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

85. Memorandum From the President’s Assistant for Domestic Affairs and Policy (Eizenstat) and the Associate Director of the Domestic Policy Staff (Schirmer) to President Carter¹

Washington, December 19, 1977

SUBJECT

• Decision Memorandum on Balance of Payments Options (At your request)

I. THE NATURE OF THE PROBLEM

A. The Forecasts (Provided by Treasury)

	($ billions)
	1976	1977	1978
Trade deficit	9	30	33–36
Current Account deficit	1	18	21–24

These forecasts are:

• (1) based on optimistic assumptions (e.g., no OPEC oil price increases in 1978).
• (2) subject to the usual uncertainties, things could turn out better in 1978—or they could turn out much worse. (A trade deficit approaching $40 billion is conceivable.)

B. Recent Performance of the dollar

In the last three months, the dollar has depreciated 9% against the German mark, 13.5% against the Swiss franc, 10% against the Japanese yen and over 6% against the British, Belgian, and Dutch currencies.

II. APPROACHES TO THE PROBLEM

Your advisors have put forward several different views of how the U.S. should deal with the balance of payments/current account deficit problem. There is, however, consensus on several points:

• • confidence in the dollar is critical to our continued ability to finance existing and projected U.S. trade and current account deficits;
• • enactment and implementation of a strong national energy program is central to our ability to deal with the trade deficit problem and our excessive dependency on foreign oil;
• • we should continue diplomatic efforts to encourage more rapid growth by our strongest trading partners; and
• • public education about the balance of trade issue is needed here at home.

A. The Blumenthal approach²

Confidence in the dollar has waned in recent weeks, and speculation has developed which has further depressed the dollar exchange rate and confidence in our currency. There is now some risk of a major speculative run against the dollar with serious implications for the preservation of the liberal trade and payments system, U.S. leadership internationally and our own domestic economy. Relationships with European monetary authorities are becoming increasingly difficult. The market disorder is receiving heavy and disturbing press play. The widespread market perception that the U.S. is not prepared to make any attempt to stop the decline of the dollar tends to deter the capital inflow needed to finance the current account deficit. Because the world monetary system is based on the dollar, lack of confidence in the dollar also damages confidence in the world economy which is crucial to global economic expansion.

While Blumenthal does not recommend efforts to slow U.S. economic growth, he does recommend actions designed to convince traders, businessmen, and foreign governments that the Administration intends to act forcefully to bring its current account under control and keep the dollar strong. This cannot be achieved solely by monetary measures such as increasing intervention in the foreign exchange market.

He also considers it psychologically important that the deficit next year be somewhat smaller than in 1977. For this purpose, he recommends that you express public concern (but not alarm) about the dollar. This statement should be supported by new energy measures as well as discussion of the Administration’s fiscal policy and tax policy objectives. He recommends a number of actions designed to reverse what he believes to be a widespread perception of “malign neglect” by the Administration even though the specific measures recommended would not in themselves reduce the deficit dramatically.³

B. The Vance/Schultze view⁴

The size of the U.S. current account deficit, particularly oil imports, is a matter for concern. Although it creates a drag on U.S. economic recovery, the deficit does not indicate a fundamental weakness in the U.S. economy. Our ability to compete is unimpaired. Our foreign markets are simply growing slowly or not at all, while U.S. economic growth leads the industrial world.

The dollar has depreciated considerably against slow-growing countries, many of which are now in surplus as a response to our deficit. The recent exchange rate adjustments will help to keep our deficit in line and reduce the surpluses elsewhere. The exchange rate changes also put pressure on the countries in surplus to take needed action to stimulate their economies. Although there may be alarmist press coverage, Vance and Schultze see little risk that exchange markets will get out of hand. In fact, this risk is likely to be increased rather than reduced by major policy reversals and high visibility statements that emphasize our alarm.

Schultze and Vance recommend low key public education, pursuit of diplomatic efforts to stimulate adjustment by countries in surplus and quiet adoption of reasonable, low-cost measures.

C. Schlesinger Comment

We must recognize that while approximately half the deterioration in our balance of trade is attributable to increased oil imports, the other half is not. Over the past two years, there has been a significant deterioration in our trade balance in the industrial products sector, and some deterioration in the agricultural sector. Our biggest single problem—the $12 billion annual Japanese trade surplus—is largely unrelated to energy imports. It is interesting to note that, considering the relative sizes of GNPs, the Japanese import the equivalent of twice the amount of oil as does the United States and yet still manage to run an enormous balance of trade surplus. Thus, when considering the balance of payments problem, we must keep the non-energy component in mind and act accordingly. This should call into question any strategy which does not focus on a broad range of remedial actions.⁵ Those actions, however should be implemented gradually, and any energy-related actions should be implemented without an explicit linkage to the balance of payments problem.

III. OPTIONS FOR DECISION

The pros and cons of each of the options suggested by Secretary Blumenthal are outlined below. Some of the impacts of these options can be described as either positive or negative, depending on the basic approach to the problem which you feel is most appropriate. For example, a highly visible expression of concern about the strength of the dollar would be a plus under the Blumenthal approach, and a negative under the Schultze/Vance approach.

1. Defer or slow down purchases for the Strategic Petroleum Reserve

Pro:

• • Deferral of further purchases until 1981 would save $3.2 billion in 1978, $1.5 billion in 1979, and $2 billion in 1980, (but would add to outflows in future years).
• • Various rates of slowdown, short of complete deferral of purchases, are available which could be selected to demonstrate our concern, particularly in 1978.

Con:

• • Legislative revision would be required for any schedule which delays storing the first 500 million barrels beyond December 1980.
• • This program is popular with the Congress and the public. It was a major element of your April 20 Energy Program,⁶ and is aimed at counteracting our petroleum import supply vulnerability.
• • Delaying SPRO may be taken as a sign that we do not really believe that the energy problem is serious, although Blumenthal suggests that it could also be cast as reflecting our perception of the easing of mid-East tension as a result of the Arab-Israeli talks.⁷
• • Surpluses in the world oil market are likely to continue over the next two to three years which should keep OPEC price increases to a minimum. SPRO purchases during these years are therefore optimal from a price and availability standpoint.
• • Vulnerability studies to date show that the SPRO, at least at the 500 million barrel level, is a worthwhile insurance policy against supply interruptions or cutbacks.
• • Deferral of SPRO would undermine efforts to encourage our allies to undertake storage programs (which may ultimately reduce the size of necessary U.S. storage.)

COMMENT: This would be the most dramatic evidence of U.S. concern over the balance of payments problem. It would reverse a major element of your energy policy which has been consistently stated since the early days of the campaign. Blumenthal believes this change would be appropriate, indicating a belief that “embargo insurance” is not as urgent as our trade deficit. Vance does not believe that the change in the deficit would be more than cosmetic.

A decision could be made to continue with the first 500 million barrels, and to adjust the fill rate (or a decision on the second 500 million barrels) if the balance of payments picture or the oil supply situation should change. Under this alternative, the immediate impact on the deficit would be foregone, but it would reduce future pressures on the picture.

Blumenthal recommends slowdown in purchases in 1978 through 1980. Vance, Schultze, Schlesinger and we recommend keeping on schedule with the first 500 million barrels but keeping an eye on the need for and the economics of the second installment.

Slow down SPRO purchases (Blumenthal)

Maintain current schedule for first increment but defer decision on next increment (Vance, Schultze)⁸

Maintain current plan for full SPRO (Schlesinger)

2. Increase rate of production at Elk Hills and expedite construction of the Sohio pipeline

Pro:

• • Would save $.6 billion in 1978 and up to $1.5 billion in mid-1980 (assuming completion of the Sohio pipeline).
• • All federal and state permit issues for Sohio have been worked out. The one remaining issue (between Sohio and the local utility) can probably be solved soon. The project has a decent chance of completion by the time Elk Hills can be cranked up to full capacity.

Con:

• • If the Sohio project cannot be completed in time, Elk Hills production cannot be increased to its maximum since no transportation capacity, even to the West Coast, will be available.
• • Would constitute a change in earlier policy, although this is not likely to be either controversial or noticed by other than local interests.

COMMENT: All parties recommend full production of Elk Hills, including moving forward aggressively to fund a new gas plant in the field and secure related transportation systems.

Begin work for full production of Elk Hills (all recommend)⁹

Continue Elk Hills slowdown

3. Encourage an immediate decision by the owners to increase the throughput of the Trans-Alaska Pipeline System (TAPS)

Pro:

• • Would add 400,000 barrels per day to domestic production saving $2 billion/year beginning in mid or late 1980.
• • If completed, Sohio can handle at least part of this additional capacity.
• • This is the single most cost effective option available to reduce the underlying levels of oil imports and the balance of payments deficit over the next 3 years.

Con:

• • The additional Sohio transmission capacity will probably not be sufficient to handle Elk Hills and Alaskan oil. Some of this oil would have to be tankered through the Panama Canal or swapped with Japan.
• • While a Japanese oil swap would not increase U.S. dependence on foreign oil, it has been violently opposed by numerous members of Congress. A swap would be politically difficult.
• • Would reverse a previously stated policy of avoiding oil swaps which received substantial favorable press.

COMMENT: Vance, Schultze, Blumenthal, and Schlesinger recommend increasing TAPS throughput and arranging for a swap with Japan if needed. We concur with this recommendation on the merits, but believe that announcing or implementing such a decision should be deferred until we have consulted extensively with members of Congress and California officials. We strongly urge you not to even float the idea of a swap until the energy bill passes and until there has been adequate Congressional consultation.

Encourage an increase in TAPS throughput and swap oil with Japan if needed. (all recommend)¹⁰

Delay announcement and implementation pending consultation. (all recommend except Blumenthal)

Continue with current policy.

4. Direct limitation of oil imports (quotas/import fees)

Pro:

• • Most direct means of curtailing consumption of oil, but would require some sort of domestic allocation or consumer rationing. Use of quotas (or fees) could reduce payments by $5 to $10 billion, depending on the stringency of the program.
• • Would constitute dramatic evidence of our determination to deal both with the trade deficit and with our energy problem.
• • Some argue that rationing is fairer means of inducing conservation than price increases.

Con:

• • Rationing in the absence of a major supply interruption would be perceived as a drastic, and probably unnecessary step by the public.
• • Reduction in oil import availability could have a significant negative impact on economic growth.
• • Any rationing system is cumbersome and expensive administratively.
• • Revised rationing plan (and other contingency plans) is still in preparation. These require congressional approval after submission, and implementation of the plans is subject to a one-house veto.
• • Other steps, short of rationing, are available to cut back consumption.
• • No rationing system can be completely equitable. Hardships would be caused in certain sectors of our society.

COMMENT: You have the legal authority to impose import quotas for balance of payments reasons. You also have the authority to impose gasoline rationing (subject to Congressional disapproval). None of your advisors recommends rationing at this time. All agree, however, that development of rationing and contingency plans (and analyses of import quotas or fees) should continue expeditiously.

Continue plan preparation, but avoid rationing (all recommend)¹¹

Proceed to develop rationing plan for immediate implementation

5. Expand CCC budget by $1.5 billion per year

In the FY 1979 budget session on agriculture you decided to increase the CCC budget from $750 million to $1.5 billion.¹²

6. Expand Eximbank lending by about $4 billion

This issue will be reviewed in detail in the Eximbank budget session on December 20 so will not be treated in this memo.¹³

7. Sell some of our gold holdings in the private market

Pro:

• • This would have a slight, but positive impact on the balance of payments.
• • It is consistent with our longer term goal of removing gold from the international financial system.
• • Sales can be timed so as to avoid disrupting the international market, or impacting upon the French elections.

Con:

• • There are a small number of highly vocal critics (including some in Congress) who believe that selling gold undermines the stability of the dollar and the entire monetary system.
• • Immediate sales could offend the French and this could become an issue in the March elections.

COMMENT: All of your advisors believe that this is a sensible policy. No announcement, however, should be made until after the French elections in March.

Gold sales should be justified on the grounds that this is sensible monetary policy, and should not be announced as part of a balance of payments strategy.

Approve gold sales after the French elections (all recommend)¹⁴

Disapprove gold sales

8. Moderate expansion of military sales for off-the-shelf items

Pro:

• • Would generate about $500 million per year

Con:

• • Would be at least a partial retreat from your efforts to reduce arms sales
• • Foreign military sales from past commitments are expected to rise from $6.9 billion in FY 1977 to up to $9.2 billion in FY 1978 as it is.
• • Acceleration of shipments in 1978 could come only by temporarily degrading our own defense capabilities.
• • The impact on balance of payments is relatively small.

COMMENT: Blumenthal recommends that sales be expanded but makes clear that this should not be publicly linked with balance of payments. Schultze, Vance, and we recommend against any such increase on the grounds that the low level of temporary impact is not significant enough to warrant contradiction of your present arms sales policy.

Approve increase in arms sales (Blumenthal)

Disapprove increase in arms sales (Schultze, Vance, Eizenstat)¹⁵

IV. PACKAGING OF THE OPTIONS SELECTED

Blumenthal believes that a demonstration of your concern is of far greater importance than the actual statistical effect to be expected from these specific measures. Therefore, he recommends that you announce your determination to maintain a strong dollar, relying primarily on:

• • policies to maintain a growing, non-inflationary domestic economy;
• • an effective energy program, but including as specific balance of payments actions such energy-related measures as you select;
• • expansion of CCC and EXIM budgets;
• • speculation against the dollar might then be stopped and some visible improvement in the current account position achieved during 1978.

Blumenthal further states that although we should continue to urge economic expansion abroad in appropriate cases, we should recognize that we have pushed the Japanese and Germans about as far as they will tolerate at this time. In an effort to avoid further currency appreciation both countries are now turning to restrictive measures on capital inflow.

Vance, Schultze, Schlesinger, and we recommend against such an announced package on the grounds that:

• • even if all of the options were selected, the total impact on the balance of payments is fairly small. If this is touted as our whole program, it may appear too small and discourage international confidence in the dollar;
• • calling particular attention to the problem could set off more alarm in the international market than not doing so;
• • the U.S. balance of payments picture is already relatively well-known by sophisticated observers and participants in international money markets and it has not seemed to do the dollar great or disorderly harm. In fact some appreciation of the mark and the yen will encourage the stimulative policies by Germany and Japan which we seek. As long as this appreciation occurs in an orderly way, it is not undesirable.

Package energy options together and link to balance of payments (Blumenthal)

Proceed to implement options, but do not expressly link to balance of payments (Schultze, Vance, Eizenstat)¹⁶

1. Source: Carter Library, Records of the Office of the Staff Secretary, Presidential File, Box 65, 12/21/77 [2]. Secret. Schirmer did not initial the memorandum. A stamped notation reads: “The President has seen,” and Carter wrote “Stu. J” at the top of the page. Attached is a December 20 note to Carter from Eizenstat that reads: “Since the final typing of this memo, Mike Blumenthal has called me to tell me that Cy Vance now favors some sort of general statement of concern on the balance of payments problem.” Carter wrote “ok” on the note. (Ibid.)
2. See Document 66.
3. Carter wrote “ok” in the margin adjacent to this paragraph.
4. See footnote 3, Document 82.
5. Carter underlined the phrase “broad range.”
6. See footnote 7, Document 25.
7. Direct Egyptian-Israeli talks began with Egyptian President Anwar Sadat’s November 19–21 visit to Jerusalem.
8. Carter indicated his approval of this option and wrote “Maintain 1985 schedule on purchases.”
9. Carter indicated his approval of this option.
10. Carter indicated his approval of this option and wrote “No reference to Japan swap.”
11. Carter indicated his approval of this option.
12. Carter made a checkmark in the margin adjacent to this paragraph.
13. Carter wrote “$3.6 Total” in the margin adjacent to this paragraph.
14. Carter indicated his approval of this option and wrote “modest.”
15. Carter indicated his approval of this option.
16. Carter did not indicate his preference with respect to these options. At the end of the memorandum he wrote: “Statement approved for use when/if needed. JC.”