Foreign Relations of the United States, 1977–1980, Volume III, Foreign Economic Policy

117. Briefing Memorandum From the Assistant Secretary of State for Economic and Business Affairs (Katz) to Secretary of State Vance¹

Washington, March 15, 1978

Effects on our Foreign Relations of Administration Inaction on Energy and Inflation

The market is losing confidence in the dollar. It is persuaded that the US is drifting, unable to take the critical measures to reduce its large oil bill or to keep price increases in its economy under control. Capital is moving out of the US, private capital inflows have fallen off, and OPEC is shifting out of dollar-denominated assets into non-dollar deposits in the Euromarket. In the absence of corrective action, these movements out of the dollar will intensify. Intervention alone will not check these movements, as the market reaction to the US-German statement on Monday demonstrated.² Indeed, unless we take early decisive action on energy and inflation—which are essential to restore market confidence in our ability to manage our affairs—we may be confronted at any time with a flight from the dollar that could swell to panic proportions.

Inaction by the Administration to check a steep decline in the dollar would have disastrous consequences for our foreign policy:

—The pressure on OPEC to raise oil prices directly or by denominating oil prices in SDR’s would become irresistible. The US—not OPEC—would be blamed by all other importing countries for this result.

—The MTN would be halted in its tracks. Our trading partners, who are already complaining that the depreciation of the dollar is excessive, indeed deliberate, and gives the US an unfair competitive advantage, would be quite unwilling to reduce tariffs or cooperate on non-tariff barriers.

—Protectionism in other countries would be given a powerful fillip and would be justified by the steep and “unfair” decline in the dollar.

—Our domestic objective of steady, stable growth at home would be undermined. Business confidence would erode, the stock market would sag, inflation would intensify as the dollar price of US imports rose and induced a further rise in the prices of US domestic goods that compete with imports, capital outflow could become feverish, and interest rates would rise.

—Economic activity abroad which is on a rising trend would be depressed as uncertainty about the economic outlook intensified and gloom became contagious.

—Depressed economic activity in the developed countries, which the increase in the price of oil would exacerbate, would hurt developing countries whose import costs would rise while their earnings fell off.

—The US would be blamed for converting a slow but steady recovery to a world-wide recession.

—Furthermore, the dollar is not only a major trading currency but the world’s most important reserve asset. The US would be accused by oil-exporting countries, the non-oil LDCs, and many developed countries who hold all or a substantial portion of their reserves in dollars, of serious mismanagement of its affairs that had caused severe losses in the value of their reserve assets, inadequately compensated by interest payments on the dollar. The accusation would be all the sharper because the US has resisted efforts by others to strengthen the SDR as an alternative reserve asset.

—The dollar costs of our military establishment overseas would mount. The rising budgetary burden of maintaining these forces would face us with difficult decisions: to curtail domestic social programs, to retrench on our defense expenditures, or to increase our budgetary deficit with adverse effects on domestic inflation.

—US leadership of the Western military and political alliance would be undermined. The weight of the US in the world economy is so great that our major allies perceive themselves as helpless to protect their own interests in the face of US drift. Leadership requires decisive action. In its absence, recriminations will intensify and cooperation with our major allies, on which our strength and security ultimately depend, will weaken.

1. Source: Department of State, Office of the Secretariat Staff, Records of Cyrus Vance, Secretary of State, 1977–1980, Lot 84D241, Box 7, International Economic Policy—1977–78–79. Secret; Nodis. Drafted by Ruth Gold, Katz’s Special Assistant. The initials “CV” are stamped at the bottom of the page.
2. March 13; see footnote 4, Document 114. A report in the March 14 edition of The New York Times on the U.S.–FRG dollar stabilization program noted that the program’s announcement had “failed to impress foreign exchange markets. The American currency, which had shown strength early in the day in Europe on high hopes that significant steps would be announced, tumbled after the measures were made public.” (Clyde H. Farnsworth, “Plan is Announced by U.S. and Germany to Stabilize Dollar,” The New York Times, March 14, 1978, p. 1)