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

26. Paper Prepared by Consultants¹

Washington, undated.

VIII. FOREIGN ECONOMIC TRENDS

The Separation Between Foreign Economic and Political Policy

Broadly speaking, the United States during the last two decades has preserved a rather sharp distinction between foreign economic policy and the main lines of foreign policy. This distinction arose partly because of an internal division of labor between economic and political issues within the U.S. Government—and within other governments—but partly also because of an underlying assumption that the most felicitous economic environment for the achievement of broad U.S. foreign policy objectives is a thriving, open, and non-discriminatory world economy. Trade is so essential to most countries of the world that successful trade performance becomes a precondition for peaceful and cooperative actions in other areas. Thus, given general guidance for the achievement of a liberal trading environment, it was felt that foreign economic policy should be left alone, free from interference by shorter-term political considerations.

There have, of course, been exceptions to this separation between economics and politics in foreign affairs. In the realm of East-West trade the United States has maintained tight and discriminatory controls for political reasons. The United States lent strong support to the formation of the European Economic Community, a discriminatory trading bloc, on grounds that were fundamentally political. Foreign aid has always been treated more as an arm of general foreign policy toward the Third World than as an aspect of foreign economic policy. But by and large, international trade negotiations and international monetary discussions have proceeded in their own way and at their own pace, aimed at the broadly political objective of freedom of trade and other economic transactions on a multilateral and non-discriminatory basis.

It may be more difficult to preserve this semi-separation between economic and political relations with other countries in the next decade than it has been in the past two decades. Two developments, in particular, introduce new complications: (1) the increasingly complex interaction between foreign trade, international investment, and domestic economic policy, and (2) the growing movement toward preferential trading arrangements. A slightly countervailing tendency is the increasing multilateralization of foreign aid, whereby bilateral political considerations tend to be removed from the donor-recipient relationship.

Trade and Investment

Economic relations among industrial countries have broadened considerably, providing today many more points of contact than the mere exchange of merchandise and occasional travelers. Liquid funds move in large volume between major financial centers. Bond markets are tied more closely together. There has been a vast increase in private American investment abroad, involving managerial control. As a result, a growing amount of international trade is intra-firm trade. All of these developments have profound implications for such traditional national economic policies as monetary policy, tax policy, and business regulation.

Pressure on national monetary policy has already become acute and has evoked such economically “disintegrative” reactions as the interest equalization tax and other restraints on capital outflows from the United States, a German tax on foreign holdings of German bonds, prohibition of foreign mutual funds in Italy, and a host of similar devices in most other industrial countries—all designed to preserve some insulation between domestic and foreign monetary conditions. Pressure on national business regulations is still moderate, but it has given rise to international attention and to foreign concern over the “extra-territorial” extension of U.S. laws and regulations, mainly to U.S.-owned firms abroad. With high international mobility giving rise to easy escape from national regulations and restrictions, the problem will grow more serious.

The increasing attention being given to “non-tariff barriers” to trade also reflects the more numerous points of contact between domestic and foreign economic policies. With tariffs and other explicit barriers to trade sharply reduced among industrial countries, the temptation will be strong to use more subtle techniques for protective purposes. And measures motivated by health, safety, or revenue considerations rather than by protectionism will nevertheless appear as irritating, and hence suspect, obstacles to actual and prospective foreign exporters.

All these developments will compel a searching re-examination, jointly with major countries, of heretofore strictly domestic policy, and this re-examination will create corresponding tension within countries between those segments of the population with a primarily domestic orientation and those whose orientations are increasingly transitional.

Preference Areas

The late 1950s and early 1960s were marked by the successful formation of a number of trade preference areas, notably the European Economic Community, but also the European Free Trading Association, the Central American Common Market, and the Latin America Free Trade Area. Countries that for economic or political reasons do not want full association have frequently pressed for partial affiliation to these various trading blocs. Such affiliation is most advanced in the case of the European Economic Community, where to various degrees Greece, Turkey, the French African countries, Nigeria, and East Africa have achieved some sort of special trading status.

These arrangements point to a substantial erosion of the U.S. objective of an open, non-discriminatory world trading economy. In combination with the factors noted above, they have led to increased pleas for direct U.S. involvement in special trading arrangements, to which the U.S. yielded in the case of the Canadian automotive pact. As these developments progress, foreign political and foreign economic policies will merge, since bilateral trade pacts not only confer favors, but also presuppose political harmony and mutual goodwill—or tutelage—for their effective operation. The United States may expect to be put under increasing pressure to acquiesce in such discriminatory trade arrangements and even to participate in them, especially to grant preferential access to Latin American products coming into the U.S. market.

For political reasons, the United States has encouraged Britain to join the European Economic Community. British membership would inevitably involve several smaller European countries as well and would create a large and formidable trading area entailing some economic costs to the United States. Consequently, British membership would give rise to internal and international frictions with considerable influence on American foreign policy.

In response to pressure from the less developed countries for special trading arrangements, the U.S. has become involved in discussions of a system of world-wide tariff preferences granted by all developed countries to all less developed countries. Certain leaders in the less developed world have laid high hopes on such a scheme. They greatly exaggerate the economic benefits it would bring to their countries, but they consider preferential trading privileges symbolic of the true intentions of the wealthy nations toward the poor ones.

The pressure for preferences reflects a very real problem that will become increasingly acute in the next decade—the need for foreign markets for the rapidly growing output of light manufacturers in the less developed countries. As the LDC’s develop efficiently, the output of some products will exceed the home demand for them, giving rise to exportable surpluses; and in any case the LDC’s will need to earn foreign exchange to keep their economies both operating and growing. The manufactured products they can export competitively are of the “low-wage” type and hence are politically sensitive in virtually all developed countries. Yet successful economic development in the Third World requires a changing structure of world trade and output which the developed countries can ignore only by closing their markets to the very products that the LDC’s, in the course of development, are able to produce efficiently. Assurance of foreign markets is a corollary of U.S. encouragement to development efforts, and in the absence of such markets many otherwise promising development prospects will fail.

International Monetary System

There are likely to be important changes in the international monetary system over the next decade. The reasons lie in the structure of the present system rather than in the purposes and actions of particular governments. Two principal deficiencies in the present system have become evident in recent years. Our method for generating international liquidity, necessary to provide the monetary base for growing foreign trade, is inadequate; and our methods for controlling imbalances in international payments are defective. The U.S. balance of payments deficit, a persistent problem for the United States that will continue for at least several years into the future, reflects these more general deficiencies.

The traditional form for international liquidity has been gold. Gold was accorded a central although unprominent role in the present payments system, laid down by American and British planners a quarter of a century ago. There is clearly not enough new gold at its present price to serve both the growing monetary needs of the world economy and the enlarged private demands for industrial and artistic uses.

The latent shortage of gold would have become evident years ago had not the U.S. dollar served as a kind of surrogate gold in providing international liquidity to nations around the world. (Indeed, one of the problems in framing a sensible policy for the U.S. balance of payments is that U.S. deficits have supplied needed liquidity to the rest of the world.) But this expanded role of the U.S. dollar has left other countries, especially in Europe, uneasy about the capacity implicit in present arrangements for the United States to pursue its international political and economic objectives without regard to the wishes of its allies, while they are nonetheless expected to finance these objectives by accepting and holding dollars in unlimited amounts. Most other advanced nations share broad U.S. objectives, but the very sharp increase in U.S. direct investment in Europe in the early 1960’s and the subsequent escalation of our military expenditures in Vietnam brought home the possibility that they might be called upon to finance very large expenditures, public or private, on which they were not consulted and to which they might even object. For this reason, there is a general unwillingness among major countries to acknowledge the reserve currency role of the dollar as a continuing and permanent feature of the payments system.

A solution to the international liquidity problem is near at hand, following five years of negotiation among major countries, in the creation of Special Drawing Rights (SDR’s). These will offer a new, manmade form of surrogate gold unrelated to any particular national currency. Creation of SDR’s will represent a far reaching step in international monetary cooperation, and with continuing goodwill it will solve the problem of a shortage of monetary gold.

The second deficiency in the payments system concerns the correction of imbalances in international payments. Countries pursue separate policies and they are subject to separate pressures and disturbances. They have divergent rates of growth, and the impact of economic growth on the balance of payments varies from country to country. Their choices between inflation and unemployment and with respect to foreign policy will differ. For all these reasons, countries are bound from time to time to experience imbalances in their international payments. The Vietnam war provides a recent dramatic example, where for reasons of national security, overseas expenditures for the United States were increased sharply.

Under the present rules, laid down twenty-five years ago, temporary imbalances in payments are to be financed out of international reserves and by borrowing directly and indirectly from creditor nations. Where an imbalance persists, it is to be corrected by a change in the value of the country’s currency with respect to other currencies; that is, a change in its exchange rate. This mode of adjustment has been difficult to apply in practice, however, and has become increasingly disruptive of international financial order. Countries in payments surplus are not under the same kinds of pressure as countries in deficit to adjust their exchange rate in response to a persistent imbalance. Considerations of international prestige dictate postponement of exchange rate changes, for a change in the value of the currency is (sometimes wrongly) taken as an acknowledgment of poor economic policies. Finally, public anticipation of changes in exchange rates give rise to large and disruptive movements of speculative funds, out of currencies expected to be devalued, into currencies expected to be revalued. With the growing international mobility of capital, these speculative movements have grown dramatically in size.

The currency crises during 1967-1969 reflect this deficiency in the present payment system. In late 1967 large movements of funds preceded devaluation of the British pound—indeed partly forced it as Britain exhausted its reserves—and large amounts of funds have been moved out of France and into Germany during the subsequent period, all in anticipation of changes in exchange rates. The absence of an effective adjustment process will induce countries in periods of financial strain either (a) to deflate their domestic economies beyond what is desirable on domestic grounds or, more likely, (b) to impose tight controls on their economic transactions with the rest of the world, thereby violating the basic open and non-discriminatory world trading economy which the United States has strived to achieve. Such controls have been used with increasing frequency, after a long period of gradual relaxation of the restraints on international transactions imposed during and immediately following the Second World War. If these violations are not to become increasingly severe and more widespread, the balance-of-payments adjustment process must be markedly improved in the coming years; for example, by improving the methods by which exchange rate changes can be utilized as part of the process.

The weakness of the structure of the U.S. balance of payments has been masked during the past year by large inflows of short-term funds attracted by high interest rates in the American economy. A change in domestic economic conditions should lead to substantial improvements in the trade balance but probably not enough to correct the basic imbalance. This is an additional reason for the United States to be interested in more general improvements in the process of balance-of-payment adjustments.

1. Source: National Archives, Nixon Presidential Materials, NSC Files, Subject Files, Box 397, A Strategic Overview. Secret. Printed here is section VIII, pp. 66-71, of the 78-page, undated paper entitled “The United States Position in the World: An Overview,” forwarded to Kissinger under cover of a memorandum from Robert Osgood on August 20. Osgood noted that the paper was his synthesis of three “sets of books” prepared by the Department of Defense, CIA, and the Department of State in response to NSSM 9 and other NSSMs and analyses, and he credited Richard N. Cooper with preparation of section VIII of the study. There is no indication of how the study was distributed or used. A copy of NSSM 9, “Review of the International Situation,” issued on January 23, is ibid., RG 59, S/S Files: Lot 80 D 212.