risks inherent in the attempt to push our present financial measures somewhat further. Three considerations are relevant to strik [Typeset Page 1447] ing an appropriate balance. First, the military redeployments have a once-and-for-all character. Once they are decided upon and we begin to execute them, the political bill falls due immediately. Second, we have in the past been more successful in extending our financing techniques than Messrs. Dillon and Roosa had anticipated. Their responsibilities have necessarily made them cautious. They remain so, and it is natural for them to emphasize their inability to guarantee success in arranging a predetermined volume of finance. Third, such independent examination of European financial opinion as is possible suggests that there is a widespread confidence in Europe that our balance of payments situation will improve over the next several years. The combination of this expectation, the availability of the IMF as a further resource, and the disagreeable consequences of any alternative course of action can be counted on to lead the Europeans to continue to provide such financing as we need.

The Europeans, in turn, may well be led to press for a more rapid evolution of the international payments mechanism than we have hitherto contemplated. This is in itself not undesirable. We have already gone much further in the evolution of the institutional arrangements under which the world payment system operates than anyone would have predicted in January 1961. In fact, given the situation of the pound, and the expectation on the part of some of the Common Market countries of balance of payments deficits of their own in the next several years, it can be argued that it is in our interest to stimulate this further, more rapid change. It is clear that the international financial community will be under continuing pressure from the British to do so. If we add our own pressure, we may have more opportunity to control the shape the evolution of the system takes.

9. In sum, an examination of the consequences of possible reductions in overseas expenditures of the Defense Department suggests the wisdom of shifting the burden of adjustment back to the Treasury Department rather than accepting Secretary Dillon’s attempt to pass it on to the [Facsimile Page 6] Departments of State and Defense. There is, however, a risk that, in the event of an unfavorable turn of events—which cannot be ruled out—Secretary Dillon would then press for a more restrictive domestic economic policy on the argument that it was necessary to satisfy our international creditors. Whether it was or not would be arguable; but this is a contingency which we can afford to face if and when it arises.

C. K.
  1. Status report on DOD’s proposals to reduce expenditures on foreign accounts. Secret. 6 pp. Kennedy Library, National Security Files, Subjects Series, Balance of Payments and Gold, 4/63–7/63, Box 291.