Foreign Relations of the United States, 1964–1968, Volume VIII, International Monetary and Trade Policy

137. Memorandum From Secretary of the Treasury Fowler to President Johnson¹

Washington, August 8, 1967.

SUBJECT

• Balance of Payments

I. Six-Month Results

We will announce second quarter balance of payments results next week. Together with first quarter results, they compare with 1966 as follows:

	Liquidity Deficit (000) (seasonally adjusted)		Official Settlements Deficit (000) (seasonally adjusted)
	1967	1966	1967	1966
First Quarter	-$544	-$651	-$1,822	-$450
Second Quarter (Prel.)	-$514	-$122	-$833	-$175
Six-Month Total	-$1,058	-$773	-$2,655	-$625

These figures confirm the picture I described to you in my memorandum of March 24:²

“Overall, it looks at this point as if we will be doing very well to limit our liquidity deficit in 1967 to last year’s $1.4 billion figure. On the official reserve transactions basis, last year’s surplus will change to a large deficit this year …”

If anything, the results are somewhat worse than anticipated, for we received $1.1 billion of help in the form of “special transactions”—long-term investments negotiated by the Treasury with foreign governments and international institutions—in the first six months of this year, compared with $600 million in the same period last year. Tab A shows where these inflows came from; Tab B contains a recent Wall Street Journal article on the subject.³ The article takes the line that these transactions are nothing but statistical gimmicks.

What accounts for the deterioration in our basic payments position?

Using complete information for the first quarter and incomplete information for the second, I would attribute the disappointing showing to

• —a lower than expected trade surplus ($4.2 billion annual rate in the first half versus our November, 1966, forecast of $4.9 billion for the year as a whole);
• —a disappointing showing by our corporations under the voluntary program, both with respect to direct investment outflows and dividend, royalty, and fee incomes;
• —a slightly higher than anticipated military deficit;
• —miscellaneous adverse changes spread across a broad range of accounts (special remittances to Israel, for example, may have cost us $90 million in the second quarter).

Both the disappointing trade surplus and the level of corporate repatriations can be attributed, in part, to lower growth rates (and corporate profitability) in overseas markets—particularly in the U.K. and Germany. Nevertheless, we simply must do better in these two areas—over both the short and long run—if we are ever to improve our overall performance.

Our gold loss in the first half was small compared to previous years. The major reason: France, our biggest gold buyer, has been running a deficit; Germany, which has now formally agreed to buy no gold, has been the big EEC surplus country so far this year.

U.S. Gold Losses

	First Six Months 1967	First Six Months 1966
Loss to Domestic Industrial Users	-62.4	-75.7
Monetary Loss	-2.8	-201.2
Total:	-65.2	-276.9

II. Near Term Outlook

As I see it, we have a fighting chance to keep the deficit for the year close to $2 billion (on the liquidity basis) if:

• —The trade surplus (which has dropped since April) again turns upward and averages out at $4.5–$4.6 billion for the year as a whole.
• —Commerce exerts enough pressure on corporations to keep direct investment to the agreed target of $2.4 billion (the interagency forecasting group believes that in the absence of such pressure the figure could be as high as $2.9 billion).
• —Treasury successfully negotiates “special transactions” of $300–$500 million in the second half—in addition to the $250 million we receive from the Bundesbank under the trilateral agreement.
• —Military foreign exchange costs climb no higher than presently estimated ($2.7 billion for the year).
• —The U.K. position is sufficiently strong to enable it to meet its year-end debt payment to us ($145 million) and to the IMF ($330 million) without spending any of the $600 million of long-term securities held here.

If these factors go against us in any significant degree, the liquidity deficit could easily move up into the $2.5–$3 billion range.

I believe that we will be able to keep our gold losses low relative to past years—whether the deficit is in the $2 billion or $3 billion range.⁴ But the higher the deficit, the more criticism we are likely to encounter and the greater the risk of crisis—and continuing jitters in the London gold market.

Against this background, we must tread a careful path

• —avoiding being forced into unnecessary and undesirable restrictionism (on trade, tourist, or capital account) and at the same time
• —persuading our public at home and our critics abroad that we intend, purposefully and forcefully, to solve this problem through measures varying in nature and timing and requiring action on the part of the public and private sector and of foreign surplus nations as well.

I am in agreement with that part of the recent American Bankers Association’s paper, “U.S. Gold Policy,” which recommends “general economic policies designed to preserve stability in costs and prices in the domestic economy [your tax program is designed to accomplish this],⁵ selective reductions in the foreign-exchange costs of Federal spending programs, and selective measures calculated to improve the net foreign exchange earnings of the private sector of the economy.”

The question is just exactly what are these “selective reductions” and “selective measures?” The ABA promises to provide answers in a later paper—at the moment they do not have any.

These are among the matters which the Cabinet Committee discussed at its last meeting on June 28⁶ and which I would like to discuss with you at our meeting on August 10.

III. Selective Reductions in the Foreign Exchange Costs of Federal Spending Programs

There are two main areas of concern here: (1) the size of our net military deficit; and (2) the problem of AID-financed exports replacing commercial U.S. exports.

(1) Net Military Deficit

At the Cabinet Committee meeting, Secretary McNamara made it clear that the net military deficit could increase by at least $600 million next year (from $2.7 billion to $3.3 billion), taking into account short-falls in the German offset ($500 million) and increased costs in Vietnam ($100 million).

Clearly, no one can realistically expect our gross military expenditures to drop over the short term. But what we must make crystal clear to the world is that we intend to continue to make every possible effort to “off-set” or “neutralize” these expenditures. I think it particularly important that this be brought into focus during the coming Kiesinger visit and the Japanese Cabinet Committee visit in September.

Tab C provides background data on the military deficit with emphasis on Germany and Japan.

The Task Force which you established late last fall to examine ways of minimizing post-Vietnam military and aid expenditures in East Asia is attempting to see how we can avoid repeating the post-World War II and the post-Korean experiences. In both these cases, we tended to underestimate the ability of the war-torn nations in question to recover and repay assistance. The work of the group to date suggests that the foreign exchange cost of military expenditures and U.S. aid programs, which amounts now to $1.9 billion annually in East Asia ($1.4 billion in developing countries and $0.5 billion in Japan), will be substantial even after the fighting stops—in all probability no less than $1 billion annually—unless new approaches are conceived. This committee will submit a report to you this fall.

(2) Relationship of AID to U.S. Exports

Treasury heads an interagency task force which has been sending teams into the field to see whether:

(a) Tied AID exports are replacing U.S. commercial exports;

(b) Sufficient attention is being given in our Missions to developing long range U.S. export markets consistent with AID development objectives;

(c) We are getting as much export “bang” for the AID “buck” as other countries.

Teams have visited Turkey, Chile, Peru, Colombia, and Costa Rica. A new mission will go to India and Pakistan later this month.

Preliminary findings indicate there is some substitution of AID-financed exports for commercial exports, and there probably always will be. But we can reduce this and improve our export performance to AID-recipient countries without jeopardizing the program’s basic objectives. The gains will not be breath-taking and will not come about immediately but could eventually total $200–$300 million annually.

IV. Selected Measures to Improve the Net Foreign Exchange Earnings of the Private Sector

In calendar 1968, the greatest single source of balance of payments improvement must come from the direct investment sector of the Commerce Voluntary Program. In my view we should aim for an improvement of at least $1 billion from the levels we had expected to reach under the 1967 program. This improvement would come from a combination of reduced outflows and increased repatriations. With respect to out-flows, we would expect at the very minimum a $500 million reduction from the $2.4 billion target figure we had in 1967.

To the extent that the 1967 program falls short of its goal, we would need a correspondingly greater improvement in 1968. But, the 1967 program should not fall short.

A number of people have stressed the need to strengthen this program—including Doug Dillon, Andre Meyer, and Bill Martin—for three basic reasons:

• —Nothing will be so convincing to Europe that we mean business. And it could be salutary to European public opinion to see us slow down what Europeans regard as “buying up Europe” and might underline that such a slow down had real costs for Europe.
• —No other program can provide as large and quick gains for our overall position, simply because the quantities involved are large.
• —Other segments of the economy both public and private which have borne the brunt of the program so far would feel that there was more equity involved. Direct investment really has suffered little cut back so far.

I have met with Secretary Trowbridge a number of times to discuss this, and an inter-agency group is working with Assistant Secretary of Commerce Shaw to see how these savings can be obtained. It is clear that this will not be an easy assignment. It is sure to stir up the business community who will say that we are killing the goose that lays golden eggs. But, I believe a strong appeal to that business community could bring favorable results if the program is conceived and managed in a very hard-headed fashion. This is an issue we have to face up to. Tab D illustrates the nature of this exploration.

At the same time we call upon industry for real short-term sacrifices on the direct investment front, we should offer them an attractive and appealing long-term package of export assistance and incentives. Here is where we stand in this area:

• —Secretary Trowbridge has already moved forward with a request for a $7.0 million supplemental appropriation for increased export promotion. His staff is analyzing the possible effects of spending substantially larger sums on export promotion over the longer run.
• —Arthur Okun is heading up a group which will shortly make recommendations designed to improve export financing facilities.
• —We are analyzing the impact of proposed EEC tax harmonization (and border tax adjustments) on our trade position.
• —We have discussed a broad variety of tax and non-tax incentives with industry and believe the following, properly presented, can help our national export effort with minimal risk of retaliation:
• —over-expensing of promotional outlays
• —extension of the 7 percent investment credit to overseas sales facilities
• —rebate of local excise and perhaps property taxes
• —accelerated amortization privileges related explicitly to facilities for export production
• —underwriting market surveys, in part or in whole.

This is a tricky, complex area, but I believe we are making progress toward a well-rounded group of export expansion measures which could be submitted to the Congress in 1968 in the form of an Export Expansion Act.

V. Timing of 1968 Program Announcements

The Cabinet Committee believes that in order to minimize speculative outflows we should announce the 1968 balance of payments program no later than October. I have been wondering, and would like your guidance on, whether we should not include a balance of payments program announcement in a gold cover message sent to Congress in mid-September. Such a message would stress the determination of the United States

• —to continue to sell gold at $35 per ounce;
• —to bring its balance of payments into equilibrium;
• —to work with other nations to produce a contingency plan at Rio which would provide a new form of liquidity to be used as and when needed by a growing Free World economy.

In connection with the balance of payments program, we could cite, as short term measures:

(1) The proposed 10 percent surcharge, designed to produce balanced economic growth without inflation in 1968.

(2) The recent strengthening of the Interest Equalization Tax.

(3) Substantial further tightening of the direct investment program in 1968.

(4) Moderate tightening of the Federal Reserve Program in 1968. (We would avoid the problem of increased out-flows in late 1967 in anticipation of tougher 1968 programs by making it clear that the new programs would take 1967 and 1968 performance, combined, into effect.)

We could cite, as basic long-term measures:

(1) A fiscal-monetary policy designed to ensure cost-price stability over the long run.

(2) A sustained effort to neutralize military expenditures both during and after the war. We would indicate that conversations with the Germans and Japanese were underway and post-war contingency planning in progress.

(3) An intensified effort to minimize substitution of AID-financed exports for commercial exports; we would summarize the findings of the inter-agency task force.

(4) A commitment to provide substantial budgetary support for export expansion in the fields of:

• —promotion (Secretary Trowbridge’s $7.0 million appropriation request would be described as a “new first step”)
• —finance
• —tax and non-tax incentives.

(5) In connection with tax incentives, a commitment—in the post-Kennedy Round world—to re-examine GATT rules, to study proposed changes in European tax systems, and to negotiate, if necessary, tax “harmonization” for U.S. exporters. We would refer specifically to the proposed change in German border taxes (which German authorities themselves say amounts to a 2–3 percent export price cut and which, in effect, is a D mark devaluation of that amount) as a source of immediate and particular concern.

(6) Pledge new legislation to encourage foreign travel to the United States based on recommendations, to be submitted this fall, by the Travel Task Force.

We will not be in a position to announce specific numbers and details on each and every one of these programs by mid-September, but it seems to me that a disclosure of the general framework of our 1968 and longer-range program could help clear the air.

Henry H. Fowler

1. Source: Johnson Library, White House Central Files, Confidential File, FO 4–1, Balance of Payments (1967–1969). Confidential. A transmittal memorandum from Fowler to the President is not printed. At the bottom of that memorandum, the President wrote: “This is well done & greatly interests me. Lets spend some time in Cab. Com. on it. We just must do better. L.”
2. This memorandum reviews the administration’s initiatives on the balance of payments front. (Ibid.)
3. None of the attachments is printed.
4. They will undoubtedly be higher, however, in the second half than in the first. [Footnote in the source text.]
5. Brackets in the source text.
6. No formal record of this meeting has been found, but a memorandum from Secretary of Commerce Trowbridge to William H. Shaw and Lawrence C. McQuade, June 28, recounted discussion at the meeting regarding the Department of Commerce’s request for expanded funding of its export promotion program. (Washington National Records Center, RG 40, Secretary of Commerce Files:FRC 74 A 20, Official Chron, June 1967, Trowbridge)