181. Memorandum of Conversation1

PARTICIPANTS

  • Germany
    • Karl Schiller, Economics and Finance Minister
    • Karl Klasen, Bundesbank President
    • Johann Schoellhorn, State Secretary in the Ministry of Economics and Finance
  • U.S. Treasury
    • Secretary Connally
    • Under Secretary Walker 2
    • Under Secretary Volcker 2
    • Assistant Secretary Petty
    • Mr. Hermberg (Recording officer)
[Page 507]

SUBJECT

  • International Financial Situation

After welcoming Minister Schiller to Washington, Secretary Connally briefly reviewed the international monetary problems. The Secretary said that in talking to the Italians in London3 he had outlined these problems as including the U.S. import surcharge and the question of a U.S. “contribution” to a settlement by a devaluation of the dollar in terms of the price of gold. Both of the above-mentioned problems were tied in with the question of an international realignment of parities and the problem of how much each country would change in such a realignment. This was a most difficult question. Since Germany, Canada, Japan and the U.S. were already floating, the Secretary continued, he had therefore suggested in his conversation with the Italians that it might be worthwhile to explore whether everyone should take off all controls and freely float for a while.

President Klasen interjected that such a proposition would be most difficult for most countries. Jokingly he continued that it would be more difficult for them than even a 20 percent devaluation would be for the U.S. Minister Schiller referred to the fact that some countries were even now floating “dirtily” and that what was needed was a “code of good behavior” for floating. In the present circumstances Germany was practically the only country which was floating freely and as a result the DM was appreciating at levels which everyone in Germany considered to be too high. As someone had said, everyone was cheating except Germany. State Secretary Schoellhorn interjected that as a result Germany might have to start cheating too. He said that the public mentioning of various suggested percentage figures for a DM appreciation by Reuss, the IMF, etc., was causing much trouble in the markets and driving the DM up. Schoellhorn observed that as a result of the DM appreciation during the last few days Japan in effect had devalued by 3 percent against the DM.

Secretary Connally said that the U.S. had talked with Japan and Canada, but that everyone wanted to proceed in a bloc and that we therefore had no one to talk to. President Klasen interjected that in the currency realignment it was necessary for everyone to know what everyone else was going to do. For Germany, thus for example, it was essential to know what France would do. Secretary Connally continued that we realized the difficulties involved for everyone. What was important was not to let these difficulties impair the excellent personal, political and military relationships between Germany and the U.S. We were flexible on how to get to a better alignment of parities and willing [Page 508]to do whatever would be helpful. We had talked bilaterally to the Canadians, Italians, and Japanese. We were prepared to talk and work with anyone bilaterally, multilaterally or both at the same time. But we could not go back to the old system and would have to work toward a new system which would satisfy us. Secretary Connally continued that he personally couldn’t care less about the price of gold—which Klasen had raised previously—but this was a political matter. To change the price of gold the U.S. Government would have to go to the U.S. Congress and one could not know what would come out of the Congress if we did this. The import surcharge was a most popular measure in the U.S. There was much Congressional pressure to bring the troops home. While the price of gold in his view was not a big substantive issue, this was a touchy political question. Decisions on it could be made only on the political level. Minister Schiller said that he agreed that the price of gold was mainly a mythological matter, but it could help facilitate things.

Secretary Connally continued that as far as the import surcharge was concerned, before we could remove it, we would have some expression from others what they will do (in addition to the currency realignment). There were some special problems with Canada, Japan and Germany, but beyond that everyone was in the same boat. As far as Europe in general was concerned, there was not a great deal that we had to complain about aside from some specific cases. Thus, for example, France recently had told a major U.S. manufacturer that he could not sell in France unless he built a plant there. At the same time France constantly complains about U.S. foreign investments. We will have to work out such bilateral problems. Offset is one such problem which we have to work out with Germany. But beyond this what role do you want us to play? We are willing to talk with France, to negotiate, to do whatever is wanted. But it must be clear that we cannot go back to the old system.

Schiller responded by asking what would be the next step. The DM had now floated upward by 11 percent. This was too much. What would be the U.S. reaction if Germany would be forced to introduce capital controls? While he personally was opposed to using capital controls, the time might come when he would have to do so. The float of others was not an honest one. The continued deadlock was hurting Germany. Klasen interjected that through this deadlock the U.S. was punishing its best friend. Schiller said that in this situation it was essential to negotiate.

Secretary Connally replied that we were prepared to negotiate immediately. Schiller said that Germany could not negotiate unilaterally. What Germany could do depended, for example, very much on what Japan and France would do. It was necessary to talk about a deal in the [Page 509]Group of Ten. Klasen interjected that Secretary Connally had mentioned a G-10 meeting in November. Germany could not afford to wait that long. Schiller said that the combination of the current rate of revaluation of the DM, the import surcharge and the discriminatory aspects of the tax credit amounted to an embargo of German machinery exports to the U.S. Klasen again stressed the unacceptability of the current 11 percent rate of revaluation of the DM and said that Germany could not continue to take the burdens of currency readjustments alone.

Secretary Connally responded that the November date for the next G-10 meeting was an Italian proposal. He stressed the current health and strength of the German economy and our readiness to do whatever the Germans wanted us to do to help. Schoellhorn suggested that the U.S. could express a willingness to participate in a realignment through an increase in the price of gold. The Secretary remarked that that was a political, not an economic, problem and asked if the German problem was a political one. Schiller responded that Germany’s problem was that it could not move without its partners. If he knew that the U.S. was prepared to move for such and such a price, then he, Schiller, might be able to make progress with his partners. In response to a question by Secretary Connally what he wanted us to do, Schiller responded “what is your price for the surcharge?” Secretary Connally replied that we must be assured that we can get our balance of payments into equilibrium within a reasonably short period of time. We must have a better burden sharing in defense, through arrangements arrived at with certain countries either in concert or individually. We must get certain trade restrictions removed, particularly by Japan and Canada. In the trade field we were not asking too much from the EC. We felt that their preferential trade arrangements with Morocco and Israel, for example, violated the GATT and there should be no increase in agricultural protection. Mr. Petty said it would be most desirable that the EC limit the product coverage of the common agricultural policy to those products now covered. Secretary Connally said he realized that we cannot turn the U.S. balance of payments around over night, but by 1973 we certainly must see some change. We must be sure of a formula which gives us a real assurance that in a reasonably short period of time we can look for equilibrium in our balance of payments.

Schiller said that it seemed as though there might not be a solution for some period of time. But in the meantime the economic situation in Germany would change. What would be the U.S. reaction if after its economy had broken down, Germany would return to its old parity. Mr. Petty asked how effective the French system of controls was. Schoellhorn answered that it was very effective. France actually had sold dollars last week. Klasen said that France and Italy could afford to wait. Germany could not. Now the country which had helped the U.S. [Page 510]the most was being hurt the most. Secretary Connally interjected that he appreciated the problems Germany was facing, but one should not lose sight of the fact that our relationship has been good to both of us and has made both of us pretty prosperous. Schoellhorn, while generally agreeing with the Secretary, mentioned German political sensitivity to inflation and the problems caused prior to the float by the inflow of liquidity. Schoellhorn continued that the Secretary had said that aside from the currency realignment we should look at problems of trade and burden sharing. Schoellhorn felt that it would not be possible to handle all three problems at once. He felt that we should start with the problem of the realignment of parities. If such a realignment could not be accomplished quickly, we would get a world of capital controls. There was very little time left.

Secretary Connally said that he felt we could do all three (trade, burden sharing and realignment) at the same time. It was not really as difficult as Schoellhorn implied. He, Connally, understood, for example, that we were very close on the offset problem—only $85 million apart. Schiller agreed that the offset was close to agreement. The Germans had adjourned the talks until just after the IMF meetings but then expected to conclude an agreement quickly. Nevertheless, Schiller felt that the conditions Connally had mentioned for the removal of the surcharge were very vague and hard.

Secretary Connally reiterated that in order to remove the surcharge the U.S. had to have a formula which gave real assurance that in a relatively short period of time we can look for equilibrium in our balance of payments. If others did not want to include trade restrictions and defense in the formula, then the currency realignment would have to be that much larger. Thus, for example, we could not get certain of our products—such as computers—into Japan at all. The Japanese tariff on our beef was over 100 percent. Exchange rate change alone could accomplish little in these situations. This was different in the case of Germany. With Germany we would not insist on including the question of burden sharing, but Germany should be interested in joining us to put pressure on Japan for the removal of trade restrictions. Schiller and Klasen agreed that pressure on Japan would be desirable.

Klasen asked the Secretary what ideas the U.S. had concerning the general realignment of parities, assuming that it received satisfaction on the trade and burden-sharing question. He felt that it was necessary to know a figure in order to have a framework. What average realignment of the dollar against the rest of world did the U.S. think to be necessary? Secretary Connally replied that we have not yet made such a calculation because we felt it would be presumptuous for us to tell others what to do. But we would now make such a calculation and tell our partners what we think they should do, what Germany should do, France, the [Page 511]U.K., Japan should do. One figure will indicate what we think it will take. Secretary Connally stressed that while our partners can, of course, question our figure, he hoped that they would not question the honesty of our intentions. We did not want to take advantage of anyone and our figure would be a reasonable one. We would get to work on the figures this afternoon and provide them before the Germans left Washington.

Schiller, in discussing the interdependence of various national parity changes, stressed the key position of France. Germany, for example, could not revalue by 10-11 percent vis-à-vis the dollar if France did not move at all. Germany had already substantially revalued against France in the last few years and a further move of such magnitude vis-à-vis the franc could not be sold to the German public—20 percent of German exports went to France, only 10 percent to the U.S.

Secretary Connally asked whether the Germans thought that in the hypothetical case of a U.S. devaluation, the French would stay put or also devalue. Klasen replied positively that France would stay put, while Schiller was not so sure. Both agreed that in such a case the U.S. should insist on a price agreement by France not to follow suit. Schiller indicated the German position on the increase in the price of gold was “cool” but they felt it could facilitate a realignment. Mr. Petty pointed out that an increase in the price of gold would be a step backward by also increasing its role in the monetary system. Klasen said that the Germans do not think that after an increase in the price of gold, the U.S. should restore the full gold convertibility of the dollar. The Secretary said he had hoped Klasen would say that, because we could not do it.

Schiller said that in the last few days he had become very pessimistic. He was afraid there would not be any movement forward and Klasen stressed that the rest of the world had become accustomed to America taking the lead in a crisis. He felt the U.S. must make some proposal. Secretary Connally said that we will do this, even though the minute we do, everyone will accuse us of trying to dictate to the rest of the world.

Schoellhorn asked if it might be possible not to apply the discriminatory aspects of the investment trade credit. He said that $600 million of German exports are involved. In addition, there is the danger that others will copy this type of tax credit.

Secretary Connally indicated that he hoped to have some further discussions with Schiller during the week.4

Sy Cross 5
  1. Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, Germany General. Confidential. Drafted on October 6 by Edward S. Hermberg, Financial Attache at the Embassy in Bonn. The meeting was held at the Department of the Treasury. A September 24 briefing memorandum for the meeting is ibid. The German officials were in Washington for the Annual Meetings of the IMF and the IBRD the following week. On the fringes of those meetings other bilaterals were held, including Connally’s meetings with Chancellor of the Exchequer Anthony Barber on September 25, with Japanese Minister of Finance Mikio Mizuta on September 27, and with Governor of the Bank of England Leslie O’Brien on September 29. Memoranda of these and other conversations are ibid., Secretary’s Memos: FRC 56 74 17, Memcons 1971.
  2. Under Secretaries Walker and Volcker had to leave before the end of the meeting. [Footnote in the source text. The G-10 Deputies were meeting on the afternoon of September 25; presumably Volcker left to attend.]
  3. Under Secretaries Walker and Volcker had to leave before the end of the meeting. [Footnote in the source text. The G-10 Deputies were meeting on the afternoon of September 25; presumably Volcker left to attend.]
  4. This meeting was presumably held on the fringes of the September 15-16 G-10 Ministerial meeting.
  5. No record of additional discussions was found.
  6. Cross signed for Hermberg above Hermberg’s typed signature.