Foreign Relations of the United States, 1961–1963, Volumes VII, VIII, IX, Arms Control; National Security Policy; Foreign Economic Policy, Microfiche Supplement

313. Memorandum from Heller to President Kennedy, November 28¹

November 28, 1961

SUBJECT

• The Balance-of-Payments Dilemma

The United States is facing a cruel dilemma of economic policy. Decisions to resolve it are hard upon us. The dilemma is this:

1. Economic expansion at home will, temporarily at least, worsen our balance of payments. The principal reason is that U.S. imports rise along with domestic production. For example, they are running about $2 billion per year higher now than in the spring.

2. Measures for quickly improving the balance of payments and reversing the gold flow will check domestic economic recovery, prolonging and increasing unemployment. Tightening of credit to keep funds from flowing abroad will also keep them from flowing to U.S. businesses and homebuilders. Raising taxes or cutting government expenditures to gain the “confidence” of bankers and currency speculators will reduce the flow of purchasing power at home.

The pressures to grasp the second horn of the dilemma are going to be very strong. But we urge you to resist them. We believe that it would be short-sighted folly to sacrifice the domestic economy for quick improvement in the balance of payments. There is a better way out.

1. The Costs of Incomplete Recovery

Consider the consequences of checking the recovery far short of full employment of labor and full utilization of capacity:

a. prolonged unemployment, increasing as the labor force grows

b. danger of another recession

c. excess capacity, low profits, high overhead costs

d. little incentive for investment which will raise productivity and make American industry competitive in long run

e. slow economic growth

f. low profits at home, providing continued incentive for American firms to invest abroad

g. political pressures for protectionism, for cutting foreign aid, and for isolationism

h. deterioration of U.S. prestige abroad from continued inability of U.S. to get its economy moving

i. dwindling chance of labor cooperation to hold wages and costs down—why should they without the prospect of full employment?

These are formidable dangers. Not only are the domestic costs of restrictive policy high, but the prospects of future permanent improvement in the balance of payments are sacrificed for a short-run improvement.

2. The Better Way Out

a. restore the U.S. economy to full employment by 1963, and take measures to modernize and expand our plant so as to advance productivity and competitiveness in world markets

b. accept the fact that the balance of payments deficit cannot be eliminated during the coming 1½ to 2 years of recovery

c. take measures to protect the dollar during the transition period

3. Protecting the Dollar

Balance of payments deficits do not automatically lead to gold losses. Foreigners may hold the dollars we pay them, rather than cashing them into gold. The trouble is that they already hold $18.2 billion ($10.5 official, $7.7 private) of short-term debt, and they may not have enough “confidence” to add more. We still have a lot of gold, and we can afford to lose some without dire consequences. However, there are several things we can do to keep gold losses from assuming frightening proportions:

a. negotiate prepayment of more of the $7½ billion long-term debts Europe owes us (half U.K., half continent)—even if we have to offer a premium it would be worth it

b. use the financial expertise of our Treasury and Federal Reserve in cooperating with other governments and central banks—not only directly, but through the Bank for International Settlements, and through OECD—to offset short-term capital movements

c. use the International Monetary Fund—that’s what it’s for

d. guarantee certain of our debts to foreign central banks against devaluation of the dollar—this would be proof positive of our determination not to devalue, and would greatly diminish the danger of large gold losses (in one sense we have already done this on a small scale ($46 million) in the case of Switzerland by pledging the repayment of the loan in Swiss francs)

Many people will be ready to tell you the disadvantages of these techniques. But the techniques will work, and their disadvantages are as nothing compared to the costs of alternative measures which would hold down the domestic economy.

4. A Historical Parallel

A final word: In 1925 Winston Churchill, then Conservative Chancellor of the Exchequer, resolved a somewhat similar dilemma the way the bankers wanted him to, i.e. in favor of a “sound” pound sterling and its world prestige, and against the domestic economy. The consequences (foreseen by Keynes in the “Economic Consequences of Mr. Churchill”) were: Britain had unemployment and depression long before 1929–30; labor was alienated by deflationary policy, and there was a bloody general strike in 1926; in the end the pound sterling was devalued anyway.

Walter W. Heller

1. “The Balance of Payments Dilemma.” No classification marking. 3 pp. Kennedy Library, National Security Files, Kaysen Series, Balance of Payments, General, 12/60–6/62, Box 362.