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

167. Information Memorandum From Robert Hormats of the National Security Council Staff to the President’s Assistant for National Security Affairs (Kissinger)¹

Washington, August 13, 1971.

SUBJECT

• International Monetary Crisis

Although I recognize that the subject of this memorandum is far from your major areas of interest, you might wish to be kept abreast of the current international monetary crisis, since it does have major foreign policy implications for the U.S.

The Problem

Throughout 1971 there has been an erosion of European confidence in the stability of the dollar. This has worsened since May, as it became apparent that the U.S. inflation was not being contained, that wage settlements in this country were extremely high, and that the U.S. balance of payments deficit was worsening. The latter is extremely important. Under the present system central banks of other governments purchase dollars when an over-supply of dollars causes the value of the dollar to drop below a given point, i.e. Britain will, if the value of the dollar falls below a specified point, buy up excess dollars and thereby raise the price of the dollar to within one percent of its established parity vis-à-vis the Pound. Thus European central banks have been taking in large amounts of dollars in order to keep the value of the dollar from falling vis-à-vis their own currencies. However, because Pounds, Marks, etc. must be spent by the central banks in order to purchase these dollars, the money supply of the major European countries has increased significantly, and severe inflationary pressures have resulted.

The crisis of this spring came when on May 3 and 4 alone, about $1 billion flowed into Germany and greater amounts were expected to follow. The Germans were thus forced to close their foreign exchange market and, on May 10 they floated the D-Mark., i.e. the Bundesbank did not purchase dollars when the price of the dollar fell and thereby allowed the value of the dollar to fall still further vis-à-vis the value of the Mark. Thus, because individuals wished to rid themselves of dollars and purchase Marks, the value of the Mark increased vis-à-vis the dollar and is now approximately seven percent above its value at the close of April. Other European countries have been forced to hold large amounts of unwanted dollars which they are legally entitled to demand that the U.S. redeem in gold.

The Present Crisis

Last week, with no end to the U.S. inflationary and balance of payments problem in sight, there was another rush by speculators to sell dollars for European currencies. Then, on Saturday, Henry Reuss, Chairman of the Joint Economic Committee on Exchange and Payments, released a report which:

• —suggested that the dollar was overvalued and should be allowed to “float” downward in value;
• —criticized the Treasury for doing too little to correct the balance of payments deficit (which could amount to $7 or $8 billion this year as compared to $3 billion last year).

On Monday, August 9-with confidence in the stability of the dollar further eroded by this publication—the sale of dollars increased and the value of dollars decreased (i. e., holders of dollars used them to purchase Pounds, D-Marks, Swiss francs, etc. because they felt these currencies would either be revalued or the dollar would be devalued in the near future). The dollar fell to its lowest point vis-à-vis D-Marks since World War II. On the same day the Treasury stated that the Reuss report did not represent Congressional views on the subject and pointed out that the reduction in the balance of payments deficit depends not on modified exchange rates but on a healthy and non-inflationary domestic economy.

On Wednesday, August 11, speculation against the dollar abated somewhat—one reason being that the central banks of France and Switzerland instituted measures to prevent domestic banks from purchasing speculative dollars. However, on Thursday over $1 billion were again forced on European central banks.

There is little likelihood that the situation will work itself out without either a revaluation of European currencies (which is the most probable course of action for the Europeans, given the present crisis); a devaluation of the dollar; or U.S. measures to restrict the imports of foreign goods to this country and encourage U. S. exports (which will take legislation). There will also probably be strong efforts on the part of the Europeans to restrict the amounts of dollars held by their central banks and to apply other stringent measures against the dollar.

1. Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 376, President’s Economic Program. Confidential. Initialed by Kissinger. A copy was sent to Sonnenfeldt.