MEMORANDUM FOR THE HONORABLE HENRY A. KISSINGER

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP80B01495R000200070009-7
• Release Decision: RIFPUB
• Original Classification: C
• Document Page Count: 23
• Document Creation Date: December 19, 2016
• Document Release Date: October 11, 2005
• Sequence Number: 9
• Publication Date: February 7, 1974
• Content Type: MF

* pp Of) Approved For R,eJease 2005/1 /
COUNCIL ON INTERNATIONAL ECONOMIC POLICY
WASHINGTON, D.C. 20500
February 7, 1974
MEMORANDUM FOR: THE HONORABLE HENRY A. KISGER
THE HONORABLE GEORGE P. SH TZ
THE HONORABLE EARL L. BUTZ
THE HONORABLE FREDERICK B. DENT
THE HONORABLE WILLIAM E. COLBY
THE HONORABLE ROY L. ASH
THE HONORABLE JOHN T. DUNLOP
THE HONORABLE HERBERT STEIN
THE HONORABLE ARTHUR S. BURNS
THE HONORABLE WILLIAM E. SIMON
Attached is an international economic review prepared by
an interagency CIEP Work Group to serve as background for
the February 11 Ministers' Conference.
Attachment: (1)
[JINFI DENTIAL
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1. The Macro Economic Impact of the Oil Price Increase
A. Real Growth (Table 1)
Real growth forecasts for 1974 as a whole fall into two classes.
The standard OECD assessment, as reported in Table 1, is that
growth for the year as a whole in the major industrial economies
will be substantially lower than had been expected prior to the
oil crunch, but should begin to recover in the second half.
The pessimistic assessment, which is the minority view, fore-
casts substantially lower growth rates for the year as a whole.
Among the optimists and pessimists there is agreement that
countries will face substantially lower growth rates in the
first half than in the second half. The differences of
opinion exist over what will happen in the second half of 1974.
The optimists expect economies to rebound by the second half
of 1974 for the following reasons.
1. Monetary and fiscal policies are expected to
become expansionary in the early part of 1974
in order. to make up for, the reduced aggregate
demand caused by the oil price increases.
2. No permanent decline in overall consumer
spending is expected--consumers will make a
relatively rapid shift from high energe use
items to low energy use items, reducing the
high savings rates expected during early 1974.
3. Stronger investment demand is expected as
relatively rapid structural shifts in each
economy occur in response to higher fuel
costs. Backlogs of unfilled orders and
capacity shortages will stimulate investment
demand.
4. World trade is expected to expand around
6-7 percent in value.
The pessimistic assessment is that the first half slowdown
may continue, or perhaps even become worse, for the following
reasons.
1. Monetary and fiscal policies have been
aimed at fighting inflation and there
is no evidence yet that monetary and
fiscal policies are becoming sufficiently
expansionary.
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2. Industries hurt by the oil price increase
can stop new investments immediately;
industries which heneit may take longer
than two or three quarters to expand
their investment. In addition, overall
uncertainty may lead other industries to
postpone investments.
3. Growing unemployment may increase consumer
uncertainty and thus slow down consumption
expenditures.
4. World trade may be disrupted because of
sharp exchange rate shifts and the possibility
of import/export restrictions.
As Table 1 shows, the oil price increase affects countries very
differently. Prior to the oil price increase, the United States
-wa.s .expecting a lower than ncOrmal growth " rate? because of cyel'ical
factors. The original U.S. forecast was reduced to zero by the
OECD in part because of the oil price increase and in part because
of reevaluation of cyclical developments. With respect to the
U.K., current labor problems are dominating the oil impact. The
U.K. forecast in Table 1 assumes that labor problems will end
by the beginning of the second quarter.
The OECD forecasts included in Table 1 and in the following tables
are based on two general assumptions concerning oil supplies and
prices:
1. OPEC prices will remain at the December 1973
level throughout 1974
2. at these prices and planned production levels,
world oil markets will clear for the whole of
1974, i.e., at the going prices, there will not
be any supply shortages except in very local
situations.
Substantial changes in oil price levels or production targets
would require a modification in the forecast.
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TABLE 1
OECD 1974 ECONOMIC OUTLOOK
OECD 1974
Total Year
Original
Forecast 1/
OECD 1974
Total Year
Feb. 1
Forecast 2/
OECD 1974
First Half
Feb. 1
Forecast
OECD 1974
Second Half
Feb. 1
Forecast
-
United States 3/ 2-1/4
0
-1-3/4
1-1/2
Canada
5-1/2
4-1/4
5
Japan
7-1/2
1-3/4
5-1/2
France
4/
5-1/2
4-1/4
3-1/4
Germany,
3-1/4
3/.4
..2.-1./4.
7-1/4
United Kingdom 4/ 3-1/2
-114/
Total: (7 above) 1.0
1/ Pre December oil price increase included
2/ Post December oil prices assumed to remain constant for the year
3/ CEA estimates are:
2.8%
4/ Gross Domestic Product
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B. Inflation (Table 2)
Inflation during 1974 will be substantially higher than
originally expected.- Price increases will be greatest
during the first half as the oil price increases work
their way through the system; the rate of price increase
is expected to moderate during the second half.
Implicit in the OECD forecast is the assumption that in
early 1974 monetary and fiscal policies will become more
expansionary. If monetary policies remain restrictive,
however, inflation may be lower than expected during most
of 1974.
Implicit in the OECD inflation forecast is'the assumption
that wage increases will be substantial, but not explosive.
Some forecasters believe that there is the possibility that
inflation rates will be higher than projected by the OECD
because of attempts by labor to not only make up lost income
due to recent inflation rates, but to anticipate future
overall price increases.
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1974 ECONOMIC OUTLOOK
GNP DEFLATOR
(Percent Change)
OECD 1974
Total Year
Original Forecast 1/
OECD 1974
Total Year
Feb. 1
Forecast
OECD 1974
First Half
Feb. 1 2/
Forecast -
OECD 1974
Second Half
Feb. 1 2
Forecast
United States 6-3/4
g-1/4
7-1/2
,?
Canada 6r3/4
.71/4 , .
Japan 9-1/4
16-1/2
17.0
12-3/4
France 4/ 7-3/4
12
13-3/4
11-1/2
Germany
7
6
Italy
13-1/2
United Kingdom 6-1/4
1/ Pre December oil price increase
2/ First half 1974 over last half 1973
3/ CEA forecasts are:
4/ Gross Domestic Product price deflator
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C. Current Account Balances (Table 3)
OECD forecast of current account balances incorporate increases
in imports by the oil producers, but do not take into account
the possible trade effects of recent exchange rate changes.
Since the beginning of October, the currencies of the major
European countries and Japan have depreciated with respect to
the dollar between 10% and 15%. Even more startling, the
dollar now stands at a higher value with respect to the
pound, and lire than it did following the Smithsonian. (See
Table 4).
It is impossible to anticipate prospective patterns of capital
flows. The oil producing countries have little alternative to
re-investing a large portion of their excess oil revenues in
the industrial countries and the combined current account deficit
of the latter will in this sense be financed by the ref lows
from the oil producers. However, the funds may not flow back
automatically to individual countries in accordance with their
needs, and measures may need to be considered to supplement
market flows if. unaecep.ta,ble? xiressures, on xghange rates and,
r"eserves ' (Table 5) ? are''to be "avo'i"ded. ' . ?
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TABLE 3
CURRENT ACCOUNT BALANCE
(In billion of $)
OECD 1974 OECD 1974 OECD 3.974 OECD 1974
Total Year Total Year First Half Second Half
Original Feb. 1 Feb. 1 Feb. 1
Forecast 1/ Forecast Forecast Forecast
United States $5.0 -4.0
Canada 0 0
Japan: .. 5?
France -.8 -3.5
Germany 1.0 -1.0
Italy -1.4 -5.5
United Kingdom -3.0
Total OECD 2.25
-2.5 -1.5
0 0
= 4 :'0'. :,,. `?`~ 3; 5' `? .
-2.0 -1.5
0 -1.0
-3.0 -2.5
-4.5 -3.5
1-/ Made before the December oil price increase
*NOTE: CURRENT ACCOUNT DEFINITION INCLUDES GOVERNMENT TRANSFERS
Q
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Changes in
Various Exchange Rates for US Dollars
February 7, 1974
'Yo Change in Current Value of Dollar from Value at:
Smithsonian
Agreement
March 19, 1973
October 5, 1973
Canada
-2.2
-2.2
-2.7?
Japan
-.3.6
14.7
11.6
West Germany
-14.2
-2.0
14.6
France
-0.7
11.0
18.9
-Uriiied Kingdom
17.5
::11;?0:
8:`9
Italy
14.0
17.3
17.2
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TABLE 5
TOTAL RESERVE ASSETS, OF SELECTED OIL PRODrICINr- COUNTRIES
(December 31, 1973) In Billions of U.S. Dollars
Value of
Total Reserves
Value of
Official Gold Assets
$14.38
$11.65
Canada
5.76
.93
Japan
12.25
4.26
France
8.53
4.97
Germany..
33.1,9
Italy
6.43
3.48
6.48
.89
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D. . Unemployment (Table 6)
All developed countries will face increasing unemployment as
real growth rates decline. Increases in unemployment for 1974
were expected prior to the oil price increase because of cyclical
declines, and the oil crunch,in adding to that expected increase,
will create special employment problems in specific sectors of
most economies including such sectors as the auto industry and
the recreation sector.
Increases in unemployment will also be accompanied by reduced
hours. In some countries, such as Germany, increasing unemploy-
ment will create pressure on migrant workers to return to their
native countries.
Higher unemployment rates will inevitably lead to an increase
in domestic political pressures.
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Projected
1973
1974
Increase
United States
4.8 %
5.5 s
+ .7
Canada
5.6
6.2
+ .6
Japan
1.0
2.0
+1
France
1.9
2.6
+ .7
Germany
1.3
2.2
+ .9
fta1y
. 6
r
-4.0
?..
. 4
United Kingdom
2.8
3.9
+1.l
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E. Monetary and Fiscal Policy in Major OECD Nations
Monetary and fiscal policies remain highly restrictive in most
of the OECD nations. West Germany is the only major country
that has recently softened its position somewhat, but its
policies still are relatively restrictive. France and Japan--
viewing inflation as the most important policy concern--have
further tightened their fiscal and monetary policies since the
beginning of December 1973. others are continuing relatively
restrictive policies with the exception of Canada, which is
the least affected by the oil situation. Although forecasters
in all of the major OECD nations are aware of the large
potential contractionary impact of the extraordinary rise in
their oil import bills, most of them cite other concerns--in-
flation, balance of payments, and international competitive
positions--as reasons why their countries would continue to
follow restrictive demand management policies.
To summarize policies by country:
1. Germany is beginning to loosen its monetary and fiscal
reins, after following'very restrictive policies last year.
?Tbe .11%-..tax on
' ?iziVestm6rtt 'has been'-"removed,' -i d'epr Ciat.ibn
has been liberalized, and incentives for housing investments
have been granted. The Bundesbank has also slightly relaxed
its tight monetary policy and is providing liquidity to hard-
pressed firms.
2. France adopted several measures to cut demand in early
December, primarily through tightening monetary policy, and
accelerating some tax payments.
3. Japan in late December raised the discount rate and, in
January, announced a 1974 budget considerably tighter than
last year's.
4. The United Kiidom--in response to its labor problems
and supply bottlenecks resulting from the reduced work-week
has taken several steps to damp down demand since December.
Expenditures have been cut, while monetary policy has been
kept tight.
5. Italy began to shift to a less expansionary monetary
policy towards the middle of 1973, and has continued to
maintain this stance during 1974.
6. Canada is continuing moderately expansionary monetary
and fiscal policies.
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In real terms, money growth (Ml deflated by the CPI) was
negative in all of the six major countries last year. Only
Japan and Italy had negative growth in total money supply
in real terms, however. Even so, except in the U.K., real
money growth grew less than GNP, and was generally restrictive.
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TABLE 7
RECENT TRENDS IN REAL MONEY SUPPLY GROWTH RATES
(Deflated by the CPI)
MAJOR INDUSTRIAL COUNTRIES
November 1973/1972 (annual rate)
~NYTRD+ STAPES'
CANADA
JAPAN
GERMANY
FRANCE
UNITED KINGDOM
ITALY
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TIIE IMPACT ON LDCs
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II. Impact on LDCs
The cost of LDC oil imports will rise from $5.2 billion in
1973 to $13-15 billion in 1974. To give an idea of the rela-
tive importance of this increase, the increase would be:
1. equivalent to 28-35% of LDC official
reverse holdings
2. about equal to the total official
bilateral flows of assistance
financing to the developing world
in 1972 of $8.6 billion
3. equal to about one-eighth of the LDCs
total exports
The projected current account deficit for non OPEC countries
in 1974 is approximately $14 billion, up from about $4 billion
in 1973. These estimates are based on the assumption that the
._J-974 -vol.um~e.of imports. wiTL remain constant at the 1973 .level.
uch"a `development would` have' serious adverse' etf-ects' c1n' LDC }7'
growth rates.
LDCs are highly dependent on oil for growth:
1. For LDCs in the Western Hemisphere, 74%
of the energy comes from oil and for the
Eastern Hemisphere LDCs' oil constitutes
58% of total energy consumption.
2. There is very little non-essential consump-
tion, similar to that present in the developed
world, which can be curtailed without appreciably
reducing output.
3. There are limited technical and economic
resources in the developing countries which
can be employed in the development and
utilization of alternative energy sources
even in those cases where alternatives may
exist in some limited form. Whereas the
U.S. can shift at the margin between coal
and oil and can devote large sums to further
exploration and development of energy sources,
the LDCs cannot.
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LDCs will suffer an additional effect of the fuel shortage
and oil price increases--limited supplies and higher prices
for fertilizer. This will reduce needed agricultural pro-
duction.
LDCs will suffer another effect because of growth rates
in developed countries will decrease demand for imports
from the LDCs.
(Not all LDCs will be affected in the same way. Table 6
ranks countries according to the relative impact of the oil
crunch).
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COUNTRIES RANKED BY EFFECT ON OIL IMPORT BILL
Which are Major Losers
Korea Chile
Philippines Uruguay
India Ethiopia
Sri Lanka Kenya
Viet Nam Sahel
Cambodia Senegal
Countries Facing Significant Difficulties
Barigladesh-
Pakistan
Turkey
Thailand
Sudan
Boderline Countries
Argentina
Colombia
Mexico
Peru
Malaysia
I4oracco ' '
Costa Rica
Honduras
Dominican Republic
Jamaica
Brazil
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IMPACT ON OIL PRODUCERS (TABLES 8 &-9)
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20
III. Impact on Oil Producers (Tables 8 and 9)
Assuming prices remain at January levels for the remainder
of the year, oil revenues flowing to producing nations will
run approximately 95 billion dollars, roughly 3.5 times their
level in 1973. Arab producers will'receive over one half of
this increase with Saudia Arabia showing the largest income
gain.
Only a small portion of these revenues can be spent for
foreign goods and services during 1974, even under liberal
expenditure assumptions. For instance, in the case of
Saudia Arabia, assuming a billion dollar transfer in grants-
in-aid to other less affluent Arab nations (primarily Egypt)
and a 20% growth in the import of goods and services, Saudia
expenditures in 1974 would only run about 4 billion dollars.
This represents only 24% of estimated increased revenues and
only 180 of estimated totaled 1974 earnings.
Other oil producers will have similar absorptive difficulties
during 1.974, even those with .a greater current need for oil
'-' a ri a=ng 1n e' th r e
programs. Normal delays in planning and decisionmaking
make It almost impossible to spend all increases in revenue
generated by the price hike during the current year. Because
of these expenditure lags, all oil producing countries will
show massive current account surpluses in 1974, as shown in
Table 8.
Official reserve holdings of oil producing countries are not
large by Western European standards at the present time. For
example, the largest reserve balances of any OPEC country in
December were held by Saudia Arabia, 3.7 billion (see Table 9).
This compares with 6.4 for Italy, 8.5 for France, and over
33 billion for Germany. However, reserve levels of producer
countries should increase dramatically during 1974 as a result
of the large current account surpluses. (Table 8)
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TABLE 8
OIL REVENUES, IMPORTS, AND CURRENT ACCOUNT
BALANCES OF OIL PRODUCING COUNTRIES
(PROJECTED 1974) BILLIONS $
1/
OIL REVENUE IMPORTS ACCOUNT BALANCE
TOTAL 94.7
ARAB 50.6
Saudia Arabia 2/ 19.9
30.2 67.4
11.5 40.3
3.5 16.6
Kuwait 7.3 1.6
Libya 7.0 1.7
Algeria 3.4 1.8 2.1
3Craq' , ..4.. ~:
1?. o?..
6.6 1.9 4.8
NON-ARAB 44.1 18.7 27.1
Iran 18.5 5.9 13.1
Indonesia 4.1 2.3 1.9
Nigeria 7.9 4.0 4.7
Venezuela 10.6 4.0 6.9
Other 3.0 2.5 .5
1 / Also includes grants and other imports for all countries
are assumed to have increased by 25% over 1973 estimated
levels.
2 / Saudia Arabia estimate postulated on the basis of a 20%
increase in emports plus 1 billion $ transfer of grants-
in aid.
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TABLE 9
PRESENT AND PROJECTED TOTAL RESERVE ASSETS OF
OIL PRODUCERS
(DOLLAR DENOMINATED)
Estimated Total Reserves Projected Reserves
End 1973 End 1974 1/
(Billions $) ( Billions $)
Saudia Arabia 3.7 20.3
Kuwait .5 6.5
? l,.ibfta t .. f. .4
Iraq 1 . 3 6.9
NON-ARAB
Iran
Indonesia
Nigeria
Venezuela
2.4 9.3
1 / Projection assumes all projected increases in
current account balances are accounted for by
increases in official reserve holdings.
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