234. Memorandum From Secretary of the Treasury Shultz to President Nixon 1
Since the British decision on June 24 to float the pound, strong speculative pressures have again developed in the foreign exchange markets. In two days at the end of last week,2 $2-1/2 billion flowed into foreign central banks. The total flow of dollars into the central bank reserves in the past three weeks has amounted to almost $5 billion.
In terms of the direct and short-term impact on the U.S. economy and trade position, this turmoil is of limited significance. It is quite possible that, without further action by us, the foreign central banks will continue to support the dollar until the present speculative pressures pass. They have a strong interest in not allowing the dollar to decline.
However, this outcome is not certain and the situation poses important potential difficulties for the United States and for the future evolution of the monetary system.
- A breakdown of the pattern of exchange rates embodied in the Smithsonian Agreement could lead to some repetition of the general uncertainties evident last Fall. A tendency for countries to act unilaterally to protect their own interests, and for the Common Market to withdraw behind a defensive wall of controls, would be aggravated. Rightly or wrongly, fears accompanying a breakdown of the Agreement could affect domestic business sentiment and, more directly, the stock market.
- This sense of failure of the Smithsonian Agreement, in circumstances in which the United States is widely felt abroad (and in some quarters at home) to be playing an entirely passive role, would be a poor launching pad for a constructive trans-Atlantic dialogue on longer-term reform.3
Certainly, some antagonism in political terms could add to the economic uncertainty.
We face an inherent dilemma in dealing with this situation. Our trade and balance of payments position is still very weak, and the prognosis is still not assured. Thus, we cannot assume present exchange rates are satisfactory—and, in the case of Japan, the rate probably sooner or later will need to change. Should a crisis result in further exchange rate revaluations abroad, these decisions would ultimately benefit our trade and balance of payments position. The dilemma is such benefits are improbable without a period of turmoil and tension, with the risks cited above.
In this situation, three general courses of action can be distinguished:
A relatively passive approach, leaving present crisis decisions virtually entirely to the Europeans. Within this general posture, we can, of course, try to convey an interested, if inevitably somewhat detached, attitude.
This approach would recognize the realities that, in present circumstances, our ability to assist in calming speculative fears is limited. In contrast, actions interpreted as acknowledging a responsibility for maintenance of present exchange rates could stimulate hopes and demands by others for limited forms of U.S. convertibility or for more generalized guarantees of foreign dollar holdings against exchange risks. In addition to the need to guard against unsustainable financial commitments, we do not want to take actions that might tend to prejudice some aspects of monetary reform in a direction against our long-term interests.
On the other hand a passive approach also means we lose an opportunity to resolve the short-run crisis and runs a large risk of encouraging already widespread beliefs that “we don’t care.”
Limited initiatives to intervene directly in foreign exchange markets to support the dollar. This would entail borrowing foreign currencies (either by the Federal Reserve or by the Treasury) and use of those currencies to buy dollars in selected exchange markets. The objective would be to obtain a favorable psychological impact both from a visible strengthening of the dollar exchange rate and from the mere knowledge in the market that the United States is prepared to take some financial risks in supporting the Smithsonian exchange rate structure.
The direct financial risks are limited to the potential loss on foreign currency borrowings if exchange rates do change. To have a reasonable chance of success, it is believed we should be willing to borrow at least $1 billion if this course is chosen. However, we would [Page 633]have serious reservations about extending this type of operation beyond, say $2 billion. The potential loss could range as high as 10 percent of the amount borrowed but would be expected to be much less. There is a good chance of no loss or small gain.
This approach is outlined in detail in Addendum B.4
In favor of this approach, our attitude would be visibly “cooperative” and “constructive.” We should, therefore, have some greater chance of influencing European decision-making. If the operation is successful, we could obtain our immediate objectives with very little cost. If the operation is unsuccessful, in the sense that the Smithsonian rates break down anyway, the attempt to help salvage the Agreement could provide a more favorable atmosphere for the longer-term negotiations.
Against this approach, limited intervention by the United States could easily lead to demands for “doing more.” The action proposed is technically neither convertibility nor a general guarantee of foreign dollar purchases. However, public pressures to move in those directions could well be heard again, on the argument the market needs still further reassurance. Moreover, chances of failure are appreciable, and our activity could possibly highlight any domestic political fallout from a breakdown of the Smithsonian arrangements.
A series of broader initiatives beyond
that discussed above, or in lieu thereof. Possible actions,
ranging from the small measures of largely psychological impact
to more substantial action, fall into several categories:
- More forceful U.S. and multilateral statements, following a special meeting of Finance Ministers. (However, a meeting, itself, would be dangerous and potentially counterproductive unless accompanied by more concrete actions.)
- Borrowing of U.S. dollars abroad from foreign central banks or privately, at somewhat more favorable terms than we pay at home. Actions of this type would have numerous precedents and would not raise awkward questions of convertibility or guarantees of dollar holdings. However, while a useful supplementary action, such borrowings by themselves would probably not have a major impact on the current situation.
- Some modification of domestic monetary and debt management policies, ranging from modest efforts to increase slightly short-term interest rates while depressing long-term rates to some visible tightening of monetary policy generally. Such actions, if important enough to have a significant impact, raise a question about consistency with domestic objectives.
- Tightening of controls on banks or corporations in an attempt to reduce outflows of short-term funds. Foreign governments would particularly welcome this action. However, it would be difficult to implement and would not be consistent with our longer-range objectives.
On balance, the practical option in present circumstances is to engage in limited exchange market intervention, as described in Addendum A [B]. I would want to keep this operation under daily review, and would not want to borrow more than $2 billion without full review with you.
- Source: Washington National Records Center, Department of the Treasury, Files of Under Secretary Volcker: FRC 56 79 15, UK British Float. Confidential. There is no indication that the memorandum was sent to President Nixon. Its probable date is July 18; see footnote 2 below.↩
- July 13 and 14. Addendum A, not printed, is a tabulation by day of central bank interventions to buy dollars following the reopening of foreign exchange markets on June 28 after Britain floated the pound. The totals for the seven banks listed on July 13 and 14 were $1,090 million and $1,450 million, respectively. The seven central banks also took $217 million on July 17, suggesting that this memorandum was prepared on July 18. From June 28 through July 17 the banks’ total purchases were $4,925 million.↩
- On July 6 the Embassy in Bonn reported that President Pompidou reportedly had told Chancellor Brandt (during their Summit meeting in Bonn) “that he considered it an anomaly that the Europeans were now ‘defending the dollar’ while the US sat by and did nothing.” The Embassy reported that Chancellor Brandt was considering a high-level approach to seek a U.S. “contribution” to the “defense of the dollar” and that the Embassy had been asked very informally how such an approach would be received in Washington. (Telegram 9346 from Bonn, July 6; National Archives, RG 59, Central Files 1970-73, FN 10)↩
- Not printed. Addendum B, “Proposed U.S. Foreign Currency Operation,” outlined use of a swap network to acquire foreign currencies, which in turn could be used by U.S. authorities to buy dollars, supporting the dollar’s value.↩