Foreign Relations of the United States, 1964–1968, Volume VIII, International Monetary and Trade Policy
18. Letter From the Chairman of the Task Force on Foreign Economic Policy (Kaysen) to President Johnson1
Dear Mr. President:
Attached is the report of your Task Force on Foreign Economic Policy. It is the product of earnest thought and discussion carried on over a period of several months. It represents a genuine consensus on the nature of our goals in foreign economic policy, their relative importance in our foreign policy as a whole, and the principal means to achieve them.
The Task Force included consultants from outside the Government, all of whom have had intimate experience with the problems of foreign economic policy in both Government and non-Government activity, and experienced and responsible officers of your Administration, charged with the formulation and execution of polices in this sphere. The report accordingly embodies not only our judgment of what is desirable, but the fruit of hard experience in assessing what is necessary and possible.
You instructed all your Task Forces to disregard narrow problems of feasibility in terms of domestic political tactics. We have followed that instruction; but we are aware that some of our recommendations do not fit the going assumptions about domestic politics that currently condition foreign economic policy. We recognize that this poses a vital question for you of assessing what kind of new political consensus can be developed and what policies it should be used to support.
May I express the thanks of the whole committee for the opportunity to be of service to you in your vital tasks.
REPORT OF THE PRESIDENT’S TASK FORCE ON FOREIGN ECONOMIC POLICY
Introduction and Summary
A. Foreign Policy in the Coming Decade—The Economic Challenge
Since the end of the Second World War, the dominant theme of United States foreign policy has been the confrontation with the Soviet [Page 35] Union, the leader of the Communist world. The main content of policy was military or quasi-military. No similar single overriding concern will dominate foreign policy in the years ahead. One central theme will be our relations with the two-thirds of the world’s people who live in the poor countries. In part as a consequence of this shift of focus from East-West relations to North-South relations, the instruments of policy will be increasingly economic. But, even within the developed world, economic concerns will grow in importance not only in our relations with the other advanced countries of the Free World but in our relations with the Communist bloc.
In the immediate aftermath of the War, American policy addressed itself to relief and reorganization of shattered nations. When the Soviet threat emerged in north Iran, Greece and Berlin, emphasis shifted to military and quasi-military responses. We deployed the weapons of economic policy essentially as an adjunct to the political-military effort to contain the Soviet thrust. Even in the Marshall Plan the element of confrontation with Communism, internal and external, was of decisive importance. Aid to the economies of Western Europe became an aspect of the development of the North Atlantic Alliance.
This emphasis on the military features of policy intensified after the outbreak of the Korean War. The bulk of United States foreign assistance went to support weak states on the periphery of the Soviet Bloc with whom we were in military alliance. In Europe our economic policies were organized around the drive toward a united Western Europe seen as a counterweight to the Soviets.
Developments of the last few years have changed the elements of this post-War policy. The Soviet Union has apparently accepted the present facts of military power in an age of nuclear missiles. So long as we maintain our own defenses at an appropriate level of effectiveness, we can anticipate that the Soviets will continue to accept these facts. Further, while we hope for progress in arms control and disarmament that will institutionalize the stability of East-West military relations, the Task Force’s recommendations do not depend on this.
Change has affected the coalitions as well as their leaders. The other countries of the Communist world are increasingly pursuing their own national interests. They are less willing to accept a unilateral Soviet definition of what their course should be. In Europe itself, which was both the main arena and the main prize of the post-War struggle, the nations of the West have renewed their economic strength and demonstrated their political stability. China, it is true, continues to be a military threat to its neighbors as well as a trouble maker all over the underdeveloped world. But, in terms of demands upon our policies and our resources, the Chinese threat is of a different order of magnitude from that posed by Soviet policy in the 40’s and 50’s. For all these reasons, the military confrontation [Page 36] that has dominated the recent past can be expected to assume a lesser position in the future.
In these circumstances, relations with the underdeveloped world will come to occupy an increasingly critical place in United States foreign policy. Eighty-five poor nations contain two-thirds of the world’s people. For the most part these nations are new, their governments are inexperienced and unstable, and they are in the grip of rapid change. In the pre-War period, most of these peoples were organized and governed under the colonial system. The disappearance of the system has made them visible and audible to the whole world. Despite their weaknesses they are a real factor in world politics. The sheer weight of numbers would make them important. Their significance is magnified by the UN system, by political and economic competition between and within the two great coalitions, and by the fact that the population of the southern hemisphere is mostly colored. For these reasons we have come increasingly to recognize that a view of the world centered on the North Atlantic is a parochial one.
All in all, the less developed world looks to be both the greatest challenge to our creative powers and the largest source of cumulating instability in the years ahead. The United States, the leading power and the richest country in the world, has an immense stake in a process of change in these countries which, though it cannot be smooth and painless, leads toward stable, open societies. That alone is sufficient to focus our attention and effort. Beyond this interest is our deeper, humanitarian concern in improving standards of life in the poorer two-thirds of the world. It is proper to argue a course of policy on grounds of interest but it would be both unwise and untrue to American tradition to deny its humane foundations. Since material progress is a necessary condition for the kind of change we seek in the less developed countries, economic questions will form the main substance of our relations with them.
Our relations with Western Europe, Canada, Japan, Australia, and New Zealand will likewise increasingly reflect economic concerns. The United States no longer occupies the dominant position it did in the first post-War decade. Their renewed strength and the military stalemate have permitted these countries to take independent and often irritating political positions. The Western Alliance, like the Communist coalition, has become looser. Nevertheless, the basic domestic political aims of governments in the Western coalition are increasingly similar and our national economies are more and more interdependent.
In the past two decades, we have made progress towards a working system of economic relations within this developed world, a system that permits all countries to pursue their common economic goals—prosperity, growing output and expanding trade. Economic welfare in all these countries, as well as our own, depends heavily on the effectiveness of [Page 37] this machinery and on further advance towards a unified economy for the whole area. Moreover, in the present circumstances, continued elaboration of common economic institutions may provide the best available approach to the goal of North Atlantic unity.
In the last analysis, developed and underdeveloped worlds are linked within the context of economic policy, even more than we sometimes thought they were in the context of military alliances. The prosperity and growth of the developed world affects the prospects of the underdeveloped world directly through the flow of trade. Equally important is the impact of prosperity in the advanced countries on their willingness to give aid. At the same time, prosperity and progress in the developed world cannot long remain secure in the face of misery and violence in the poor countries.
This picture, with its strong emphasis on economic, rather than military, problems, is drawn in the broadest strokes. The concrete everyday world of foreign policy will doubtless continue to be filled with alarms and uncertainties, whether in the familiar terrain of Berlin, the Taiwan Straits, the Congo and Indonesia or in new arenas. Yet even these will alter because they are less likely to trigger a Soviet-American clash.
Economic policies by their nature operate over the long term. Thus there is ordinarily some leeway in the timing of decision and the execution of policy. But this should not blind us to the need to initiate action well before crises develop, and to persevere even when results are not immediately visible.
Our effectiveness in achieving the goals toward which the recommendations of the Task Force are directed will bulk large in the historical appraisal of America’s performance in these years.
The subsequent sections of this summary contain the most important recommendations of the Task Force and the reasoning supporting them. A more detailed analysis of the basis of these recommendations and further proposals for action are contained in chapters on Aid (I), Trade (II), and Money (III).
[Here follow the rest of the Introduction and Summary; Chapter One, “Aid;” and Chapter Two, “Trade.” Chapter One and pages 19–26 of Chapter Two are printed in volume IX, Document 20.]
Three important tasks remain on the agenda of international financial policy for the newAdministration. These are (I) Ending the deficit in the U.S. balance of payments. (II) Protecting U.S. gold reserves against conversion of outstanding dollars. (II) Reforming the international monetary system.[Page 38]
Solid progress toward all three goals has been made in the past 3–1/2 years. But we are not yet out of the woods. As the leader of the Free World, the U.S. continues to bear heavy commitments overseas for defense. Elsewhere in this report the Task Force stresses the critical need for increasing development assistance and for liberalizing trade flows especially from developing countries. Another task force urges the importance of full prosperity and rapid economic growth at home. International financial difficulties can seriously jeopardize both U.S. leadership abroad and U.S. prosperity at home. It is the job of international financial policy to facilitate the basic objectives of foreign and domestic policy.
I. Ending the payments deficit
Table I indicates the progress that has been made in reducing the deficit since 1960. The reduction of the officially financed deficit, col. (3), is especially encouraging. This is the part which we must finance either from our reserves of gold or its equivalent or by adding to the potential claims on our reserves held by foreign central banks and governments. It must be our objective to reduce this figure to zero, or even to convert it to a surplus for two or three years. The remainder of the total deficit represents accumulation of short term dollar claims by private individuals, businesses, and banks abroad, and by nonmonetary international and regional organizations. Since expansion of world trade and the world economy increases their needs for dollar balances, a moderate deficit in column (2) is normal and poses a distinctly lesser threat to U.S. reserves.
U.S. Balance of Payments Deficits 1960–64 (billions of dollars)
|Calendar Year||Regular Deficit||Privately Financed 1||Total||By Gold||By Short Term Claims||By IMF||Otherwise 2|
- Includes nonmonetary international and regional organizations.
- Advance repayment of long term debt to U.S., advances on U.S. military exports.
Further progress depends mainly on a continuation of current policies. There are no new measures that deserve serious consideration unless the situation deteriorates or unless improvement is disappointingly slow. Some measures currently in force are expedients counter to basic U.S. policy and should be abandoned when the situation permits.
Capital movements. The Interest Equalization Tax, effective retroactively as of July 1963, has helped the balance of payments by cutting the [Page 39] outflow of portfolio capital by $1 billion a year. It is scheduled to expire December 31, 1965; hence a decision is required fairly soon whether to ask for extension.
As of now, an extension appears necessary. However, the measure is not desirable as a permanent fixture and it will become less effective the longer it is used. Some issues now postponed because the tax is expected to be temporary will be floated when it is extended. Ways of evading the tax will be found. Funds will flow out through channels not now taxed or controlled, such as direct investment by U.S. corporations. Meanwhile we may hope that the development of European capital markets and the decline of profit opportunities in Europe relative to those at home will reduce the investment outflow. In this connection, it is important to maintain strong incentives for domestic investment, especially an expanding domestic economy operating close to its capacity. It is also important to maintain diplomatic pressure, in OECD and elsewhere, for the improvement, liberalization, and internationalization of European capital markets.
If, contrary to present indications, the balance of payments deteriorates, further measures to limit capital outflows would be the first line of defense. Under existing legislation, the President can extend the Interest Equalization Tax to bank loans beyond one year—a step which could have substantial results. The present exemption of Canadian issues from the tax can be terminated. Additional steps would include further measures to tax or control all bank lending to foreign borrowers. In the event of a serious deterioration, corporate direct investment in developed countries could be temporarily limited. Although capital controls are not desirable and are difficult to administer, they are used by almost all other countries and it is the view of the Task Force that they are preferable to restrictions on trade or tourism.
European governments have kept the U.S. under considerable diplomatic and economic pressure to tighten monetary policy and to raise interest rates. Anti-inflationary monetary policies in several European countries have recently raised interest rates there.
In the U.S. during the past 3–1/2 years, the policies of the Federal Reserve and the Treasury have partially reconciled and partially compromised the conflicting claims upon them—external pressures for higher rates and the needs of the domestic economy for monetary expansion. The Task Force does not believe that these policies have assigned too low a priority to external balance. As the balance of payments stands now, we would not recommend tighter monetary policy until and unless it is appropriate for the U.S. economy. We cannot in the long run solve our persistent payments problem by attracting funds at rates which are out of line with domestic profit opportunities. Of course the Federal Reserve must be ready to engineer sharp temporary increases in short term rates in case of a speculative flight from the dollar.[Page 40]
Government outlays abroad. Federal overseas programs already bear a large share of the burden of adjustment to the payments deficit. Government outlays abroad must pass a more severe test than other budget expenditures. To save foreign exchange, preference in procurement is given to U.S. suppliers even when their costs are higher, and foreign aid is tied to purchases in the U.S. These programs must be continued, at least for the immediate future; indeed, the expansion in aid the Task Force recommends will have to be so far as possible an expansion of tied aid. But the Task Force does not believe we should otherwise extend measures of this kind. Over the long run, indeed, as the balance of payments improves, we should try to return to the principle that all government expenditures, whether in dollars or foreign currency, should be judged by the same criteria, balancing their benefits against their dollar costs. Of course, economies justified on their own merits should always be sought. In the next few years, considerable savings may be possible in military outlays overseas.
Goods and Services. The U.S. has a large and growing export surplus. Although the steady expansion of business activity has increased our imports, our exports have advanced even faster. U.S. exports have been helped by the continued expansion of the European and Japanese economies and by an improved competitive position. American labor costs and prices have been stable while our major competitors have been experiencing moderate inflation. Price and cost stability continues to be important for the U.S. We do not yet know what upward pressures on wages and prices will result from further reduction in unemployment and excess capacity. Lacking direct powers, the Administration has no choice but to continue the policy of “moral suasion” exemplified by the wage-price guideposts, choosing carefully the strategic occasions when the influence of the President and of public opinion can be effective.
The government can do very little else in this field. Campaigns for promoting U.S. exports and attracting tourists to our shores can be continued and improved. We have rightly avoided both export subsidies and the imposition of import duties or quotas for balance of payments reasons. In the Kennedy Round and other commercial policy negotiations, we must of course protect the balance of payments. But it is doubtful that these negotiations can improve our position. U.S. travel abroad is a large and growing deficit item. But restrictions on such travel would be difficult to enforce, politically unpopular, and contrary to the larger interests of U.S. foreign policy.
II. Managing Existing Dollar Holdings
The $12–1/2 billion of official short term dollar obligations held by foreign central banks remain a serious problem to the United States. By ingenuity, innovation, and tireless negotiation, U.S. officials have managed over the past 3–1/2 years to increase this figure by about $2 billion while losing only $2.2 billion of gold. Nevertheless, it is clear that some [Page 41] countries would prefer more gold and fewer dollars than they now hold. Solution of the U.S.’s chronic balance of payments difficulties would undoubtedly increase foreign willingness to hold dollars. Even then, however, gold withdrawals might be triggered by temporary U.S. deficits or by political events; and they can always be used as a diplomatic weapon against the U.S.
The present situation reflects a delicate balance of interests. The parties have some interests in conflict, and some in common. The U.S. wishes to protect its gold reserve while maintaining the convertibility of gold and dollars at the established rate. Therefore, the U.S. is led to take measures, sometimes in serious conflict with basic objectives of foreign and domestic policy, to maintain the confidence of its short term creditors. While their potential claims on gold give these creditors considerable power, they cannot press the U.S. too hard. Large withdrawals of gold from the U.S. might force the U.S. off gold, impairing the gold value of the creditors’ dollars and damaging the whole international monetary system. Moreover, while these countries push the U.S. to solve its balance of payments problem, not all solutions are palatable to them. They do not welcome the prospect of an increased U.S. export surplus, a solution which would subject them to increased competition at home and abroad. Neither do they welcome reduction of U.S. military outlays in Europe. They prefer U.S. measures to limit public and private flows of capital.
Thus the U.S., though superficially in the suppliant position of a debtor dependent on the goodwill and forebearance of its creditors, holds some strong cards. It is not easy to play them, or even to make credible threats to play them. The cards must remain implicit in the background of the dialogue. But it is important that neither side forget they are there. All countries have a common stake in the effective functioning of the payments system. We should use these realities, so far as possible, to obtain understandings that our existing obligations will not be converted into gold.
This is one important objective of U.S. international monetary negotiations in the next few years. A second and broader objective is permanent general improvement in the world monetary system, for which studies and negotiations are already under way. (See Part III.) These two goals of negotiation are interrelated. The extent to which existing dollar obligations need to be consolidated and the time when this should be done depend in part on the course and the success of the wider negotiations. A general strengthening of the system will diminish its potential instability and increase confidence in the gold-dollar parity. What the U.S. must guard against, however, is the danger that our share of the benefits of general monetary reform might be dissipated in paying off old short term debts. Any general monetary improvement, whether in the IMF or elsewhere, will make additional reserve assets or additional [Page 42] international credit available to the participants, including the U.S. The purposes are to smooth the adjustment to future imbalances, not to alter the financing of past deficits, and to add to the stock of world reserves, not to replace the dollars now in use. These purposes would not be accomplished if, as the French proposal originally contemplated, the U.S. were forced to use the new international reserve and credit facilities to repay old debts. If this were the only benefit to the U.S., the game would not be worth the candle.
We need have no apologies for providing the world with dollar reserves in the past. We must insist that bygones be bygones, and that the improvements in the monetary system are built on the assumption that existing dollar debts continue to be held in one form or another.
Long-Run Borrowing in Foreign Currency. The most promising method of consolidating debts is probably to convert them into long term debts carrying an exchange guarantee.
Over the past three years, we have introduced a new type of instrument into the world’s payments system in the form of U.S. securities denominated in foreign currencies. At present we have outstanding to four European countries a total of $1 billion in obligations denominated in their currencies, with maturities ranging up to two years. For the creditors, these securities provide an exchange guarantee in terms of their own currency and their issuance thus removes one important reason for reluctance to hold U.S. obligations. Our issuance of such securities has provided a means for dealing with new dollars coming into official reserves abroad from current transactions and for converting existing dollar holdings into longer term debt.
We should seek much longer maturities for these obligations. The U.S. is certainly a prime credit risk and the precedent of the Marshall Plan should have some weight. The Task Force believes that the U.S. could over time contemplate gaining $5–7 billion of such longer term loans with maturities of, say, ten to fifteen years. In some cases, central banks may be convinced that the extension of long-term credit is a feasible use of their reserves. In other cases, the foreign governments themselves must be convinced of the desirability of budgeting for such investment funds received from taxes or domestic borrowing. Either result will take time to accomplish but the objective of longer term credit should remain.
To some extent countries will be reluctant to tie up their international reserves in longer term loans for fear that their own payments positions will deteriorate meanwhile. This fear can be allayed by bilateral or multilateral arrangements which would insure that in such contingency the U.S. will either repay the loan early, or transfer it to another country in a strong reserve position, or to the International Monetary Fund. The development of such techniques will introduce a new degree of transferability for these longer term obligations and may thus provide [Page 43] additional flexibility for the U.S. in dealing with its international payments position.
The Gold Cover Requirement. One unilateral action which could help to defend U.S. gold reserves is to repeal or modify the 25-percent gold reserve requirements now imposed on the Federal Reserve Banks. At present approximately $13 billion of our total gold stock is impounded as reserves against the deposit and note obligations of the Federal Reserve Systems. These liabilities are the base of our domestic monetary system. They will grow as the economy grows, and the required gold cover will increase along with them.
The United States and Belgium are the only major countries still retaining a domestic monetary reserve requirement in the form of gold. Most other industrial countries suspended or abandoned their legal reserve requirements during the War or post-War periods and have not reinstated them.
Actually, U.S. law permits the Board of Governors of the Federal Reserve to waive the 25-percent requirement for an initial 30-day period and to renew such waiver for successive intervals of 15 days. No limit is placed on the number of successive renewals which the Board may make. There are other provisions of law, however, which impose progressively increasing charges upon those Federal Reserve Banks for whom the Board has issued waivers. These charges would be nominal until the gold stock had fallen to about $6.5 billion.
The present law clearly contemplates the possible use of the required gold in the event of a crisis. President Kennedy stated at the outset of his Administration that the entire gold stock is available for monetary use in defense of the dollar. Chairman Martin has subsequently made public statements to Congressional committees and elsewhere, which make clear the Board’s understanding of its present authority. Nevertheless, there remains some nagging doubt around the world concerning the ready availability of the “impounded $13 billion” for use in meeting United States external obligations. The risk remains that any crisis which led to the outflow of a substantial part of our present “surplus gold” (the excess over the required gold) would cause a rush to purchase on the part of other central banks and monetary authorities. As the actual level of our gold reserves approached 25 percent, concern would mount that the United States might in practice impose a gold embargo.
The best defense of our existing gold stocks against this eventuality would be to eliminate or greatly to reduce the present gold cover requirement. However, serious questions of psychology and confidence are involved, and the proposal will have to be carefully timed and explained.
The public case for change should not be related to the possibility of gold losses. It should instead be focused on the restraint implied for our own domestic economic growth by the existence of the 25-percent requirement.[Page 44]
An expansion of basic bank reserves and of currency in circulation is necessary to service our expanding economy, even at stable prices. Such expansion has already brought the effective gold ratio for the Federal Reserve below 30 percent. In prudence, it can be suggested, the United States must economize further on the use of its underlying base of gold reserves, before the 25-percent limit is reached. The comparable requirements until 1945 were 40 percent against Federal Reserve currency and 35 percent against the deposits kept in Federal Reserve Banks by commercial banks. Those ratios were combined and lowered to 25 percent at the end of World War II when Congress saw that they would otherwise impose an unnecessary brake upon the expansion of the money supply and of the national economy. On the same grounds, a clear need will soon appear for further reducing or removing the requirement.
A choice will have to be made, when the right time arrives, between full removal or some modification of the requirement. Full removal is preferable but may not be politically possible. As a fall-back position, one possible modification would be to remove the requirement for gold against deposits in Federal Reserve banks, while keeping the requirement only against the issuance of Federal Reserve notes (currency). Another might be to lower both the deposit and note requirements to 15 percent, or 10 percent. If any requirement is kept, the Federal Reserve should be permitted to count not only gold but holdings of convertible foreign currencies and other international reserve assets.
As to the timing of legislative action by the United States, it would be desirable to propose the change when the dollar is reasonably strong and exchange markets are calm, and when there are good prospects of Congressional approval without lengthy debate. A new Administration with a strong popular mandate and a large Congressional majority should seize the opportunity to take action early in 1965. Obviously it is essential to succeed in Congress with whatever recommendation the Administration makes. Failure to secure fairly prompt Congressional approval could trigger a gold flight.
III. Improvement of the International Monetary System
The Needs. Since the Second World War the nations of the free world have used gold and dollars as the principal means of settling the net balances in their transactions with one another. Broadly speaking, countries in surplus have added to their official monetary reserves in gold and dollars, and countries have financed deficits by drawing down their reserves of gold and dollars. The United States has played a unique role in this system, a role which has carried with it both advantageous privileges and burdensome responsibilities. The use of the dollar as a reserve currency has permitted the U.S. to run chronic deficits, since they could be financed simply by incurring further short term dollar liabilities to foreign central banks and governments. At the same time, the U.S. has committed itself to maintain the convertibility of these dollars into gold [Page 45] at a fixed price on demand. Consequently, at the discretion of foreign governments, the U.S. can be called upon not only to finance its current deficit in gold instead of dollars but to sell gold for the dollars they have previously accumulated.
The gold-dollar reserve system has worked well. Its success has been due in part to the availability of supplementary means of financing payment deficits. The International Monetary Fund has, from its beginning in 1945, been an important source of financing for underdeveloped countries. In recent years it has become increasingly important for industrial countries, including the U.S.3 Consequently, drawing rights in the International Monetary Fund are increasingly recognized as supplementary reserves which countries in deficit can count on.
The past few years have been rich in other financial innovations, thanks especially to the imaginative leadership of the U.S. The major governments and central banks have developed a number of lending techniques which make it possible for countries to finance short term deficits without use of dollars and gold. From the beginning of the swap arrangements in mid-1962 through last August, total drawings by all central bank partners amounted to $1.9 billion—thus providing that amount of liquidity at key points of strain. Developments during 1964 have given ample evidence of the great potential for meeting liquidity needs that exists in the execution of currency swaps with other countries, the orderly handling of forward operations in other currencies, and, as discussed earlier, the issuance of United States Government obligations denominated in foreign currencies. In addition to these government obligations, it should be possible to aim at increasing the outstanding lines of currency swaps, that now amount to $2 billion. Over the long run, continuing efforts should be devoted to enlarging them, and in the next few years it might be possible to double the outstanding amount.
Nevertheless it is generally agreed that further and more systematic innovations in international monetary arrangements need to be made in the next few years. At the official level, recognition of this need led both the “Group of Ten”4 and the IMF to study improvements which might be adopted by multilateral agreement. These international studies, begun in 1963, are still under way, although interim reports were made this year and discussed at the annual meeting of the IMF in Tokyo in September. [Page 46] As the studies continue, they assume more and more the character of a negotiation which will shape the final outcome. Therefore, it is important for the U.S. Government to have a clear position regarding its objectives and its bargaining strategy.
Why is it that the gold-dollar system needs further modification? There are two main reasons:
First, it is doubtful that the world supply of reserves in the form of gold and dollars can match the world’s need for reserves. To provide a desirable margin of safety in assessing probable reserve needs, we should anticipate that imbalances in international payments will grow at least as fast as the world economy and world trade. But the stock of gold and dollar reserves cannot in the long run be counted on to grow so fast. At the same time, year-to-year increases in the supply are likely to be erratic and unreliable, and may bear little relation to the needs of the world economy.
The major sources of new gold are South Africa and the Soviet Union. These supplies depend on technological and economic developments affecting the profitability of gold mining. They are also vulnerable to political developments. Some new gold disappears into private hoards, in amounts that vary with tastes and speculative whims. Purchases of new gold by monetary authorities have been increasing total reserves by an average of only one percent per year since 1960.
The long run growth in dollar reserves will cease altogether as soon as U.S. payments are, on the average over a period of years, in balance. It is indeed the reluctance of foreign countries to accept increases in reserves in this form which makes it necessary to end chronic U.S. deficits. Their reluctance stems in part from fears that the U.S. will not be able to maintain covertibility of dollars into gold. But it also stems in part from a feeling that no one country should have the privilege of “printing money” to run unlimited deficits—a privilege the U.S. would possess if its currency were automatically accepted by other governments without limit. In the financial field, as elsewhere, we are confronted by demands from our allies that international arrangement should be more symmetrical and multilateral than in the past.
But when the U.S. is in balance on average over a number of years, its payments position will no doubt fluctuate. Deficits in some years will provide dollars for international reserves, and surpluses in other years will withdraw them. But the timing of these deficits and surpluses may not coincide with overall needs for changes in the supplies of reserves.
Second, the gold-dollar system contains some danger of instability. Large scale conversions of dollars into gold are always possible. Such conversions would not only diminish the gold reserves of the U.S.; they would also reduce the total world stock of reserves, since the converted dollars would simply disappear from international use. The opposite is also conceivable. The world supply of reserves could be suddenly [Page 47] inflated if other countries wearied of gold and decided to convert some of their gold reserves into dollars.
There is now considerable international agreement on this diagnosis. There is also agreement on the obvious implication—new international reserves of some kind must be created.
One possibility is the use of other national currencies. The U.S. has already acquired other convertible currencies in token amounts. Future U.S. surpluses would not extinguish reserves if the U.S. accumulated the currencies of countries then in deficit rather than repaying its own short term debts. This possibility has merit, but its usefulness is limited by the reluctance of countries other than the U.S. and the U.K. to assume the responsibilities of reserve currency status. Consequently there is agreement that major reliance must be placed on multilateral creation of reserves.
Here is where agreement ceases. The main issues were made clear in discussion at Tokyo. The French and Dutch favored the creation outside the Fund of a new reserve asset, the Collective Reserve Unit, to replace national currencies in the reserves of the members of the Group. The U.S., supported by Canada and the U.K., emphasized improvement and expansion of the International Monetary Fund. The technical details of these proposals are discussed in an Appendix.
As originally designed, the CRU proposal does not meet the world’s monetary needs, and it is particularly disadvantageous to the U.S. It restricts rather than facilitates expansion in the supply of reserves. It links the total supply rigidly to gold. To the outside world it might appear as a premium gold price and thus stimulate private speculation. It takes no account of the monetary needs of countries outside the group. It diminishes the importance and usefulness of the International Monetary Fund by vesting crucial monetary functions in a rival agency. For the U.S. it may well mean an initial loss of gold reserves, with no commensurate quid pro quo.
These defects are not inherent in the notion of a composite reserve unit, and no doubt the plan could be revised to eliminate them. But reserve creation can be achieved within the IMF, which already provides a reserve asset based on a mixture of national currencies in agreed proportions. Therefore—and especially in view of the restrictive spirit in which the present CRU proposal has been advanced—it seems better for the U.S. not to try to recast the CRU proposal but to work toward the alternative of improving the IMF. Indeed, developments since Tokyo indicate that the French proposal has very little support even within the Six. The studies of the Group of Ten will apparently focus on the IMF, although at least one major country, Germany, is not at present particularly receptive to either approach.
One feature of the CRU, but not unique to the CRU proposal, is the idea that all countries should move toward a uniform ratio between their [Page 48] gold holdings and their other primary reserves. This suggestion has some merit for the long run. The U.S. has experienced gold losses in the past simply because dollars moved from a central bank with a low customary gold ratio into a central bank with a high gold preference. But the U.S. must certainly resist proposals which would increase the average gold ratio and require the U.S. to pay out gold either to conform to a common ratio itself or to enable European countries that now have large dollar holdings to reach a high gold ratio.
The Task Force believes that, now that the issue has been joined, the U.S. should support the Fund vigorously in the coming negotiations. There are strong political reasons for this approach. The Fund is a world-wide organization. U.S. leadership should seek to strengthen world-wide organizations such as the Fund rather than building up competing organizations of narrower membership. Underdeveloped countries will, in one way or another, share the deliberations and the benefits associated with reserve creation in the Fund. They will be excluded from the decisions of a rich country’s club and from their fruits. The U.S. obviously has a strong interest in avoiding suspicions and tensions between have and have-not countries.
Once the idea of acting outside the Fund is abandoned, European pressure is likely to take the form of proposals to set up with the Fund special monetary arrangements and decision procedures for the Group of Ten.
The idea of a club within the Fund continues and enlarges the precedent established by the General Arrangements to Borrow. The U.S. should seek to avoid this so far as possible and to build changes in the Fund into its normal procedures of operation and government. This does not mean that all advantages of membership of the Fund must be available to all members at all times. But eligibility must be defined by universalistic rules, applicable to all members, rather than by arbitrary distinctions between members. And Fund decisions should be made in its Board, where the Ten have in any case a preponderance of the weighted votes.
It is true that since 1960 the pressure of events has necessarily limited the number of countries involved in major international monetary consultations, negotiations, and actions. Bilateral ties between central banks and other financial officials have become closer. The U.S. Federal Reserve System has participated actively and regularly in discussions among major central banks at the B.I.S. in Basle. In the OECD, the international financial situation is regularly reviewed by Working Party 3, in which only the Eleven are represented. In their recent report the Group of Ten agreed to a “multilateral surveillance” of credits granted and received, to be carried out in the consultations at the B.I.S. and OECD.[Page 49]
The development of monetary institutions in which only rich countries participate has already aroused some suspicion and resentment on the part of the other 92 members of the Fund. One reason is that the underdeveloped countries correctly understand that it is in part European reluctance to grant them larger credits which lies behind European preference to work outside the Fund. From the viewpoint of the U.S., the major aid-giving country, any multilateral assistance to underdeveloped countries which may be a by-product of international monetary expansion is pure gain.
The open disclosure at Tokyo of differences of view regarding the role of the IMF was probably a good thing. Previously, the success of our day-to-day and month-to-month negotiations to defend the dollar seemed to depend on blurring and postponing this issue. Now that the Ten have agreed to disagree on that point, at least temporarily, the U.S. is free to take leadership in pushing for monetary improvements within the Fund.
Until now, we have acquiesced in the view that no changes in the Fund can be seriously proposed without unanimous support of the Ten. If the French and the Dutch persist in their current attitudes, the time will soon be at hand for us to try a new strategy. At some point we must make clear that we will press for certain changes in the Fund whether or not France and Holland agree. It would be fortunate if our balance of payments and reserve positions were strong at the time, but the issue may not wait that long. We should try to split the Six, especially to obtain the support of Italy and Germany, countries which are more disposed to sympathize with the U.S. position. We can probably count on the support of the U.K., Canada, the Scandinavian countries, Japan, and most of the rest of the world. If a large majority of the IMF, both in weighted votes and in number, agrees to important change in the Fund, it is doubtful that France will refuse to participate in new arrangements.
Technically, the IMF can be easily adapted to meet new monetary needs. A variety of procedures are available, and it is no exaggeration to say that anything which might be done outside the IMF can be done inside the IMF. Use of the IMF has the advantage of building on familiar procedures and utilizing an experienced organization. The IMF is already recognized as a supplementary source of reserves for financing payments deficits. Its use in this role can be greatly increased without abruptly overturning present arrangements, in particular the continued use of dollars as international reserves.
The IMF provides its members both unconditional and conditional liquidity for meeting balance of payments deficits. Both kinds can be increased, in whatever proportions desired. The major techniques for increasing the contribution of the Fund to international liquidity are listed below. But the choice of techniques is a less important matter than agreeing, both within our own government and with other governments, [Page 50] on our objectives. In the opinion of the Task Force, the U.S. should aim high. Along with new monetary gold, the Fund will be the major source of new unconditional reserves. Its contribution should be sufficient to enable total reserves to grow roughly at the same rate as the world economy. The availability and use of other Fund credit should grow at a similar pace. The U.S. will want to be strongly on the side of frequent and adequate expansion of the Fund.
The major techniques available, discussed in further detail in an Appendix, are as follows:
- Increasing quotas. General agreement to a 25-percent increase in quotas has already been reached. However, the customary requirement that one quarter of new quotas be paid in gold threatens the U.S. with a gold loss of $650 million, of which $400 million would be the gold subscriptions of other members. Consequently, we must press, even over the opposition of the French and others, for ways to increase quotas without gold payments. If this problem is solved, we should seek a further general increase in quotas and perhaps a system of regular annual increases. Meanwhile, it is also important that additional special increases in quotas be arranged for European countries whose weight in the Fund is now too small.
- Increased automaticity. The U.S. should seek to make a larger part of the quota (50 percent instead of 25 percent) available to members on a virtually automatic basis.
- General Arrangements to Borrow. The U.S. should support a renewal of the agreement under which the Ten will lend their currencies to the Fund in case of need. But our aim in the long run should be to give the Fund sufficient command over resources that it does not need to borrow currencies in circumstances which give the lenders special powers of decision over Fund operations.
- Fund investments and deposits. There are a variety of possible transactions by which the Fund could provide members with international reserve assets in exchange for other assets. Essentially through these transactions the Fund would create international reserves by acquiring member currencies, or World Bank bonds, or long term obligations of member governments. The U.S. should support the evolution of the Fund in this direction.
New arrangements of this kind can achieve within the Fund whatever positive results could be accomplished by creation of a new reserve asset, like the CRU, either outside the Fund or in a club nominally inside the Fund. But they would have none of the disadvantages of the CRU proposal. The reserve asset within the Fund would be one whose value and usefulness to members is already established by experience. Its supply and use need not be tightly linked to gold. Nor does it need to supplant the holding of reserve currencies outside the Fund, encourage [Page 51] private speculation in gold, or promote a general move toward less economy in the use of gold by central banks.
- Source: Department of State, S/P Files: Lot 70 D 199, Economic Policy—1964. Secret.↩
- Secret. The Appendixes are not printed.↩
- The fear that use of the Fund would be an admission of weakness which would impair confidence has been overcome. Under a $500 million standby arranged with the Fund in 1963, the U.S. has drawn $300 million. This “broke the ice” and, because it was skillfully timed and explained, it has caused no difficulties for the dollar in foreign exchange markets. [Footnote in the source text.]↩
- The major monetary powers—technically the members of the IMF who participate in the IMF’s General Arrangements to Borrow: Belgium, Canada, France, Germany, Italy, Japan, Netherlands, Sweden, the United Kingdom, and the United States. With Switzerland, the Ten become Eleven. [Footnote in the source text.]↩