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Remarks Prepared for the U P P E R M I D W E S T CON FERENCE ON A G R I C U L T U R A L EXPORT TRADE, Minneapolis, Minn. M a y 18, 1966 TRADE, AID, A ND M O N E T A R Y ISSUES IN THE U.S. OF PAYMENT S P R O B L E M BALANCE H u g h D. Galusha, Jr., President Federal Rese rve Bank of M in n e a p o l i s M y assignment, as I understand country's balance of payments problem: it, is to talk to you about our about h ow we came to have a problem, what progress we have made in solving it, and what the prospects are for finally ridding ourselves of it in the years immediately ahead. Naturally, I shall endeavor to be faithful to the announced title of my remarks. go along, As I I shall give p articular a t t e ntion to how the behavior of U.S. ex ports and imports and aid and m i l i t a r y expenditures have contributed to our payments p r oble m and its solution; and I shall finish up w i t h a few o b s e r v a tions about the domestic and international m o n e t a r y aspects of our i n t e r national position. I embark on my task of this noonti me w i t h trepidation. probably are very recent years about There few of you here today w ho h a v e n ft heard a great deal in the U.S. balanc e of payments problem; and, what is worse, ma ny of you may already have heard more than you have cared to about it. Nor is it that I have star tlingly new facts or interpretations to offer. What I shall say is v e r y m u c h a piece of Prof essor Ga lbrai th's ’’conventional wisdom.” I am consoled, healthful alternati ve F r o m this it wo uld however, by the fact that you do have a pleasant, to listening; you can always take an after-l unch nap. seem that I am in a fortunate position. enlighten you in some small degree or, if not this, Either I shall then by lulling you to sleep contribute more d irect ly to your happiness and well-being. - 2 - Before getting into substance, of Minnesota, I must co ngratulate the Univer sity the Depart m e n t of Ag r i c u l t u r e and all the organizations whi c h have cooperated in the staging of this conference. of those respon sible I m a y doubt the judgment for m y b ei ng here as a speaker, but, quite seriously, there c an be no doubt about the immense value of the conference itself. As one having a measure of r espons i b i l i t y for improving the economy of the Upper Midwest, I can congratul ate those respo nsible for orga nizing the conference and you who have come to participate. N o thin g could be more consistent w i t h improvement of our region's economy than an e xpansion of agricultural exports. And as one ha ving a m e a sure of r e s ponsi bility for h e lping solve the U.S. international payments problem, I can offer my congratulations. considerable extent in an e x pa nsion of U.S. and, of course, are seeking, It is to a exports-- agricu ltural exports non agric ultura l exports as w ell-- t h a t we shall a permanent solution to the U.S. find what we payments problem. •k But, now, to get on w i t h my task. you back to the years ago w h e n the U.S. To begin, immediately after World War II, I should like to take to a time light years found it easy to produce what by present standards were huge m er chandi se and current account surpluses. In 1947 the volume of w orld trade was m u c h smaller today and yet our in that year. $10 billion. largest postwar m e r chandi se account surplus was recorded In 1947 mer c h a n d i s e exports exceeded mer c h a n d i s e imports by In 1964, our best year in a long time, surplus was only $6.7 billion. altogether freakish one. averaged $6.9 billion. A n d 1947, the m e r c h andise account even if a record year, wasn't an Over the four years 1946-49 our m e r chandi se surplus But over the most recent four years, mer c h a n d i s e account surplus averaged only $5.2 billion. than it is 1962-65, our A nd over the late - 1940s our current account averaged $8.0 billion. surplus, 3 - or balance on goods and services account, In contrast, through 1962-65 it averaged only $6.7 billion. As mos t everyone is aware, days." though, the late 1940s were not "good old The v e r y large and impressive U.S. m e rc handis e and current account surpluses of this period wer e the product of unnatural, circumstances and, more particularly, pean economies. politi cally unheal thy the blo w w h i c h Wor l d War II dealt E u r o That these c ircumstances had to be altered the U.S. a cknowledged when, early on in the postwar period, grant and loan p r o g r a m s - -in cludin g that monum ent the Marshall Plan. In recent years, of course, government it adopted large-scale to enlightened self-interest, the total of government grants and loans to foreigners has b een c onsid erably less than it was in the late 1940s, w h e n this flow averaged $5.5 b i l l i o n per year. Perhaps the most important effects of the Ma rs h a l l Plan wer e p o l i tical in nature. of U.S. But by m a k i n g po ssible a greater volum e of E ur opean purchases prod uction than otherwi se there could have b e e n - - b y m a king possible, in other words, the large m e r c h a n d i s e and current account surpluses of w h i c h I have spoken--the P l a n probab ly speeded up Eur o p e a n recov ery and hastened the decline of the U.S. as the overwh e l m i n g l y dominant power in world markets. In exp laini ng this decline, Plan. though, one must go beyond m e n t i o n of the M arshal l M e n t i o n must be made of the E urop ean exchange rate d evaluations of 1949 and the K o r e a n War. The 1949 dev aluati ons improved co nside rably the E u r ope an comp etitive position. And so presumably did the K o r e a n War, w h i c h produced more than a little inflation in the U.S. have reduced, at least for a time, m arkets and reawake ned U.S. The K o r e a n War may also the supply of U.S. interest output to foreign in E u r o p e a n goods and services. I might note here in passing that m a n y students of international economics believe - 4 - the full effects of the 1949 devalua tions and the K o r e a n War were not i m m e d iately reflected in our ba lance of payments account; competitive adv antag e was quite sharply reduced, they believe the U.S. but that this was only gradually revealed w i t h the continui ng r ecove ry of E u r o p e a n economies from the devast ations of Wor ld War II. ic it ic it ic The first year of the K o r e a n War, 1950, w i t n e s s e d very sharp declines in our m e r c h andise and current account surplus and, inition at least, by the ffl i q u i dityM d e f our first postwar balance of payments deficit. m a n y years thereafter our merch a n d i s e and current account to run at levels m u c h b e l o w those of the late 1940s; these surpluses averaged, respectively, they had averaged over the years For a good surpluses continued over the years 1950-56 42 per cent and 29 per cent of w hat 1946-49. A n d the deficits persisted through 1956, altho ugh they w e r e for the most part smaller than those of 1958 and the years following. Our shrunken surpluses and persis ting payments deficits did not, . however, a l a r m the government. else were other countries could d i smant le In fact, the deficits wer e welcomed. to gain reserves, or reach the p o sition w h ere they foreign exchange controls and make their own currencies generall y convertible? And these deficits of the earl y and mid-1950s, the most part r e l ati vely small, did not result in large gold the end of 1949 and the end of 1956, billion; and, more importantly, larger, by almost $2 billion, It is well the U.S. losses. for Betw een gold stock declined but $2.5 at the end of 1956 the gold stock was still than it had b een at the close of Worl d War II. to remind ou rselves that through most of the 1950s the dollar, an international reserve asset, was a m u c h better for some countries anyway, How as substitute for gold than, it is today. Eve n at the end of 1956, then, after seven years of deficits ranging - 5 between $300 m i l l i o n and $3.6 billion, the dollar was still several years from the standpoint of the U.S. - any sort of crisis of confidence in in the future. A n d the year 1957 was, balance of payments, a good one. largely to the Suez crisis, we had a large current account a surplus w h i c h for the first late 1940s. Further, Thanks surplus in 1957, time in m any years came close to those of the in 1957 we experienced an over-all balance of payments surplus and an increase of mor e than $1 bi ll i o n in our gold stock. three years 1958-60 were not good ones. during these years; indeed, current account surplus. Current account in 1959 there was D u r i n g these years, But the surpluses w ere small for all practical purposes no then, there were no large current account surpluses of foreign exchange w h i c h could be used to finance overseas mil i t a r y expenditures, government aid payments. increased somewhat from prior years, and Or to finance long- term investments in Europe and elsewhere around the world. The combined private long- term capital outflow, direct investment and portfoli o investment, would gro w larger in the 1960s, but it first became consider able in 1956. In sum, there wer e through 1958-60 large b alance of payments deficits. And these years w i t nesse d a gold o u t flo w of dramatic proportions; end of 1957 and the end of 1960 the U.S. b e t w e e n the gold stock declined $5 b i l l i o n or 22 per cent. Thus, watershed. 1960--or, m ore exactly, October 1960--was the top of the If the U.S. had a balan ce of payments p r o b l e m before our officials or economists w ere aware of it; prescient individuals, but not many. 1960, few of there und o u b t e d l y were some R e s pon sible o fficials could not, however, fail to grasp the significance of the speculation in gold w h i c h occupied the late summer of 1960 and w h i c h in October pushed the L o n d o n gold m arket price to $40 per ounce. By the admiss ion of highly placed U.S. mo n e t a r y officials, 6 - - it was this Oc tober 1960 episode w h i c h convinced them that the U.S. badly needed to re store confid ence in the dollar and would h e n c e f o r t h have to examine all domestic economic policies for their balanc e of payments i m p l i cations . •k For m ost of us, v? -k the tendency is to associate balance of payments deficits w i t h prosperous or even e xce ssivel y prosperous times. We tend to think of domestic economic e x p a nsio n as increasing the demand for imports, decrea sing the supply of exports and, resource utilization, to a high level of as throwing the balance of payments can there be any doubt about this; than the postwar record of the U.S. wh o l e of our story, if it proceeds for evidence one has into deficit. Nor to look no further Yet p r o s perity at home c a n ft be the for 1958 and 1960 we re not years of low unemplo yment or rapid economic advance. There was rapid advance in 1959 and this was r e f l e c t ed in the behavior of our exports and imports. But even in 1959 unempl oymen t av eraged as high as it did in 1954, w h i c h was a r ece s s i o n year. What we must conclude, 1960 caught the U.S. It found the U.S. mild recession; I believe, is that the dollar crisis of late not in the grip of inflation but of excessive u n e m p l o y m e n t . not on its w ay to an in flationary cyclical peak but in a and, on trend, the U.S. ec onomy was m o v i n g not rapidly upwards but prett y near l y sideways. N o w the nice feature of traditional payments surpluses and d e f i c i t s - - i n which, most of the time--is thinking about bala nce of as I !ve said, most of us indulge that it keeps domestic and international or internal and external economic objectives consistent. If balan ce of payments deficits occurred only in prosperous or exce ssive ly prosperous only in times of excessive unemployment, times and surpluses then the a p p r opria te domestic - economic po licies would always - serve p e rfectl y the external objective of balance in the international account. seen, no sweet harmony. 7 But in 1960, there was, as we have D omesti c economic conditions demand ed an ex pansionary economic policy. A n d our international po sitio n deman ded a restrictive economic policy. Or if not a restrictive a restrictive m o n e t a r y policy. over-all economic policy, at least It mat tered not w h e ther in fact the E u r opean devaluations of 1949 and thereafter and the infla tionary outbursts w h i ch marked the early and m i d-1950 s had seriously impaired the U.S. position, for this is what m u c h of the w e s t e r n wor ld believed. curren cy country, like a bank, must respond /V objective of a r eturn to f u l l - e m p l o y m e n t . seems to me. Back in late had to adopt as a p o licy objective a But it was also clear from the start that this o bjective was only one of several. c o u l d n ft be ab r u p t l y ended./ think. i< virtual el imination of balan ce of payments deficits. objectives c o u l d n !t be disregarded. A nd a reserve to what its creditors What I !ve just b een saying can be put differently. 1960 it became clear that the U.S. international There was the And m i l i t a r y and foreign policy Overseas m i l i t a r y and aid expenditures Or so the government believed. And rightly, it ^ Actually, if in 1958-60 the U.S.'s international position, mea sured by its over-all payments surplus or deficit, as suddenly worsened, this w o r s e n i n g w asn't caused by a sharp increase in overseas aid and m i l i t a r y expenditures. The net o u t f l o w of government grants and loans did average slightly mo r e over the years con sidera bly less, the 1960s. I m ig ht add, but than over the late 1940s or than it w ould in A nd overseas m i l i t a r y expenditures were higher in the late 1950s than in the mid-1950s, 1958-60 than it did over the mid-1950s, but not m u c h higher. One cannot therefore find a simple total expla n a t i o n for the payments deficits of 1958-60, w h i c h brought in our first dollar crisis, in the behavior of U.S. overseas and military expenditures. I said just a moment ago that our government has apparently never felt it was w is e to sacrifice m i l i t a r y and foreign poli cy objectives quest for bala nce of payments equilibrium. I didn't m e a n to suggest, to a however that noth i n g has bee n done to make overseas m i l itary and aid expenditures more consistent w i t h our international position. Quit e the contrary. The net o u t f l o w of government grants and loans did increase b e tween 1959 and 1964 and over the years 1961-65 averaged about $500 m i l l i o n more than over the years 1958-60. But the higher outflows of recent years probab ly had a less unfavorable effect on our over-all payments positi on than did the smaller outflows of the years 1958-60. I of course have in mind the efforts of the gov ernment to " t i e 11 aid expenditures, goods and services. say, to m ake aid recipients purchase U.S. E v e n gr anting that aid expenditures are, as the experts " f u ngibl e,11 there must have b e e n some net gain obtained from these efforts. A n d if overseas aid e xpenditures have increased, e x p en diture s have bee n decreasing. overseas m i l i t a r y Or were until quite recently. E ven in 1965 overseas m i l i t a r y expenditures w ere only i nfinit esimal ly greater than in 1964. This is remarkable, given the expans ion of the V iet N a m war effort, and indicative of the drive the D e fe nse D e partme nt has made to make our milit. c ommitments incr easin gly consistent w i t h our international posi tion ✓ V /V /V V? /V A m o n g the several promises implicit in the anno unced remarks of mine, there is one--to talk about m o n e t a r y issues title of these in the U.S. bal ance of payments pro b l e m - - w h i c h I've hardly beg un to fulfill. I did indicate a few mome nts ago that late 1960 and early 1961 found admin istra tion and Federal Re s e r v e officials alike facing c onflicting demands, economy closer deficit. to fu ll-employment and, at the source, The issue, then, reduce our payments for ad mi n i s t r a t i o n and Federal R eserve officials alike, was how to resol ve these conf lictin g demands. done bett er to say seemingly c onflic ting demands. ernment restricts to move the Actually, I would have It is true that if a g o v itself to using either m o n e t a r y po licy or fiscal policy, it cannot achieve b oth a r e d u c t i o n in the u n e m ployme nt rate and a redu ction in its payments deficit. ment; it will also, A n e x p ansion ary m o n e t a r y poli cy will reduce however, increase the payments deficit. m o n e t a r y and fiscal policies in concert, unemploy But by using a government can simultaneously pursue the seemingly c o n f lict ing o bjectives of lower u n emplo yment and a smaller payments deficit. And using mone t a r y and fiscal policies in proper c o m b in ation is p re cisely what the admini s t r a t i o n and Fe deral Reserv e did through the period 1961-65. Fiscal polic y was expansionary; spending increased only slowly at times, 1964 and 1965. if government there were tax r eductions in 1962, A n d the effects of the expa nsiona ry fiscal p olicy were offset-- b u t , most i m p o r t a n t l y , not e n t i r e l y --by the effects of what was as the years went by an increas ingly r es tricti ve m o n e t a r y policy. Such s o phis ticati on in the d e s i g n and execut ion of m o n e t a r y and fiscal policies as we got through 1961-65 praise. troubles gained a new impetus, I h a sten to add. Federal Reserve, of our in the spring of 1965--about the time our for w h i c h I can be given no credit either, m a y Not that the coordinated effort of the ad mini s t r a t i o n and the the coord inated use of m o n etary and crowned w i t h complete success. I believe, I ca n say this in good taste for I joined the Federal Rese rve Syst em late in this peri od--to be exact, outlook, is deserving, fiscal policies, was We had a payments deficit about w h i c h m o r e presently, is for another last year and the in 1966. Still, we have - survived. 10 - Indeed, we have come a long w a y toward our objec tive of full- employment, poss i b l y even a bit too far, and yet the dollar is stronger today than it was in 1960-61. In some considera ble measure, the adm in i s t r a t i o n to deal of course, it was the willin gness of selectively w i t h capital ou tflows --to institute the Interest E q u a l i z a t i o n Tax and the Vol u n t a r y Credit Re strain t Program-that enabled us to make progress b o t h d ome s t i c a l l y and internationally. But in parceling out credit, we shouldn't o verlo ok the p rop erly coordinated m o n e t a r y and fiscal policies of the last few years. it * -k So far I have bee n speaking of the past, U.S. balance of payments p r o b l e m and, ment responded to the problem. I shall have to be brief; and of the emergence of the if ver y incompletely, I should like to turn now, for several reasons, of h ow our g o v e r n then, the most important of w h i c h is that the role of a soothsayer is frought w i t h far m o re dangers of a historian. But I wo u l d to the future. than that like to say a little s omething about the bal ance of payments o u tloo k and a little something about a second m o n etar y issue in the U.S. bala nce of payments problem, In late 1965, a g e n c i e s --anno unced equilibrium. that of international m o n etar y reform. the T r e a s u r y - - l a t e l y our most optimistic of federal that 1966 would see the U.S. re tu r n to balanc e of payments Since then even Secretary F owler's o p t i m i s m has faded. There was the es c a l a t i o n in Viet N a m w h i c h will m ake overseas m i l i t a r y and aid expenditures greater than it was thought they would be. was n ' t A nd last fall it foreseen that the economy would be as buoyant as it has been. I said before, there is no denyin g the effect of economic expansion, levels of resour ce utilization, therefore, on a country's bala nce of payments. And, as or high Now, the outloo k is for little if any improvement in our balance of - payments this year; 11 - it could even be that unless there is a tax increase or further m o n e t a r y res traint there will be a m odest deterioration. What we must be careful of, however, this year. is m i s r e a d i n g what happens Suppose it turns out that this y e a r fs deficit as last y e a r !s. Or even somewhat greater. is about the same We s h o u l d n ’t be too quick to interpret such a result as " b a c k - s l i d i n g . 11 We s h o u l d n ’t be surprised or dismayed to find that a country living through a b o o m of great proportions and fighting a costly overseas war should experience a slight d e t e riorat ion in its balance of payments. namely, There is something to w o r r y about in the present economic situation-<x~ the poss ibility of sharp rise/ in the prices of our manuf acture d goods. A If we get such a rise, then truly we shall have lost ground. In recent years our current account surplus, w h i c h in a m ann er of speaking pays aid expenditures and foreign investments, the years for our overseas has on trend b e e n increasing. 1963-65 this surplus averaged $7.2 b i l l i o n or about $5 bi ll i o n m or e than over the years 1958-60. A n d over these same years our m erch a n d i s e surplus averaged $5.5 b i l l i o n or $2.5 bill i o n mo r e than over the years 1958-60. is in this Over There fact the suggesti on that our com petitive p o s i t i o n has improved, that if we lost international c ompetitive position d uring the 1950s, we have man aged some improvement since. But because an even larger m ercha n d i s e account surplus than we have lately averaged is imperative if we are to persevere to a final solution of our balan ce of payments problem, essential that we keep free of inflation. A n d quite essential, it is quite I might add, that mo re conf erences of this ver y sort be held around the country. •k * rk ie I a m opt imistic that one day soon, w i t h i n the next few years, we shall find ourselves h a ving reattained balance of payments equilibrium--and 12 - - without the help of selective control of capital outflows. and economists believe this and, prospect. p a r a d o xi cally enough, M a n y officials are w o r r i e d by the It is the prospect of the U.S.'s retu rn to payments e q u i l i b r i u m w h i c h makes us wonder from whe r e n ew supplies of international reserves, entirely n e cess ary for the continuing grow th of w orld trade, come. For years now, the U.S., ing the w orld w i t h reserves. mounted, in running payments deficits, Of course, are going to has been s u p p l y as foreign dollar holdings have the dollar has b ecome a less good reserve asset. But the prospect of no flow of dollars into wor l d reserves is still disconcerting. As you know, current gold p r o d uction i s n !t anywhere near great enoug h to meet the e v e r growing worl d demand for international reserves. It was a reco gn i t i o n of w hat the U . S . ’s ret u r n to international e q u i l i b r i u m w ould m e a n that prompted Secretary of Trea s u r y Fowler to call together the leading industrial countries of the w e s t e r n world to find a solution for the p r o b l e m of international reserves and these c o u n t r i e s 1 r epre sentat ives have be en hard at it. we p r e s umably should k n o w presently, of T e n is scheduled of interest, for mid-year. there is still time. reserves; H o w far they have got from the so-called Group We m u s t n !t be too optimistic. political and economic, involved are great and will not, for a report for almost a year D iffer ences and o p inion b e t ween the v arious countries I believe, be easily compromised. Fortunately, There is at present no great shortage of international an immediate retreat into economic isolatio nism i s n ft in the offing. We can take some comfort in not having wait ed on the threat of near-c a t a s t r o p h y before starting international m o n e t a r y discussions. But w he t h e r we shall make mu c h progress before other c o u n t ries-- those w h i c h a r e n ft res erve currency countr ies-- see clearl y that the handwr iting on the wall was mean t read,, IS f it it it it it for them to Excerpt from remarks made by Governor J . Dew ey Daane before the Investment Bankers A s sociat ion m e eting At White Sulphur Springs, West Virginia, May 12, 1966 ............If one asks oneself what have been the sources of new i n t e r national reserves over the last decade or so, rest of the world has depended to a very the answer is that the large extent on increases in holdings of dollars and on gold mainly acquired from the United In other words, the rest of the world has been dependent on balance of payments deficits in the United reserves. States. States for increases in international - 13 - Meanwhile, we have enough to occupy us at home. As I hope I fve mad e clear, we still have a bala nce of payments p r o b l e m to solve. considerable progress in reducing our payments deficit, W e fve made but in some meas ure by resorting to direct control of foreign investment and w e must look forward to the d ay w h e n such control will no longer be necessary. to think that our interest in investing abroad will our foreign polic y and m i l i t a r y objectives will It would be w r o n g soon diminish. Or that soon change in such a w a y as to put sharply lessened press ure on our international payments position. must look for m e r c h andise and current account those of the past few years. We surpluses even greater than And in achieving these surpluses, there are roles to be played by both the government and the business community. The government has got to ma ke sure that domestic in flation does not erupt and impair our business c o m m u n i t y ’s competitive position. p ress ing for greater access to foreign markets for U.S. It has got to keep bus ine s s m e n and c o n tinue its efforts to acquaint t hem w i t h overseas opport unitie s And what have U.S. b u s i n e s s m e n to do? Not hing beyond searching out pr ofitable opp ortun ities abroad w i t h the same zeal they have displa yed d omestic markets. for profit. in searching
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