119. Volcker Group Paper1



Unless there are some changes in the international monetary and payments system, cumulative strains could develop over the next few years that could result in increasingly serious disturbances in the framework of international monetary relationships. One aspect of this strain on the monetary system could be heavy reserve losses for the United States, through the conversion of dollars into gold by foreign monetary authorities. The balance of payments on the liquidity basis may well continue at $2-3 billion a year. A strong anti-inflation program, though absolutely necessary, may not be sufficient to shrink our liquidity deficit in a highly competitive world. This prospect would be underlined by a vigorous program of relaxing restraints on capital outflow, in a future situation of relative monetary ease. The present official settlements surplus results from heavy short-term borrowing by United States banks, which pulls money out of foreign official reserves. This is a factor related to credit stringency here, and may prove to be temporary. We may face attrition of our reserves, and periodic currency crises can add to our gold losses.
Our strategy therefore calls for either (a) negotiating substantial but evolutionary changes in present monetary arrangements, or (b) suspending the present type of gold convertibility and following this with an attempt to negotiate a new system, in which the United States would undertake a more limited and less exposed form of convertibility of the dollar. The second course, which would necessarily imply unilateral action by the United States, would involve an initial shock to other countries. The extent of the shock would vary with the circumstances preceding such a decision. The reaction abroad might be less nervous if the decision were made at the time of an exchange crisis and after large U.S. gold losses.
In our judgment, substantially more needs to be done in 1969 and 1970 to improve the monetary system than the European monetary [Page 311] authorities realize. Their present horizon is limited to a cautious activation of Special Drawing Rights in an amount of no more than $2 billion a year for five years. While we cannot of course expect negotiations on a more far-reaching package of improvements to be completed within a few months, we do believe that the United States needs to reach its own judgment before June 1969 as to whether there is a reasonable prospect of carrying on with our present responsibilities in an improved system.2 That is, on the basis of soundings taken with officials of other major countries, we should decide by late spring whether or not we have a fighting chance to obtain European support for our program of improvements by stages in 1969-70. Aggressive negotiations, with high level support, would be essential to push such a campaign forward, should we decide to undertake it.
The elements in the first approach are set forth briefly below:
An activation of Special Drawing Rights of $15-20 billion during 1969-73, beginning in September 1969, with a front-end load factor in 1969 and 1970. This is substantially more than the maximum amount of $10 billion in 1969-73 that has been mentioned in the past as an illustrative figure, and has been regarded by some observers as the European maximum. We would be prepared to compromise to some extent, but $10 billion would not be enough.
We would support a general increase in IMF quotas in 1970, but not at the expense of postponing SDR activation beyond 1969. We would not now join in putting pressure on Continental European creditor countries for a quota increase (which may be desired by the IMF staff, the developing countries, and the French, but resisted by the surplus countries).
We would seek an appreciation of the Deutschemark and either exchange appreciation or some substitute such as border tax adjustments from other surplus countries. We would accept, as part of such a program of exchange rate adjustment, a moderate but not excessive depreciation of the French franc.
We would determine by June of this year whether intensive consultations should begin with other leading countries on the proposals for limited exchange flexibility—moving parities or wider bands, or a combination of the two. We feel that these may be important to facilitate longer-term adjustment of imbalances, but have not taken a decision. At the present time the Europeans are negative, and it might take two years or more for their attitudes to thaw. What we have to determine this spring is whether we think they will thaw, and whether we want them to.
This program would be supplemented by a strong drive to achieve a more satisfactory NATO offset; and by the adoption of border tax adjustment techniques by the United States, without a change in the U.S. tax structure. The latter would be a substitute for exchange adjustments, which is not feasible for the United States so long as other currencies peg their exchange rates to the dollar.
In return for European cooperation in (a) to (e) above, the United States would undertake to relax controls on capital outflow only in accordance with progress on the anti-inflation front.
The United States would resist European pressure to agree in advance to convert enough dollars into gold in future years to prevent a rise in global dollar reserves. If absolutely necessary to reach an understanding with the Europeans, we might undertake to do so if dollar reserves were to reach the outside limit of some range that would allow considerable flexibility to cover the substantial swings in dollar holdings that can occur, as well as a reasonable growth in dollar holdings desired by some countries.
An increase in the official dollar price of gold would not be part of either approach. Our bargaining position hinges importantly on firm resistance to an increase in the official gold price.
The second approach would begin with unilateral United States action to remove the privilege of gold convertibility at the initiative of foreign monetary authorities. We could then allow some time to elapse to see how foreign countries reacted. Presumably many countries would continue to peg to the dollar and no basic change would take place. With others, reluctance to hold dollars might lead to appreciation of exchange rates, to floating rates for capital transactions, to direct measures cutting down the inflow of dollars or to the use of central banking techniques for rechanneling dollars into international money markets. In the political sense, the world might tend to split into a dollar area, comprising (a) those countries that were quite willing to accumulate dollars, and (b) countries, principally in Europe, that would prefer to hold down their dollar accumulations. In the light of developments, we would proceed with calm and unhurried negotiations looking toward all of the elements of paragraph 4 above, but with generally less emphasis on the speed of decisions. However, it would still be desirable to activate Special Drawing Rights in September 1969.
In the transitional phase, following the suspension of convertibility at foreign initiative, there could be some initial confusion in the exchange markets, until the policies of the major countries had been clarified. It has been suggested that some private and official holders of dollars might move into Swiss francs, Deutschemarks or other strong currencies. If this happened, the United States and these countries [Page 313] would have to consult to determine whether the United States would be willing to repurchase any of these dollars with gold or drawings on the IMF. If the United States did not wish to do so, the countries concerned might decide to appreciate their exchange rates or take other steps to hold down their dollar accumulations. All in all, during the transition period the United States might not wish to relax restraints on capital outflow or ease monetary policy, to avoid adding to the flow of dollars with which the stronger currency areas were coping.
The most difficult question under this second approach is whether the United States would go back to convertibility, and, if so, what type of convertibility the United States would be willing to resume. Presumably this would mean that the United States would pay out gold and/or Special Drawing Rights for dollars under some new convertibility principles. Presumably most of the present official dollar holdings would be exchanged for Special Drawing Rights or some special type of reserve asset, so that the United States would not be exposed to the risk of large-scale conversions. Establishing the new principles might require intensive monetary negotiations, which might take months or years. A specific United States position on the new type of convertibility has still to be formulated.
One reason for deciding on our basic strategy before June is to try to turn to our advantage any international consultations that may result from exchange crises affecting the French franc, the pound sterling or the Deutschemark. If we are agreed upon our objectives, we might be able to accelerate progress in the desired directions, since important decisions sometimes emerge in the heat of crises.
General Conclusions
Suspension of gold convertibility is not proposed now. Moral suasion would continue to restrain gold losses.
We propose taking some risks by negotiating hard to raise the European horizon on the monetary system. There is a risk that they will drag their feet on SDR activation, because they think we are too greedy and want too many SDRs to help finance a continuing deficit. There is a risk that some countries will ask for gold, fearing that we are heading toward a suspension. We believe these risks are justified, as we must see a chance to improve the system so as to:
give the United States more flexibility for domestic and foreign policies,
halt the spread of selective restraints and restrictions.
We don’t believe we should become locked in to the evolutionary approach for too long.
If it becomes clear that progress on evolutionary improvements is too halting, this year or next, we should resign ourselves to the need [Page 314] for suspension of convertibility and a resumption of negotiations with the Europeans from that different posture.
  1. Source: Washington National Records Center, Department of the Treasury, Volcker Group Masters: FRC 56 86 30, VG/LIM/31-VG/LIM/50. Confidential; Limdis. The paper is marked “Treasury Draft.” Another copy is ibid., Deputy to the Assistant Secretary for International Affairs: FRC 56 83 26, Contingency Planning 1965-1973. This paper was presumably the result of discussion at the March 11 Volcker Group meeting; see Document 118.
  2. The President met with his advisers to discuss international monetary issues on June 26; see Document 131.