20. Paper Prepared for the Cabinet Committee on Balance of Payments1


1. Progress to Date

Our deficit on regular transactions now looks to be between $2–1/4 and $2–1/2 billion for 1964.

  • —That will be well below $3.3 billion 1963 deficit, but progress has fallen short of widely shared earlier expectations of decline to $2 billion or less.
  • —Deficit has widened to about $3 billion rate for second half, perhaps reflecting in some part side effects of U.K. crisis.

    With the deficit smaller and good first half results contributing to confidence, the net gold outflow subsided, but large December losses now expected to bring gold drain for year to estimated $175–$200 million.

  • —The earlier stability was partly fortuitous—reflecting first large Russian sales early in year and then some backwash of U.K. difficulties in form of gold sales to us.

2. Looking Ahead

Our technical experts foresee further limited gains in 1965, bringing the deficit on regular transactions slightly under $2 billion. If realized, that would be the smallest deficit since the balance of payments became a problem in 1958—but little if any better than what had been hoped for this year. Thus, the outlook is for the eighth straight year of large deficits.

3. Elements in the Problem

Our commercial trade surplus should reach a record $3.4 billion in 1964—a better-than-expected gain of $1.1 billion. Strong markets abroad helped, but in addition, our own price stability is beginning to pay off in strengthening our world-wide competitive position.

—However, on present reading, we cannot count on so large a commercial trade surplus in 1965; our experts now foresee a decline of about $750 million. The U.K. import surcharges and slower growth in Canada and some other markets will tend to restrain export growth, while an inventory buildup in steel and elsewhere is expected to swell imports.

On Government overseas account, President Kennedy scheduled a $1 billion reduction from the 1962 level by the end of this year—with full effect in 1965. This included savings of $500 million through tying of aid, $300 million from lower defense spending, and $200 million from reduced purchases by AEC abroad. That target, on present schedules, should be closely approached.

  • AID has virtually reached its target.
  • —Defense is about $35 million behind schedule, partly reflecting pay increases. Moreover, plans for certain additional military reductions have been set aside, largely for political reasons, and $125 million of approved further reductions are not scheduled to be effective until 1966.
  • —Purchases by AEC are being reduced on schedule.

Clear slippage is apparent in private capital outflows, despite the restraining influence of the Interest Equalization Tax on purchases of foreign securities.

  • —Bank loans—only partly related to exports and special Japanese needs—ran at a record $2.2 million annual rate in first three quarters, despite declines in short-term lending over the summer.
  • —Direct investment is reaching a new peak of over $2 billion.
  • —Some liquid funds have moved abroad, despite effort to maintain short-term interest rates at competitive levels.
  • —New Canadian securities—exempt from IET—turned out to be larger than expected, particularly in recent months.

The travel account is another important drag on progress. Tourist spending abroad continues to rise rapidly, reaching $2.9 billion, $1.7 billion more than foreigners spend here.

4. Evaluation

Continuing, visible progress toward reducing our deficit is essential to assure adequate financing for our deficit and to maintain confidence—already affected by side effects of the U.K. crisis.

  • —In this context, the technicians’ current forecast would be judged disconcertingly high by European creditors—too high to be fully certain of orderly financing.
  • Present policies must be continued and reinforced—and “emergency backstops” prepared—to assure that forecast can be bettered and the ground laid for further significant progress in CY 1966. The “safety margin” today is not adequate.

5. Indicated Program


Basic to all else is continued price and cost stability—the key both to export expansion and continued confidence in our longer-run prospects.

—This suggests reiteration of “guideposts”, close attention to key wage and price decisions, and continued emphasis on measures to spur productivity and cost-cutting.

On that foundation, our export effort should be further strengthened through:
Increased emphasis by Commerce on locating foreign markets, contacting potential new exporters, and promotion of cash sales which are more immediately productive than credit sales on extra liberal terms. Strong Presidential backing will be needed for adequate appropriations to carry out this program.
More flexible policies by Maritime Administration to (a) permit shipment of Government-financed exports in foreign ships where necessary to make sale, and (b) correct shipping cost differentials that discriminate against U.S. exports.
Exploration by affected agencies of opportunities for developing Iron Curtain markets, including judicious use of credit where this leads to accompanying cash sales.
Re-examination of targets for reductions in AID and Defense spending abroad is required to prevent slippage and to seek out further areas for savings. Necessary actions should be taken to assure: (1) Germany meets commitment [Page 59] for military orders and payments to U.S. which fully offset U.S. defense spending in Germany during 1965 and 1966, and (2) the $125 million additional DOD reductions approved in October 1963 for implementation in calendar 1966 are carried out.
To restrain the losses on travel account, it is essential to:2
Extend legislation limiting duty-free tourist imports, possibly with a reduction in present $100 per trip limit.3
Invigorate the “See America Now” program with adequate appropriations, centralized responsibility, and top level support.
Assure that fare decisions by the CAB take into account balance of payments implications of foreign travel.4
As a major “backstop” for our effort, we should devise a workable tax on overseas U.S. tourists for possible implementation well before heavy summer tourist season.5
Reductions in the heavy net capital outflow are essential to achieve the needed reduction in the balance of payments.6
Renewal of the basic Interest Equalization Tax legislation will be required.7
Implementation of tax changes and other measures required to improve climate for foreign purchases of U.S. securities should be expedited.
We must be prepared to close Canadian exemption if anything like present borrowing rate is maintained ($380 million in fourth quarter). However, the Canadians have indicated clear recognition of need for lower rate next year.
Increasing domestic loan demands may slow rise in foreign bank lending. If not, the IET will need to be extended to bank term loans.
Monetary policy is doing what it can at the moment to minimize outflows of short-term funds while supporting domestic growth. Its flexibility in meeting future contingencies must not be impaired. Monetary policy will also need continued support from Treasury debt operations [Page 60] and from intervention in foreign exchange markets to meet objective of avoiding incentives to shift liquid funds abroad.
In the best of circumstances, we must be prepared for further gold losses. Declining ratio of gold to Fed note and deposit liabilities (now near 28 per cent) underscores need for relaxing 25 per cent gold cover requirement, making gold unambiguously available in defense of dollar. (The primary public justification for this move lies in coming need to provide for the long-run expansion in the monetary base required by domestic growth.)8

6. Recommendation

A tentative decision should be taken to send a special balance of payments message to the Congress on or about March 15, when detailed figures on 1964 results first become available. This message could reiterate Presidential determination to substantially improve our payments and to take all needed measures to that end.

It could report results of effort to reduce Government expenditures overseas, request extension of Interest Equalization Tax, emphasize need for action on other items in legislative program and announce any further steps which may be necessary.

  1. Source: Kennedy Library, Herter Papers, Balance of Payments (January 29, 1963 thru April 24, 1965), Box 6. Limited Official Use. The source text bears no drafting information. A copy of the paper, without the handwritten notations, is in the Johnson Library, National Security File, Subject File, Balance of Payments, vol. 2 [2 of 2], Box 2. A December 9 covering memorandum from Dillon to the members of the Cabinet Committee on Balance of Payments is ibid. The Cabinet Committee comprised Secretaries McNamara and Hodges; Under Secretary Ball; David Bell; Christian Herter; Kermit Gordon; Gardner Ackley, Council of Economic Advisers; McGeorge Bundy; and William McChesney Martin, Board of Governors of the Federal Reserve System. The paper was distributed in preparation for an afternoon meeting with Secretary Dillon on December 9 and for a meeting with President Johnson on December 10.
  2. A handwritten notation in the left margin reads: “too strong.”
  3. A handwritten notation at the end of this sentence reads: “study on effect now underway.”
  4. A handwritten notation in the left margin reads: “Unclear what BP effect would be. Study needed.”
  5. A handwritten notation in the left margin reads: “Ball strongly disagrees. Capital outflows more important. Distorted social values. Tourism has helped our internat’l position.”
  6. Two handwritten notations appear below this paragraph. One reads: “Balance with something on private capital outflow.” The second reads: “Include OECD study of border tax policies.”
  7. President Johnson recommended an extension of the Interest Equalization Tax for 2 years beyond December 31, 1965, in a speech to Congress on February 10, 1965; see Public Papers of the Presidents of the United States: Lyndon B. Johnson, 1965, Book I, pp. 170–177.
  8. A handwritten notation in the left margin reads: “Move fast. State of Union.”