Foreign Relations of the United States, 1969–1976, Volume III, Foreign Economic Policy; International Monetary Policy, 1969–1972

131. Action Memorandum From the President’s Assistant for National Security Affairs (Kissinger) to President Nixon¹

Washington, June 25, 1969.

SUBJECT

• Your Meeting on International Monetary Policy on June 26 at 10:30 a.m.

The following memorandum outlines the policy choices which you face in the international monetary area, summarizes the options for implementing them presented in the paper submitted by Secretary Kennedy (Tab A),² provides a political assessment of the options, and makes recommendations. Comments by Paul McCracken are at Tab B.³

U.S. Policy Issues

The U.S. balance of payments is a problem because it can place constraints on both our domestic economic policy and our foreign policy. Our basic objective is to minimize those constraints. In addition, we seek a smoothly functioning international monetary system because it will promote world economic development and our basic foreign policy objectives. We have four broad alternatives, which in practice can of course be combined, for dealing with the problem:

1. We can try to finance our deficits. There are four ways to do so:

(a) Borrow explicitly, from the International Monetary Fund or elsewhere. This would subject us to increasing foreign influence over our domestic economic policy and would only postpone the problem since all explicit loans of large magnitude would have relatively short maturities.

(b) Borrow implicitly by inducing other countries to build their dollar holdings. At the extreme, this would mean getting (or forcing) the world to go onto a “dollar standard”. The probable magnitude is much greater here and would carry no fixed maturities. However, the outstanding dollar balances would always represent a threat to our reserves. They could also be a source of instability for the overall system unless the “dollar standard” were formalized, which could cause serious political problems.

(c) Get large enough creation of Special Drawing Rights (SDRs). The scope here is decidedly smaller, since we are likely at best to get about $500 million of freely usable SDRs annually for the first five years of the scheme, compared with payments deficits which may run to several billion dollars.

(d) Sharply increase the price of gold. This would give us a windfall reserve increase of $10 billion if the price were doubled. Some or most of it might, however, have to be used to convert outstanding dollar balances, which now exceed $15 billion in official hands and another $20 billion in private foreign hands. Foreigners might be unwilling to add to their dollar holdings in the future—cutting off our main present avenue of financing. The net effects are thus not clear even in a financing sense. (I discuss this option in broader terms below.)

2. We can seek equilibrium in our balance of payments by deflating our domestic economy sufficiently. All the experts think this would require much more than the disinflation which is needed for purely domestic reasons. It is thus rejected outright in the paper. I agree with this conclusion and note also that a severe U.S. recession—which would probably be necessary—would be disastrous for foreign policy as well as domestic economic reasons since it would so drastically affect the living standards of so many other countries.

3. We could continue to apply controls to some or all of our external transactions. The paper concludes that we will probably have to maintain some controls whatever path we follow. I am not sure that this is right. I am sure that reliance on controls would require us to extend them well beyond where they are now—to cover all capital movements, Government transactions, and probably trade itself. Such reliance would increase greatly the pressures to bring back troops from Europe and cut aid. It would increasingly poison our international relations as well as be contrary to our basic economic philosophy.

4. We could seek a change in the exchange rate of the dollar vis-à-vis at least some of the other major currencies. This is probably the only lasting way to really move toward equilibrium in our payments position. It could be done either by:

(a) A small increase in the U.S. price of gold without comparable increases by at least some other countries. (A change in the price of gold per se does not mean a change in the exchange rate between the dollar and other currencies if they maintain their present peg to the dollar and simply accept the higher gold price in terms of their currencies as well.) The Kennedy paper rightly points out that this course has so many economic disadvantages that it should be rejected.

(b) Upvaluations of their exchange rates by other countries, notably Germany. This is a necessary step under any satisfactory reform scheme and is probably a prerequisite for the next item. The problem is getting enough other countries to upvalue by enough.

(c) Adoption of a system of greater flexibility of exchange rates. (b) is a one-shot change while this would provide a fundamental reform aimed at maintaining the new equilibrium. It could either be negotiated multilaterally, adopted by some key countries unilaterally, or forced on the world by a unilateral U.S. action to suspend convertibility of the dollar.

Options in the Kennedy Paper

The paper presents three alternative policy courses for the United States:

1. A negotiated multilateral solution which would essentially include:

(a) Sufficient activation of SDRs. Large amounts are needed both to give us adequate financing and to help remove the present tightness in the overall system. The paper recommends that we ask for $4.5 billion annually but be prepared to accept a smaller amount, probably around $3 billion.

(b) A realignment of existing exchange rates, particularly upvaluation of the German mark. It is recognized that we will probably have to accept French devaluation to get the mark upvalued. The paper is not sanguine about getting additional upvaluations which would help the United States.

(c) Active and sympathetic exploration of greater flexibility of exchange rates. This would be the hope for lasting equilibrium in the system over the longer run.

(d) Willingness to help “buy” the package by permitting an orderly decline of our gold stock by another $2 billion, to about $8 billion.

2. Unilateral U.S. suspension of gold convertibility. This would force other countries to take action which would lead to one of the following:

(a) Greater flexibility of exchange rates and hence lasting adjustment of our position.

(b) Financing for the U.S. via dollar accumulation by others. It is the most likely route to a near-global “dollar standard”.

(c) Imposition of controls by other countries to avoid (a) or (b). We would thus be back about where we started, except for the important difference that other countries would be applying the controls.

3. An increase in the price of gold which would increase world liquidity and hence provide some additional financing for the United States. It would achieve no other objectives and hence represent at best a temporary “solution” to the problem.

Political Assessment

The negotiated multilateral option is most consistent with our overall foreign policy. It would seek a solution through working together with our allies, mainly those in continental Europe. Success in this effort could mark a major milestone in building a truly cooperative Atlantic Community and represent a major foreign policy achievement for this Administration.

Either alternative approach would represent a unilateral move by the United States which would antagonize a number of major countries. It might thus be less costly, in political terms, to apply considerable pressure on the Germans and others in an effort to carry off key parts of the multilateral approach if by so doing we could avoid the need to use one of the unilateral routes.

This sharp distinction becomes very much blurred in practice, however. It will undoubtedly take a great deal of negotiated effort—including your personal intervention—to achieve a satisfactory solution through multilateral negotiation. This is because external constraints on the U.S. can be reduced to a safe level only if we get much greater allocation of SDRs than most Europeans want, much more realignment of exchange rates than most Europeans are willing to do, and much faster movement toward greater flexibility of exchange rates than most Europeans are even contemplating at the moment.

At the same time, we have already moved a long way towards suspension of the gold convertibility of the dollar. Germany has explicitly agreed not to convert (under the implicit threat of troop withdrawals as part of an earlier “offset” agreement). All other major countries are afraid to queue up for gold for fear that we will close the window. We are thus already achieving much of the gain from suspension—essentially through accumulation of dollars by others—while minimizing the political costs of blatantly unilateral U.S. action. We are compromising, however, because we maintain controls, offset agreements, tied aid, etc. to try to avoid a crunch by minimizing the amount of dollars that they will be forced to accumulate.

In addition, formal suspension could have a desirable political effect. It would force the Europeans to make the difficult choices which they can avoid under the present system. It might thus provide a major impetus toward closer European integration, much as our Kennedy Round initiative forced them to make basic choices on their trade policy. And it might even help UK entry since the continentals would feel forced to band together to “counter a unilateral U.S. initiative” and could well decide that maximum size was desirable in doing so. On the other hand, it must be recognized that they might not be able to get together and the result could be a further atrophy of the integration process with some of them linking to the dollar and others going their own way.

The main political effect of either suspension or an increase in the gold price is to break a U.S. commitment which dates to 1934. It is not clear which would be worse from a foreign policy standpoint.

Suspension could cast doubt on the dollar value of countries’ gold holdings but this is not very serious since the free market price of gold is above the official price. The main effect would be on the major gold holders: the continental Europeans, South Africa, and the Soviet Union.

An increase in the official gold price would break faith with all those who have helped us for a decade by holding large amounts of dollars, meaning most of the world outside continental Europe and even some of the latter (e.g. Germany). It would raise domestic political problems in many countries and the Japanese say that their government would fall if we raised the gold price.

I would guess that the short-term political costs of suspension might be greater, precisely because it would force the Europeans to make hard choices. But because they would have to make these choices and get the system reformed, suspension would probably lead to a better political result over the longer term.

An increase in the gold price would effectively eliminate the impetus to basic reform by appearing to solve the problem and would also stimulate general belief that any future crisis would be met by another gold price increase—increasing the instability of the system and the likelihood we could no longer get much, if any, dollar financing.

The key countries in any reform effort are Germany, because it is the strongest surplus country and will undoubtedly stay that way short of major new East-West tensions, and France, because of the desire of the rest of the Six for a common position. In fact, only France could probably play a leadership role in forging a common U.S. position since the others would fear and resent any German effort to “impose its view” and the others do not have the necessary strength. The UK is not a factor because it is financially prostrate and Japan simply does not play a role commensurate with its economic power.

The outlook for German cooperation is cloudy. Their recent decision not to revalue may be blamed on the coming election but it is not clear that they will move even thereafter. The Germans are also moving very cautiously on the size and even timing of SDR activation.

If Strauss remains important in financial affairs after the September election, there can be only a limited prospect of sufficient German cooperation to make the negotiated multilateral approach succeed. On the other hand, the bulk of informed German opinion—including many businessmen and bankers—are coming to understand that only upvaluation of the mark and greater flexibility of exchange rates will enable Germany to avoid inflationary pressures from abroad. SPD victory would hasten the likelihood of implementation of these views but even then it would be uncertain.

Pompidou’s approach to these issues is certain to be less dogmatic than De Gaulle’s and the weakness of France’s external financial position will circumscribe him a great deal. Pompidou reportedly argued with the General that France should support SDRs and Giscard d’Estaing is one of the intellectual fathers of the scheme. Nevertheless, the French are unlikely to move very fast from the General’s positions and will thus probably not accept large activations of SDRs, let alone move on to other basic reforms.

Issues for Decision

Political realities thus suggest that it will be extremely difficult to reach a negotiated multilateral agreement on a sufficient scale within a relevant time period unless the alternatives are clearly perceived as worse by the key Europeans.

There are three key operational questions:

1. Should we even attempt to pursue the negotiated multilateral approach and, if so, how long should we persist?

2. What should be our balance of payments policy while we pursue this approach?

3. If we abandon the multilateral effort, which alternative—suspension or an increase in the gold price—should we pursue?

The answer to the first question depends on the cost of pursuing that alternative. If we resolve not to let the present system constrain us seriously—meaning that we are prepared to move to one of the other options if it does—then I see no harm in doing so.

In practice, this means that we would answer the second question by continuing to reduce our controls over private capital and our aid programs and perhaps taking a more relaxed position on issues like the German offset. We would not let external pressures force us into policies undesirable in and of themselves. Resolve to pursue this course will require steady nerves.

If forced to move to one of the other approaches, I would opt strongly for suspension. I agree with the economic case made in the Kennedy paper and would add that it would seem to me less politically harmful in the longer run than an increase in the gold price—and by forcing the Europeans to face some difficult choices could perhaps even provide a new impetus toward European integration.

Recommendations:

I therefore recommend that:

1. You authorize continued pursuit of the negotiated approach to international monetary reform. Specifically, we should:

(a) Seek a large amount of SDRs;

(b) Support exchange rate realignment without bringing coercive pressure;

(c) Provide crisis financing for the British as needed;

(d) Take a public position in favor of greater exchange rate flexibility as soon as our negotiators think the time is ripe.

2. You make clear that you are not prepared to purchase such agreement by tightening controls over the U.S. economy and our foreign policy, and that you wish to continue the process of relaxing those controls. We should pursue a passive balance of payments policy while pursuing the negotiations for monetary reform.

3. That you accept the recommendation of the Kennedy paper that we suspend gold convertibility of the dollar if the effort toward a negotiated multilateral solution breaks down or if we are forced to take defensive action as result of a crisis.⁴

Tab B

Washington, June 25, 1969.

Memorandum From the Chairman of the Council of Economic Advisers (McCracken) to President Nixon ⁵

SUBJECT

• “Basic Options in International Monetary Affairs”

The “Basic Options” paper prepared by the Volcker Group is a clear and perceptive summary of the major international financial issues.⁶

I

The Council of Economic Advisers, which has participated in the drafting of this paper, is in general agreement with its formulation of the options and with its recommendations. In particular, I agree that the evolutionary approach now being followed (option a) should be pursued. I take a more positive view of the merits of limited exchange rate flexibility than the paper does, but since the U.S. dollar would not move under such a scheme, our bargaining position in advocating this scheme is admittedly limited. It should nevertheless be stressed that our hopes of establishing a less crisis-prone international monetary system rest primarily on achieving limited flexibility. The fear that an endorsement of limited flexibility would further unsettle the foreign exchange markets seems exaggerated, and it tends to induce inaction on this matter.

I also agree with the paper in regarding the suspension of gold convertibility (option b) as a major break in international cooperation, and therefore not to be undertaken unless the evolutionary approach turns out to be unpromising. In particular, I do not support the view, implied in para. 56, that we should suspend convertibility if the other countries are unwilling to activate more than $2 billion in SDR’s (Special Drawing Rights) per year. Although SDR’s will no doubt be an important addition to international liquidity, this additional liquidity can make only a modest contribution to the adjustment process by which nations with different rates of price movements, different objectives of economic policy, and different rates of technological development adjust to each other. It is the present system’s inability to effect these adjustments, by excessive rigidity of exchange rates, that is the main cause of current troubles. Consequently I do not believe that a large amount of SDR’s, while desirable, should be regarded as the touchstone of success for the evolutionary approach.

I agree with the report’s rejection of an increase in the gold price, whether large or small. If it ever comes to a choice between options b and c we should demonetize gold, which is what option b amounts to.

II

There are a number of points not fully covered by the paper which you may wish to pursue in the meeting on Thursday.

1. Public posture and Presidential leadership. The paper does not give you anything to say for public use, even though an insufficient sense of direction on the part of the financial and business community is a current problem. If you agree to the evolutionary approach, it might be desirable to recognize publicly that flexibility of exchange rates must be part of achieving a less brittle system. Of the two other components of the evolutionary approach, SDR’s are by now somewhat shopworn and a realignment of parities cannot be mentioned in public.

2. Balance of payments controls. The paper does not hold out any hope for a further relaxation of controls in the immediate future. While maintenance of controls is seemingly justified by the precarious state of our balance of payments, it is not clear that relaxation must await a return to equilibrium. In fact it is not clear how much controls contribute to reducing the deficit, and they do come at a heavy cost in other matters. A subcommittee of the Volcker group is working on this subject and you may want to express an interest in its results. Indeed, we might want to consider a phased relaxation of controls as a major policy objective in its own right. If this puts a strain on the international monetary system, it would be evidence that the system needs modification. If we do not press forward here, the momentum generated by the April 4 relaxation may be lost, and this Administration may become no less committed to controls than its predecessor.

3. Sterling. Although I agree that for the moment (say, through the summer) sterling should hold at its present parity, it would be most unwise to supply Britain with further credit. This would require Congressional approval. And it is probably not in the interest of the United Kingdom to go even further into debt. Moreover, there are indications that sterling has a long-term tendency to depreciate, which makes it an ideal candidate for the so-called crawling peg form of exchange rate adjustment. Whenever the next sterling crisis erupts, Britain should be encouraged to adopt such a device in order to avoid resorting to direct controls.

Paul W. McCracken

1. Source: National Archives, Nixon Presidential Materials, NSC Files, Agency Files, Box 215, Council of Economic Advisers. Confidential.
2. Document 130.
3. No record of the June 26 meeting was found. During an August 25, 1997, interview with the editor, Bergsten characterized it as, in effect, the NSC meeting that had been contemplated in NSSM 7, which had been canceled (see footnote 2, Document 109 and Document 16). According to the President’s Daily Diary, Kennedy, Rogers, Martin, Mayo, Burns, Kissinger, McCracken, Volcker, Samuels, and MacLaury attended the meeting, which was held in the Cabinet Room from 10:40 to 11:36 a.m. (National Archives, Nixon Presidential Materials, White House Central Files, President’s Daily Diary)
4. Presumably at least Recommendations 1a, 1b, and 1d were approved during the June 26 meeting; see Document 140. Recommendation 3 was one plank in the New Economic Policy President Nixon announced on August 15, 1971.
5. Confidential.
6. See footnote 2, Document 130.