Forex: 'Cosmetic Control'

The United States has increasingly resorted to direct controls and ad hoc measures to improve its balance of payments position.

Following Galbraith's colorful terminology, the controls to date may be divided into two classes: those with 'cosmetic' or 'public relations' value, and those more basic.

The economic impact of the former is impossible to assess, but it is probably not great.

'Cosmetic' controls include a number of devices, some of which are here used as examples, with no pretense to completeness. U.S. Department of commerce undertook trade fairs abroad, in 1963, the provision of information on possible markets for individual exporters, etc.

The program was not vigorously pursued, largely because it would hardly have been worth its cost.

Similarly, the stimulation of tourist travel to the United States, attempts to discourage American tourism abroad.

The reduction of duty-free imports from abroad or to inhibit the travel of their dependents attempts to 'persuade' Japan and even Hong Kong to reduce their textile and other exports to the United States.

All of which are ad hoc, humiliating to Americans, restrictive of American freedom, an unable even in the aggregate to alter the fundamental balance of payments position.

On the contrary, the measures have been criticized because each contains elements of self-delusion, and false tranquilization of the public may merely postpone more relevant action.

A further danger is the ever present temptation to extend such measures.

It was recently proposed to Congress, for example, that Americans should forcefully be prevented from living abroad, presumably on the theory that Manhattan, Carmel and East Hampton are tolerable substitutes for Paris and Capri.

These are in effect exchange controls, although they have never been so labeled openly. In July 1963,the Interest Equalization Tax was requested - but with retroactive effect. The IET was a rather fast response to the country's huge capital outflows happening that time.

Its provisions impose a tax on purchases of long-term foreign securities of up to 15 percent of the purchase price, depending on the maturity of the security.

In effect, the tax was designed to raise the interest cost of foreign borrowing in the United States by about one percent per year and thereby to remove the incentive for the sale of foreign securities in the United States, and thus reduce the capital outflow.

When it became law in September 1963, it exempted Canadian securities issues in U.S. capital markets as well as borrowings by underdeveloped countries.

The interest equalization tax had an important impact on capital outflows from the outset. New issues of foreign securities in the United States declined from $1.8 billion in the first half of 1963 to $0.6 billion in the second half.

Simultaneously, trade in outstanding securities switched from a $302 million outflow in the first half to a $204 million in the second.

In 1964, these low rates were maintained. However, loans by the banks in the U.S. for terms longer than one year, seeking higher interest rates abroad began to substitute for the foreign security issues as a source of capital outflow.