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

41. Memorandum From the President’s Special Assistant for National Security Affairs (Bundy) to President Johnson¹

Washington, February 9, 1965.

SUBJECT

• Your call to Prime Minister Pearson on Balance of Payments

1. The object of this call is to get Pearson’s consent to a reaffirmation of the existing Canadian commitment to avoid excessive borrowing from the U.S. What Dillon would like is for you to read to Pearson the paragraph which we want to put into the message on this subject.² It reads as follows:

“To stop the excessive flow of funds to Canada under its special exemption from the Equalization Tax, I have sought and received firm assurance that the Canadian government will take the steps needed to hold these outflows to levels consistent with that special exemption.”

2. You can point out to Pearson that this language merely reaffirms existing clear Canadian undertakings, and that it is of great importance to be able to use it in your message if you are to avoid heavy pressure from many quarters to set a strict dollar limit for Canadian borrowings.

3. The fact is that we will have to impose such a limit

• —if Canadian reserves continue to grow
• —if Canadian interest rates rise sharply
• —or, if Canadian banks start pulling back to Canada money which they now hold in the United States.

4. You will probably also want to tell Pearson that you are about to invoke the Gore amendment and impose the Interest Equalization Tax on bank loans of one year or longer, with no exemption for Canada. Pearson is probably expecting this news, but he is entitled to hear it from you. The Canadians will not be very much hurt by it because they have been raising their money by selling bonds instead of by borrowing from our banks.

5. Pearson may argue that the Canadians are already doing all they can to limit their long-term borrowing in New York. You will probably not want to get into the details of the long argument in Douglas’ memorandum (Tab A). You can simply say that your experts (Dillon and Martin) strongly disagree—and that in any case you have no real alternative but to ask for performance on the existing Canadian undertaking.

6. On a separate subject, Dillon tells me that if the Canadians agree to this language, the Japanese would like a sentence or two about what has been happily agreed with them. No one sees any objection to these sentences, but Douglas wants to be sure that you were informed of their existence.

McG. B.

P.S. On the Canadian air agreement,³ you probably will not wish to raise the subject yourself, but if Pearson mentions it, it would be worthwhile to say that you have been reviewing it yourself and that the plan which you have now approved (very slightly different in language from the last Canadian proposal) goes just as far as we can possibly go. This may help him get past any lingering doubts in his Cabinet over a bargain which is clearly better for Canada than what now exists.

Tab A⁴

Washington, February 8, 1965.

MEMORANDUM FOR THE PRESIDENT

I. Canada has become a special problem for the United States balance of payments position.

A. Net capital flows from the United States to Canada have always been large but have become appreciably larger in the past three years.

1. Final figures for 1964 are not yet available in detail but we can identify the following flows:

a. Sales of new Canadian issues in the United States through our capital markets in 1964 totalled $687 million. These were exempt from the Interest Equalization Tax. (There are regular repayments and redemptions of outstanding securities each year. In 1964 these are estimated at about $100 million. The net new issue figure thus would be smaller than the gross figure of $687 million.)

b. Other transactions which affect our balance of payments and which are exempt from the Interest Equalization Tax—mainly purchases of Canadian securities in Canadian markets and buying of Canadian mortgages in Canada by U.S. residents totalled gross about $300 million.

c. At the end of September, 1964, reported short-term claims of U.S. nonbanking corporations and individuals were $285 million larger than on the comparable date in 1963. On the other hand U.S. banking claims on Canadian banks at the close of November, 1964, were just equal to their year earlier level.

d. Direct investment by U.S. corporations in Canada in 1964 was much smaller than usual—perhaps no more than $50 million.

B. All of these flows added to our balance of payments problem.

1. But it is important to note that Canada buys far more goods and services from the United States than she sells to us—about $1.4 billion more.

a. The Canadians assert that they have to get capital inflow from abroad to balance their trade and service (current account) deficit. Since their deficit with the United States is so large and since they are neighbors they look to us for most of that capital inflow.

1. In 1964 they estimate that net capital inflow was about $550 million on long term and about $300 million on short term. Most of this was from the United States.

2. Gross long term inflow to Canada from the United States was about $950 million. Gross flowback to the United States was about $400 million and includes redemptions and repayments. (The British Columbia hydroelectric power transaction inflated both gross inflow and outflow figures in 1964. About $250 million of the long term inflow to Canada was accounted for by this transaction; about $200 million of the reflow from Canada to the United States was also due to this transaction.)

b. If shut off from United States capital flows in any great degree, Canada asserts she would have to cut back on imports from the United States. This is certainly correct.

II. Mr. Deming met on last Wednesday and Thursday with Mr. Plumptre, Canadian Deputy Minister of Finance, to explore possibilities of reducing United States capital outflow to Canada.

A. A key point in the discussions was the size of the prospective 1965 current account deficit for Canada.

1. This figure is critical because it represents the amount that has to be financed largely through capital flows from the United States.

a. In 1964 the current account deficit was about $515 million.

b. Long and short term capital inflow was about $850 million net.

c. The Canadian increase in reserves was thus about $335 million, although about half of this $166 million represented a repayment of their borrowing from the International Monetary Fund. Their published reserve figure rose only about $81 million.

2. The official Canadian estimate of their 1965 current account deficit is $825 to $925 million, some $300 to $400 million more than in 1964.

a. The prospective increase, they say, reflects mainly a return to no more than normal grain sales to the USSR (the special 1964 sales added $300 million to their receipts) and an expected growth in imports as their GNP expands.

b. We believe the 1965 deficit estimate is too high; in fact, in December Canadian career officials told us privately that they expected the deficit to be no more than $600 or $650 million—about $100 million more than in 1964. [2 lines of source text not declassified]

3. The importance of the figure is that if Canada operates on the basis of a $900 million current account deficit and continues to receive the exemption from the Interest Equalization Tax on the basis that she will borrow no more than to keep her reserves constant, she will borrow in the United States in 1965 at least as much as in 1964.

4. If the current account deficit is no more than $600 million, the amount of Canadian borrowing in the United States in 1965 might be $200 million less than in 1964–-a real saving in capital outflow and a real reduction in our overall deficit.

B. Mr. Deming, however, could get nowhere with Mr. Plumptre on a smaller figure for the 1965 Canadian current account deficit and consequently could get no assurance of any lessening of Canadian borrowing in the United States.

1. The major form of such a reduction in new borrowing probably would be in a smaller volume of new Canadian issues in our capital markets.

2. Mr. Plumptre did express the opinion that such borrowing probably would not be larger than in 1964 and might be a shade less.

3. He also offered to explore the possibility of retiring about $100 million in Government of Canada bonds now held mostly in the United States by selling an offsetting issue in Canada. This would have the same effect as a reduction in new issues in our markets.

4. The Canadians also promised to do what they could on interest rates as to keep them in their present rough balance with U.S. rates and thus moderate the flow of short term U.S. capital to Canada. They also offered to explore their entire rate structure to see whether something more might be done in this field. (Further action to reduce Canadian interest rates is clearly possible if the Canadians so desire and probably would actually help the Canadian economy.)

C. But, in essence we have no positive assurance of any lessened drain on our capital account by Canada.

III. We need to come to some sort of working agreement with Canada for 1965. You already have discussed the problem with Mr. Pearson. Ideally we would like agreement along the following lines:

A. Some reasonably firm assurance that new Canadian issues in our markets would be held to no more than $500 million in 1965 ($200 million less than in 1964) or that any excess over that figure be offset by the retirement of Government of Canada debt held in the United States. (Canada may be unable to give this reasonably firm assurance. There is no constitutional power possessed by the Dominion Government to control the form or level of provincial borrowing.)

B. Some reasonably firm assurance that Canada will attempt to encourage an interest rate structure which will decrease short term flows from the United States. (Canada can give this assurance if it so desires.)

C. Reasonably firm assurance that Canadian banks will not actively seek to attract additional U.S. dollar balances. Such action would tend to negate our efforts to cut our bank lending abroad.

D. Reasonably firm assurance that Canadian banks and their U.S. branches would not pull back to Canada funds now held in the United States. A very large share of present balances owned by U.S. residents but deposited in Canadian banks is used in our money markets. Should these be withdrawn in order to make loans in Europe, it would adversely affect our balance of payments and also would hurt our U.S. banks competitively—which would make it difficult to carry out our moral suasion efforts to reduce U.S. bank foreign lending.

The Bank of Canada can certainly be helpful in both Items C and D.

I suggest that you call Prime Minister Pearson and read him the text of what you would like to say in the Balance of Payments Message regarding Canada and seek his agreement. You might point out to him that unless you can make such a statement the pressures to fix a dollar limit for Canadian borrowings might prove irresistible. You might also point out that the same would be true if Canadian reserves continued to grow or if Canadian banks did not cooperate in the efforts which we will be making in the bank field. Such a conversation may well produce the results we desire. If not, it will certainly pave the way for any future action we may feel compelled to take.

Douglas Dillon

1. Source: Johnson Library, National Security File, Subject File, Balance of Payments, Vol. 2 [1 of 2], Box 2. No classification marking. Attached to the source text are two notes from McGeorge Bundy, both dated February 9. The first to Juanita Roberts, Personal Secretary to the President, reads: “The President should make the call as early as possible this afternoon.” A handwritten notation on the upper left corner of this note reads: “3 pm Feb. 9, 1965.” The second note informed the President: “This is the scenario for your call with Pearson. He may need time to consult, and you can give him a few hours—but not more—because the message has to go to bed tonight.” The President telephoned Pearson at 4 p.m. on February 9 (ibid., President’s Daily Diary), but no record of their conversation has been found.
2. Reference is to President Johnson’s balance-of-payments message.
3. Canadian and U.S. representatives held two rounds of meetings, concluding on May 1 and July 23, 1964, concerning the renegotiation of the Air Transport Agreement of 1949 (10 UST 773). It was decided to report to their governments on the results achieved and to meet again following further study with a view to concluding the negotiations. See Department of State Bulletin, May 25, 1964, pp. 884–885, and ibid., August 10, 1964, p. 188.
4. No classification marking.