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

94. Memorandum From Secretary of the Treasury Fowler to President Johnson¹

Washington, May 10, 1966.

SUBJECT

• Balance of Payments—1966

I. Appraisal of the 1966 Outlook

The balance of payments picture continues to be disturbing. The first quarter deficit, which will be revealed publicly on May 18 for the first time and in some detail—in the regular quarterly Department of Commerce Report—will total about $600 million, seasonally adjusted, on an over-all (liquidity) basis. This is an annual rate of $2.4 billion, compared to a $2.8 billion deficit in 1964 and a $1.3 billion deficit last year.

On an official settlements basis, the first quarter deficit, seasonally adjusted, amounted to about $300 million which annualizes at $1.2 billion, compared with $1.3 billion last year. As you recall, we began publishing this deficit along with the over-all deficit starting in the final quarter of 1965, as a result of the recommendations of the Bernstein Committee.²

The Cabinet Committee on Balance of Payments is in unanimous agreement on additional measures that would, if successfully implemented, yield savings of about $800 million. Such savings would bring the 1966 deficit back to $1.6 billion, assuming no underlying deterioration from the deficit rate in the first quarter. Unfortunately, there is reason to believe such deterioration may be taking place. If this proves to be the case, the measures on which the Cabinet Committee has reached agreement will not only fail to achieve, by a substantial margin, our goal of equilibrium, but the year could end with a deficit substantially worse than in 1965. The fundamental problem can be summarized as follows: our trade surplus is shrinking; growth of our services surplus is being held back by the growing tourist deficit; together, our surplus on goods and services combined will not be sufficiently large to compensate for

• —the governmental dollar outflows now increasing substantially because of the superimposition of new Southeast Asia costs on the costs of our other commitments throughout the world; and
• —private capital outflows, despite the fact these have been reduced by our two voluntary restraint programs instituted in February 1965 and tightened in December and by the operation of the Interest Equalization Tax enacted earlier.

What we do about this situation and what we say about it involve decisions as important as any your Administration will have to make.

This memorandum is designed to shape the issues.

II. What We Have Been Doing About It

When the 1966 program was announced on December 3,³ the following assumption was publicly presented as one of the reasons for the belief we could reach equilibrium this year.

—our trade surplus will widen from the annual rate of $5.0 billion generated in the first nine months of 1965 but is likely to remain somewhat below the high level of $6.7 billion in 1964. In 1964, our trade position benefited from an unusual convergence of events including strong industrial demand abroad, large agricultural sales, and shipments in anticipation of a dock strike. In 1965, events have been less favorable, including unusually strong domestic demand, less strong demand from key nations abroad, a dock strike, and a high level of steel imports in anticipation of a strike in that industry.

This seemed reasonable at the time in view of the fact that the preliminary figures for the third quarter and October indicated a favorable upturn from the lower levels in the first two quarters.

However, when the figures for the fourth quarter become available in January,⁴ the possibility of a less favorable trade surplus began to emerge.

Moreover, there had been a significant change in the 1966 gross national product estimates from the $710 billion level which characterized the mid-November period when the 1966 balance-of-payments program was determined. The Economic Report in January estimated $722 million, giving rise to the probability of a substantially increased volume of imports.⁵

Also there were indications from the Department of Defense in late January that the balance-of-payments costs in Southeast Asia were running at or beyond the high end of the range forecast in November exercise.

When these developments became observable in January, we adopted the policy of hoping for the best but preparing for the worst.

Accordingly, Treasury instituted a quiet “nuts and bolts” tightening exercise of the type used in the fourth quarter. For a description of the steps taken see Attachment A.

More significantly, we began to forge additional measures and to explore others which could compensate for the deterioration which might develop from these or other sources.

Treasury Assistant Secretary Trued and Deputy Assistant Secretary Knowlton conducted a penetrating review which developed the issues described in a memorandum dated March 3, 1966 (“Summary of Balance of Payments Review”)⁶ which Mr. Bator and I discussed with you early in March.

During the first few weeks in March, I held a series of bilateral discussions with

• —the Vice President and Secretary Connor on the tourist problem;
• —Secretary McNamara on military expenditures;
• —Administrator Bell on the aid program; and
• —Budget Director Schultze on the gold budget.

By the end of March it had become clear that an additional $1.5 billion of savings would be required this year to bring us into equilibrium (cf. my memorandum to you dated March 30). (Attachment B)

The full Cabinet Committee on Balance of Payments met on March 25 to discuss a wide range of possible new measures;⁷ it has continued to meet, on an informal basis, throughout April and early May.

On May 3, it reconsidered, at your request, the proposed tourist tax.⁸ The Committee still finds itself overwhelmingly opposed to such a tax—providing it is submitted to Congress as an isolated proposal. An important new factor in our most recent negative appraisal was the belief, based on additional statistical analyses done by Treasury, State, and CEA, that the measure was not likely to generate net annual savings of more than $300 million with the per diem rate set at $6. By doubling or tripling the per diem rate, of course, we might achieve higher returns but it seemed exceedingly doubtful to the group that these would amount to more than $600–$800 million. In 1966, with nearly five months gone, the savings would be much smaller. A minority of the Committee believes the tax would deserve more serious consideration if it were proposed as part of a broader tax package that would include higher income taxes and a strengthened Interest Equalization Tax covering direct investment outflows.

As a result of these deliberations (covering a period of nearly three months), the Cabinet Committee, as noted at the beginning of this memorandum, has reached agreement on additional measures which could provide savings of $800 million in 1966. A list of these recommendations, which we have already begun to implement, is attached. (See Attachment C) The bulk of savings would come, essentially, from further cutbacks in the balance of payments costs of the military program, from prepayment of debt owed the U.S. by other countries, and by diversion of a portion of official foreign holdings of dollars into long-term investments in the U.S.

III. Fundamental Decisions That Face Us Now

It is clear that we have reached the stage where we must make new and fundamental decisions about the nature of our whole program. The actions upon which we are agreed will not bring us into equilibrium in 1966, or even close to it. A number of them, quite frankly, are designed to “buy time”; they will help us, as in the case of debt prepayments, in 1966 but will not constitute recurring factors of strength.

We are faced with the following basic alternatives. (Alternatives (2) and (3) are not mutually exclusive but can be used together, in varying combinations):

Alternative (1)

Live with a substantial deficit—in the range of $1.5–$2.5 billion—for the duration of the Vietnam conflict, avoiding major changes in foreign policy and any major additional restrictions on imports, private capital outflows, and tourism, other than those incorporated in the present program.

We would state publicly that our goal was still that of reaching equilibrium but acknowledge that because of Vietnam it would be more difficult and take more time to achieve than previously anticipated.

We would pledge to continue to make every possible effort to minimize the balance of payments impact of present government programs. We would continue the voluntary restraints on capital outflows, and we would intensify efforts to stimulate exports looking to the long run improvement of the trade balance. But we would not fundamentally change the nature of our present program.

Alternative (2)

Reduce the deficit by cutting back U.S. commitments overseas.

This alternative would call for major changes in our foreign policy. It would require important reductions in our foreign economic assistance and military programs.

Alternative (3)

Reduce the deficit by introducing new economic and balance of payments measures at home.

This approach would require consideration of an income tax increase and a basic change in the character of our voluntary restraint program for capital outflows.

An income tax increase is not likely to have an important effect on the size of the deficit in 1966. It could not be passed until later this summer, and, unless it were substantially larger than anything we have recently been contemplating, it could not take more than a small bite out of gross national product until next year. However, it would have a constructive impact on psychology abroad; it would be construed as evidence of the seriousness of our intent in coping with our payments problem. This, in turn, could help to limit conversions of dollars into gold. And by gradually moderating the rate of increase in domestic demand, an income tax increase would, over time, help to reduce the pressure of imports and provide a margin of excess manufacturing capacity for exports.

In conjunction with our consideration of a domestic income tax increase, we would take another look at the impact of monetary policy on our payments position to see whether any further tightening would help and whether it could be tolerated here.

Private capital outflows could be further restricted by converting the Interest Equalization Tax into a broad, flexible instrument that would, in addition to capital outflows presently covered, apply to direct investment. This would not only change the character of our present program—subjecting corporations to law instead of appeals for voluntary compliance—but would involve for the first time a drastic cutback, instead of a moderation, in the rate of direct investment. If necessary, the Federal Reserve’s voluntary restraint program for financial institutions would be tightened at the same time.

Regardless of your decision on the above alternatives, we will want to make suitable attempts to minimize gold conversions or other disruptive impacts on foreign exchange markets. (See discussion in Part V below.)

IV. What We Say About It

What we say at the time of the Department of Commerce Report in the first quarter and what we do thereafter are matters of considerable significance.

So that you may know what we have said in the past, let me review the highlights from public statements starting last September at the IBRD and IMF meeting.

From your address to the World Bank and International Monetary Fund last September:

“The U.S. has taken firm action to arrest the dollar drain. Should further action be necessary in the future, such action will be taken.

“I want to be very clear about this. We must in our own interest and in the interest of those who rely on the dollar as a reserve currency, maintain our payments in equilibrium. This we will do.”⁹

From your public letter to me of December 2, 1965:

“We have done well, but we must do even better. The deficit has been much smaller since February 10 than for several years past. At its peak, in 1960, it reached $3.9 billion, three times the rate so far this year. But the present deficit is still too large. To assure that the dollar will remain as good as gold, we have to show the world that we can bring our accounts into sustainable balance, and keep them in balance.”

From my statement at the White House press conference on December 3:

“Against this background, and after an analysis of the other relevant balance of payments accounts, we concluded that new measures were necessary to reach our goal of equilibrium—by which for next year we mean a quarter of a billion dollars or so either side of exact balance on an overall basis. With these new measures we are confident, barring unforeseen circumstances, that we will reach that goal.”¹⁰

From your Economic Report to the Congress in January, 1966:

“Decisive progress was made in 1965 toward reducing our balance of payments deficit. Though the results for 1965 are gratifying, we cannot afford to relax. We have not yet balanced our external accounts.

“For 1966, external balance is our goal.”

In view of developments in January and early February, I took advantage of the February 14 press conference on the fourth quarter Department of Commerce report to lay the groundwork for an unfavorable turn, should it later develop.¹¹

I said, after analyzing the 1965 performance and discussing the key items on which we were counting for improvement in 1966:

“Now I would like to go over with you some of the main components of this 1965 record as they bear upon the future. There are both favorable and unfavorable elements.

“The $1.5 billion net reduction in the payments deficit on an overall basis occurred despite heavy outflows on private capital account during the early months and despite setbacks for the year as a whole in trade and other accounts. The improvement is in very large part attributable to the effectiveness of the program of voluntary cooperation which President Johnson called for in his balance of payments message of February 10, 1965.

“This 1965 record, and the tightening and sharpening of this phase of the President’s balance of payments program for 1966, give reason to believe that there will be continuing improvement in the private capital area.

“I would hope particularly that the Foreign Tax Investors Act, now in the House Ways and Means Committee, could become law this year, providing the basis for a long term expansion of the scale of private foreign portfolio investment in the United States.

“This prospect, the increase in investment income, a moderation of direct investment outflows, and a movement toward an expanding trade surplus, interrupted in 1965 by special circumstances, offer the most promising areas for our march toward equilibrium in 1966.

“Of course the two main imponderables are the rising balance of payments costs in Southeast Asia in both the military and the aid programs which are the result of Vietnam and the direct and indirect impact of Vietnam on the domestic economy and the balance of trade.

“With this in mind, we must certainly make every effort—we must not fail in our continuing efforts, both in and out of government—to find and to make every reasonable and practicable offset to the impact of Vietnam on our balance of payments.

“But, it should be kept in mind that the balance of payments costs of the Vietnam conflict are not permanent or ordinary costs, and that, although we have made provision for an increase in these costs in our outlook for 1966, it is simply not possible to say at this time how greatly, in fact, they will affect our balance of payments in 1966.

“What I can tell you now is that we still have equilibrium, as we have defined it, as our goal for 1966, but we cannot be certain that present measures as they currently operate will lead us to that goal if the foreign exchange costs of Vietnam rise sharply over the increases presently projected. Let me add and emphasize that as of now the program we have is an effective program, and we see no reason to change its character.” (Underlining ours.)¹²

It has been the custom for Secretary Connor, Chairman Martin, Governor Robertson and I to hold a press conference concurrently with the release of the Department of Commerce quarterly reports. To fail to have the customary press conference on this occasion and attempt by a non-technical statement and question-and-answer period to deal with the problem would be undesirable. Accordingly, unless you advise me otherwise, I intend to go through with it.

A text of what I should say is of the first order of importance and is Item 1 on the agenda for discussion.

Attachment D describes, in a preliminary way, the major changes that appear to account for the difference in first quarter results from our original forecast in November.

V. What We Do To Prevent A Crisis

We may have difficulty in the weeks immediately ahead in persuading other countries—particularly the important surplus countries of Western Europe—that we are still serious when we say we mean to solve our balance of payments problem. What we say on May 18th will, of course, have an important bearing on this, but no matter how effectively we rationalize the first quarter deficit, there is a possibility that our determination to move toward equilibrium will be questioned. And if so, we could be faced with a further deterioration of the deficit; acceleration of dollar conversions into gold; and a speculative run on the London Gold Market.

I hope this will not come to pass but we should clearly prepare for the contingency. Treasury and the Federal Reserve will work together, utilizing the tools at hand, to minimize the dangers of this kind of chain reaction and to place us in the strongest possible technical position should it arise.

If we are not confronted with an immediate crisis, there is still the real possibility that we will have one later in the year. Instead of coping with these threats on an ad hoc quarterly basis, I wonder if the time has not come for the U.S. to try to make informal arrangements with the major dollar holding nations of the world that would preclude such a crisis for the duration of Vietnam conflict.

Under Secretary of the Treasury Deming is leaving for Rome on Thursday, May 12, for the next round of negotiations with the Group of Ten; Chairman Martin leaves for Europe on Monday, May 16, for talks with a number of central bankers; and later this month I am scheduled to attend an American Bankers Association meeting in Madrid and Granada, where I may see a number of my European counterparts.

I propose that we give serious consideration to asking the key dollar-holding nations, during these visits, to pledge not to convert dollars they presently hold and not to convert any additional dollars that may accrue to them as long as the Vietnam struggle continues. To accomplish this, we will have to state in the strongest possible terms that:

1. We most emphatically do intend to bring our balance of payments into equilibrium.

2. The Vietnam conflict, with its attendant direct and indirect balance of payments costs, has made it difficult for us to do this as soon as we had hoped. But we will do it.

3. We are bearing virtually the entire burden of the Vietnam conflict. We view this as a commitment on behalf of all free nations. We do not ask others to see it this way, but we do ask that they not act in a manner that will prevent us from meeting our commitments and/or destroy the international financial institutions that are such a vital part of the world we are attempting to defend.

4. We believe that the major dollar-holding nations of the world have a choice: they can exercise patience and restraint, minimizing pressure on the dollar; or by making abnormal, new demands on our gold supply, they can risk serious disruption to the international monetary system—to the detriment of us all.

Henry H. Fowler

Attachment A¹³

STEPS TAKEN DURING 1ST QUARTER TO IMPROVE OUR BALANCE-OF-PAYMENTS POSITION

1. We persuaded the IBRD to invest $71 million of its liquid dollars in long-term certificates of deposit.

2. We successfully negotiated a Brazilian investment of $50 million in long-term certificates of deposit and a prepayment of a $29 million gold loan.

3. We arranged for the Bank of Italy to purchase $40 million of non-negotiable, non-convertible, medium-term U.S. government bonds against military orders to be placed in the U.S.

The above provided $190 million of first quarter savings. At an annual rate—excluding the one-time repayment of the gold loan by Brazil—this amounts to $644 million.

Attachment (B)¹⁴

Washington, March 30, 1966.

MEMORANDUM FOR THE PRESIDENT

SUBJECT

• Cabinet Committee on Balance of Payments meeting of March 25

Your Cabinet Committee on Balance of Payments met Friday, March 25, to review current balance of payments prospects on the basis of the latest information. This review showed that our target of equilibrium this year—or even a deficit short of that goal by any reasonable amount—is unlikely to be achieved without further action.

We do not have at this point any detailed forecast of the balance of payments this year. Nevertheless, some key changes in the assumptions we used last November indicate the clear likelihood of a short-fall. The principal change lies in the trade surplus forecast which may fall $1.5 billion below the November forecast of $6 billion. This anticipated change results from the modification of the $710 billion GNP assumption used last November to something in excess of the $722 billion used in your January Economic Report. As a rule of thumb, for every $5 billion of additional GNP on top of an already burgeoning economy one might expect a drop in the trade balance of three to four hundred million dollars. In addition, outflows related to our commitment in Vietnam have moved up by $341 million.

Under these circumstances, your Cabinet Committee on Balance of Payments believes it only prudent to make a further intensive review of our payments program with the view toward finding steps to cut $1.5 billion off whatever deficit now seems in prospect.

In fact, I had already initiated the development of some proposals for additional steps along the lines of the attached “Summary of Balance of Payments Review”, dated March 3, which I handed you on March 4 when you, Francis Bator and I had a brief meeting on this subject.

Attachment C¹⁵

Additional Measures For Balance-of-Payments Savings in 1966 Agreed Upon Unanimously By the Cabinet Committee on Balance of Payments.

The Cabinet Committee on Balance of Payments agrees unanimously that the following measures should be taken as promptly as possible. Potential savings are estimated at $800 million.

1. The Department of Defense and AID must again intensify their efforts to reduce the balance of payments costs of their programs. Secretary McNamara believes that he can cut the adverse 1966 impact of military activities by about $300 million from $2,150 million to $1,850 million—which would bring the military deficit within $50 million of our original forecast of last December. AID, however, believes that only nominal further cuts in the balance of payments costs of its program are possible (see attachment).¹⁶

2. Under Secretary of the Treasury Deming will begin negotiating immediately with a number of major European countries to obtain prepayment of debt owed the U.S. The potentials of this exercise depend importantly on the willingness of the French and Italians to prepay. Our present judgment is that we have a reasonably good chance of obtaining $200–$300 million.

3. Assistant Secretary of Treasury Trued has left for the Far East on Tuesday, May 10th, to obtain agreement from Japan, Korea, Taiwan, and the Philippines to invest as much of their official dollar reserves as possible in the United States in forms that help our payments statistics. The reserves of these countries are higher than they otherwise would be because of U.S. expenditures for the Vietnam war. At the same time, the U.S. economic task force in Vietnam will urge the Vietnamese authorities to place a portion of their dollar reserves in long-term instruments in the U.S.A. Thailand is already cooperating with us in this matter. All told, the possible returns from these six countries could come to $200 million.

Mr. Trued will also explore the possibility of a Japanese debt prepayment. If deemed necessary to obtain meaningful help from the Japanese, we will send a team to Tokyo to negotiate a military offset agreement.

4. We will also attempt to persuade key Latin American and Middle Eastern countries with strong reserve positions to place a portion of their reserves in long-term instruments here. These countries are not necessarily beneficiaries of the Vietnam war but they have, in a number of instances, benefited from U.S. economic assistance and investment, and they can be made to understand that failure of the U.S. to solve its balance of payments problem will pose serious difficulties for them as well as for us. There may be another $150 million potential from such countries as Mexico (where negotiations began during my recent visit), Venezuela, Saudi Arabia, and Kuwait.

The Cabinet Committee also believes the following measures—the savings from which are more difficult to quantify but probably do not exceed $100–$200 million—should be promptly implemented (agreement is not unanimous in all cases):

1. Better review procedures should be developed to assure effective functioning of gold budget controls.

2. Every effort should be made to gain maximum advance payments during 1966 under the German offset agreements (negotiations are presently in progress).

3. In its management of its voluntary program, the Commerce Department must make every effort to see that companies that are over their direct investment targets are brought back to the target level. If no companies are over the target and some are under, we should be able to reduce direct investment below the $2.4 billion forecast.

4. The U.S. Travel Service should assume centralized management of the Government travel program, performing liaison with States and the private sector and administering all funds directed toward promoting tourism in the U.S. To this end, all agencies should support a request for a substantially larger budget for USTS before the Congress.

5. A proposal to cut the customs duty-free allowance from $100 to $10 should be considered along with other tax measures for possible submission to the Congress. (Savings could amount to $20–$30 million in 1966; up to $100 million in 1967.)

6. The Export-Import Bank is considering the advisability of establishing a limited rediscount facility to reinsure the availability of export financing. The facility should be introduced as soon as possible.

7. Emphasis should be given to the need for U.S. businesses to remain export conscious and to insure that an appropriate part of output continues to be sold abroad—over the longer run, this is essential to maintaining markets.

8. Export consciousness should be reinforced throughout our missions abroad, including aggressive effort in aid recipient countries, to reinsure the effectiveness of “tying” and to help gain additional markets.

9. The United States must be in a position to respond if the Soviet Bloc offers to make further purchases of wheat in the free world. In the immediate case, a method of subsidized transport costs to overcome the 50–50 shipping requirement must be available.

10. Consideration should be given to raising the export price of wheat further upward if the 1966 crop outlook makes it feasible.

11. We should maximize sales from stockpile. (Items which we import and which are in stockpile surplus include: aluminum, $700 million; bauxite, $85 million; lead, $400 million; nickel, $225 million; rubber, $475 million; tin, $325 million; and zinc, $380 million.)

Attachment (D)¹⁷

FIRST QUARTER 1966 BALANCE-OF-PAYMENTS ANALYSIS

The following paragraphs show how first quarter performance for certain major items in our balance of payments—some of them still estimated—differed from that visualized in the projection sent to you on November 26, 1965. We will not have firm data for certain items for some weeks.

Trade. In our November projection, we looked forward to a $6 billion trade surplus in 1966. During the first quarter, the trade surplus ran at a $4.5 billion annual rate, compared with $4.8 billion for the year 1965 and $5.1 billion (annual rate) in the fourth quarter.

Exports in 1966 were expected to amount to $28.7 billion. They ran at an annual rate of $28.4 billion in the first quarter, about $300 million higher than the fourth quarter 1965 annual rate.

Imports in 1966 were projected at $22.7 billion. In the first quarter, they ran at an annual rate of $23.9 billion, about $900 million higher than the fourth quarter annual rate.

Military. Firm figures are not yet available for the first quarter, but it is possible that the net military balance-of-payments deficit has been running at an annual rate several hundred million dollars higher than the $1.8–$2.0 billion forecast in November.

Government Grants and Capital (AID, etc.). So far as we know, there has been no significant change from forecast.

Direct Investment Income and Outflow. Firm figures are not yet available but it is likely that direct investment outflows are running above the $2.4 billion rate forecast for the year as a whole, and that investment income also may be lower than expected. These first quarter shortfalls could conceivably amount to $1 billion at an annual rate.

New Foreign Security Offerings. We were hurt here in the first quarter, primarily because of $150 million of Canadian offerings postponed from late 1965. (The Canadians partially offset this by buying back $45 million of their own securities from U.S. holders.) In our November forecast, we expected foreign security offerings in 1966 to total $1.1 billion. In the first three months, excluding the $150 million of postponed Canadian issues, they are estimated to have totaled $300 million, equivalent to an annual rate of $1.2 billion.

Bank Claims. In the November forecast, we anticipated an outflow of $400 million from the bank sector in 1966. Instead, there was a first quarter inflow of $260 million which consisted of inflows in January and February offset by about a $100 million outflow in March. Annual rate of inflow in the first quarter was $1 billion.

1. Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. 3 [1 of 2], Box 2. Secret.
2. See footnote 3, Document 67.
3. See footnote 3, Document 83.
4. See Document 85.
5. For text of report, January 27, see Public Papers of the Presidents of the United States: Lyndon B. Johnson, 1966, Book I, pp. 96–109.
6. Not printed. (Johnson Library, National Security File, Subject File, Balance of Payments, Vol. 3 [1 of 2], Box 2)
7. See Document 88.
8. An apparent reference to the meeting on May 4; see Document 93.
9. Johnson made these remarks on October 1, 1965, at the annual meeting of the World Bank and the International Monetary Fund in Washington. For full text, see Public Papers of the Presidents of the United States: Lyndon B. Johnson, 1965, Book II, pp. 1030–1034.
10. Regarding this statement, see footnote 3, Document 83.
11. No transcript of this press conference has been found, but most of Fowler’s statement on that occasion is quoted below.
12. Printed here as italics.
13. Secret.
14. Secret.
15. Secret.
16. An attachment identified as “Memo to Secretary Fowler from Administrator Bell (AID), 5/3/66,” was not attached and has not been found.
17. Secret.