142. Backchannel Message From the Under Secretary of the Treasury for Monetary Affairs (Yeo) to Secretary of State Kissinger and Secretary of the Treasury Simon 1

  • Subject: Deputies Meeting—Section II.

We had an extensive discussion of the monetary situation. The discussion was confined to our “super tranche” idea and Italy. In the case of the latter, several things became clear: [Page 508]

There has been remarkably little analytical work done by the other governments represented here. This explains why there was only a dim perception on the part of the French and the English re the prospective financing requirements for Italy;
The French have a distinct tactical approach—it involves low-keying any discussion of Italy per se in Puerto Rico or anything that would obliquely relate to Italy. Seemingly they would wait the Italians out in initiating any steps that could be construed as helpful from a financing standpoint until the Italians had formed a government and had produced an acceptable economic and financial stabilization program. This was somewhat surprising since the French had been heavily affected by the depreciation in lira but is characteristically French in approach. We debated whether the French approach is advisable. A number of questions are raised by it. In the wake of the Italian elections, could discussion at Puerto Rico be avoided? Which provides the maximum incentive for the formulation of an economic program—no financing facility or a financing facility tied to the development of an economic program? While our debate on tactics was inconclusive, it was clear that the Germans and the English do not share the French view. In terms of our proposal for super tranche, the French characterized it as ingenious but then attacked it on two counts: the tactical issue as to timing and tactics as mentioned above, and the conflict—real or imagined—with the Financial Support Fund. De Larosiere, quite clearly at Brossolette’s instruction, had a grand time working me over on our failure to legislate our Financial Support Fund. Technically, the Financial Support Fund can come into existence after the French administration tenders the necessary documentation to the OECD. Note, the French Parliament has ratified the Financial Support Fund and this brings the countries approving above the 60 percent limit which can trigger creation of the Fund. The French don’t plan to formally complete the ratification process until, and if, our Congress has acted.

I suspect the French problems with the super tranche are as follows: (a) They do not want to come up with the money that is implicit in the creation of the super tranche—these funds would come out of their reserves and after losing $5 billion in two months and facing a current account deficit, de Larosiere (watchdog of the purse) is feeling poor; (b) MIA [ MFA ?] feeling that in any but a very general sense financing availability should follow formation of an Italian Government and an Italian program; (c) Pique, probably on the part of Brossolette, that initiative for funding a way of dealing with problem of European country had come from us.

The Germans and the English had a generally favorable reaction to the idea of a super tranche. Note—the French position on the second day was appreciably easier than on the first. The German concern is [Page 509] that if there were two facilities—super tranche and the Financial Support Fund—they might have to pay out more than if there were only one. Our answer to the Germans’ concern centered on the idea of using the super tranche first and the Financial Support Fund only in extreme emergency. This explanation was tentatively accepted by Poehl in part because he and his colleagues have doubts about the financial structure of the Financial Support Fund; specifically, the way in which funds are raised and would like to avoid having to use that mechanism. A summary of our discussions of the monetary section would be as follows: super tranche is technically feasible and attractive in many respects; however, there is some confusion about its relationship to the Financial Support Fund and some anger regarding the lack of progress on the Financial Support Fund by Congress, and a definite lack of consensus as of the close of this meeting re the tatics to be followed in connection with the Italian situation. Finally, there is concern as to how the super tranche for developed countries could be presented to the LDCs without causing LDCs to ask for more.

At the close of the first day we laid down the following paper on the super tranche.


I. The Problem

Looking ahead, the international payments pattern is likely to be as follows: continued large OPEC surpluses; continuing but sharply reduced LDC deficits; and substantially increased deficits in the developed countries.

For the LDCs the financing needs will be reduced as economic recovery in the industrial world leads to increased inventories and raw material exports move higher in volume and price—a process that is already well underway. While there may be selective individual LDC financing problems, the group of developing countries in general will be able to meet its reduced financing needs through continued use of private credit and the expanded IMF financing available under normal drawing, the liberalized compensatory financing facility, the new extended fund facility, and the 45 percent stretching of tranches agreed at Jamaica.

For the developed countries, the prospects are mixed. Most will be able to handle the deterioration in their payments positions—through a reduction of surpluses (such as the $15 billion turnaround in the U.S. position), attraction of capital into private markets, and use of private credit, supplemented by normal IMF drawing facilities.

There are however some major developed countries which have not yet restored stable conditions to their domestic economies, which thus face large payments deficits, but which will not be able to meet [Page 510] their financing needs solely through these channels. These “special needs” countries have more or less exhausted their ability to borrow in private markets, cannot attract inflows of capital, and have only limited remaining access to official credit from the international institutions.

There is a danger to the international community that when these developed countries run out of money and credit, and reach the limit of their ability to support their currencies, there will be very disorderly adjustments. Such disorderly adjustments could be characterized by sharp depreciation in exchange rates, possibly import and exchange restrictions, and internal and international financial strains which have the potential for inflicting severe damage on the entire international monetary system.

II. A Proposal

Consideration should be given to arrangements for dealing with this problem of the developed countries facing the combined difficulties of domestic economic and financial instability, very large payments deficits, and limited or exhausted financing availabilities.

Specifically, the need is to combine, for such a country, additional official credit, complementing the IMF regular resources and the Financial Support Fund, to be related to a specific set of national policies which will correct in a moderately short time period the underlying domestic economic problems which caused the disequilibrium in the country’s international financial position.

One possibility is to build on the provision of the Jamaica Agreement permitting “in special circumstances” drawings from the IMF beyond the normal standards of availability. In this way, a member which had already reached the limit of 245 percent of quota under the IMF’s normal facilities could, because of the member’s “special circumstances”, be provided additional IMF credit tied to a rigorous and detailed program to restore domestic economic stability.

Use of such a “special circumstances” arrangement or “super tranche” could be coupled with activation of the General Arrangements to Borrow, under which the G–10 countries are able to lend to the IMF for drawings from the IMF by G–10 countries. GAB commitments total $6.3 billion at present exchange rates. (The Swiss have parallel bilateral arrangements for simultaneous lending to the IMF.)

Use of the GAB has the advantage that countries are able to make the funds available quickly and without any prior legislative action other than that already on the books. Under the existing agreement GAB loans are to be made to the IMF “when supplementary resources are needed to forestall or cope with an impairment of the international monetary system.” The present situation plainly presents such a need—in light of the dangers to the monetary system noted above with respect [Page 511] to those developed countries with “special needs”, and in light of the fact that the IMF’s usable currencies now total only $7 billion and are being heavily drawn upon by non-members of the GAB.

Repayment of GAB loans by the IMF under the existing agreement is to be made in five years (or less, under some conditions). A GAB claim on the IMF can be shifted by one participant to another in case of need, enabling the claim to be treated as reserves if desired. Interest is paid by the IMF at the rate the IMF earns on the drawings made using GAB funds—thus credit provided under a “super tranche” concept need not be limited to the 4–6 percent charges on normal IMF drawings but could be closer to a market rate.

The limit on drawings from regular IMF facilities of 200 percent (245 percent temporarily) has been strictly observed in the past, and any departure from that limit should be marked by exceptional conditions, both to assure a correction of the disequilibrium causing the need for the special financing and to limit calls on any super tranche to the absolute minimum of critical cases. Financing alone will not solve the problems of these countries and will carry little or no conviction in the exchange markets in the absence of credible domestic programs that will correct, and be seen to correct, the domestic and financial problems causing the payments disequilibria. Accordingly, access to any super tranche facilities might be subject to more detailed and more stringent conditions with respect to domestic fiscal and monetary policy than those applied for access to regular drawings; might be phased with prescribed performance criteria over a period longer than the present one year; and might be subject to higher interest charges than present IMF drawings. The possibility should also be considered that super tranche credit be accompanied by financing from outside the IMF, with such financing also phased with the prescribed performance criteria, in order to give additional leverage for meaningful and internationally acceptable adjustment programs. Section III of this message to follow.

  1. Source: Ford Library, National Security Adviser, KissingerScowcroft West Wing Office Files, Box 11, Economic Summit Conference, 6/76, Items AA–DD. Top Secret; Immediate. Also sent to Scowcroft, Seidman, and Hormats.