39. Memorandum From Secretary of the Treasury Dillon to President Johnson0

SUBJECT

  • Report on the Balance of Payments

At the time of the inauguration, the dollar was under heavy pressure as a result of three successive years of heavy balance of payments deficits and the heavy gold losses which occurred in the fall of 1960 and continued during the first three weeks of 1961.

We were faced with two necessities, both serious, but one far more acute than the other. The first and most acute necessity was to reestablish confidence in the value of the dollar and thus put an end to the heavy losses of gold. The second necessity was to devise a program that would lead as rapidly as possible to the achievement of balance in our payments. It was recognized from the beginning that this second objective could only be achieved over a period of several years, but it was also recognized that steady and observable progress was necessary if confidence in the dollar was to be maintained.

We have had marked success in achieving our first objective, the restoration and maintenance of confidence in the dollar. However, while progress has been made toward our second objective, the achievement of balance in our payments, it has not as yet been adequate, and more rapid and sustained results are now necessary. Fortunately, there are reasonable indications that programs presently underway can bring us the improvement we need.

The restoration of confidence in the dollar involved convincing the world of our determination to maintain the gold value of the dollar at $35 an ounce, and to end our payments deficits. In providing protection for the dollar we have created a whole series of new financial tools and mechanisms, designed to offset speculative surges and conserve our gold stock.

Among these were:

1.
The establishment of close cooperation between the Treasury and Federal Reserve on the one hand, and European Finance Ministries and Central Banks on the other.
2.
Currency swap arrangements with foreign Central Banks which now total $2 billion.
3.
The informal London gold pool that has prevented undue speculation in gold and served to channel gold to Central Banks in an orderly manner.
4.
Medium term, i.e. 2 year, borrowings by the U.S. in foreign currencies to avoid conversion of unwanted dollars into gold.
5.
Establishment of the $6 billion borrowing arrangements in connection with the International Monetary Fund, primarily so as to strengthen its ability to defend the dollar against speculative attack.
6.
Inauguration of a study by the Group of Ten, i.e. the countries party to the IMF borrowing arrangements, to determine what, if anything, can or should be done to further strengthen the functioning of the international monetary system. Under Secretary Roosa is chairman of this study group which held its first meeting in early November and is expected to report to a meeting of the Ministers of the Ten next summer. I am attaching a fuller description of the Committee’s work and objectives, prepared by Mr. Roosa.

We have had two programs to improve our balance of payments both contained in Presidential Messages to the Congress, one in February 1961, and the second in July 1963.1 The February 1961 program involved stress on export expansion, the creation of a new system of export insurance comparable to those in use abroad, the establishment of strict buy-American policies for our foreign aid program and our military forces overseas, the shoring up of short-term interest rates to check outflows of funds, and an attempt to moderate the outflow of direct investment through the removal of tax incentives to investment overseas. Our efforts in the tax field were only about 50 percent successful as Congress refused to adopt our entire tax package. The investment credit and the 1962 depreciation reform were also part of this program since they were designed to improve our competitive position by speeding up modernization of plant and equipment. They have been helpful in this regard but tax incentives to new investment are still somewhat greater overseas than in the United States.

By early 1963, it became obvious that the 1961 program was not adequate and that further steps would have to be taken. Our hopes for increased exports had not been realized, the Berlin augmentation of our military forces in Europe had offset the savings made by Defense in their Buy-American program, and Congress had only accepted half of our tax program on direct foreign investment.

Consequently, early last spring a study was undertaken of ways and means of further reducing overseas government expenditures. The Treasury also initiated studies of methods of restraining the outflow of [Page 103]portfolio capital which had started to reach alarming proportions. The result was the July message.

In this message, the President reiterated the importance of export expansion, suggested a “See America Now” program for 1964 to make travel at home a more appealing alternative to foreign travel, announced that the United States had arranged a standby facility with the IMF for up to one-half billion dollars, announced that the rate of Federal overseas expenditures would be reduced by $1 billion by the end of 1964, and proposed the Interest Equalization Tax.2 This tax is designed to increase the cost to foreigners of raising money in our markets by 1 percent a year. A new program to stimulate foreign purchases of U.S. securities was also announced.

Finally, the Federal Reserve raised the rediscount rate to 3-1/2 percent from 3 percent. This action has brought our short-term interest rates into approximate balance with those abroad and was the culmination of a two-year joint Treasury-Federal Reserve effort to raise short-term interest rates while maintaining the availability of credit and avoiding upward pressure on the long-term rates that are so vital to domestic economic progress. Short-term rates are now about 1-1/4 percent higher than in early 1961, while long-term corporate and municipal rates have changed little, if at all, and mortgage rates have actually declined by an average of 1/2 of 1 percent.

Last summer’s increase in short-term interest rates and the proposed Interest Equalization Tax brought sharp improvement in our third quarter figures. The third quarter produced the best results of any quarter since 1957. This improvement is being relatively well maintained so far this quarter. Nevertheless, 1963 will show little, if any, improvement over 1962 because of the heavy capital outflows during the first half of the year.

For the future it is essential that the $1 billion annual saving in government spending overseas be achieved as scheduled by the end of next year. If at all possible, and I believe it is, the target should be exceeded. It includes $300 million in defense savings overseas which involve numerous redeployments of service and air force combat units. When approving this program, President Kennedy asked Secretary McNamara to develop recommendations for an additional $300 million in savings. This further program has now been under discussion between State and Defense and with the Joint Chiefs for some months. It should soon be possible to reach firm Presidential decisions on this program. Most of the redeployments involved in the July program will take place either late [Page 104]next spring or next fall, so their full effect will not be felt before 1965. Because of the long lead times involved it would be helpful if early decisions could be reached on the additional $300 million program requested by President Kennedy.

Redeployments do not involve combat forces in Germany because Germany is currently fully offsetting the dollar cost of our forces in Germany by the purchase of U.S. made military equipment.

Present indications are that 1963 balance of payments results will approximate those of 1962—a deficit of about $3.5 billion before accounting for debt prepayments or other special intergovernmental transactions designed to hold down the final total. After all such transactions, 1963 should approximate the $2.4-$2.2 overall level of 1961 and 1962.

Assuming enactment of the Interest Equalization Tax and continued vigorous action to hold down dollar expenditures abroad, 1964 should witness a substantial improvement and 1965 could well see the deficit on regular transactions brought down to the neighborhood of $1 billion from the current $3.5 billion.

In short, the balance of payments problem is many faceted and requires constant attention on many fronts. However, the combination of the 1961 and 1963 programs, plus such further savings as may prove possible in the defense area, now appear to be adequate to bring very substantial improvement over the course of the next year.

The likelihood of these future gains may be foreshadowed by the relative improvement in our gold position that is taking place this year. It now looks as if our 1963 gold loss will only approximate $500 million, compared to $890 million in 1962, $857 million in 1961, and $1,703 million in 1960.

Douglas Dillon3
  1. Source: Kennedy Library, Dillon Papers, Memos to President, 1963. Limited Official Use.
  2. See Documents 2 and 29.
  3. Additional documentation on preparations for legislation for an Interest Equalization Tax is in Washington National Records Center, RG 40, Secretary of Commerce Files: FRC 68 A 5947, Correspondence: Secretary Hodges; and ibid., Treasury Department.
  4. Printed from a copy that indicates Dillon signed the original.