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

33. Report From the Cabinet Committee on Balance of Payments to President Johnson¹

Washington, undated.

REPORT TO THE PRESIDENT ON BALANCE OF PAYMENTS

I. Situation and Program

Fourth Quarter Results.

Preliminary data for the fourth quarter show a sudden and substantial worsening of our payments position. As compared with a November projection of about $900 million, the actual fourth quarter deficit is now estimated to have been almost $1.6 billion. Most of the $700 million difference is apparently accounted for by larger than projected outflows of short-term funds and long-term bank loans and by a failure to receive the British debt repayment of $138 million.

Factors contributing to the fourth quarter deterioration appear, in part, to have been temporary, but

• —the sudden change for the worse, plus
• —the failure to achieve a more rapid reduction in our stubbornly large deficit that has persisted for seven years, plus
• —the resumption of large gold outflows

have revived serious concern about the strength of the dollar.

Prompt action is needed to deal with the situation. This can best be announced by a special balance-of-payments message in early February. This message should contain a strong reaffirmation of your determination to defend the dollar and a description of actions which you have ordered or are requesting from Congress to improve the situation.

Trend in the Deficit.

Some improvement has been made in our balance of payments since 1960, our worst year.

• —Our commercial exports in 1964 were $4.4 billion above the 1960 level, thanks to an exceptionally large increase ($2.8 billion) last year, partly due to unusual agricultural exports to the Soviet zone.
• —Our imports were only $3.8 billion above the 1960 level, showing a percentage increase lower than the growth of our national income.
• —Private investment income was $1.9 billion higher in 1964 than in 1960, with an exceptionally large increase during 1964 due to several special transactions.
• —Government expenditures abroad last year had a $1 billion lower net balance of payments impact than in 1960. Included in the decline was about $675 million of net military expenditures.
• —The adverse balance on travel on the other hand, was almost $400 million larger in 1964 than in 1960, although it showed no deterioration from the 1963 level.
• —Long-term bank credits to foreigners were some $850 million higher in 1964 than in 1960 and direct investment abroad was almost $500 million higher.
• —Short-term capital outflows (presently estimated at about $2.2 billion) were also about $850 million higher than in 1960, but this outflow is highly variable, having been as low as $550 million in 1962 and as high as $1,550 million in 1961.
• —Net purchases of foreign securities in 1964 were at about the 1960 level, but would have risen by a substantial amount in the absence of the Interest Equalization Tax. As it was, the tax discouraged all U.S. security flotations by the advanced countries at which it was directed.

These various changes were reflected in the regular transactions deficit which showed the following trend:

Years	$Billion
1960	3.9
1961	3.1
1962	3.6
1963	3.3
1964 (est.)	3.1

The $500 million reduction in the last two years combined is much too slow a rate of improvement to ensure the avoidance of a serious crisis of confidence in the dollar. A reduction in the 1965 deficit significantly below $2 billion, with clear prospects for further substantial improvements in 1966, must be our objective.

Outlook for 1965.

Table 1 shows the composition of our estimated $3.1 billion deficit on regular transactions for 1964–-final figures of this breakdown will not be available until early March—and a projected range of $2.5 billion to $3.2 billion for 1965.² (The upper limit of the range would have been raised by several hundred million dollars by one agency representative and the lower limit would have been lowered by several hundred million dollars by another agency representative, but the majority favored the range shown.)

This range is to be interpreted as follows:

• —The upper limit of $3.2 billion indicates that under our present program the deficit could well be greater than the 1964 deficit, even in the absence of a crisis of confidence in the dollar.
• —The lower limit of $2.5 billion indicates that the deficit, under the most favorable circumstances, will probably not show more than a moderate decline from the 1964 level.
• —The mid-point of $2.85 billion indicates that, in the absence of a crisis of confidence, the deficit will most probably show only very slight improvement from the 1964 level.

But in absence of marked improvement from the 1964 position there is no assurance against a crisis of confidence, particularly in view of resumption of gold losses. To get assurance, we must adopt measures which can be expected to reduce the deficit by more than $1 billion in 1965 (bringing our probable deficit well below $2 billion), and by an additional amount in 1966.

Program and Possible Savings.

Table 2 shows nine agreed measures and potential savings for 1965.³

These measures do not offer equally firm prospects for savings. (There is not sufficient experience with moral suasion to afford confidence in estimating results. There is also no sound basis for checking individual banker’s judgments as to how much in additional exports would be achieved in 1965 by expanded export financing facilities.)

They also differ in respect to the time-pattern of the expected savings. (In case of moral suasion, for example, effect is likely to be rather quickly achieved but could be short lived.)

Finally, indirect effects of measures—particularly in stimulating possible evasions—vary greatly. A tax on one form of capital will lead to some increase in outflow through untaxed channels. Allowance was made for this in estimated savings by keeping them on conservative side, rather than by showing more optimistic amounts accompanied by partially offsetting increases in other forms of outflow.

II. Agreed Program of Immediate Measures

The agreed measures provide total estimated savings of $1,470 million in 1965. These measures, however, as noted above, are not of equal firmness as far as savings anticipations are concerned. The first six measures in Table 2 which are the firmest in this respect total only $630 million. Each of the measures is commented on in the following paragraphs.

If the measures finally adopted should not constitute an effective program, the only alternative would be a considerable tightening in bank credit availability, with inevitable repercussions on our domestic economy.

Apply and Broaden Gore Amendment.

Gore Amendment. Application of the Gore Amendment by Executive Order on the data of your message to the Congress is expected to reduce the $1,300 million of projected disbursements under long-term bank loans to advanced countries to about $1 billion. Net disbursements (after estimated repayments) to advanced countries would then be about $300 million.

Despite the tax Japan will probably want to borrow $200–$300 million in view of its high domestic rates and customary recourse to the U.S. for financial capital. At the present schedule of tax rates, a number of other advanced countries will also want to continue borrowing here. Their residents even now are reportedly committing themselves to reimburse the lending U.S. bank for the tax, if it is applied.

Higher IET Rates. If Congress were to raise the schedule of tax rates and make it applicable to all U.S. long-term bank loans made after the date of the message—measure number 3 of Table 2—some of these borrowers would drop out of the U.S. market and an additional $200 million of savings for the balance of payments would probably be achieved.

Non-Bank Long-Term Lending. The above savings estimates make an allowance for some leakage through other channels, although as noted below such leakage might be somewhat restricted through a strong moral suasion effort. One of these channels of leakage which it seems appropriate to restrict by application of the tax is non-bank long-term lending to foreigners—measure number 2 in Table 2. Such lending has not been sizable (apart from a special transaction last year in connection with the British Columbia Hydroelectric Project); but it could grow as an escape channel from the tax on long-term bank lending unless it also were subject to the tax. A modest saving of $20 million is projected in 1965 from applying the tax to long-term non-bank loans—for example, loans by insurance companies, trust funds, etc. The export and less developed country exemptions to bank loans would also apply to non-bank loans.

Military Expenditures Abroad.

In view of the previous actions taken by Defense, further substantial reductions in expenditures could be effected only through a major realignment of our forces overseas. Possible additional actions by Defense include cutting purchases of petroleum abroad with substantial increases in budgetary costs (increases range from 25% for returning Av Gas to approximately 100% for jet fuels and roughly 200% for Navy special fuel oil), holding Army strength overseas generally below author-ized levels, thinning out of personnel in certain selected countries and other economies which are also likely to increase budgetary costs. Further savings in 1966 are possible through similar actions. No withdrawal of combat units per se is contemplated under these strength restrictions. Balance of payments savings are estimated at $50 million in 1965 and $100 million in 1966, excluding contingencies which may arise in Southeast Asia.

State notes that in light of our existing situation abroad, particularly in the Far East, these proposals would require careful consideration in detail to assure that our political military interests abroad are not undercut.

Tourist Duty-Free Imports.

Request Congress in extending tourist duty-free exemption for two years to reduce amount of exemption from $100 to $50 and confine it to items accompanying tourist; also remove the special exemption for liquor.

Possible savings: approximately $40 million in 1965 if put into effect by May 1; $50 million to $60 million in 1966. The combined savings from these actions have been estimated conservatively to allow for possibility that reduced expenditures for foreign goods may be offset to some extent by increased expenditures for services within the foreign country.

Such action would leave U.S. policy still as liberal or more liberal than that of other advanced countries. Some increase in administrative cost would be necessary to make reductions effective but most, if not all, would be offset by additional revenue earned.

Encourage Foreign Portfolio Investment in U.S.

This measure would involve new legislation permitting easier tax treatment of foreign portfolio investment in the United States. Modest savings are projected for 1965 since the bulk of the effect would be expected to accrue only with a lag. Effects in later years could be substantial.

Moral Suasion.

After extensive discussion, there was unanimous agreement that, under present circumstances and at the present time, a strong across-the-board campaign of moral suasion over all forms of direct investment and bank and non-bank lending will produce as favorable results as tax action and would avoid the very real dangers of attempting to secure legislation in this area.

As Applied to Non-Banking Business Community. The business community strongly believes that direct investment abroad benefits the balance of payments in the long run because of the repatriated profits and because of the exports which many direct investment projects generate. Large balance of payments savings could result if firms were consciously to consider the impact of their total operations on our immediate balance of payments problems. They should be urged

• —to reduce over the coming months their holdings of short-term investments abroad;
• —to exercise restraint in financing their direct investments abroad with U.S. funds;
• —to avoid or postpone direct investments in projects which do not promise clearly to be profitable, i.e., marginal projects should be avoided;
• —to increase the repatriation of income earned abroad;
• —to increase their exports to and through their manufacturing and sales affiliates abroad; and
• —to open up new export markets in countries where they are not now active.

A special White House meeting of the operating heads of the two or three hundred non-banking corporations most involved in direct investments and in exporting would be arranged, at which you could give a frank statement on our balance of payments situation.

• —You would appeal to them to assess carefully the impact of their decisions on the balance of payments.
• —To measure the degree to which such cooperation was forthcoming, you would request that each corporation send to the Secretary of Commerce a quarterly report on changes in their short-term investments abroad, changes in their direct investments, their repatriated earnings and their exports, and a report on actions taken to reduce the outflow of funds from the United States or increase the inflow of funds to the United States.

Large outflows of direct investment, particularly to Western Europe, as Table 3 shows, suggest the possibility of large balance of payments savings by some form of restraint, without serious short-run reduction in net income from accumulated direct investment abroad.⁴

In addition to their direct investment in foreign subsidiaries, many large U.S. companies make investments in liquid assets abroad (bank deposits, foreign Treasury bills, etc.) directly out of the U.S. head office. Also, firms that do not have subsidiaries frequently keep deposits or holdings of money market instruments abroad as a form of short-term investment.

• —Such liquid funds held in advanced countries as of the end of last September amounted to over $2 billion of which over $1.5 billion was in Canada, $300 million in the U.K. and about $125 million in Japan.
• —A small part of these holdings represent working balances for operations abroad; the great bulk of them represents short-term investment.

It is recommended that in your address to business leaders you also exert moral suasion for a reduction in these short-term foreign investments in the interests of helping our balance-of-payments position.

• —The small number of companies which hold a large portion of these funds abroad may be even more receptive to reducing these holdings than to cutting back their plans for direct investment abroad over the next few years.
• —The short-term investments yield only slightly higher interest earnings than what they could earn in the U.S., whereas direct investments generally offer much wider profit differentials over a period of time.

A fairly substantial response to moral suasion on this item might, therefore, be expected from the large corporations.

Substantial withdrawal of funds on their part may well exert some upward pressure on interest rates in foreign money markets which would tempt other U.S. firms or individuals to add to their holdings abroad. Hence, we have estimated a net saving of only about $200 million from this moral suasion effort.

Care would have to be exercised in this effort to avoid disrupting the money and exchange markets in countries from which funds might be withdrawn by U.S. corporations.

• —If large amounts were actually transferred back to the United States, repercussions would undoubtedly be felt on both the London and Japanese markets; there would, in fact, be a substantial risk of aggravating the sterling crisis and of creating difficulties for Japan.

  (U.S. funds held in Canada are either reinvested back in the U.S. or in London, so that no serious repercussion on the Canadian domestic money market is foreseen although the banks there would lose some profitable middleman business. To the extent Canadian banks respond by reducing their own American investments, our balance of payments as presently calculated would be improved, but the change would not affect the net flow of dollars into official hands abroad or pressure on our gold stock.)

• —Since we do not want to aggravate the weakness of sterling or create a crisis atmosphere in the Japanese money market, an abrupt “across-the-board” withdrawal of funds from abroad would be dangerous, and this must be considered in implementing this measure.

As Applied to Banking Community. In addition to the application of the IET to long-term bank loans, moral suasion on banks to reduce their loans to foreigners would be exercised through the Federal Reserve, the Comptroller of the Currency, and the FDIC. This moral suasion would be accompanied in the case of banks by some reduction in credit availabilities (lower level of net free reserves) so as to reinforce the moral suasion effort.

The Federal Reserve could also be encouraged to consider amending Regulation A so that extension of rediscount facilities to a member bank could be based in part on whether or not that bank is expanding its total foreign lending activity.

Savings from this operation are estimated at $100 million.

Moral suasion would be particularly effective if it also involved a Federal Reserve request to banks to limit the increase in loans to foreigners, both short-and long-term, to 5 percent a year. (It was 36 percent in 1964.) An additional $100 million of savings, or more, could be achieved.

Note: With taxation of long-term bank loans to foreigners—intensified if the schedule of tax rates is raised by Congress, at our request, as recommended above—and with application of moral suasion on both long-term and short-term bank lending to foreigners, we will want to give particular attention to any resulting problems affecting Japan because of both political and economic considerations. Any recommendations in this area will be forwarded in a separate memorandum to you.

As Applied to Canadian New Issues. Canadian security issues in this country have for nearly a decade fluctuated between $200 million and $700 million a year. Before 1963, the annual totals of such issues did not exceed about $450 million; only in 1963 and 1964 were the record totals of about $700 million reached. Canadian issues promise again this year to reach a large volume unless restraint is exercised.

It is essential that the volume of new issues of Canadian securities sold in the U.S. during 1965 be significantly reduced from the 1964 level. This will require, at the least, strong representations to the Canadians, including a further conversation on your part with the Prime Minister, or, as an alternative, the exercise of your authority to set an over-all limit on Canadian borrowing here. (Savings in either event should total at least $100 million.)

Export Measures

Long-range health of our payments balance depends in large measure on our success in this area. A one per cent increase in our commercial exports over the 1965 forecast would reduce the deficit by about $225 million.

The most basic requirement is for maximum emphasis on, and success in, the maintenance of continued cost and price stability in our domestic economy.

Combined with this, reinforcement of our export promotion program is needed. Here relatively inexpensive measures can pay off in a substantial way. The export expansion program, with a fiscal year 1965 budget of less than $10 million, clearly earns many times this amount in additional foreign exchange.

• —The Administration should press Congress vigorously to grant the full fiscal year 1966 export expansion budget request of somewhat over $12 million. If the export promotion measures made possible by the expanded budget combined with the trade development proposals in the Magnuson Bill (establishing trade development corps of private businessmen, use of local currencies for trade promotion and establishment of sales and service centers abroad) were put into effect, the estimated gain in exports during 1965 would be $20 million and much more in later years.

• —Support Federal Maritime Commission’s efforts to investigate and eliminate apparent discrimination against U.S. exports in shipping rates. (Requires no legislation.) No savings are estimated from this action during 1965.

  Commerce Department consulted with a group of major banks involved in export financing. Each bank gave its estimate of the minimum total figure per year in export financing business that, in its judgment, is lost to that bank because of the inflexibility of the present export financing program and the lack of a program of the kind contemplated by the Magnuson bill. Each bank has also given what it thinks is a minimum estimate of the total business being lost each year by all the banks on short and medium-term credit. The consensus of the banks with whom this was discussed was that a minimum of $300 million of desirable export business on short and medium terms is not now being done because of present Exim Bank limitations. With a 20 per cent down payment by foreigners on $300 million of additional purchases in the U.S. and a $40 million installment payment by foreigners later in the year, the gain in balance of payments receipts during 1965 is estimated at $100 million. In view of the above

• —current Export-Import Bank procedures should be eased to assure fully competitive risk-taking in financing of U.S. products and services and in extension of export guarantees.

“See the U.S.A.”

Vigorous implementation of a program to persuade Americans to travel more at home and less abroad would achieve some savings for the balance of payments during 1965. The savings would be small, however, due to the fact that many spring and summer travel plans are made in January and February. A promotional program may divert to domestic attractions some of the travel which otherwise would go to Mexico and Canada. But it seems unlikely that the bulk of the contemplated trips to Europe would be affected during 1965. A substantial travel tax would be required for this purpose, as discussed below.

—You should appoint an administrator of the “See the U.S.A.” program who would launch measures designed to reduce American over-seas travel in 1965 and 1966. (Estimated savings in 1965—$20 million; in 1966—$100 million.)

III. Other Measures

Travel Tax.

—Legislation establishing for 2 years a travel tax to all foreign countries outside the Western Hemisphere, with an exemption for students and teachers (including those covered by Government programs—e.g., Fulbright scholars) departing the U.S. for at least a nine months’ period of study abroad, and for Government personnel on official business.

(Estimated 1965 savings @ $100 per trip—$140 million.)

(Estimated 1965 savings @ $200 per trip—$275 million.)

Arguments for:

Travel outlays by Americans, including fares, are one of the largest outflow items in the balance of payments and are expected to total over $3 billion in 1965 in absence of any action. While U.S. receipts from foreign tourists began to rise in past two years and our net tourist deficit in 1964 appears to have remained constant, further large increases in American travel abroad are expected.

The tax would be directed at an expenditure item which for the most part is in luxury category, and can be postponed with relatively little hardship. At same time, reduction in this category, perhaps more than in any other, will be at the expense of the countries of continental Western Europe in the best position to absorb the reduction.

Reduction in expenditures contemplated would still leave total payments for tourists for 1965 and 1966 at about the same level as in 1964, thus would not be significant reduction in earnings of activities depend-ent on tourist industry such as U.S. or foreign airlines and shipping lines. In addition, no significant effect on U.S. aircraft sales to foreign countries seems likely since (a) the tax is for only 2 years, (b) the bulk of the savings will not come from reduction of the number of travelers (but from shorter stays and less spending per trip) and (c) the effects which are expected on the number of travelers will largely be limited to potential increases.

Tax on this item would broaden balance-of-payments program

• —by having a favorable psychological effect on the million U.S. military personnel and their dependents serving overseas who are well aware that previous programs have omitted any actions relating to tourism, and feel very strongly that they have had to bear a major burden of previous action programs.
• —and tending to lessen opposition and adverse reaction of financial community to variety of measures restraining investments, which, in contrast to tourist expenditures, offer eventual large return.

It would bring sizeable needed savings in a way that cannot easily be affected by leakages.

Arguments against:

Many countries look on all current account transactions as basically same in nature and would argue that restriction on tourism contradicts U.S. stand on liberalizing international trade. Some feel could compromise our position in current Kennedy Round negotiations under GATT.

The tax would be regressive. Lower income travelers, who spend relatively small amounts on their trips abroad, would not be able to afford the tax. The big spenders would; and would spend as much abroad as before.

Less developed countries outside the Western Hemisphere might make protest since many of them trying to build up their tourism business.

In longer range context, there is also the question of the merit of curtailing international travel and contacts with foreigners. Private travel may have important long run benefits to our international relations, and U.S. citizens may feel that freedom of movement is being challenged.

Some retaliation by foreign countries may occur. This could both reduce net effect of tax by reducing our tourist receipts, and raise problems involving our political relations abroad. Some believe there is a possibility of repercussions on the trade account—e.g. aircraft sales. The increase in costs to American tourists from the tax could bring added pressures by air and shipping lines to reduce fares.

Taxes on Direct Investment and Short-Term Investments.

The Cabinet Committee on Balance of Payments unanimously agrees that present circumstances do not require action in these areas. Vigorous efforts at moral suasion offer the best hope of gain in the immediate future and run far less risk of triggering widespread anticipation of comprehensive controls which, by inciting heavy outflows of funds, could defeat the entire program. The State Department and Council of Economic Advisers however believe that consideration should be given to a tax in these areas if a tax on tourist travel is to be adopted.

As regards direct investment, some suggest that it be limited to so-called “takeover” transactions; this would involve serious technical problems of definition and administration. Application of the tax would also raise difficult technical questions of how to exempt exports, associated with direct investments abroad, without either virtually losing deterrent effect of tax, on the one hand, or taxing many direct investment operations which possibly would create additional U.S. exports, on the other hand. The Department of Commerce feels that the business community would strongly resent such action and would continue their projects despite the tax.

1. Source: Washington National Records Center, RG 40, Records from the Office of Franklin D. Roosevelt, Jr., Under Secretary of Commerce, 1963–June 1965: FRC 68 A 5947, Correspondence: The President, 1965. Confidential. The source text is attached to a February 1 memorandum from Secretary Dillon to the Cabinet Committee on Balance of Payments in wich he requested “final comments, if any, to Acting Assistant Secretary Trued by noon on Tuesday, February 2, 1965, so that we may transmit the report to the White House on Tuesday afternoon.” A copy was also sent to Martin, Chairman of the Board of Governors, Federal Reserve System.
2. Table 1 is not printed.
3. Table 2 is not printed. The nine measures are discussed in detail in Section II below.
4. Table 3, entitled “U.S. Direct Investments, 1963 and 1964,” is not printed.