Foreign Relations of the United States, 1964–1968, Volume VIII, International Monetary and Trade Policy

161. Minutes of Meeting of the Cabinet Committee on Balance of Payments¹

Washington, December 21, 1967, 4 p.m.

Secretary Fowler commenced the discussion and said this meeting was basically a reporting session although he would welcome comments. In general, the balance-of-payments figures for 1967 are grim. He emphasized the need of holding closely all information in this meeting and to impart it only on a “need-to-know” basis.

Historically, from 1958 to 1960 the United States was running an annual liquidity deficit of about $3.9 billion; from 1961 to 1964 this deficit was reduced to $2.5 billion; and in 1965 and 1966 it was reduced to about $1.3 billion in each of those years. The 1965 figures would have been even better had (1) the U.K. sterling problems not caused the liquidation of about $500 million in securities and (2) additional military costs of about $400 million due to the step-up in Vietnam. In 1967 we targeted a deficit in line with the results of the two prior years. However, by mid summer the annual rate deficit was $2 billion and by the time the year is over we will be in the $3 to $4 billion range.

Secretary Fowler said there are three factors presently at work which make our balance of payments planning an entirely new ballgame. The first is the size of the deficit we are running and the basic deterioration which can not be attributed to Vietnam. The second concerns the Special Drawing Rights arrangement which is being detailed in the International Monetary Fund and which should be ready for use, following ratification by the member countries, perhaps some time early in 1969. When this arrangement is operational it could supply through the deliberate creation of reserve assets the needs of the international monetary system. I look upon the SDRs as the light at the end of the tunnel. Before, when this Committee was considering the alternatives available, we were apprehensive about taking drastic measures which might serve to unsettle the position of other countries, recognizing that the substantial reduction of our deficit could cause disorder in other areas of the world financial system. The third development which makes it a new ball game is the devaluation of sterling which places the dollar in the front line and makes it essential that we right our imbalance.

We have been examining various additional alternatives these past several months and at our meeting on June 30,² we discussed many of the options available. This Committee has discussed this subject in the past as if we were passing a hot potato around the room waiting only for the whistle to blow to see whose hands were burned. Today, we have four to five hot potatoes to pass around the room.

Border Taxes

Ambassador Roth introduced his portion of the “package” which concerned trade. He argued that he is primarily concerned with the retaliation which the imposition of a U.S. border tax would probably involve, pointing out that our surplus makes us uniquely vulnerable. It is the net benefit which we must seek. He agreed that something must be done in order to show a complete package but he emphasized that other areas, especially capital flows, must be covered: if the restrictions in the area of capital flows are strong it is possible to go further in the area of trade.

Both the Dutch and Germans will increase their border taxes on January 1, 1968. The Dutch will go up 1–2 percent and the Germans, moving from their present cascade indirect tax system to the added-value system, will move from about 4 percent to about 10 percent. In considering what we might do in this area we must be mindful of the limitations of GATT. Can we put together our own border tax based upon our own tax structure that gives us something similar to the advantage the Europeans enjoy? Treasury has compiled the secondary indirect taxes in this country; a figure of 2–2.5 percent represents various state and local taxes, customs duties and some federal excise taxes. This figure is increased to 4.3 percent if property taxes are included. If these secondary indirect taxes were rebated on a product-by-product basis they could be considered legal under GATT. However, it is true that five European countries rebate these “hidden” taxes and compensate at the border on a basis somewhat closer to a national average basis than to a product-by-product basis.

Ambassador Roth pointed out that the basic question was not one of legal niceties but one of retaliation. We all agree that Canada, the U.S., Japan and maybe some EFTA countries would have to adjust with us. There are two basic proposals. The Treasury approach which would announce the legislation and seek discussions subsequently and the Roth approach which reverses the procedure.

(See Attachment A for the detailed alternatives presented by Ambassador Roth.)

The key issue is whether the Europeans will retaliate or not. The second approach is designed to reduce this possibility without sacrificing more than two or three weeks of time. Assistant Secretary Solomon pointed out that the proposal reduces the chances of retaliation, compared to the U.S. Treasury proposal. He indicated that it was necessary to consult with the nations which would probably follow our action; moreover, the request for a GATT waiver would make it difficult for the Common Market countries to retaliate.

Secretary Fowler emphasized the importance of our trade surplus and he referred to the President’s May 23 directive to study ways to fire-up the producers of our countries to make them more active in export trade.³ He emphasized that the keystone of equilibrium is a larger balance-of-trade surplus. As we have needed to restrict the private and public sector we can no longer neglect the trade account. We have scraped the bottom of the barrel on special transactions. He cited the Joint Economic Committee report which pointed out that the border taxes hurt our trade.⁴ We must take action now that makes our export lazy producers export conscious. Treasury believes that there must be action now combined with serious efforts at negotiations. Moreover, the Treasury proposal would be prepared to exempt the less developed countries.

Ambassador Roth questioned whether the difference was really one of only 2.5% and 4%. If we are to make trade gains in the use of the border tax other countries must exercise restraint. Normally, in trade negotiations others would say, “What would you pay to achieve these trade gains?” Would you pay an injury clause in your countervailing duty law? Would you amend Section 22 of your Agricultural Assistance Act?

Under Secretary Rostow said that it was important for the President’s statement to be firm and effective. The statement could say that legislation is being considered. He reminded the Committee of the recent OECD ministerial resolution that the balance-of-payments positions of member countries are “a matter of common concern”.⁵ The risk of retaliation is great and therefore pursuant to this resolution and through negotiations perhaps the risk of retaliation can be minimized. Concerned as he was with retaliation he seemed to be favoring Alternative Two.

Chairman Ackley pointed out that we needed retroactivity in announcing our border tax and it was also necessary to specify an exact rate to avoid anticipatory imports and a delay in exports waiting for the rebate. We must be mindful of the impact of the President’s statement upon the exchange markets. If we get a big boost from the border tax announcement will the props be knocked out of it when the retaliation starts?

Secretary Fowler referred to the visit today of an old friend who was familiar with the border tax area. Secretary Fowler read from Weir Brown’s memorandum, dated December 21, on the border tax.

“The draft now under consideration in the Treasury is built on a good central principle. This central idea is that we could adopt a tax adjustment for imports and exports without introducing a new sales tax on domestic sales.

“My (Weir Brown) modifications to the present plan would be as follows:

• “1. We should state that the U.S. has been aware that many of its major trading partners have for years made tax adjustments to their imports and exports. They have justified this essentially on the grounds that imported goods had not been subject to their domestic tax system and that exported products were to be consumed abroad.
• “2. These countries are now in the process of making further increases in the levels of these border adjustments, having a still further impact on trade of other countries. The U.S. Government has questioned the wisdom of these increases, and in fact of the border adjustment system as a whole. We recognize, however, that Europeans have their own special reasons for their actions, including the objective of harmonization among the Six.
• “3. The U.S. Government has now determined that—given the prevalence of border adjustments by certain other countries and given the need to correct its balance of payments deficit—it will adopt its own form of border adjustment. While it is impossible to identify exactly the tax component of prices for any country, our Government has determined that a suitable rate for us to adopt would be 8 per cent (or 6), and this figure would be used in calculating a rebate on exported goods and in applying a levy to imports.
• “4. The foregoing border adjustment would be applied by the United States to imports coming from and exports going to all those countries which themselves now practice a system of border adjustments. (This would have the effect of excluding the applicability of the border adjustment from trade with Canada and Japan. I believe it would be possible also, by legal interpretation, to declare that the British purchase tax is not an across the board system and that the U.S. adjustment would not apply in the U.K. case.) Although many LDC’s would automatically be covered by the foregoing provision, we could make a specific exemption for LDC’s.”

Governor Daane asked if the program would be adequate and convincing without the border tax? It seemed to him that we must go more in the direction of the Treasury alternative because we are concerned about the actions Germany and Holland are taking and, therefore, we are entitled to respond. Responding to a question from Under Secretary Nitze, Secretary Fowler said the program might achieve $1.5 billion improvement without the border tax and the border tax might contribute an additional $1.5 billion to perhaps $2–1/2 billion. Ambassador Roth said that he thought the State Department estimated net trade gain figure, after retaliation, might be in the $800 million range.

The Vice President commented that anything you can do under alternative number 2 you can do under alternative number 1. The basic issue is how do you best get into a negotiating position. No one can tell me the Germans are easy to negotiate with, they may be more stubborn than de Gaulle. Alternative number 2 says that there will be time enough; but in his judgment the time has gone by. They will not change their January 1 implementation date; nor will Congress wait. If you are going to be asking for a tax bill from Congress you have to offer them something like this. Why don’t you admit that you are the world’s biggest cowards? The Europeans are feeling their oats and we should show some of our muscles. It is time to treat a crisis like a crisis. We need a package and one without cosmetics. It must be firm; it must be creditable; and it must have muscle. We must also take administrative action. The Europeans do not think we have the guts to do it and let’s be frank; the President cannot have Vietnam and the dollar crisis at the same time next summer! We need a program and we need to show that we mean it. The balance-of-payments position of the United States is worse than the public knows and we cannot have this creditability issue coming up again by us appearing to sweep something under the rug. Remember this, there are no votes in Germany. That is the Humphrey message for the day.

Ambassador Roth pointed out that alternative 2 did not involve long negotiations; just two weeks. Secretary Fowler said that it was time to move on and said that he would accept written comments to all items on the agenda by 4:00 p.m., Friday, December 22.

Government Expenditure

Secretary McNamara said he strongly supported the views of the Vice President; the border tax was the only substantive item in the entire package, practically nothing else is left. We cannot pull our troops out of Korea right now for political reasons even though we have 50% more than we need. We cannot pull our troops out of Western Europe right now because it would mean the disintegration of NATO. Again, this is a political decision because militarily we could do more with redeployment. Other reductions in expenditures are almost impossible. In effect, we have had a variable rate on the dollar for some time because we pay up to 50% additional cost to save foreign exchange. In the case of petroleum, we go as high as 120%. On offsets, we should try more but that might be mostly talk. We may get $500 million more in Germany and that may involve trilateral negotiation as well. We could repeat our statements about the obligations for Europeans to neutralize our military cost and this might get some help from Belgium and Italy—but this is more psychological than financial.

Under Secretary Deming said that he was not quite as pessimistic as Secretary McNamara. He pointed out that the gross NATO expenditures were only $30 million higher in 1967 than they were in 1966. In the Common Market countries U.S. military balance of payments costs were:

CY 1966	CY 1967(millions of dollars)	CY 1968
-446	-213	-683

This latter figure includes $250 million from Germany invested in long-term bonds.

In 1968 we will be lucky to reduce the EEC area military balance of payments costs to the 1967 level. In the Far East we hope to get $300 to $500 million from Japan and, in Southeast Asia, while some funds may come, the prospect for improvement are not bright. Secretary Fowler at this point read a list of countries which, over the last three years, had increased their reserves $100 million or more. The realities of life call for a major diplomatic initiative. The Treasury can no longer go around the capitals with its hat in its hand.

Capital Movements

Secretary Trowbridge said he agreed with action in the trade field and probably alternative number 1.

With respect to the Commerce Voluntary Program he pointed out that there were many areas of agreement in the approach: it should be voluntary and the administration must be greatly stepped-up. It is essential to continue a voluntary program because this is the best way to get the support of the business community, support which is vital to the success of the VCP. The coverage should be expanded to the LDCs, targeting for the future the $900 million figure of reinvested earnings and direct investment outflow which we expect to be the level for 1967. This could sort of act as a lid but it would not involve any cut-back and 1967 itself will be a peak year. The administration of the program will involve more frequent and more intensive consultation, undertaken by a three-man review board. This board will discourage investment in unfriendly countries, reduce total outflows, gross plant and equipment expenditures, and discourage take-overs. In 1966 this figure was $427 million, which included the $182 million Texaco deal. (A 10% or more purchase is a “take-over” under these statistics.) This left a $245 million figure for take-overs in the Common Market, of a $400 million figure on a worldwide basis (net of Texaco). In addition, the balance of payments package includes a tax proposal which would eliminate the deferral on the unreasonable accumulation of liquid assets held abroad.

The difference or unresolved issue is the level of the target. What level can we reduce the program to and still keep the support of the businessmen? Secretary Trowbridge said he can see total reductions of $784 million from the 1967 projected actual of $2,766 million (of reinvested earnings and direct investment outflow of the programed countries). This involves a quarter reduction under that forecasted for 1967, leaving a combined new target of $1,908 million as opposed to the reduction of $800,000,000 the Treasury Department is proposing, or a 45% cut, down to $1,257 million. I think that the $800 million is attainable but it would be one hell of a sweat. This is a judgment; no one can say at what level things fall apart. The Vice President asked what part of the Corporate Program is mandatory—after all tourism will be mandatory. Secretary Trowbridge said nothing is mandatory. Secretary McNamara said he thought there would need to be legislation to make the program mandatory. Secretary Fowler said authority did exist.

Governor Robertson in commenting on the balance of payments problem said that the problem is even bigger than that presented. He said that we have reached the point where the voluntary approach is inadequate and either the Interest Equalization Tax had to be extended or new legislation obtained. Since the programs started the banks had $150 million in outflow, against the $7.5 billion direct investment outflow over the same period. A $600 million improvement in the direct investment goal is inadequate and the program should become mandatory. If the Commerce Department program would disapprove of take-overs, the Federal Reserve program would disapprove of take-overs. The Board unanimously recommends that the bank target for 1968 be reduced from 109% to 103% and this might provide an improvement of $500 million. The Fed program already prohibits the increase in non-export lending to developed countries. He would reduce the amount of the outstandings by not permitting roll-overs except, of course, for commitments already outstanding. This would include all loans, including short-term loans to developed countries in Continental Western Europe, except for export loans. With respect to non-bank financial institutions there is only a portfolio of about $1,800 million. Their holdings of liquid foreign assets would have to be reduced to zero, with no new credits to Western Europe, and a new form of individual consultation would be commenced.

Secretary Trowbridge in commenting on corporate flows pointed out that each year the remitted earnings far exceeded the direct investment outflow. He added that the banks are now at a 101% and he felt that the target should be reduced below the 103% recommended. Governor Robertson said this would not leave enough money available to finance exports.

Under Secretary Rostow said he believed that the gravity of our balance of payments position required mandatory controls and, in this regard, through employing the IET retroactively, a promising system could be found. He pointed out that Tony Solomon almost persuaded him that a voluntary program would be as good as to extend the IET but he doubted that the target is enough. He wants something clean, perhaps a 50% improvement. Moreover, he very much opposed operating with a LDC ceiling, inasmuch as the only hope for growth in these countries is through private investment. We must achieve stiffer cuts for developed countries and exempt the LDCs. Moreover, perhaps we should have public reports from the review board from time to time.

Administrator Gaud pointed out that the AID Task Force would make recommendations to the President contrary to the proposed Commerce program. AID is trying to encourage more private investment in LDCs. He argued that 75–80% of all investments in LDCs represented exports from the United States. Moreover, the $900 million no doubt included oil and extra-active industries. If you had to go down this road perhaps the thing to do would be to exclude all agricultural products and anything associated with the War on Hunger.

Secretary Fowler read from his draft letter to the President, the paragraph pertaining to additionality. Next, he pointed out that the $900 million figure only included the Venezuelan and Nigerian oil countries. Finally, he asked, in an effort to create a balanced program can we afford to exclude LDCs under the present conditions? Can we afford to leave a “sky-is-the-limit” atmosphere? Secretary Trowbridge said that the base of 130% is well above the historical average. Administrator Gaud said it does not make any sense to use the meat axe approach, bearing in mind all the work we have been going through to get private investment in the fertilizer industry in India. Assistant Secretary Solomon said that perhaps we could rely upon the three man review board to see that the LDC exemption does not become a source of “significant leakage”. The Vice President concurred with this idea. Secretary Fowler said that he hoped to get a reporting system which would keep us better informed on these flows. Secretary McNamara said that he strongly disagreed with Secretary Trowbridge’s idea. The Vice President concurred.

Governor Brimmer raised the issue of the Export-Import Bank and its contribution to the balance of payments. He pointed out that in fiscal year 1965 the Export-Import Bank contributed $27 million; in the fiscal year 1966, it cost $100 million; and fiscal 1967, it cost the balance of payments $500 million: it may well exceed this figure in 1968. Moreover, we should have an increase in their interest rate. Assistant Secretary Solomon said that he strongly disagreed, in fact, he argued that we should go in the opposite direction and have a subsidized interest rate.

Assistant Secretary Knowlton outlined the tourist program. This included restraints up until December 31, 1969. The objective was to create a convincing program with major savings involving perhaps $500 million. A simple procedure was desired. The idea would be to favor the lesser developed countries, the Western Hemisphere and Canada.

There are several ideas out on the table:

(a) Per diem charge which would involve an advance deposit of $100–$150;

(b) Give a worldwide exemption for five days; or give a ten-day exemption to the Western Hemisphere and none at all to other places;

(c) Make the per diem tax more progressive;

(d) Exempt the first trip in five years;

(e) Create a 15–25% transportation excise tax.

A ticket tax would catch worldwide transportation and the per diem might apply just to Western Europe. The passport fee might be increased to $25 and Customs exemptions reduced.

The Vice President spoke and said that if we go the extreme and introduce a tax on tourism, you cannot get by with a Voluntary Program on direct investments. This balance of payments program must have equity and it must have balance. Certainly travel must be included and he pointed out this represented a major change of position for him. We should look at this Customs reduction down to $10, the tax on the tickets, and the passport fee.

The Vice President said, now, you can argue and quite forcefully, that the mandatory program on capital investment is both political suicide and bad economics; but at the same time you can place the freedom of movement of capital against the freedom of movement of people. He could get speaking engagements at all the women’s clubs throughout the country arguing the importance of “getting-to-know” people better. In conclusion, he said, that he would be opposed to tourism unless there were provisions for mandatory action on direct investment.

In response to Under Secretary Rostow, Assistant Secretary Surrey said that what a mandatory control is aiming at is usually a certain level of outflow. The question then comes, what form best achieves that desirable level. When you consider the issue of corporate leverage and various returns on invested capital that vary from industry to industry, it is simply impossible to set a percentage to achieve a given volume of outflow. To do it practically, you must set an absolutely prohibitive tax, slowly working the percentage down until the desired level is achieved. But that does not make much sense. The IET system, therefore, is difficult and we ought to look more closely at the auction system. Secretary Fowler concurred and said that the IET on direct investments was a pig-in-a-poke. It would simply not be able to achieve the task assigned to it. The Vice President pointed out that the public does not particularly like foreign direct investment. It means taking away investment from home and exporting jobs. The Vice President said that we must pay for national security just as we have to pay for health insurance. We also have what we call LDAs, that is, Lesser Developed Areas, right here at home. Secretary Trowbridge emphasized the importance of the private sector and the over-all contribution this element makes to the balance of payments. The Vice President agreed and said that this was a serious matter and emotion should be left out of the discussion. Ambassador Roth said that mandatory controls would permit you to get away from the border tax action.

John R. Petty

1. Source: Johnson Library, White House Central Files, Confidential File, FO 4–1, Balance of Payments (1967–1969). Confidential; Eyes Only. Drafted by John R. Petty. A list of 29 participants is not printed. The meeting was held at the Treasury Department. Four attachments, none printed, are as follows: A, “Possible Trade Account Action with Regard to Border Tax Adjustments, 12/21/67: Alternatives I and II; and Background Discussion;” B, “Table: Year-by-Year Record of Commerce Program, 708 Firms, 12/18/67;” C, “Table: Outflows to Less Developed Countries (708 Reporting Companies), 12/21/67; and D,” Tables: Reserve Increase of $100 Million or More in Past Three Years; Reserves of NATO Countries; and Reserves of Selected Countries, dated 12/21/67.”
2. No record of this meeting has been found.
3. The President expounded on this proposed study in his May 23 remarks upon pre-senting awards for excellence in developing export markets; see footnote 2, Document 123.
4. This report has not been found.
5. This resolution has not been further identified. The OECD communique, December 1, does not contain the quoted language but expressed the same concern. For text, see American Foreign Policy: Current Documents, 1967, pp. 316–318.