Foreign Relations of the United States, 1969–1976, Volume III, Foreign Economic Policy; International Monetary Policy, 1969–1972

166. Memorandum From the Acting Assistant Secretary of State for Economic Affairs (Katz) to Secretary of State Rogers¹

Washington, August 13, 1971.

FINANCIAL UNEASE

The Setting

The dollar is under severe pressure in major financial markets in Europe and Japan. By pressure I refer to the fact that the dollar is worth less in terms of such currencies as the German mark, Dutch guilder and Canadian dollar, which are floating, and that enormous amounts of dollars are being purchased by central banks in other financial centers in order to comply with the IMF rules of maintaining parity relationships between their currencies and the dollar.

In this atmosphere impressive sums are moving speculatively, betting that the dollar will be devalued. Large companies are hedging in order not to lose money should this occur. Countries like Japan, which hold large amounts of dollars as a proportion of total foreign reserves, are uncertain as to what to do since a devaluation of the dollar could be costly to them by reducing the real value of these reserves.

This uncertainty in Japan and elsewhere makes countries reluctant to reach agreements with us on other economic and political issues until they can see the overall situation more clearly.

There are many reasons for the weakness of the dollar. These include our persistent and growing balance-of-payments deficits; the fact that our trade account has moved into deficit, with every indication that this deficit will grow; our gold stock is diminishing; respectable voices in the financial community and in academia are asserting with some vehemence that the dollar is overvalued and that this situation should be corrected; there was a report last week by a subcommittee of the Joint Economic Committee, chaired by Congressman Henry Reuss, which advocated the devaluation of the dollar.² That our economy is sluggish and our inflation continuing does not help.

Most observers expect us to do something, and foreign governments and private traders are now behaving under the assumption that we will do something; this heightens the speculative fever.

What Can We Do?

The classic remedies for persistent balance-of-payments deficits are either devaluation of one’s currency and/or slowing down internal economic activity. A devaluation makes imports more expensive and exports more lucrative, thus helping to shift output from internal to external markets. Deflation, by reducing demand pressure, works in much the same way. Because of the central role of the dollar as the currency to which most other currencies are pegged, we have always felt that devaluation of the dollar was not a proper course. We have tried deflation over the past several years but it has not worked. We have had the worst of all worlds, a sluggish economy with more inflation than desirable, and a growing balance-of-payments deficit. It is this demonstration that past policy has not accomplished its balance-of-payments function that heightens the present unease.

The President, for political as well as technical reasons, may be reluctant to devalue the dollar, despite the fact that we are getting such advice from many in Europe and at home. The dollar could be devalued by raising the price of gold (which would require Congressional approval) only if other countries consented not to similarly raise the price of gold in relation to their currencies; that is, the relationships among currencies would thus be altered. We also could devalue by closing the facility which permits foreign central banks to convert their dollar holdings into gold at $35 an ounce, if other countries then permitted the dollar to float vis-à-vis their currencies until it found a new devalued level, or if we then devalued outright. This is essentially what Congressman Reuss advocated. Since other countries would have to consent to letting the dollar depreciate with respect to their currencies, a dollar devaluation would require some advance negotiation among the major countries.

If other major currencies revalued upwards in relation to the dollar, such as Switzerland and Austria recently did, and which Germany and Canada and the Netherlands are in fact doing through their present floats, this in effect means devaluation of the dollar. The one important currency that all agree is now undervalued is the Japanese yen. One major problem with revaluations by others is that we leave the initiative to them, and in the case of the Japanese are put in the position of demandeur.

In addition, changes in currency relationships operate effectively only with time lags so that the impact on our balance of payments might take some time, perhaps even a year or so, to work itself out.

Another set of possible correctives would be to change only the prices of imports and exports, which in effect would be a devaluation of the dollar only on trade account, rather than across-the-board, to include as well such things as tourism and capital transfers, in which our accounts also are in deficit. Under the GATT, countries in balance-of-payments difficulties are authorized to impose quotas on their imports. However, this requires complicated administrative machinery to institute. Quotas also operate through controls rather than through the marketplace. For these reasons, in recent years countries which have taken trade actions have preferred not to use quotas.

One trade technique now under intensive examination, and which Wilbur Mills and the Williams Commission have advocated, is to impose a surcharge on all imports of an amount sufficient to have a significant effect in diminishing imports. The surcharge would raise the price of imports, and thus operate here the way a devaluation would. The trade impact could be even more powerful if we were also to give a subsidy to exports as an initiative to encourage these. I use the word “could” since other countries could take action to offset the effect of an export subsidy. The combination of import surcharges/export subsidies could have a powerful trade effect if it were large enough, say of about 15 percent. The budgetary cost of the export subsidies (say 15% of about $40 billion of exports, or $6 billion a year) could be met mostly by the extra revenue raised from the import surcharges. The two need not go together, and indeed there is much more international experience with import surcharges, but the two in tandem on all imports and exports are more powerful than either alone. We expect that were the United States to impose a surcharge this would be understood by most important foreign countries despite its lack of explicit GATT sanction; an export subsidy would be more controversial. A subsidy/surcharge system also could have a stimulative domestic psychological impact.

I will not go into the complex detail here on how surcharges or subsidies might work administratively. We would have to make clear that these trade actions were intended to be temporary until the situation was corrected, and that the rate of surcharge/subsidy would decline over time. These assurances would not be easy to accomplish legislatively. The initial rate would have to be sufficiently large to convince the world that it would work. We think such trade action on our part would be credible only if it were accompanied by further domestic measures to cope with inflation; these might include some policy on prices and wages.

Action only on trade account would maintain what others would consider to be an overvalued dollar for capital movements, and this certainly would lead to criticism by others that it permits U.S. investors to buy up foreign enterprises cheaply.

Conclusion

The choices open to the U.S. at present thus fall into one or a combination of three overall categories.

• The first is that we do nothing and ride out the present storm. I doubt that this is feasible since everybody now anticipates that we must do something; and if the Executive does not act, it is probable that the Congress will act, such as by imposing import quotas on a haphazard basis. Much more significant than this, however, is the danger that the speculation against the dollar will continue and perhaps accelerate, and the Europeans and Japan could force us to take action by demanding that we exchange the dollars they are getting for other reserve assets, such as our declining gold stock.
• The second choice is to alter exchange rate relationships, either by devaluation of the dollar, or upward revaluation by others (particularly the yen), or most likely a combination of these. Any effective U.S. devaluation would require consent of others.
• The third choice is some partial action, such as dealing primarily with the trade account. (In the past we have taken partial actions to limit capital outflow, such as our foreign direct investment controls, and theoretically capital controls could be further tightened. We doubt that the President would wish to do this.) Many would interpret trade measures as a precursor to dollar devaluation.

We are urgently proceeding with analysis of these options and we know that other agencies are doing the same. We are in touch with them.³

Recommendation

If you have not already done so, you should speak with George Shultz about this subject (a) to reflect our great interest in making an input as the choices are examined; and (b) to make certain that our expertise on how one would implement any scheme internationally is brought into play sufficiently early no matter what choice is made.⁴

1. Source: National Archives, RG 59, Central Files 1970-73, FN 10. Confidential; Nodis. Drafted by Deputy Assistant Secretary Weintraub.
2. See Document 164.
3. On August 13 Volcker sent the following note to Connally: “I just got a call from Jack Irwin urgently requesting that State be involved in any decision-making in the international monetary area. He had been talking with Rogers, who is at home. I simply told him I would not be making this decision but would pass it on to you but also said I understood his concern.” (Washington National Records Center, Department of the Treasury, Records of Secretary Shultz:FRC 56 80 1, Economic Game Plan Background, Camp David 8/13-15/71)
4. Although there is no indication if Rogers approved or disapproved the recommendation, he wrote in the margin, “This was done,” and initialed. The date of August 17 is stamped below the Secretary’s initials.