THE most important new influence on American policy to emerge during the past year came from the most unexpected quarter. For more than a decade we had been worrying about the "dollar shortage"--the supposedly persistent tendency of the United States to run a surplus in its balance of payments. But some time last summer we woke up to the startling fact that the United States was running a large payments deficit.

During the years 1958 and 1959 the excess of our foreign payments over receipts totalled some $7 billion. This deficit was financed by a $4 billion increase in foreign holdings of dollars and a $3 billion reduction in the United States stock of gold. As these lines are written, we continue to run a deficit, though at a somewhat reduced rate, and later this year foreign holdings of dollars will surpass our holdings of gold for the first time in American history.

There is no question about the ability of the United States to close the deficit in its balance of payments. We could strike a balance by drastically curtailing foreign military spending and economic aid, restricting our imports and our private foreign investment, or painfully deflating our domestic economy. But these measures would solve our balance of payments problem at the cost of our security and prosperity and that of the entire free world.

The real question is not whether we can reduce our deficit but how much we ought to reduce it and how we can make this reduction without sacrificing policies which are vital for the achievement of our national aims.

In the first excited reaction to the turnabout in our payments position we seemed in some danger of upsetting vital foreign policy programs. The Administration started to "tie" our foreign aid spending to purchases in the United States. It was reported to be contemplating a drastic reduction in our military establishment abroad and deep cuts in aid to less developed countries. It was under heavy pressure to modify its moderately liberal trade policy. Except for the decision to put a "Buy American" label on Development Loan Fund spending, however, we weathered the first winter of concern with the payments deficit without overturning any important elements in our present foreign policy.

The threat to existing policies will recur, of course, if we fail to reduce the deficit below the high level of 1958-1959. But this is not the only danger. Preoccupation with our payments deficit may smother new and creative policies now struggling to be born. To promote our national objectives in the decade of the 1960s we shall need bold programs to reduce our import restrictions and increase our aid to less developed countries. Such programs are unlikely to be adopted if we continue to run large payments deficits.

II

Much of the discussion about our payments deficit has assumed that our national interest would be served by eliminating it as soon as possible. Unfortunately, the problem is not so simple. The payments question has to be looked at not solely from the U. S. viewpoint but from the viewpoint of the free world as a whole.

In order to have an expanding free-world economy, monetary reserves must grow at about the same rate as international trade. In the 1950s, the free world's gold supply grew only one-third as rapidly as free-world trade. The rest of the reserve needs of the free world outside the United States were met from the deficit in the U. S. balance of payments. During the decade as a whole we fed $14 billion in reserves to the rest of the world, $4 billion in the form of gold, $10 billion in the form of increased foreign holdings of dollars. The dollar thus became the world's principal reserve currency. Without this supplement to liquidity the substantial economic achievements of the 1950s would never have taken place.

It would be unwise for the United States to seek to solve the liquidity problem all alone during the next decade by running deficits of the present size. Such large and recurring deficits could eventually destroy foreign confidence in the dollar and trigger a massive conversion of dollars into gold. This would force us to trim our foreign payments drastically through restrictive measures destructive of free-world security and growth. Yet if we eliminate our deficit entirely, or convert it into a surplus, we leave the free world short of reserves it desperately needs. The answer to this dilemma will not be found in the International Monetary Fund in its present form, since the national quotas are not large enough to cover future liquidity requirements and are not regarded by member countries, in any event, as reserves. In the years ahead, therefore, we shall have to find some new multilateral solution to the liquidity problem. Whether the answer lies in converting the Fund into a world central bank as proposed by Dr. Robert Triffin, or in some other institutional innovation, is beyond the scope of this article.

It may take several years to find a generally acceptable multilateral solution to the free world's liquidity problem. What do we do in the meantime? Probably the best compromise is for the United States to aim at very moderate deficits in the years ahead, deficits on the average of about $1--1.5 billion a year. This would feed the free-world's reserves much less rapidly than we have done during the last two years, but about as rapidly as we did during the 1950s as a whole.

Annual average deficits of $1--1.5 billion would not impose an intolerable strain on the United States. Various measures are suggested later which could minimize the risks involved and insure that the deficits were financed mainly through the accumulation of foreign dollar holdings rather than withdrawals of gold. Although it may not serve the interests of private holders to accumulate dollar balances at interest rates low enough to support our domestic economic expansion, the foreign governments and central banks which are the only holders in a position to demand gold and start a "run on the dollar" must act on larger economic and political considerations. They have every reason to agree to small annual increases in their dollar balances, especially since there is no immediately available alternative for increasing free-world reserves. They would go a long way to avoid weakening the very currency in which they hold a substantial portion of their reserves. Moreover, the United States, as the biggest importer and the biggest supplier of funds for free-world growth and defense, has unequalled sanctions at its disposal to induce the coöperation of the principal foreign dollar holders. These countries are not likely to take any action which would embarrass or weaken the very country on which they most depend for their prosperity and defense.

III

Just how strong is the tendency toward imbalance in U.S. payments? Will a reduction in our deficit take place as a result of "natural economic forces" or will a balance be increasingly difficult to achieve?

To begin with, the events of the postwar years should warn us against jumping to the conclusion that an imbalance in world payments is permanent. Only a few years ago a considerable body of expert opinion accepted as inevitable a tendency for the United States to run persistent surpluses in its accounts with the rest of the world. As late as 1957 Sir Geoffrey Crowther, former editor of The Economist, proudly reminded a Harvard audience that for 20 years he had preached the doctrine of "a permanent and organic shortage of dollars . . . the more time passes the more convinced do I become that I am right. . . . It is difficult to believe that there can ever have been another case of a country where the demand of the rest of the world for its products was so urgent and its demand for the products of the rest of the world so indifferent."[i]

Where the experts talked of "dollar shortage" a few years ago they now debate the "dollar glut." What has happened in the interim? To begin with, our definition of the problem has changed. We used to measure the imbalance in world payments in terms of our commercial surplus minus foreign investment, on the grounds that our overseas military spending was "temporary" and foreign aid was a "balancing item" to finance the surplus. Today we no longer exclude foreign aid and military spending in measuring the imbalance in world payments. Some time during the last few years we came to regard these as relatively permanent items necessary to finance the growth and defense of the free world. With this recognition the problem changed from how the rest of the world could finance our troublesome commercial surplus to how the United States could generate a sufficient commercial surplus to finance payments for free-world growth and defense. Accordingly we now measure imbalance in world trade by our payments deficit--the extent to which we lose gold and foreigners accumulate dollar balances.

This, of course, is only part of the story. The size of the U.S. deficit has increased. It was some $2 billion larger in the period 1958-59 than 1953-56. The increase in the deficit resulted almost entirely from a decline in the surplus of our merchandise exports over merchandise imports. This was due, in part, to some temporary adverse factors--lagging business recovery abroad compared to recovery here; special circumstances hampering key exports like cotton and civilian aircraft; and the steel strike. The elimination of these temporary factors is expected to result in a substantial increase in our merchandise surplus in 1960 and a reduction in our payments deficit this year to less than $3 billion.

The drop in our commercial surplus during 1958-59 led some people to conclude that the United States has lost its ability to compete--that "we have priced ourselves out of world markets." Plausible as it seems on the surface, this theory is supported by very little evidence. Wage rates, wholesale prices and consumer prices in the United States have all increased rather less in recent years than in Britain and France and at about the same rate as in Germany, Italy and Japan. To be sure, our prices have risen more rapidly than prices elsewhere on certain commodities (some steel products, automobiles and farm products under price supports). But there is no evidence of a substantial increase of our average export prices relative to the average export prices of our principal competitors.

We are facing keener competition in world markets than a few years ago, but price changes are not primarily responsible. Thanks in large part to the Marshall Plan and our other postwar aid programs, Europe and Japan have markedly increased their capacity to produce and deliver goods at existing prices--goods of high quality and new kinds of goods in anticipation of changing consumer demands. We have also promoted competition for our exports through the establishment by American companies of branches and subsidiaries overseas.

Yet despite this encouragement of foreign competition by foreign aid and investment, our ability to compete in world markets remains fundamentally unimpaired. Recent studies by the U.S. Department of Commerce confirm that the recent drop in U.S. exports reflected difficulties--some temporary--in three or four big items and not a loss of markets all along the line.[ii] Our share in world exports remained virtually unchanged between 1950 and 1958. Moreover, as of today, we have a larger share in world exports of manufactures than we had before the second World War.

Accompanying the drop in merchandise exports has been a substantial rise in merchandise imports. As in the case of exports, this increase can probably be explained less by price changes than by the growing capacity of our industrial competitors to deliver the goods. Probably there has also been some shift in American consumer demand in favor of imports as a result of higher income levels, greater sophistication in taste and increased tourism and business travel. Yet even in 1959 imports barely exceeded 3 percent of our gross national product--the share they have held with remarkable consistency over the last 30 years except during the war and immediate postwar period.

Even if we leave aside the temporary circumstances which made our payments balance particularly adverse in 1958 and 1959, our present payments for world growth and defense still overbalance our commercial surplus by around $3 billion a year. Our problem is to bring this deficit down to the $1-1.5 billion target outlined earlier by increasing our commercial surplus or reducing our foreign payments and doing so without impairing policies necessary for the growth and security of the United States and the entire free world.

IV

Sound domestic politics are first of all the ultimate foundation on which our new dollar diplomacy will stand or fall. If we are to finance the foreign economic and military expenditures necessary for free world growth and freedom, we must increase the size of our commercial surplus. To do this we must check the creeping inflation of our costs and prices, or insure at least that we inflate somewhat less rapidly than our main industrial competitors. Labor will have to show greater restraint in limiting demands for wage increases to increases in productivity. Moreover, our balance of payments should not be subjected to the strain of another nation-wide steel strike. This underlines the need to find better ways of settling industrial disputes in basic industries.

In the domestic field we particularly need a concert of government policies to assure a faster rate of economic growth. Unless we achieve greater average annual increases in our production we shall experience growing difficulty in providing ourselves with higher levels of consumption and basic services while at the same time financing our defense and foreign policy and paying our way in world trade. We should place much greater emphasis on investment in research and technology. Faster productivity advances will help develop large new export markets for the United States even with moderate increases in money wages.

Sounder domestic policies should be supplemented, secondly, by a national export drive. Our exporters developed some bad habits during the sellers' market that prevailed during and after the war. We can no longer afford to take for granted foreign customers for American goods or regard foreign markets as a minor extension of the market at home. To meet stiffer foreign competition we have to develop new and better products adapted to changing foreign demands. We must sell them more aggressively, service them better, and supply them on easier credit terms.

Although the primary responsibility for staging an export comeback rests with the business community, the Government can provide some help. It should support exporters with mediumterm credit facilities at least as favorable as those provided by our main competitors. It should do a better job of informing American businessmen of possibilities for foreign sales by strengthening economic and consular staffs abroad and improving advisory services at home.

The third element in our dollar diplomacy must be action to speed the removal of foreign restrictions against American goods. During the postwar years our exports have been suppressed by an elaborate network of exchange controls and import quotas, some of them expressly discriminating against the United States. Others, though non-discriminatory, severely restricted our foreign trade. The main industrial countries of Europe and Japan which have benefited from the recent redistribution in world reserves can now dispense with all or nearly all of these controls.

Some progress has been made in this direction. Britain, France, and other countries have recently announced significant liberalizations of import restrictions which will help to increase our exports in the years ahead. But much more remains to be done. We should take every opportunity in international and bilateral negotiations to press for the removal, by countries with adequate reserves, of their restrictions on American exports. In appropriate cases these countries must remove controls not merely on their imports of our goods but on their imports of services--e.g. tourism in the United States. Furthermore, we must go beyond the removal of direct controls and do some hard bargaining for the reduction of some of the high tariffs which confront us on many important export items. This is another strong reason for strengthening the President's presently inadequate tariff-reducing powers. Although further reciprocal tariff reduction will increase American imports as well as exports, the freeing of trade all around will enhance the efficacy of the adjustments we make to cope with stiffer international competition.

The liberalization of other countries' restrictions on imports from the United States should be accompanied, in the fourth place, by the easing of restraints on capital outflow. Even those of our industrial allies which have made progress in import liberalization have done comparatively little in this direction. With the continued improvement of their reserve position they could give greater freedom to their citizens to invest abroad. With the easing of restrictions on capital outflow a substantial amount of European long-term capital would come to the United States during the years ahead through the purchase of American securities and the establishment of productive enterprises.

Fifth, we should stop our encouragement of American investment in other than underdeveloped countries. In view of our payments deficit, indiscriminate incentives to foreign investment are a luxury we can no longer afford. We should enact the Boggs Bill providing deferral of United States income tax on the income earned abroad by a new class of American foreign business corporations, but only after amending the bill so that deferral is available only on income which is reinvested in underdeveloped countries. Moreover, we should enact a "Boggs-Bill-in-reverse" to take away the deferral privilege now available to foreign corporations in advanced countries which are owned or controlled by Americans. This would help to slow the surge of our investment in Canada and Western Europe and stimulate the backflow of profits now being accumulated in these countries.

Sixth, a greater share in aid to underdeveloped countries should be assumed by Western Europe and Japan. The increased aid efforts of our industrial allies should be channelled through new multilateral institutions such as the proposed International Development Association, now awaiting Congressional approval. The proposal of Under Secretary Douglas Dillon to expand the O.E.E.C. into an aid-coördinating institution is a further step in the right direction.

We should remember, however, that the present level of Western aid for less developed countries is still far below the level necessary to assure a rate of growth compatible with American and free-world interests. In view of this fact, a larger aid effort by Western Europe and Japan must not mean a smaller effort by the United States. On the contrary, the United States should probably aim at a $1--2 billion annual increase in its economic development efforts during the next decade.

An increase in economic aid efforts by foreign countries, therefore, will provide no direct saving for our balance of payments. But it may help us indirectly. If the trend toward "untied" lending by our industrial allies is allowed to continue, a considerable portion of their aid may be spent on American exports. It it unfortunate that we should have set our allies a bad example in this respect by tying the disbursements of the Development Loan Fund. Given liberal trade policies here and abroad, the United States can expect to be a major beneficiary of the expansion of foreign markets that will result from a faster pace of development in the less developed countries.

The seventh element in our dollar diplomacy should consist of new efforts to reduce foreign military spending. We cannot place the security of the free world at the mercy of our balance of payments. If certain military expenditures abroad are necessary to assure the survival of freedom in this world, we will have to find the means to finance them. At the same time, our payments problem does justify additional measures to prune unnecessary military expenditure.

We are currently spending some $3 billion annually on troops and bases overseas. By reducing some PX privileges and requiring some fraction of military pay to be banked in the United States we would serve the double purpose of reducing conspicuous consumption abroad by our troops and their dependents (a major cause of anti-American feeling) and cutting somewhat this $3 billion drain.

A large part of the $3 billion in our foreign military spending goes for the operation and maintenance of American bases in Europe. The benefits of these bases are enjoyed by our allies as well as ourselves; the costs should be shared in accordance with capacity to pay. The same observation applies to the several hundred million dollars worth of military hardware we have been shipping free of charge each year to our NATO allies. Payment for some of these supplies would mean a welcome increase in our export earnings. We shall have to move cautiously in this area to avoid political difficulties. But the difficulties involved should not deter us from beginning a collective reëxamination of out-dated formulas for sharing the burden of common defense.

V

The seven policies outlined above should be enough to reduce the deficit to our target level of $1--1.5 billion a year. But they may take some time to work. Moreover, we may have to run larger deficits in some years to push ourselves out of future recessions and cope with other unforeseen economic, political and military contingencies. Quite apart from these problems, we must be prepared to sustain the continuing small average deficits until such time as the free world's liquidity problem is solved by a major institutional innovation. For all these reasons, we should consider resorting to four transitional measures which, while making no fundamental contribution to balancing our payments, will buy time and give us greater freedom to manœuvre. Although our reserve position is strong already, there is no reason for taking chances. We do not want to live the next few years under the lengthening shadow of a "dollar crisis."

First, we should explore the possibilities for the accelerated repayment by the European countries of loans that they have received from the United States. Still outstanding are several billion dollars in Marshall Plan loans and special postwar credits such as our 1946 loan to Britain. Acceleration of loan repayment by mutual agreement would mean interest savings for the foreign governments and substantial reductions in our payments deficit. Some prepayment has already taken place on an ad hoc basis. Now we might reach agreements with particular countries for further prepayment in the event that they accumulate a substantial additional amount of reserves at the expense of the United States.

Second, we could guarantee the gold value of the dollar balances held by foreign governments. This would encourage the four or five countries principally concerned to settle their surpluses with us by accumulating interest-bearing dollar claims rather than running down our gold supply. Although gold clauses in private contracts are no longer enforceable in American courts, an internationally binding gold guarantee could be given by the United States Government. Since devaluation of the dollar is in any case an inappropriate remedy for our balance of payments difficulties, we would only be committing ourselves to avoid doing what we do not wish to do anyway.

Third, we could eliminate, or at least reduce, our gold reserve requirement. Under present law, the Federal Reserve Banks must hold gold certificates equal to 25 percent of their note and deposit liabilities. This has no effect on our monetary policy. But it ties up $12 billion of our gold stock, leaving only $7 billion free for use in foreign trade. Modification of the requirement would have no adverse domestic effects and would provide massive additional support for the dollar's international position.

Fourth, we could make use of the International Monetary Fund. With all the talk of dollar weakness in the last two years we have continued to be a net creditor in the Fund to the tune of $2 billion with additional unused drawing rights of $4 billion. This situation is absurd. It underlines the Fund's practical shortcomings as a provider of international liquidity. But we do not have to stand idly by awaiting modifications in the Fund agreement. We are entitled to liquidate our present creditor position in the Fund and get a stand-by credit entitling us to exercise part of our other drawing rights at will. To avoid possible adverse psychological reactions we should take these actions at a time like the present when our payments position is improving.

VI

The dollar diplomacy outlined above may be described as the liberal-collective--as contrasted with the restrictive-unilateral--solution to our payments problem. The policies are liberal in the sense that all of them, in greater or lesser degree, mean more economic freedom and a better allocation of resources at home and abroad. They are collective in the sense that most of them rely for their success on harmonious coöperation with other countries. Many of the policies require self-discipline and sacrifice. But all of them are worth undertaking for their own sake, quite apart from our payments problem.

Are we willing--and able--to employ this dollar diplomacy? The answer is still uncertain. We have yet to adopt most of the elements of the liberal-collective solution outlined above. At the same time we have embraced one element of the unilateral-restrictive solution--"tied-lending." Last October the Administration announced that henceforth Development Loan Fund credits to underdeveloped countries must normally be spent in the United States. Later it confirmed the "Buy American" trend in U.S. foreign aid by declaring that specific capital projects of the kind presently administered by the International Coöperation Administration would be transferred as quickly as possible to D.L.F.--and thus be governed by the new policy.

The "tied lending" policy has been justified as an important means of reducing the payments deficit. This argument will not withstand analysis. About two-thirds of the foreign aid to which the policy applies is already spent on our exports or on the exports of less developed countries heavily dependent on American aid. This portion represents no net drain on our balance of payments. About one-third of aid dollars are spent by the recipients on imports from our industrial competitors. These dollars are "lost" to the United States only to the extent that our allies hoard them and refuse to re-spend them on American goods. Now that our allies have built up their reserves and have begun to dismantle their import controls, somewhat less hoarding may be expected to take place. Even on the most favorable of estimates, the "tied lending" requirement can increase our foreign receipts by only 10-20 percent of the foreign spending to which it applies.

In 1960 "tied lending" will make practically no difference in our balance of payments because it does not apply to the $800 million of D.L.F. loans already committed but not disbursed. In 1961, spending by the D.L.F. might reach $600 million. In that event some $60-120 million might be saved by the "tied lending" policy--about 2 to 4 percent of our present deficit.

Two more plausible arguments are frequently made in defense of "tied lending." The first is that it helps to pacify the powerful forces who would want to apply much worse medicine to deal with our payments problem--quotas, tariffs, cuts in foreign aid and military spending. This argument overlooks the fact that concessions of this sort to opponents of liberal trade and aid policies rarely succeed in their objective, but rather encourage demands for additional concessions. The appetite for unilateral-restrictive measures in foreign economic policy tends to grow by what it feeds on.

The second argument advanced in defense of "tied lending" is that it was needed to force our industrial allies to "finance their own export surpluses"--i.e. give more aid to underdeveloped countries. But there is no reason to believe we could not achieve the same result by persuasion in the various international forums available to us. In view of the whole tendency of our postwar foreign economic policy, we are obliged to exhaust the possibilities of the carrot before resorting to the stick.

Since "tied lending" has applied only to the smaller portion of our foreign aid, its ill effects so far have been mainly symbolic. But it has quite practical disadvantages as well, which would be felt increasingly if the policy were extended to other parts of our foreign aid program. Being trade-diverting rather than trade-creating, the policy wastes world resources in the same way as quotas, subsidies and high tariffs. By forcing the less developed countries to purchase in the United States even when foreign products are cheaper or better suited to their needs, it reduces the value of our foreign aid. By subsidizing U.S. exports regardless of price and quality it encourages the very slackness which has reduced our competitiveness in world markets. By encouraging our allies to tie their loans it could deprive our balance of payments of the benefits of their growing foreign aid efforts.

"Tied lending" is not merely a retreat from liberalism in foreign trade; it is a retreat from the principle of collective action. We have expended huge amounts of energy, time and money over the last 20 years to build agencies of free-world economic and political coöperation--the International Monetary Fund, the International Bank, the General Agreement on Tariffs and Trade, the Organization for European Economic Coöperation, the North Atlantic Treaty Organization and many others.

These institutions could help us solve our payments problem, if we use them with vigor and imagination. When defenders of "tied lending" argue that it is necessary to "force our allies into financing their export surpluses" they forget we are part of a free-world alliance. As suggested earlier, our intimate connection with our allies through bilateral and multilateral financial, trade and military arrangements gives us plenty of possibilities for adjustment. Only when we have exhausted these possibilities, which we have not even begun to do, are we justified in substituting unilateral sanctions for collective negotiation.

The tendency towards large deficits in our balance of payments may plague us for years or may disappear as suddenly as it has come. It will probably take some time to find out. Meanwhile we can solve our problems by the new dollar diplomacy described above--a diplomacy which is not really new at all except in the application of familiar principles in new and more difficult circumstances.

[i] "Balance and Imbalance of Payments," p. 34, 48.

[ii] Foreign Commerce Weekly, Dec. 21, 1959, p. 16-18, 21.

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