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Notes in Preparation for a Meeting of the Balance of Payments Committee of the Business Council September 19* 1963* 1* The baslo problem remains much as It has been, although the published figures for the seoond quarter of 1963# shoving a deficit at an annual rate of §5*2 billion gave the problem an alarming and presumably exaggerated tinge* 2* Nevertheless it was the knowledge of this kind of o second ouarter reoord, and of the step-up in U. 3. portfolio In* vestment in foreign securities whloh was the Imitdkat® cause of the worsenljjg figures, that triggered th# hasty proposal of an "Interest equalization tax" to try to gheefc BUOh in vestment* 3* Whil© this tax 1§ in the no-man18 land between exeoutlve pro posal and Congressional action, this type of capital flow Is in a state of suspended animation* I doubt If It Is possible to produce figures which would accurately lndioate what Its effect on the movement of portfolio capital* over time# f f y be If ti and when It Is In actual operation. Nor has three been time and opportunity to see what Its ultimate effects mftftlibabQjAon foreign confidence in o&r maintenance of freedom from' control of other dollar movements. In principle* however, I tee no reason to revise earlier views that the proposal of an interest equalization tax was a mistaken departure from a gtntral polley of non-interference with the International movtsmtrits ©f privatt capital* The proposal attempts to zero in on on® Beotor Of a market which is notably fluid In character, and whieh wllX find ways to function, abetted by the variety of extractions from th® tax which have been found necessary to make it tven partially workable* In effect. It Is a proposal for a capital issues experiment, the mechanics of which involve the arbitrary die* tlnotlon between developed and less developed countries» the difficult distinctions in equity between direct end portfolio investment abroad, and the plAofeng of the power in the hands of the President, by executive order, to i j f n exemptions In ipct the "interest of international monetary stability". (The Canada escape hatch - and maybe others*) If our situation had reached the point at which freedom of international access to our cap ital market had to be curtailed, It would be less confusing and more directly effective to have a capital issues committee,4* I do not think we have reached that extremity. The relative strength of our economy and Its ability to compete In the mar kets of the world is still unquestioned* We are a most solvent nation. It is our liquidity position whloh has been Jeopardized by a succession of years of large deficits In our balance of payments and by the apparent check to Improvement in our posi tion during the past year* But we Btill have the resources to protect our liquidity position, if we adopt a program of imp rovement in our balance of payments which carries within Itself the seed of success* Our domestic reserves are still large, and can be further enlarged If we find It neoeasary to reduoe our - 2 - gold reserve requirements. Our access to drawing righto ?nd credits at the International Monetary Fund and our bl-lat©ral currency arrangements with the principal countries of western Europe are a substantial defense against sudden adverse devel opments. We still have time to finish putting together a pro«* gram which will attack a basic weakness Instead of fluttering around the edges of the problem* 5* Such a program, of course* Is the one we have been recommend** ing, which transfers to fiscal policy (tax reduotlon) more of the task of promoting economic growth at home and releaea monetary policy to deal more actively with International capital movements by way of Impersonal and pervasive changes in the availability of credit and In Interest rate!* 6* It Is noteworthy,I think, what muffled emphasis has feten nlaaod on tax reduction as an Important factor In Improving our bal&ne© of payments# It has been mentioned, but fearfully if It would stir up too much opposition, from those wHo want e»eitr^ not tighter^ money and lower^ not higher#, interest rates# if the connection were stressed* It would stir up opposition# Of course, but we can’t lick this problem with gifts for everyone* If the fiscal-monetary policy mix is to work, there has to be room for a further Increase in short term fcatea, if necessary# and for some increase in long term rates also# if necessary* The dangers of this prescription for the domestic economy have been over-stated, parWiiyularly as it relates to long tfffn rates* An economy stimulated Dy the Increased demand and the inereaeed retention of profits by the private sector# inheriflt in a re* duction of individual and corporate income taxes, Qguli stand an Increase in long term rates without faltering, n&rtiiuiirly as lmportantllong term markets - mortgage, coneiym§f» and municipals - have their own forms of insulation .from iPdinary market effects foi higher rates* C'? A** rti'etk b.< < y T m v4. 7* We 3hould again press for the combination of tax reduction snd a less easy credit policy to be Justified, in an important way oa a major means of Improving our balance of payments position* And we shouldn't, at this stage, encumber our advocacy with reservations demanding some specific reduction of estimated federal expenditures in fiscal 1964, There is too much spending already built in to fiscal '64 to (»njke this a practloal approaoh* The time to curb federal expenditures will be in subsequent fiscal years, to prevent their rising with the increase in gov ernment revenues which is the hope of tax reduction, ultimately* The study of the balance of payments made by six economists for the Brookings Institution, at the request of the President through the Council of Eoonomic Advisers, does little to help us in our present situation. The estimates of the balance of payments In 1968, biased on a variety of assumptions (the quality of which is admittedly speculative) showing a "basic balance" somewhere between a surplus of $1*9 billion and a deficit of &500 million, does little to meet the doubts of 1963# 1964 and 3 1965* And the counsel to avoid nre-occupatlon with the Immediate discipline of the balance of payments, because It may interred with more Important goals of national and International policy, is positively misohievous* The integrity of the dollar and other goals of national and International polloy are one and Indivis ible. Finally, the diversion of attention, In the policy raeom«* mendatlons of the report, to the asserted need for tneasuroa to improve International liquidity Is an excursion Into a realm beloved of scholars and the British, who have been beating this drum for years* To adopt the major policy recommendation of the report that the U. 3. should Immediately b e < j l n to press for g i j * Lll agreement to strengthen Infc&matlonal liquidity, and that Its major effort should be directed toward achieving an adequate international liquidity mechanism, would be the equivalent of saying the present mechanism has broken down, or is about to break do«rn, which could not help but harm the position of the dollar in terms of fears of ultimate devaluation* ’Further study” by the International Monetary Fund is ’ indicated here; not pressure by the U. S. to retrieve British chestnuts. The Freeman proposal of a tax incentive to promote ©*pert@f wMSthh was distributed on July 29, 1963# seems to me to be wrong; in principle and wrong In practice. In principle, it wouldi b© an attempt to subsidise exports which Is the kind of export oompeil* tlon between the leading industrial countries which has already sone pretty far, and which we should be seeking to abate* not promote* In practice, Mr. Freeman describes It, a tax reduction related to an increase in exports over some base period would lead to a variety of inequities between competing firms whleh have . developed their export lines and those which have not# companies which have made larje direct investments Abroad §n| thQig which have not, and between large and small firms. And a te* credit which would enable some firms to export at © "msdtsi profit or eteen at cost" 'because an increase in exports would rtdus® the tax on its income from domestic buBlnesfl, sounds like f poeket* t full of flfch hooks* *««**#««*»# ***#