Regional President Speech

Remarks of Frank E. Morris, President of the Federal Reserve Bank of Boston at the Twenty-third Annual Reunion The Stonier Graduate School of Banking - New England Group Parker House, Boston, Massachusetts January 30, 1969 "PAX AMERICANA AND THE U. S. BALANCE OF PAYMENTS" During the past 19 years, the United States has had balance of payments surplus, measured on the liquidity basis, in only two years -- 1957 and, according to preliminary estimates, 1968. The 1957 surplus, which amounted to only $578 million, was the fortuitous consequence of the Suez War and the disruption to world trading patterns which it produced. It appears that we had a small surplus in 1968, a surplus produced by the effectiveness of our control programs on capital exports. In the remaining 17 years out of the past 19, this country showed a deficit in its international accounts. The Reason for the 1968 Surplus It is ironic that 1968 should be the year in which the United States produced a balance of payments surplus. 1968 was a year in which our merchandise trade surplus almost withered away. While the final figures are not yet in, it seems probable that we had the smallest merchandise trade surplus since World War II. 1968 was also a year in which the balance of payments costs of our military programs abroad rose to more than $4. 5 billion. It was a year in which we had both the lowest unemployment rate since 1953 and the most rapid advance in price levels since 1951. These are not the sort of characteristics which one would normally associate with an economy breaking into surplus for the first time in many years. -2- All told, 1968 was a most improbable year for us to run a balance of payments surplus. There is nothing in any economic textbook which would suggest that this would happen. There are two reasons why it did happen: first, the great success of the control programs on direct foreign investment and banking lending abroad, and second, the unprecedented flow of European capital into U. S. equities. In recent months, I have often heard the control program on direct foreign investment described as self-defeating. If I were a businessman struggling to keep a growing international operation flourishing in the face of these capital controls, I would c e r ta in ly be inclined to call the program a lot of names too; but in the face of the facts at hand, I do not think the program could be called self-defeating in terms of its near-term balance of payments impact. The program was a very considerable success in 1968. We have detailed figures on capital movements only for the first three quarters of 1968. They show that during the first nine months of the year, ' American corporations sold $1. 6 billion of new securities in foreign markets to finance foreign investments. In addition, they borrowed $700 million abroad and American banks reduced their loans to foreigners by $300 million. The full year figures are likely to be even larger. The capital controls, which produced these results, made the difference between another sizeable deficit and the small surplus which we actually recorded - - a surplus which has kept the U. S. dollar strong n the foreign exchange markets during a very turbulent i year. -3- Why Has the United States Been a Chronic Deficit Country? Rather than concentrate on the near -te.rm balance of payments situation, I would like to focus on a more fundamental question - - why is it that the United States has been a chronic deficit country in its international accounts? Certainly any country which can show only two surpluses since 1949 would seem to be in chronic deficit, and without the capital controls program there would have been only one surplus year smce 1949. I would like to explore with you the reasons for the paradox that the nation which is generally regarded throughout the world as having the strongest, most progressive and technologically advanced economy should be a chronic deficit nation in its balance of payments accounts. That the U. S. economy is generally regarded as the strongest economy in the world can be documented in many ways. Perhaps the most impressive documentation is the unprecedented inflow of foreign capital into our securities markets this year -- $1. 2 billion during the first nine months of 1968. In a part, this inflow is t'r-ibute to the breadth and efficiency of our securities markets as well as to a basic confidence in the U. S. economy. A world fleeing from currencies and searching for equity investments can find only two broad and highly organized securities markets in which to invest -- the markets of the United States and Great Britain. But the British have not enjoyed any similar inflow of foreign capital into their markets. They have not because world confidence in the British economy is at a low ebb. The European financial press provides daily manifestations of the basic confidence which exists in Europe with respect to the U. S. economy. -4- Their press is filled with articles about the technological gap in favor of the United States (most of which conclude that Europe will never eliminate the gap), stories about the brain drain of young scientific talent from Europe to the United States, and articles about the vast superiority of American management and organization. How can it be that an economy which is viewed with this degree of respect around the world should be the economy of a chronic deficit country? The answer, I believe, is not complex: the U. S. economy, as such, has not been a deficit economy in its international accounts, it is simply that the private U. S. economy has not been able to generate sufficiently large surpluses since 1949 to finance the foreign exchange costs of the enormous military and aid programs of the United States Government around the world. Our International Accounts: Private and Governmental I would like to quote a few numbers to you which I think may illustrate this point. Our Research Department has attempted to split the U. S. balance of payments accounts into two segments: the payments and receipts produced by the actions of the private economy, on the one hand, and the payments and receipts produced by the actions of the U. S. Government, on the other. This sort of split is not easily accomplished; since the balance of payments accounting was not designed for this purpose. Therefore, cases did arise in which the proper classification was in doubt. In such cases, the benefit of the doubt was given to the U. S. Government accounts. The resulting figures show that, during the 18-year span from 1950 through 1967, the private U. S. economy had a balance of payments surplus -5- in 14 years and a deficit in only four years. The four deficit years were 1960, 1962, 1963, and 1964. For the 18-year period as a whole, the balance of payments surplus of the private sector was enormous, amounting to almost $34 billion. This private surplus was much more than offset, however, by a staggering U. S. Government balance of payments deficit of more than $71 billion, resulting in an over-all balance of payments deficit for the country during those 18 years of more than $37 billion. In financing this 18-year deficit, our gold stock declined by more than $12 billion and liquid liabilities to foreigners rose by more than $26 billion. Perhaps these figures will take on more meaning to you if, instead of talking about the aggregate figures for the 18 years, we discuss what an average year during this period looked like. In the private balance of payments accounts, an average year in the 1950-67 period would show the following: a surplus on goods and services of $4. 9 billion, against which we charged a -ne t outflow of capital and grants of $3 billion, producing an over-all private balance of payments surplus of about $1. 9 billion per year. Looking at the U. S. Government accounts in the average year during the 1950-67 period, we find the balance of payments costs of military spending abroad averaging $2. 8 billion, with an additional $5 billion outflow in grants and loans. Even with some considerable offsets credited against these expenditures, the U. S. Government balance of payments deficit, according to our figures, netted out at about $4 billion in the average year. Deducting the average private surplus of $1. 9 billion from the average U. S. Government deficit of $4 billion results in an average annual over-all balance of payments deficit for the country -6- during this period of $2. 1 billion. In financing the $2. 1 billion average deficit, our gold stock declined by almost $700 million per year and liquid liabilities to foreigners rose by about $1. 5 billion per year. The 1960-67 Experience If we look only at the most recent eight years, 1960 through 1967, we find a similar pattern. The private sector produced an average annual balance of payments surplus of about $300 million, the smaller surplus reflecting the much higher level of private investment abroad during this period. The Federal Government sector showed an average balance of payments deficit of $2. 8 billion, the smaller government deficit reflecting the strenuous efforts to offset partially the impact of our military and aid programs. Nevertheless, although the composition of accounts changed somewhat, the average deficit of the 1960-67 period was roughly the same size as the average for the longer period -- $2. 5 billion per year . . Why Have the Deficits Persisted? In reviewing these statistics, a number of questions naturally arise. Perhaps the most basic question is this: why have we persisted, year in and year out, in pursuing a set of foreign policies which has made it impossible for our country to attain balance of payments equilibrium - - a fact which has frequently had the perverse effect of reducing the influence that the United States could bring to bear in foreign affairs? The answer to this question cannot be a simple one, but I believe that part of the answer lies in the fact that, when most of these policies wer_e originally established in the early postwar years, we had a set of economic conditions in the world which made these policies temporarily supportable. -7- During the years immediately following World War II, the economies of Europe and Japan were weak and disorganized. There was, as a conse quence, a virtually unlimited demand for U. S. goods for a few years. The only real constraints on our exports during these years were the availability of dollars abroad and the capacity of American industry to supply foreign demand and still meet the needs of a booming domestic economy. In 1947, for example, the United States had a merchandise trade surplus of $10 billion. If this figure were adjusted only to reflect price changes, it would be equivalent to a 1968 merchandise trade surplus of $13 billion. I think it is safe to say that if we had a $13 billion trade surplus now, we could easily afford to remove our capital controls and to sustain the current level of the U. S. Government programs abroad, Vietnam War and all. It was back in this early postwar era, a time when it was thought that there would always be a chronic shortage of dollars, that the present frame .w o r k of our international commitments was formulated. Since then the structure of the world economy has changed enormously. Western Europe and Japan have long since recovered and have developed strong, dynamic, highly competitive economies. There is no longer an unlimited demand for U. S. goods. We can no longer assume, as we once could, that any dollar cast adrift in Europe or Asia will come home in the form of a demand for U. S. goods. Since 1949, $37 billion of these dollars have either stayed abroad or have been exchanged for our gold rather than our goods. Unfor - tunately, this dramatic change in the .wo r Id economy and, along with it, the change in our ability as a nation to finance governmental commitments abroad, has not yet been reflected in commensurate changes in our foreign policies. -8- A Case in Point: NA TO To take one concrete example, let us look at NA TO policy, which is embodied in a treaty signed in April, 1949. Every year our military estab lishment in Europe incurs foreign exchange costs to the United States of about $1. 5 billion. The figure for fiscal 1968 is estimated at $1. 6 billion by the Defense Department. Ours is not an occupying army living off the land. Our military establishment in Europe is fed and sheltered by U. S. dollars. I am not arguing that NATO is obsolete; the recent Russian invasion of Czechoslovakia has made it clear that an American military presence in Europe is still needed; but I am arguing that a way must be found to reduce substantially the foreign exchange burden of our NA TO operations on the United States. The foreign exchange costs of NATO have amounted to two thirds of our aggregate balance of payments deficit since 1960. I am no military expert or geo-politician, but I am certain of one -th in g: if NATO were being set up from scratch today, the United States Government would not accept the balance of payments burden of the existing system. This burden is a heritage of the day when we did not have to be concerned about the international strength of the dollar. As such, it is an anachronism. A NA TO Clearing Bank? Our efforts to offset the NA TO foreign exchange costs through bilateral negotiations have not been entirely satisfactory - - to us or to our allies. A multilateral approach in finance would seem to be called for to parallel the multilateral defense effort. Perhaps a NATO Clearing Bank might be the answer - - an international financial body d e s i grre.d to eliminate -9- the foreign exchange burden of NA TO by shifting balances from those nations gaining foreign exchange through NATO activities to those countries losing foreign exchange as a consequence of their role as NATO members. The NATO treaty comes up for review in 1969. Its military mission will certainly be reappraised in the light of the changes in the world since 1949. Let us hope that the treaty review will produce a much needed re - appraisal of the foreign exchange burdens imposed by NA TO. The Future of Capital Controls To those of you who are unhappy with the control programs on direct investment and on bank lending, let me say that I sympathize with you. In economic theory the most highly developed nation of the world should be the world Is banker and should be a major capital exporter. It is upside -down economics for the most highly developed nation of the world to be a net importer of capital from less highly developed nations, as was the case last year. However, I think we must ultimately face the uncomfortable fact that there are limits to American power. This is the great lesson that we should learn from Vietnam. We had to impose a tax increase to make room in our domestic economy for the requirements of the Vietnam War. As a nation, we found that we could not have both guns and butter. Similarly, the capital controls were needed to make room in our balance of payments accounts for $4. 5 billion of military spending abroad in 1968. As a nation, we have found that we could not afford to play an unlimited role both as the banker for the free world and as its military protector. -10- The merchandise trade surplus of the United States is now at an unusually low level. It will certainly rise in 1969 and, hopefully, in the years to follow. However, I think it is unrealistic to believe that the United States can generate a merchandise trade surplus, year in and year out, of a magnitude sufficient to finance an unlimited role as world banker and at the same time to meet the present financial requirements of the Pax Americana. I believe that we face one of three options: to scale down our governmental commitments abroad, to refinance those commitments so that our allies will assume an equitable share of the foreign exchange burden, or failing this, to resign ourselves to continuing to live for an extended period with restraints on our natural role as a world banker and capital exporter. ' . . A FIRST APPROXIMATION TO THE INTERNATIONAL TRANSACTIONS OF THE U.S. PRIVATE AND GOVERNMENT SECTORS, 1950-67 (in millions of dollars) Total / Annual Average U.S. All trans- U.S. All trans- Credits (+);debits(-) Private1 Government actions Private1 Government actions Exports of goods and services (including \ military sales contracts and grants) . 442,661 78,041 520,702 24,592 4,336 28,928 Merchandise . 317,054 65,012 382,066 17,614 3,611 21,226 Income on U.S. investments abroad . 57,756 6,244 64,000 3,209 347 3,556 Other UoS. services ...................•..•.. 67,851 6,785 74,636 3,770 377 4,146 Imports of goods and services . -354,315 .-61, 944 -416,259 -19,684 -3,441 -23,126 Merchandise (excluding military) .. : ..•..•.•. -273,571 -273,571 -15,198 -15,198 Military expenditures ....................••• -50,812 -50,812 -2,823 -2,823 Income on foreign inv~stments in U.S •....•• -12,741 -4,594 -17,335 -708 -255 -963 Other foreign services .•.•...•.......•.••••. -68,003 -6,538 -74,541 -3,778 -363 -4, 141 Balance on goods and services (including military) . 88,346 16,097 104,443 4,908 894 5,802 Unilateral transfers, net (including military grants) . -9,949 -74,132 -84,081 -552 -4, 118 -4, 671 U.S. capital, net; outflow(-) .......•...•..•... -54,808 -16,047 -70,855 -3,045 -892 -3)936 Long-term . -45,360 -12,091 -57,451 -2,520 -672 -3,192 Short-term · ~ -9,448 -3,956 -13 ,404 -525 -220 -745 Foreign capital, net; inflow(+) ...••••••.....•. 10,286 2,723 13,009 571 151 723 Long-term . 9,119 585 9,704 507 33 539 Selected short-tenn ••..••.••••.••••.•.•..••• 1,167 2,138 3,305 65 119 184 Balance on capital transactions •.•......•.••••.• -44,522 -13,324 -57,846 -2,473 -740 -3,214 Errors and omissions ...•..•..••..•.•.....•. • • • • • -23 -23 -1 -1 Ba lance on liquidity basis ....•. · ...••...•••.••.. 33,852 -71,359 -37,507 1,881 -3,964 -2,084 1rncludes state and local goverrunents,which are not separately identified in published statistics. Note: Data are not availa~le on exports financed by goverrunent spending prior to 1960, except for military. Source: Survey o·f Current Business, June, 1968, pp. 28-29, 39. ·1/28/69 A FIRST APPROXIMATION TO THE INTERNATIONAL TRANSACTIONS OF THE U.S. PRIVATE AND GOVERNMENT SECTORS, 1960-67 (in millions of dollars) Total Annual Average U.So All trans- U.S. All trans- Credits.(+); debits (-) Private1 Government actions Private1 Goverruncnt actions Exports of goods and services (including military sales contracts and grants) ..•••....• 246,531 48,574 295,105 30,816 6,072 36,888 Merchandise . 170,807 39,388 210,195 21,351 4,924 26,274 Income on U.S. investments abroad .•..•.•.•.• 36,869 3,880 40,749 4,609 485 5,094 Other U.S. services ..••..•...••••.••••.••... 38,855 5,306 44,161 4,857 663 5,520 Imports of goods and services ....••.•.....••....• -205,058 -33·, 464 -238,522 -25,632 -4,183 -29,815 Merchandise (excluding military) ...•.•••..•• -155,195 -155,195 -19,399 -19,399 Military expenditures ............•••.••.•..• -26,047 -26,047 -3,256 -3,256 Income on foreign investments in U.S ••••.•• -8,619 -3,438 -12,057 -1,077 -430 -1, 507 Other foreign services ...••.••..•...•.•...•• -41,244 -3,979 -45,223 -5,156 -497 -5,653 Balance on goods and services (including military) • • • • • • • • • • • • • • 41,473 15,110 56,583 5,184 1,889 7,073 Unilateral transfers, net (including military -4,893 -28,377 -33,270 -612 -3,547 -4,159 grants) ······••.•········••·• ·U.S. capital, net; outflow(-) .........•........ .-36, 116 -11,969 -48,085 -4,515 -1,496 -6,011 Long-term . -28,854 -10,377 -39,231 -3,607 -1,297 -4,904 Short-term . -7,262 -1,592 -8,854 -908 -199 -1,107 Foreign capital, net; inflow(+) .•.........•...• 6,910 2,552 9,462 864 319 1,183 Long-term · . 6,014 585 6,599 752 73 825 Selected short-term .••••••.••.••.•••.••••••. 896 1,967 2,863 112 246 358 Balance on capital transactions ••••••••••••••••• -29,206 -9,417 -38,623 -3,651 -1, 177 -4,828 Errors and omissions ••.•••.••••••••••••.••••••.• -4,897 .-4,897 -612 -612 Balance on liquidity basis .•••••••.••.••••••••••• 2,477 -22,684 -20,207 310 -2,836 -2,526 1 Includes state and local goverrunents,which are not separately identified in published statistics. Source: Survey' of Current Business, June, 1968, pp. 28-29, 39. 1/28/69

Frank E. Morris (1969, January 29). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19690130_frank_e_morris

@misc{wtfs_regional_speeche_19690130_frank_e_morris,
  author = {Frank E. Morris},
  title = {Regional President Speech},
  year = {1969},
  month = {Jan},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19690130_frank_e_morris},
  note = {Retrieved via When the Fed Speaks corpus}
}