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

29. Letter From the Chairman of the Board of Governors of the Federal Reserve System (Martin) to Secretary of the Treasury Kennedy¹

Washington, October 21, 1969.

Dear Dave:

I regret that I shall have to miss tomorrow’s meeting on the 1970 balance of payments measures.²

Enclosed with this letter is a statement on the balance of payments problem, which provides strong reasons for minimizing any relaxation in the programs and for pressing toward equilibrium in the U.S. balance of payments.

I am sending copies of this letter and the enclosed statement to the other participants in tomorrow’s meeting.

Sincerely,

Bill

Enclosure

1. For almost two years foreign monetary authorities as a group have experienced a drain on their dollar holdings. Despite the worsening in the structure of the U.S. balance of payments, the inflow of short-term funds through U.S. banks has kept the dollar strong in exchange markets by making the holding of dollars attractive to private individuals, business and financial institutions abroad.

a. In 1968 the deficit on the liquidity basis improved substantially as a result of the January 1 balance of payments program, and the surge of foreign purchases in the U.S. stock market, despite a fall-off in the trade surplus. But the official settlements position improved even more, as a result of the Eurodollar inflow.

b. In the first half of 1969, the liquidity balance deteriorated sharply for a variety of reasons: a further fall in the trade surplus, a drop-off in stock purchases by foreigners, an increase in direct investment outflows, and the attraction of American funds to the Eurodollar market. But the official settlements balance was in sizable surplus, again because of the Eurodollar inflow.

c. The U.S. payments position has thus been protected in the past two years by short-term borrowing—in an amount exceeding $10 billion.

2. This protection has come to an end. A mere cessation of the Eurodollar inflow is enough to throw the official settlements balance into deficit (as has happened in the past two months). If, as seems likely, U.S. banks begin to repay Eurodollar borrowings, the official settlements deficit will probably exceed the liquidity deficit.

3. Thus foreign monetary authorities will very likely be accumulating large amounts of dollars next year and beyond.

a. No doubt, there is some appetite abroad for additional dollars at the moment. Some countries—notably the United Kingdom and France—have debts to repay. Others would be pleased to rebuild their dollar holdings, which have been depleted in the past two years.

b. But the appetite is limited. A large official settlements deficit is very likely to lead, rather soon, to a large drawdown of U.S. reserves (gold, our IMF position, SDR’s).

c. The attitudes of foreign monetary authorities toward the accumulation of dollars, in counterpart of our large official settlements deficit, will no doubt be influenced by whether they regard the large deficit as temporary or permanent. Some reversal of the surplus of 1968-69 will be regarded as normal.

d. But if the U.S. authorities are seen to be dismantling the programs to restrain capital outflows in the face of a large deficit, foreign monetary authorities are likely to be disturbed and to conclude that the United States deficit is here to stay. This in turn is likely to lead them to ask for conversion of greater amounts of dollar accruals into gold, Fund positions, or SDR’s.

e. Beyond this, many officials abroad, particularly in the Group of Ten countries, might well regard a significant relaxation of balance of payments restraint programs in the face of a large deficit as somewhat of a breach of faith. They were willing to go along with SDR activation on the grounds that it would help the balance of payments adjustment process. Thus they overlooked the unsatisfactory U.S. payments position in agreeing to SDR activation. A significant relaxation of restraint programs now would embarrass those European officials who were so cooperative regarding SDR activation in substantial amounts. It would also very likely jeopardize future negotiations regarding SDR’s.

4. Beyond these considerations, there is the basic question of where the United States is heading with its balance of payments policy.

a. The initiative of Secretary Kennedy regarding a study of limited exchange rate flexibility is unlikely to lead to sizable revaluations of other currencies against the dollar, over and above the present upward move of the DM.

b. Apart from stopping inflation in the United States and bringing about a gradual improvement in the trade balance, there is little else the United States can point to as a policy to improve the payments position.

c. In these circumstances, a sizable relaxation of capital restraint programs can only be seen by close observers as leading to some sort of crisis—presumably a suspension of convertibility of the dollar into gold.

d. While this possibility has been in the minds of many officials abroad, it has been regarded as a last resort in circumstances of unavoidable crisis. In such circumstances, suspension would be understood and accepted in relatively good grace abroad.

e. But if avoidable U.S. actions themselves precipitate the process that leads to suspension, the financial and political repercussions abroad are likely to be grave.

5. All these considerations point to the desirability not only of minimizing the extent to which the Commerce and Federal Reserve programs are relaxed for 1970 but also of continuing to press toward equilibrium in the U.S. balance of payments.

1. Source: Washington National Records Center, Department of the Treasury, Office of the Assistant Secretary for International Affairs: FRC 56 76 108, BOP Improvement Measures, Volume 4, 66-69. No classification marking. A handwritten notation on the letter reads: “Copy for Mr. Volcker 10/21 6:45 pm copies to Messrs. Petty and Schaffner.”
2. The meeting has not been identified, but on October 29 Paul H. Boeker sent a memorandum to Assistant Secretary of State for Economic Affairs Trezise informing him that “interested USG agencies are having second thoughts about the Fed’s proposed revisions in the VFCR Program announced at last week’s meeting of the Cabinet Committee on Economic Policy.” Boeker explained that the Fed had consistently opposed increased export credit extension because of its adverse short-term balance-of-payments impact but that “all member agencies of the Cabinet Committee on Export Expansion except the Fed expressed support for the exemption of all export credit from VFCR guidelines.” Boeker recommended Trezise contact Governor Brimmer to support further interagency study of the practical consequences of the proposed revision of the VFCR program (before any announcement of new guidelines was made). Trezise’s handwritten note on Boeker’s memorandum reads: “Call to Brimmer not necessary now. PHT.” (National Archives, RG 59, Central Files 1967-69, FN 6 XMB)