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

174. Report by the Under Secretary of State (Katzenbach), the Under Secretary of the Treasury for Monetary Affairs (Deming), and the Special Representative for Trade Negotiations (Roth) to President Johnson¹

Washington, January 7, 1968.

SUBJECT

• Report on Our European Balance of Payments Trip

Introduction

This report contains the principal findings of our European trip. (We have also taken into account Phil Trezise’s talks in Scandinavia and Luxembourg.) Our conclusions are based on the preliminary reactions of the people with whom we talked. Obviously, the President’s B/P program cannot be easily or quickly comprehended, nor could the effects of the measures on individual countries be thoroughly analyzed in the short time between the announcement and our visits.

The purpose of our trip was to convey at the highest possible political level the rationale behind the program, and seek whatever cooperation was appropriate and possible. We put particular emphasis on the President’s desire to maintain our commitments to European security and to a liberal trade policy. We emphasized that European leaders must not judge our measures on the basis of narrow technical considerations, but rather in terms of the high political stakes involved in maintaining a healthy and strong American economy.

As an over-all impression, we feel that the President’s program is regarded as necessary and desirable. The central bankers approved in general of the total program and its parts—a domestic tax increase, reduction of expenditures and B/P measures. They seemed prepared to see their reserves fall somewhat and agreed that activation of the new special drawing rights in the IMF would have to come more quickly. The government people, while approving the strength of the total program, and specifically its domestic parts, were more critical about the B/P aspects—with the criticism varying from country to country.

We sought both understanding and, to the extent feasible, undertakings not to retaliate against our measures. Nobody, however, was prepared to give us a firm commitment until they had studied the program and weighed the possible consequences. We sought, therefore, to set a favorable political climate for the decisions they will have to make.

U.S. Domestic Policies

We were met with one common response—although with varying emphasis—everywhere we went, i.e., a successful program depends on our ability to get additional taxes and to cut Government expenditures. European reactions clearly will be strongly influenced—and tempered—if we can demonstrate that we can carry through tough measures to bring our own house in order. If we are to get European cooperation and understanding—and we must make the Hill understand this—we will have to move ahead on the domestic front.

Border Taxes

There was no immediate indication that a modest border tax—if it could be justified under the GATT—would face retaliation. There are, however, risks. The overwhelming size of our economy places a special responsibility on us for maintaining the health of the world economy. Thus, whether we like it or not, our conduct is judged by a set of standards substantially different than those applied to others. While European political leaders recognize and understand our domestic problems, what we do is likely to set the tone for the entire world trading community.

We must, therefore, weigh the domestic political and economic benefits of introducing a modest border tax against the reactions of others. One thing is certain—we must justify the border tax within existing GATT rules. If we keep the rate at something between 2–2–1/2% we can, we believe, stay generally, although not necessarily strictly, within the rules. Then the Europeans, who understand the political nature of our domestic problem, will probably be able to overcome the doubts of their technicians and, at least in the Common Market and in Switzerland, will be able to avoid counter measures. This is predicated on the assumption that our tax will be announced as a temporary measure pending further discussions in the GATT on the general questions of border taxes and of the B/P adjustment process. It also assumes that legislation can be controlled and that it will dampen rather than enlarge protectionists’ fires.

In Bonn, Brussels and The Hague, we raised the possibility of a suspension of recent or contemplated actions in the tax field. While some effort might be made to explore compensating measures for the border tax effect of the new TVA tax system, the legislative problem is so great that we do not feel this is a realistic possibility in our time frame.

Harold Wilson clearly indicated that he could not suspend the British export rebate at a time when the United States was introducing a similar system.²

Both the Swiss³ and the British made the point that the imposition of a border tax implies that a currency is overvalued and warned us that this might be a conclusion drawn in certain business and banking circles. None of the Common Market countries made this point.

Tourism

The uniform European reaction—although everyone agreed that the President could not ignore such a large element in our B/P deficit—is that any U.S. action to restrict tourism would hit unfairly at airlines and hotels and probably would not achieve the desired purpose. They were happy to learn we were not contemplating exchange controls. Again they will probably accept some modest limitations—particularly if they are part of a broader B/P program.

There is real substance to the European view that we should do much more to encourage tourism in the U.S. Greater emphasis, for example, on package tours, which give the middle income traveler a better idea exactly how much he will have to spend, would do a lot of good. We should also urgently examine the feasibility of persuading airlines to give lower preferential air fares to round trips originating in Europe.

Two other suggestions are worth studying:

• —If we decide to put a small tax on passports, impose a ticket tax or a head tax, we might earmark the income to promote foreign travel to the U.S. (this would do much to make the tax more politically acceptable at home);
• —We should take a very hard look at ways to simplify or eliminate our tourist visa requirements.

Investment

There was almost uniform (if at times grudging) approval of our decision to control U.S. investment outflows, but several countries expressed concern. Belgium, in particular, was quite worried; Holland was concerned about its North Sea oil and gas; Italy by its problems in the south. The UK also had some worries but accepted the program as necessary. The Commerce Department should be prepared to exercise some flexibility in administering the program. Obviously we cannot grant so many exceptions that we fail to reach our target. But we should at least encourage American business overseas to attempt, as far as possible, to meet this highly political need as they make their investment decisions.

While in Paris we met with a group of American businessmen, who raised an issue that deserves Commerce’s urgent attention. They pointed out that U.S. business has found it indispensable, when raising money in Europe, to offer a parent company guarantee. In some cases they have gone so far as to incorporate in Delaware simply to make their issues more appealing to European investors. These guarantees very rarely come into play, but their existence apparently is important.

We asked the businessmen to get their comments and suggestions about the particular effects of these measures into Washington quickly. It will be of the utmost importance to work closely with the business community in order to meet their legitimate concerns, while at the same time assuring that the program is not frustrated by their ingenuity.

Finally, we are all a bit concerned by Debre’s remarks that he wondered how the U.S. could regulate American affiliates and still want them to receive equal treatment “in countries such as France” (see Secun 30).⁴ He may well be preparing the ground for later GOF moves against U.S. affiliates in France—where and when it suits the French. But such action will be difficult technically to devise.

Export Expansion

All of us—and Phil Trezise on his swing through Scandinavia—reassured the Europeans that the President’s proposed export expansion measures would not set off a credit race. It is important that we explain publicly and repeatedly that we want to increase the efficiency of Ex-Im in the credit field—not to move toward a system of subsidized interest rates.

Neutralization of Military Expenditures Abroad

Every NATO partner we talked with was grateful for the President’s determination not to play into the hands of those in the U.S. who want, for other reasons, to see substantial American troop cuts in Europe. For bargaining purposes (particularly in Bonn)—and despite the fact that we realized it would probably not be possible—we emphasized the need for full neutralization of our foreign exchange costs. The trilateral talks last year bought us some time, but it is important that we begin discussions with the FRG as soon as we can on arrangements for the next two years.

During each visit we mentioned the need for future multilateral arrangements. Everyone expressed interest, but recognized that we would probably have to proceed on a bilateral basis for the next two years. State and Treasury have already begun consideration of a multilateral system which we might propose in NATO; we will now make it a priority SIG agenda item.

The importance of the British problem must not be underestimated. If the U.K. fails to get a 100 million pound off-set agreement (or very close to it) and, as a result, cuts the BAOR, pressure for cuts of our own may well reach intolerable proportions. Harold Wilson made very clear that he would withdraw troops without the off-set.

Gold

Everywhere we went the question of the 25 percent gold cover was raised—not nervously, but with a question as to why we had not yet acted on it. We explained the Federal Reserve powers to suspend—a point already known to the central bankers—and said any legislative action would in any event have to await a propitious time.

Conclusions

At a time when both the U.S. and British Governments are trying to improve their payments positions by an aggregate figure of over $4 billion, we cannot ignore the possible cumulative effects of the measures taken by the two countries on our own economies and the economic fortunes of the world at large.

We must put our best economic brains to work on this problem—and soon. We recommend that the President appoint an advisory committee, or perhaps use the existing Dillon Committee (which includes people such as Walter Heller, Francis Bator, Bob Roosa and Kermit Gordon), to undertake an immediate examination of the measures we have taken or are likely to take. If these experts conclude that the US/UK program may cause serious economic problems, the U.S. should call for a conference—perhaps sponsored by the Economic Policy Committee of the OECD—to propose ways of ameliorating conditions arising from UK/US balance of payments measures. We must, for psychological reasons even more than technical ones, demonstrate our determination to create conditions for an expanding world economy—with deficit countries assuming their responsibilities, surplus countries playing their proper role, and both responsive to the needs to LDCs.

Also, as many of our European friends seem to recognize, the reduction or elimination of our deficit makes it even more important that we proceed as quickly as possible to approve and implement the special drawing rights mechanism. While this may be a modest step, it will have an important bearing on developing a sense of purpose and responsibility.

It is important that we continue to analyze the domestic and international consequences of various legislative proposals—particularly their net effect on the B/P.

How we handle ourselves in dealing with our partners abroad is almost as important as the measures themselves. It is extremely important that the USG speak with one voice, and that we handle our negotiations with the utmost skill. There will naturally be differences of view between the various Washington agencies concerned with specific aspects of the program, but the political stakes are high and we must find some way to settle our differences quickly and constructively.

We were heartened, but at the same time sobered, by the recognition abroad of the importance of US leadership and responsibility. Without exception, the people we talked to are aware of the tremendous burdens the President carries, and all (except France) spoke with admiration that forceful and positive action had been taken.

1. Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. V [2 of 2], Box 3. Secret. No drafting information appears on the source text. The text of this report was sent to the LBJ Ranch in telegram CAP 80173, January 7. (Ibid., 1968 Balance of Payments Programs, Memos and Miscellaneous [2 of 2], Box 4) Katzenbach also prepared a country-by-country summary of his European meetings, which was derived from his telegraphic messages. This summary was transmitted under cover of a letter from Katzenbach to Representative Mills, January 16. (Department of State, Central Files, ORG 7 U)
2. Katzenbach’s report of his conversation with Wilson is in telegram 5279 from London, January 7. (Department of State, Central Files, ORG 7 U)
3. Katzenbach’s account of his conversation with Swiss Government officials and bankers on January 3 is in telegram 3831 from Brussels, January 3. (Johnson Library, National Security File, Subject File, 1968 Balance of Payments Programs, Cables [1 of 2], Box 4)
4. Another series indicator and number for telegram 5277 from London, January 6, sent to the President in Document 173.