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

98. Memorandum From Secretary of the Treasury Blumenthal and the Chairman of the Council of Economic Advisers (Schultze) to President Carter¹

Washington, January 19, 1978

SUBJECT

• Contingency Planning with Respect to the Dollar

You asked for a memorandum identifying the options open to us in meeting contingencies with respect to the dollar.²

Our basic objective with respect to the dollar and our balance of payments is to maintain a position which enables us to pursue our domestic economic objectives both in the short run and in the longer term within a healthy world economy.

Contingencies

The fact that we are growing faster than most other industrial nations, in combination with our large oil imports, has tended to put downward pressure on the dollar.

The contingency we need to worry about is not a modest and orderly further depreciation of the dollar. That should cause no major problem for us, although some other countries—Germany in particular—would complain. Given an outlook that shows no improvement in the U.S. trade balance over the next two years, we do not want to close the door on gradual exchange rate adjustment as a means of ultimately reducing the deficit.

We would be in serious trouble, however, if there should occur a massive capital flight from the dollar and a sharp depreciation of its value in foreign exchange markets. Failure to get an energy program might lead to this result. And, given the nature of foreign exchange markets, it could conceivably be set off by events we cannot now foresee.

Such a development could:

—Depress economic growth and reduce unemployment abroad by adversely affecting business investment and consumer spending.

—Create major disturbances in money, capital and commodity markets that could threaten the stability of the domestic and international financial systems.

—Detract from U.S. ability to exercise leadership in world affairs, both political and economic. Foreigners equate a strong country with a strong currency.

—Exacerbate inflationary pressures in the United States by increasing import prices.

—Increase protectionist pressures as sentiment grew to curb imports as a means of aiding the dollar.

—Lead OPEC to raise the price of oil and shift to other currencies for oil investments.

We must avoid such developments.

Current Situation

Since the beginning of 1977, the dollar has declined by more than 20% against the Swiss franc and Japanese yen, and by 10% against the Deutschemark—but by only 4.7%³ against all OECD currencies on a trade weighted average. The bulk of this change occurred in the fourth quarter when there was downward pressure on the dollar in the markets reflecting:

1. growing awareness of the size of the U.S. trade and current account deficits;

2. a perception that no effective actions were likely to be taken to halt and later reverse the deteriorating trend—and in particular, doubts that an effective U.S. energy policy would be introduced;

3. recognition that with the German economy (and others) growing very slowly, our exports were not likely to show much expansion; and

4. a perception that the U.S. was not concerned about its exchange rate.

Recently the situation has stabilized as a result of:

—your December 21 statement that we would intervene in the markets to the extent needed to counter disorderly conditions;⁴

—announcement of a new Treasury swap facility with the German central bank, providing us with additional DM for intervention;

—a greater perception of U.S. concern about the dollar exchange rate;

—more U.S. market intervention: since December 21 we have sold foreign currencies (Deutschemarks) to the extent of $977 million. Recently the problem has been particularly the DM–dollar rate.

The markets have been calmer lately. Nonetheless it is not clear that the psychology has turned, and the situation could deteriorate rapidly at any time. Our options:

More Intervention in the Exchange Markets

We are considering several techniques to obtain more foreign currency to finance intervention:

A. Expand short-term Fed and ESF swaps with the Bundesbank and possibly other foreign central banks. A problem is that intervention expands the German money supply, which worries the Bundesbank. Treasury and the Fed are exploring possible ways to mitigate this effect, which could increase the Bundesbank’s willingness to enlarge the present $3 billion of swap arrangements.

B. Sell special drawing rights for foreign currency. The U.S. could use some of its SDR holdings of SDR 2.3 billion ($2.8 billion equivalent) to acquire foreign currencies. Preliminary discussions with the Germans suggest some willingness to sell us DM for SDR, up to several hundred million dollars.

C. Issue medium-term, DM-denominated Treasury securities, as proposed by Arthur Burns. There are two possibilities: issues on the market or to official holders. This approach could provide us with substantial intervention resources that would not have to be repaid in the short-term. But there are major disadvantages:

—Such issues would imply long-term support of the exchange rate, which we do not want to commit and which could draw substantial Congressional criticism;

—If the terms were attractive enough to induce foreigners to purchase the securities, the offer could induce exchange transactions in the wrong direction, by encouraging dollar holders (including Americans) to sell their dollars to switch to this new DM asset;

—U.S. willingness to issue such bonds would trigger strong demands by OPEC and others for exchange rate guarantees on their large dollar holdings—OPEC has been pressing for such “indexation” for some time;

—Specially attractive Treasury issues for foreign investors would bring strong U.S. public and Congressional criticism; and

—Although perhaps of relatively minor importance, such issues would expose the Treasury (the Fed would not be involved) to potentially very large exchange rate losses—the U.S. went this route once before in the 1960’s and is still paying off the debts at substantial cost.

We may in the end need to sell a limited amount of such issues to foreign officials—specifically the Bundesbank—if market conditions do not permit reversal of outstanding swaps within one or two years. Refinancing the swaps would provide a defensible rationale for confining such guarantees to one or a very few countries and currencies. But we believe the serious problems with foreign currency issues in general argue strongly against such issues except in this limited contingency situation.

Another possibility, which we do not recommend for consideration at this time, is a U.S. drawing on the IMF. We have a reserve position in the IMF of about $5 billion, which could be drawn upon a formal representation of balance of payments need. Large U.S. drawings, however, would virtually eliminate the IMF’s balances of usable currencies, would raise serious questions about U.S. participation in the Witteveen Facility and could trigger an adverse market reaction as a sign of U.S. weakness.

Other Possible Actions

Although it is not a source of foreign exchange, we are planning to initiate modest gold sales as you have authorized. Such sales might reduce net U.S. gold imports by $400 million or more per year. We have not decided on the timing, in part because of the forthcoming French elections. Again, however, any implication that gold sales were being instituted as a desperate measure to defend the dollar could have a perverse market reaction.

At this point we are hopeful that expectations can be changed so as to reduce the market pressures on the dollar. Much will depend on early Congressional approval of an energy program, public appraisal of the economic policies you will be announcing in the next few days⁵—and prospects for European economies (e.g., growth in Germany and political developments in Italy). Fukuda’s 7% growth target is helpful, but German unwillingness to take more expansionary measures is very discouraging and damages the prospects.

What Else, If necessary

If developments are not favorable—if Congress fails to pass an energy bill—the market situation could worsen seriously at any time in the months ahead. Market intervention in such event would probably not be adequate. There is too much potential for shifts in the timing of payments for our trade (running at $300 billion per year) and for shifts of financial assets out of dollars. We would have difficulty financing the intervention, and other countries (most specifically Germany) would not want the impact on their domestic money supply.

Should such a situation develop, we might need to consider much more significant moves in the energy area—such as a temporary import fee on oil. The fee would be designed to remain in effect only until a satisfactory energy bill were in place. Such an action might help to galvanize public pressure for action on the energy legislation.

Another possibility would be to suggest a more rapid build-up of the wellhead tax on domestic oil.

Some More Extreme Steps

If these various measures failed and we came face to face with an imminent threat of massive capital movements, we would have to consider

—controls over international capital movements,

—a surcharge on all (or most) imports, or

—sharp reduction in our domestic growth rate.

Any of these actions would have severe negative consequences. Capital controls would, moreover, probably be ineffective in stopping capital flight. The other alternatives might stop the exchange market pressure but would themselves pose threats to world trade and economic growth almost as serious as those posed by an exchange market crisis. We should not consider them except in a serious emergency. Certainly reducing our domestic growth rate through significantly higher interest rates because of dollar problems should be last on our list.

A final point: it seems to us that any major additional steps taken by the U.S. in coming months to stabilize the dollar should be accompanied by a renewed effort to convince Chancellor Schmidt to speed up growth rate as a companion action. The Germans share responsibility for the DM/dollar exchange rate. They are also the key to growth in all of Europe—the French, for example, have said that if the Germans would grow faster they would also be willing to do so. Nothing we could do would have as positive an impact on that rate as an announcement from their side that they are increasing their target for economic growth above the present inadequate level.

Summary

We are proceeding with exploring expanded swaps and sales of special drawing rights, as well as planning gold sales. We do not plan to issue foreign-denominated securities at this time.

Any significant action on oil will be dictated principally by the pace of progress on the energy legislation.

We do not contemplate any of the more drastic steps at this time—these further steps would, of course, involve major Presidential decisions.

1. Source: Carter Library, National Security Affairs, Brzezinski Material, Subject File, Box 8, Balance of Payments: 12/77–2/79. Confidential.
2. See Document 94.
3. An unknown person underlined “4.7%.”
4. See footnote 2, Document 86.
5. Carter’s message to Congress accompanying the President’s Economic Report, his message transmitting the FY 1979 budget to Congress, and a message to Congress on tax reduction and reform, all January 20, are printed in Public Papers of the Presidents of the United States: Jimmy Carter, 1979, Book I, pp. 129–144, 158–189.