175. Memorandum From the Under Secretary of State for Political Affairs (Rostow) to Secretary of State Rusk1


  • The Balance of Payments Program: Next Steps after the First Round of Talks

These observations were written on the plane coming back. They reflect reactions of the talks we had in Japan, Australia, and New Zealand, and to what we read of Nick Katzenbach’s talks in Europe.

The first reactions to the announcement of our balance of payments program on January 1 have been constructive. The speculative pressure on the dollar through the gold pool has stopped, for the moment at least. The governments and central bankers, by and large, have said two things: (1) the American action was necessary, courageous, decisive, and useful, but (2) they are also worried about its possible impact not only on their own economies, but on the world economy as a whole. They are concerned about the prospect of an acute shortage of funds, credits, and reserves, causing higher interest rates; about the risks of an outbreak of protectionism, especially if we decide to move for border tax legislation; and about an atmosphere of uncertainty which could express itself in the postponement of investment decisions, and a rising tendency to sell securities and hold assets in liquid form. Such a tendency could break some of the weaker currencies, and even lead to a pell mell for liquidity, in the pattern of 1931.

Action by the United States has an entirely different psychological effect from that of any other country. If we take limited protective steps which other countries take as a matter of course men react altogether differently. The fact that we have undertaken a mandatory balance of payments program is in itself a shock. That we are considering a border tax adjustment as part of the program—effectively a devaluation pro tanto or an increase in tariffs—is a double shock, and a doubly disturbing one.

It is not yet clear whether the increase in confidence stemming from the announcement of the program outweighs the increase in anxiety, and whether the reduction in our own balance of payments deficit will work towards equilibrium or disequilibrium in the world economy as a whole.

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We shall need to move rapidly during the next few months if the opportunity implicit in the crisis is to be used effectively, and the several major risks of the situation avoided.

This memorandum attempts to deal with some of the substantive problems of the period immediately ahead, and with procedures to be considered in dealing with them.

I. Managing the adjustment between the US deficit and the E.C. surplus.

For several years, we have advanced the thesis that the balance of payments relationship between the United States and Europe was a joint responsibility of the surplus and the deficit nations, to be handled cooperatively.

Actually, our thesis requires some qualifications. Both we and the Europeans have recently lost some reserves to the Less Developed Countries. The situation is no longer ours alone to control. And only Germany and Italy of the Community countries have significant current surpluses. What we are really thinking about is a move towards equilibrium which would involve (1) a cut in our deficit; (2) a reduction of current surpluses for Germany and Italy; and (3) a reduction of reserves on the part of France, Belgium and the Netherlands.

One key to the success of our present effort is whether Europe can provide the world economy with $1.5 billion in additional capital this year, to replace that amount in American credits and investments covered by our mandatory action. Last year, European sources increased the availability of capital to foreign borrowers by approximately 100% over 1966.

Will the increase continue, and if so, at what rate? Should international action be taken to help stimulate the response of supply to increasing demand, or should the process be left to the market? If international consultations are indicated to guide the adjustment process, through what procedure, and to what ends?

The magnitude and abruptness of the adjustments envisaged, and the nature of the political and economic risks if things go badly, make it essential to utilize existing (or new) procedures of consultation for the purpose of harmonizing policy with respect to the adjustment process as a whole, and to its several interrelated parts as well. In fact, I suggest that this cooperation be organized on a Crisis Management basis, both within our government and internationally, and handled for the next few months by a small, high level, international working party, in continuous session, probably in Washington.

Viewing the adjustment process in all its aspects, governments should act at the level of political responsibility to lay down certain agreed policy guidelines for their officials in the areas of trade, finance, and banking who will have day-to-day responsibility. The general object [Page 503] of these guidelines should be cooperation to achieve balance of payments equilibrium at high levels of employment and investment.

This sentence should not be regarded as a cliche.

It should explicitly mean a willingness on the part of surplus countries to lose reserves if necessary, within a pattern of cooperative reserve surveillance, to sustain existing levels of investment at home and abroad, and correlatively to offset tendencies towards excessive credit restriction or liquidity in the coming months, due to severe competition for existing funds.

Secondly, this principle should mean cooperation to maintain existing parities, through the gold pool or otherwise. In this connection, the Solomon plan2 should be discussed and negotiated.

Thirdly, it should mean a willingness to examine all problems that bear on the viability of the monetary system—issues relating to sterling, the availability of reserves during a period of contracting dollar supply, and so on.

I have put the issues relating to the impact of our balance of payments program on the monetary system first because they are primary. If the dislocations of this period start another round of monetary turbulence, the damage may be harder to contain, and more fundamental.

We should explore with Secretary Fowler and Chairman Martin how monetary cooperation of the types mentioned should be organized and handled. To launch the process, I suggest a carefully prepared meeting—conceivably of the Chequers type, or a Special Session of the OECD Ministerial Council—either before or after the meeting of Working Party 3 scheduled for January 22–23rd, and the Honolulu meeting of the same period.

II. The Issues of Trade Policy.

We have taken the view that flexibility in trade policy should be part of the armory with which governments handle the balance of payments adjustment process.

To this end, we have proposed a change in GATT rules to authorize such flexibility. This proposal must imply either movable tariff rates or balance of payments surcharges as an alternative to import quotas.

Point 6 of the President’s Seven Point Program of January 1, 1968, is “Non-Tariff Barriers”. Reaffirming that trade liberalization remains the basic policy of the United States, it calls for long range post-Kennedy Round negotiations to tackle non-tariff barriers in general. It calls also for discussions about the possibility of “prompt cooperative action among all the parties to minimize the disadvantages to our trade which arise [Page 504] from differences among tax systems”. Mr. Katzenbach explored the possibility of these discussions in Europe last week. One of our most urgent tasks, beyond cooperative surveillance of the workings of the monetary system, will be to appraise the results of these explorations—that is, the chances of success in quick negotiations to reduce border taxes, and perhaps other non-tariff barriers, as an alternative to American legislation to establish border tax adjustments of our own. On the trip another way to reach the same end—that is, the end of reducing the level of European tariffs or tariff equivalents—was suggested: that some of the chief surplus countries put their Kennedy Round tariff cuts into effect in advance of the agreed schedule. The feasibility of this idea is now being staffed out. If it seems promising, it could be examined in the same negotiating format.

From our talks in Japan, Australia and New Zealand there is no doubt that a decision by the President to propose border tax adjustments would cause profound and far-reaching concern. These governments would expect such a move on our part to trigger a world-wide series of protectionist steps, and they are convinced such a process would be nearly impossible to contain. They would strongly prefer prompt negotiations to reduce European border taxes (and perhaps some other non-tariff barriers) as an alternative to American border tax legislation. The Japanese specifically offered to make a contribution to such a process of reducing non-tariff barriers, if we chose that course rather than its alternative.

It is nearly certain—however irrational this thought may be in fact—that a border tax proposal on our part would be taken as signalling a profound change in the direction of trade policy.

I believe that the announcement of our program and the first reaction to it have given us some time. If we get the tax bill through soon, international opinion will be even calmer, and the risk of a new round of gold fever (absent trouble for sterling) will be correspondingly reduced.

I suggest that we use this period of time—a couple of months at most—to follow this course urgently—the course, that is, of prompt negotiations to reduce European border taxes and other non-tariff barriers, while we mark time on the decision to initiate border taxes.

Such a course would improve our chances for success in organizing monetary cooperation along the lines indicated in Part I.

  1. Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. V [2 of 2], Box 3. Secret. The source text is a copy sent to Walt Rostow at the White House, whose handwritten notation on the source text directed Lois Nivens, a secretary at the White House, to provide a copy for Fried “for urgent comment & discussion.” In a January 8 memorandum to Fowler, Sam Y. Cross and Robert G. Pelikan, two Treasury officials who accompanied Rostow, provided another report on this trip. (Johnson Library, Fowler Papers, International Balance of Payments—Classified Material: 1968 Balance of Payments—Cables, Box 44)
  2. Not further identified.