Foreign Relations of the United States, 1961–1963, Volume XXII, Northeast Asia

376. Memorandum of Conversation⁰

Washington, August 1, 1963.

SUBJECT

• The Under Secretary’s Meeting with the Japanese Foreign Minister¹

PARTICIPANTS

• Under Secretary Ball
• Foreign Minister Ohira
• Ambassador Takeuchi
• Mr. Taketoshi Yamashita, Financial Minister, Embassy of Japan
• Mr. Yoshihiro Nakayama, Director of Economic Affairs Bureau, Japanese Ministry of Foreign Affairs
• Mr. Michio Mizoguchi, Interpreter (Second Secretary, Embassy of Japan)
• Mr. Roger Hilsman, Assistant Secretary for Far Eastern Affairs
• Ambassador Reischauer
• Mr. Benjamin Caplan, Director, Office of International Finance and Analysis
• Mr. Leonard L. Bacon, Acting Director for East Asian Affairs
• Mr. M. D. Goldstein, Deputy Director, Office of International Finance and Analysis
• Mr. James Wickel, Department of State Interpreter

The Under Secretary explained to the Foreign Minister the American thinking underlying the proposal of an interest equalization tax.² He referred to the increase in the outflow of long-term capital at a time when foreign short-term claims against the dollar were also increasing. To meet this situation Secretary Dillon had pursued the least restrictionist policy, preferring the mechanical method of an interest equalization tax to any form of direct controls. The proposed tax afforded the best method, short of direct controls, of equating U.S. interest rates with the world level while permitting our friends to have continued access to the U.S. capital market with the least harmful effect on their economies. We believed that the tax, the equivalent of a 1 percent increase in U.S. long-term interest rates, would eliminate marginal borrowing, particularly in areas like Europe where interest rates were close to those of the United States and where capital would be available were the capital markets better organized. The tax would, in effect, spread the burden of providing capital for world-wide economic expansion. The best advice of the New York financial community was that while the tax might reduce access to the U.S. capital market, it would not seriously interfere, for example, with Japan’s ability to finance her programs. No long-term restrictive effect was anticipated in view of the difference in Japan’s equity and interest rate structure even though the immediate effect would be an increase in interest and equity costs for Japan. The Under Secretary recognized that Japanese financial experts disagreed with these views and suggested that the experts explore the question.

The Foreign Minister replied that Japanese financial experts were aware of the American belief that the tax would not interfere with normal Japanese access to the American capital market. He pointed out that investment in Japanese stocks came to an almost complete standstill when the new tax was announced.³ Should the tax be imposed, little return could be expected from Japanese bonds; the return was so slight already that hardly any difference existed between American and Japanese bonds.

The Foreign Minister stated that Japan had based her economic policies on the premise that the United States was firmly committed to the maintenance of a free dollar and would take no steps to control access to the American capital market. In his view, the new policy would have serious effects in Japan and, unless changed, could have serious political consequences. Japan understood that the new policy had been formulated because of the need to protect the dollar. He hoped that the talks between the experts could be expedited with a view toward reaching, as rapidly as possible, a resolution of differences which would spare Japan from unfavorable consequences of the proposed tax.

The Under Secretary assured the Foreign Minister that all concerned desired a solution which met Japan’s financial and political problems as well as our own balance of payments problem. We were, however, restricted in our search for an easy solution by the tensions existing in world capital markets; he noted the growing movement against the dollar in the previous week, particularly in Switzerland. This results from the belief in financial circles that the United States must consider political affairs in the world as carefully as the strength of the dollar. Scepticism about American efforts to stem the outflow of capital was a factor which could not be ignored in seeking a solution which would demonstrate our sympathetic understanding of Japan’s situation.

The Foreign Minister said there had been no change in the Japanese Government’s position of cooperating in the defense of the dollar. He understood that the United States Government must be firm in this purpose. He did not intend to advocate a change in this basic policy. However, within the framework of this policy and U.S.-Japan cooperation, he felt that the two countries can, and indeed must, achieve an adjustment of their differences.

Ambassador Takeuchi inquired whether any estimate of Japanese needs to borrow in the American market had been made in the course of the U.S. Government’s study of the effect of the tax on Japanese borrowing. The Under Secretary replied that he did not know, adding that Secretary Dillon would discuss this question. The Treasury conducted these studies in which, because of the sensitivity of the matter, the Department of State did not participate until just before the proposal was advanced.

Ambassador Takeuchi asked whether the United States Government had any intention of reducing the amount of money which Japan can borrow in the United States. He said that the dollar had not been endangered by Japanese borrowing in spite of an increase of $100 to $150 million over 1962.

The Under Secretary replied that market forces would determine the flow of capital which would continue to go to those countries having the greatest differential in interest rate. If the differential was less than 1 percent, then capital flow would be reduced. The out-flow of long-term capital, he believed, would ultimately be reduced to $400 to $600 million a year, the same result as would be obtained from a 1 percent increase in interest rates.

Ambassador Takeuchi said that many Japanese feel that the impact of the proposed tax on Japanese borrowing needs had not been studied carefully. This feeling had been strengthened by the action taken with regard to Canada,⁴ a country about which the United States should have known more. Apparently something happened to occasion an exemption for Canada. Many Japanese feel that the same situation applies to Japan.

The Under Secretary commented that this question should be raised with the Treasury which undertook the studies. The studies themselves were global and not national in nature. European interest rates had been studied and it was felt that the tax would divert borrowing from the American to the European market, provided the 1 percent tax equalized the interest rate differential.

The Foreign Minister observed that his Prime Minister and Government believed that Japan, by leaving her earnings and borrowings in the United States to finance imports from the United States, had not aggravated the outflow of capital. Japan has cooperated with the United States in this matter and was dismayed at this step taken by the United States.

The Under Secretary said it was his impression that part of Japan’s dollar holdings had gone to finance Japan’s adverse trade balance with Europe. He felt that the U.S.-Japan trade balance might have reached a state of equilibrium. However, the tax was directed at Europe rather than elsewhere. While there might be some reduction in the flow of American capital to Japan, he felt there would still be a substantial flow, particularly in the form of portfolio investment. There is no desire to impair the development of the Japanese economy. The American interest is in the solution of the political and economic problem, which is difficult to achieve in view of the sensitivity of the world financial markets.

Ambassador Takeuchi asked whether the United States would consider measures which would permit Japanese borrowing if it can be proved in the near future that the tax would prevent Japan from financing her programs, thereby endangering both the programs and the government itself. He said he was not seeking a guarantee but he wondered whether the logic of Japan’s position was not evident.

Ambassador Reischauer commented that this was precisely the question under discussion.

Ambassador Takeuchi asked whether the same result might not be achieved by voluntary controls rather than by a tax. In reply, the Under Secretary said that was a matter to be explored with the Treasury. The problem was extremely sensitive and must be handled without leading to further erosion in the position of the dollar.

Ambassador Reischauer asked what Japan’s capital needs were expected to be. The Foreign Minister replied that the need was great from the standpoint of Japan’s balance of payments and economic growth. Japan’s current transactions were generally in balance but there was a deficit of about $400 million in invisibles which was covered by capital borrowing. $300 million would be the minimum required for investments which would permit a continuation of Japan’s growth rate. When Mr. Kaplan pointed out that the tax would apply to portfolio but not direct investments, the Foreign Minister said that $600 million was the figure for all capital borrowing, including direct investment.

Ambassador Takeuchi wondered whether the new policy was not successful in Europe in view of the absence of any protests against it. The Under Secretary agreed that there did not seem to be so much concern in European nations which could find capital at home and have turned to the United States only out of convenience. Japan and Canada had been the countries of greatest concern to the United States in this matter.

The Under Secretary assured the Foreign Minister of our desire to be helpful, adding that the Treasury should take the lead since it is responsible for the United States balance of payments. Policy would be guided, he cautioned, by the impact of any decision on the financial community.

Ambassador Takeuchi noted that the draft legislation was general in terminology and did not exclude the possibility of an exemption for Japan. Should Administration officials make any statement in their testimony before Congress advocating excluding Japan from exemption, this would have a very adverse effect in Japan leaving no room for improvement of the situation. The Ambassador pointed out that the Japanese stock market had taken a downturn immediately following a press article attributing to a high United States official the view that Japan was not to be exempted from the tax.

The Under Secretary concluded the meeting by noting that some possibilities might come to light during subsequent discussions by the experts. These could be reviewed before the Foreign Minister’s meeting with the President.⁵

0. Source: Department of State, Central Files, POL JAPAN-US. Confidential. Drafted by Wickel and John F. Knowles of EA/J and approved in U on September 18.
1. Ohira had arrived in Washington August 1 to make representations regarding the proposed interest equalization tax.
2. President Kennedy had presented this proposal to the Congress on July 18 in a special message to the Congress on the balance of payments. For text, see Public Papers of the Presidents of the United States: John F. Kennedy, 1963, p. 580. Purpose of the proposed tax was to effect an increase of about 1 percent in the cost to foreigners of capital raised in the United States, and thereby to help bring the U.S. balance of payments into equilibrium without raising domestic interest rates. It was approved on September 2, 1964, as P.L. 88-563; see 78 Stat. 809.
3. In a telephone conversation between Dillon and Ball at 10:15 a.m. on July 27, Ball agreed with Dillon’s statement that “it is very clear that their [Japan’s] problem [with the interest equalization proposal] is more face and that sort of stuff than it is economic.” Dillon also asserted that “we” had received a telegram stating that the Bank of Japan did not believe the proposal would really hurt Japan but that it didn’t want this statement attributed to it. (Notes of telephone conversation; Kennedy Library, Ball Papers, Japan)
4. Concerning the nature of the “exemption” granted Canada, see the joint U.S-Canadian communique, dated July 21, in Department of State Bulletin, August 12, 1963, p. 256.
5. See Document 377. Ohira also met with Rusk on August 1. (Memorandum by Wickel and Knowles; Department of State, Central Files, POL JAPAN-US) See the Supplement.