Waging the Gold War

Gold--and the U.S.'s steady loss of it--has been the prime preoccupation of the free world's financial strategists since John F. Kennedy declared repeatedly in Europe last month that "unless we master our gold problems, they will master us." Last week, under pressure from European financial leaders who fear that the continuing gold drain could start a worldwide deflationary cycle by further undermining the dollar, the U.S. took three actions. It set higher interest rates on short-term borrowing, put indirect controls on longer-term exports of U.S. money, and surprisingly indicated a readiness to borrow from the International Monetary Fund, which the U.S. originally helped to set up at Bretton Woods in 1944 to bail out poorer foreign countries.

Limit for Freedom. The three moves were quite a change from Washington's earlier attempts to nibble at the problem by reducing tourists, duty-free imports and inducing allies to prepay their postwar debts. As the U.S. Treasury reported that U.S. gold stocks have dropped $100 million so far this month, to a 24-year low of $15.6 billion, a top economic adviser to President Kennedy conceded that "our old program had become an obvious failure." Washington hopes that its new program will cut the U.S. balance-of-payments deficit--which rose to an annual rate of $3.2 billion in the first quarter and is growing worse--by $2 billion in the next 18 months. It now predicts a payments surplus by 1967 or 1968. But despite the new moves, two of the biggest drains on gold--U.S. foreign aid and military spending abroad--remain unaffected.

For the first time in 30 years, foreign rather than domestic considerations prompted the Federal Reserve Board to raise interest rates. Lifting its discount rate to member banks to 31% from 3%, where it had stood for three years, the Fed said that its move was designed to discourage foreign borrowers, who raised well over $1 billion in the abundant U.S. capital market last year. Though the U.S. earns interest on these foreign loans and stands to get them back in the future, the exported dollars flow into foreign central banks and are often swapped for U.S. gold.

The U.S. prides itself on having completely free capital markets. That boast shrank somewhat when President Ken nedy last week ordered an indirect control called an "interest equalization tax." If Congress approves, as expected, U.S. purchases of most new foreign stocks and bonds will be dampened by a tax on American buyers of up to 15% of face value. The purchaser of a 20-year, $1,000 foreign bond, for example, will be taxed 12.25%, which would raise his overall costs to $1,122.50. The U.S. hopes that purchases of such securities --now running to $1.8 billion a year--will be slashed to the $500 million-$600 million rate of the late 1950s. This means that for foreign governments and companies, money in U.S. markets will be much harder to come by.

More startling was Washington's "standby" arrangement to draw $500 million worth of convertible foreign currencies for one year from the IMF. The IMF is already stocked up with its full quota of dollars. The U.S. will therefore swap its borrowed currency for dollars held by foreign countries that need hard currencies to pay off debts to the IMF but cannot use dol lars to do so. These countries will thus be less tempted to convert the dollars they hold into U.S. gold. Sighed one U.S. official to the IMF: "I never thought I'd see the day when the U.S. would be standing at the door."

Historic Drop. The sweeping U.S. money-policy change climaxed a yearlong backstairs dispute in Washington and represented a victory by Walter Heller's activist Council of Economic Advisers over the more conservative Treasury. Treasury Secretary Douglas Dillon has been worried that even in direct controls on capital movements might cause foreigners to fear that stiffer controls were coming, and thus precipitate a run on the dollar. Under Secretary Robert Roosa was opposed to any U.S. drawing from the IMF. The Treasury learned only recently that it had lost the battle inside the Administration, was given the job of drafting the tax measure and arranging for the IMF loan, both of which it has now come around to favoring.

As for the Fed's increase of the dis count rate, some leaders in Congress complained that President Kennedy had reneged on the Democrats' campaign pledge of "easy money." The Administration replied that the discount-rate rise is aimed at affecting only short-term credit in the U.S. and not long-term borrowing for mortgages and business expansion. U.S. dealers in foreign securities also grumbled that they now face hard times; such foreign shares as Royal Dutch Shell and Aluminium Ltd. plummeted on the New York Stock Exchange.

Canada, the largest foreign borrower from the U.S. and a nation that of late has shown an increasing tendency to hobble U.S. investments, did not like the taste of its own medicine; stocks on the Toronto exchange fell 21% in one day. Japan's stock market suffered its worst one-day loss in history, the decline being led by companies (such as Sony and Hitachi) that depend heavily on U.S. public financing.

European financial leaders, however, generally applauded the U.S. move; most of them are convinced that their continent's prosperity depends on a sound dollar. "The U.S. payments-balance deficit could not, in fact, be allowed to go on any longer," said French Finance Minister Giscard d'Estaing. Added Dr. Otmar Emminger, chief of the German Federal Bank: "The U.S. has taken ingenious measures that avoid direct exchange controls and do not affect its domestic economy."

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