28. Memorandum From Secretary of the Treasury Dillon to President Johnson1


  • Balance of Payments Problems with Canada

We have one balance of payments problem with Canada which it would be important for you to mention to Prime Minister Pearson.2 This is the necessity for continued reasonable restraint by the Canadians in the sale of new security issues in the American market, under the exemption which you have given them from the provisions of the Interest Equalization Tax.3

In 1963, when the principle of the exemption was agreed with the Canadians,4 they indicated that they could and would control the volume of their borrowings in the United States by lowering their long-term interest rates so that Canadian sales of new issues in our markets would not lead to any increase in overall Canadian monetary reserves. Measuring from the introduction of the Interest Equalization Tax in July 1963, Canada has generally fulfilled this obligation with the exception of a $180 million repayment of their debt to the International Monetary Fund. They have claimed that this did not add to their reserves while we felt that it should be included. However, an honest misunderstanding was certainly possible on this item, and in any event it is now water over the dam. We now have a clear agreement with the Canadians that any further transactions with the IMF will count as additions to their reserves.

When we look at the year 1964, however, the situation is different. Overall Canadian reserves did rise by $81 million during the calendar year, without counting the IMF repayment of $180 million which served to hold down the rise in published reserves. During this period the outflow of dollars into new Canadian issues amounted to $676 million which is much too high for a permanent level. This situation became particularly acute in the fourth quarter when the new issue outflow to Canada rose sharply to $359 million or an annual rate of over $1.4 billion. The [Page 80] reason for this sudden burst was that some Canadian borrowers had held up their borrowings pending final approval of the Interest Equalization Tax and assurance by the President of a Canadian exemption. The Canadians now assure us that they expect a sharp decrease in new issues in the coming months. This is in accord with our own best information.

I raised this matter with Finance Minister Gordon in Tokyo in early September,5 and we stressed its importance to the Canadians during November and early December when the Governor of the Bank of Canada, Mr. Rasminsky, who negotiated the original exemption, came to Washington to talk with me.

As a result of these conversations, Finance Minister Gordon informally suggested to the Canadian Provincial authorities that it would be helpful, in the coming months, if they maximized their use of the Canadian market for new borrowings and avoided the New York market. At the same time, and for the first time since July 1963, the Bank of Canada by its operations in Canadian government bonds lowered the interest rate differential between long-term Canadian bonds and U.S. government bonds to approximately .80 percent from the 1 percent differential which had long been customary. Early in January, in accord with this policy, the Ontario Hydroelectric Commission successfully sold a $79 million new issue in Canada which under other circumstances would undoubtedly have been done in New York.

While the Canadians are now cooperating reasonably well, one reason for their cooperation is their knowledge that the Interest Equalization Tax will probably have to be extended later this year. They wish to build a record in the coming months that will give assurance to our Congress that the Canadian exemption can be safely maintained. There is a danger that renewal of the Act will again be followed by a burst of Canadian borrowing in New York.

It is important for you to indicate to Prime Minister Pearson your awareness of this problem, and its importance to our over-all balance of payments situation. It would help if you could stress the need for Canada to reduce her dependence on the New York market to the maximum extent possible not only prior to Congressional action on the extension of the Interest Equalization Tax but also thereafter. You could tell Prime Minister Pearson that any new bulge in Canadian sales in the New York market after the extension of the tax would put great pressure on you to set a ceiling on Canadian borrowings under the terms of the law.

Prime Minister Pearson may reply that Canada will make every attempt to carry out her agreement, but that the prospects are for a deterioration [Page 81] in the Canadian current account balance during 1965 which will have to be made up by borrowing abroad. The Canadians have a habit of being unduly pessimistic about their trade prospects. They expected their 1964 trade balance to be worse than the 1963 results. In fact, it turned out better. If Pearson should answer in this vein you might tell him that we are more optimistic than they regarding Canadian balance of payments prospects, and that, in any event, borrowing in our market should be held down until actual results in other areas of their payments clearly indicate a necessity for some increase in order to maintain the level of their overall monetary reserves.

Douglas Dillon
  1. Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. 2 [2 of 2], Box 2. Limited Official Use.
  2. Canadian Prime Minister Lester B. Pearson met with President Johnson at the LBJ Ranch January 15–16. For an exchange of remarks between the President and the Prime Minister on January 16 prior to their signing of a U.S.-Canadian agreement on trade in automotive products, together with the text of the agreement, see Department of State Bulletin, February 2, 1965, pp. 191–194.
  3. A handwritten notation in the left margin reads: “See also p. 3.”
  4. See Foreign Relations, 1961–1963, vol. IX, p. 180, footnote 2.
  5. Secretary Dillon was in Tokyo for the joint annual meeting of the IMF and the IBRD September 5–11, 1964. His meeting with the Canadian Finance Minister has not been identified.