199. Memorandum From Secretary of the Treasury Fowler to President Johnson1
The present crisis in France offers both a threat and an opportunity.
- —A threat to the international monetary system that could destroy it in its present form.
- —An opportunity to make a major structural improvement in U.S.-Europe balance of payments and thereby strengthen the monetary system.
I. Background
The threat comes from two factors—possible devaluation of the franc and consequent pressure on sterling, which might cause the U.K. to float.
[Page 560]Even before the crisis, the franc was regarded as the weakest currency in the Common Market. French industry has not been in a strong competitive position. The French balance of payments was headed for deficit; the French economy was operating well below capacity. Whatever the settlement with the unions turns out to be, it will weaken the French cost/price position and make her less competitive. Her economy may expand faster than desirable, with inflationary results, and hurt her balance of payments position still further.
Barre, Vice President of the EEC Commission, is now visiting Washington. He is an extremely well informed and well qualified French observer. The Commission estimates that the prospective union settlements in France will add 23 percent to wages in 1968 and 1969, 10 percent to prices, and produce a $1 billion balance of payments deficit. Despite this, Barre thinks France should not devalue.
Schweitzer of the IMF thinks that such additions to costs and prices will lead inevitably to a franc devaluation—although he does not expect it until fall.
Mendes-France—a possible new government head in France—is reported to favor devaluation quickly.
Present French policy suggests no early devaluation—they have borrowed from the IMF and imposed exchange controls.
In sum—anything could happen. Quick follow-up of the big wage increases by devaluation would be unpopular politically in France—a new government could probably get away with such a step better than the present one. With respect to timing, the best that can be said now is that devaluation before the election is highly unlikely. A new government might take action early in July; the present government would be more likely to wait until fall.
France has large reserves and substantial international borrowing power. She could well afford to lose some of her reserves while she tried to work out of prospective cost increases. But fear of inflation and balance of payments deficits is almost pathological in France, and she might act quickly on the ground that “fundamental disequilibrium” was so certain, even if not yet proven, that there was no reason to wait.
Obviously, the extent of possible devaluation can only be guessed at. There is no real economic basis for such a guess. Any devaluation has to carry credibility. Probably 10 percent is as good a guess as can be made. Ordinarily, that would be classed as mild devaluation.
Mild devaluation of the franc should not cause so much substantive economic shock that it would threaten the international monetary system. But the monetary system is in such fragile condition that even a mild devaluation could bring about massive fund movements—into Germany and perhaps Italy, where revaluation might take place, or into Switzerland for safety. Almost certainly, it would have an adverse effect on sterling, which [Page 561] is still very weak. The U.K. reserves are short and are mortgaged to the hilt. Much pressure on sterling could force the U.K. to float. Should that happen, there would be repercussions on the dollar and, perhaps, general monetary chaos—with everyone trying to get out of currencies and into gold.
Whether the monetary system, in its present form, could survive this series of steps is problematical. The U.S. might well have to cut the gold convertibility link to the dollar and float itself. And that would destroy the present system and probably badly cripple world trade.
The opportunity comes from the possibility of revaluation of the Deutsche mark and perhaps other EEC currencies. Germany probably is in fundamental disequilibrium on the surplus side, and the other Common Market countries have currencies probably undervalued relative to the franc and certainly not overvalued relative to the dollar or sterling.
There is good reason to believe that the Germans regard revaluation of the Deutsche mark as probable—perhaps inevitable. Timing of such action is far from definite—most likely, it would be delayed until there was more calm in international monetary affairs. If the U.S. and U.K. balance of payments programs were showing good results and the gold frenzy was abated by year-end, the move might well take place then.
Until quite recently, it was regarded as highly unlikely that one EEC country would change its parity against the others. The EEC might move as a bloc, but only as a bloc. That doctrine no longer seems valid. French authorities were cautiously suggesting a Deutsche mark revaluation before the crisis. There is no mechanical or technical reason why Germany could not move alone.
Italy could be regarded as a revaluation candidate but does not so regard herself. Perhaps the strongest exponent of preserving all present parities is Carli.2 The Italian surplus is shrinking, and the elections seem to forecast a further turn to the left in government and probable increases in government spending and in wages. Only four years ago, the lira was regarded as overvalued—Italy corrected its deficit by stringent policies. Among the EEC countries, Italy has seemed to be proceeding on the best economic course—good growth with reasonable price stability.
Holland and Belgium offer little economic reason for revaluation, but Holland is tied so closely to Germany by trade and other relations that she would probably have to move concurrently in time, but perhaps not as much in amount, with Germany, if the Deutsche mark were revalued.
Another possible candidate for revaluation is Switzerland. On its face, the Swiss franc is a strong currency. But the basic Swiss balance of payments position is not strong—the Swiss franc is strong because ofx the Swiss banking situation, which attracts money seeking safety.
[Page 562]II. Course of Action
Your advisers recommend a three part course of action.
- A.
-
The most constructive action that could be taken is to get a realignment of rates in the EEC—ex-France—vis-á-vis the rest of the world.
The advantages are great—if the action can be carried through successfully. It could prevent a franc devaluation and it could settle the uncertainties about possible parity changes in Germany and Italy. This should help stabilize the whole monetary system. It would make a major contribution to the adjustment process by helping to eliminate the big EEC surpluses and reduce deficits in the U.S. and U.K.
Proper timing and handling is an important factor in this approach. Any change in parity is a sensitive subject and generates fund movements. We do not intend to run hard at this program right now. The French elections are June 23 and 30; it is unlikely that there would be any devaluation before then—although, as noted below, we are planning contingently for such unlikely event. Passage of our own tax-expenditure package would put us in far stronger position to talk about EEC revaluation—and probably would produce a calmer atmosphere in the markets under which revaluation could take place. The Germans seem to be thinking seriously about some Deutsche mark action, but generally seem to think of its timing as late this year.
Thus, we propose to do no more at this time than quiet but pointed conversations. We should start with the Germans—they are the key—and Rostow and Deming will be in Bonn this weekend to discuss the offset. This will provide an opportunity to lay the base for contingency planning with the Germans through conversations with the Chancellor, Schiller and Blessing.
The key point we want to get across is that either franc devaluation, which forces sterling to float, or a sterling crisis, which forces a float and brings down the franc, could be fatal to the present system.
We will not ourselves push the possibility of Deutsche mark revaluation at this time. Our objective is to get a serious conversation going with the Germans which will stress the German responsibility to maintain and strengthen the system and start the Germans thinking about their exchange rate. Sometime in late June or early July—depending on the situation at the time—we may want to press this course of action with more vigor. On the other hand, it may prove better to postpone the hard push until fall. We simply cannot be certain right now.
- B.
- We are staffing out the economic and balance of payments consequences of franc devaluation and EEC—ex-France—currency revaluation. Some work has already been done—we hope to complete it fairly quickly. This will give us a better basis to talk harder and in more practical terms.
- C.
- We are developing immediately contingency plans against the possibility—highly unlikely as it is—of a quick and surprise franc devaluation and/or sterling float.
Much of the work done here will be continuation of work already under way, which will be useful and perhaps necessary in any event:
- —solution of the sterling balance problem;
- —multilateral support for sterling as needed;
- —central bank cooperation in neutralizing massive currency flows.
It would be useful to have a small meeting with you tomorrow (Friday) to brief you on our planning.
- Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. V [1 of 2], Box 3. Secret. The source text is Tab A to a June 7 memorandum from Rostow to President Johnson. Rostow’s memorandum indicates that a meeting between the President and his senior advisers on all these matters was scheduled for 6:30 p.m. the same evening. No record of this meeting has been found. The memorandum also summarizes Fowler’s memorandum, endorses his recommendation for a meeting on the franc-sterling monetary crisis, and proposes that at the meeting the U.S. position on the offset talks with Germany should be reviewed. Another June 7 memorandum from Rostow to the President, which provides background information on the German offset talks, is ibid.↩
- Guido Carli, Governor of the Bank of Italy.↩