From Special Relationship to Third Option: Canada, the U.S., and the Nixon Shock

By Muirhead, Bruce | American Review of Canadian Studies, Autumn 2004 | Go to article overview

From Special Relationship to Third Option: Canada, the U.S., and the Nixon Shock

Muirhead, Bruce, American Review of Canadian Studies

The articulation of the so-called Nixon Shock of August 15, 1971, more formally called the New Economic Program (NEP), was an epochal event in the history of Canada-United States relations, that stimulated Ottawa to consider a new world in which the U.S. did not bulk so large. (1) The Canadian assumption that the United States would always accord their country consideration when calculating the American interest as, for example, it had when it had exempted Canada from the Interest Equalization Tax in 1963, was shaken on that day. (2) Much to their surprise, Canadians found themselves no different in American eyes than Western Europeans and the Japanese.

The "special relationship" (3) that had existed between the two North Americans at least since the Second World War, was officially over as the various elements of the NEP took effect, among them the temporary ten percent import surcharge, the Domestic International Sales Corporation (DISC), which encouraged export activity by allowing tax deferral within the DISC while it was more or less exclusively engaged in export sales activity, a ten percent tax credit for investment in American-produced machinery, and a job development tax credit. It was an article of faith in Ottawa in the dog days of summer 1971 that these measures would hinder Canadian sales to the U.S. causing widespread economic dislocation.

The NEP was made necessary by the declining position of the United States in the global economy, or so its author, Secretary of the Treasury John Connally, believed. He was determined "to head off what the Administration believe[d] to be the most important non-military threat to U.S. national security: economic competition from Japan and Western Europe." (4) This had been made worse by the United States' involvement in a debilitating war in Vietnam that sapped the moral fiber of the country and took its gold to pay for bombing runs in the North and troops in the South. As well, American technology seemed to be second-rate when compared with that of Japan, as did U.S. business organization and practice. In short, on various levels decision-makers were forced to confront the reality that their nation seemed to be less powerful and less essential to global prosperity than it had been in the past. It also made Americans more defensive and less willing to adopt a policy of noblesse oblige when considering requests by smaller petitioners like Canada. It reflected "a certain self-doubt, ... a rather pervasive pessimism." (5) And the fact that the U.S. current account balance struggled to maintain itself in the black through most of the 1960s, and went from a small surplus in 1970 to a deficit of US$3 billion in 1971, did not help at all, especially as Canada seemed to be doing quite well, at least in terms of its trade surplus with the U.S.; that had increased from CDN$750 million in 1970 to CDN$1.1 billion the following year. (6)

The NEP was draconian and as the Canadian political scientist, Peter Dobell, has pointed out, "It [was] no exaggeration to suggest that the effect in Canada of these short-term measures and of the negotiations that followed their introduction produced a national catharsis." (7) They were also, as one critic later characterized them, the equivalent to "putting a gun to the head of the rest of the world." (8) The program vaulted the U.S. back into the center of Canadian calculations from whence it had strayed following the publication of Canadian Prime Minister Pierre Trudeau's vision of foreign policy contained in Foreign Policy for Canadians which had minimized comment on the United States. This article investigates the effects of Nixon's 1971 announcement on Canada, providing a lens onto relations between the North Americans as Ottawa sought to cope with its changed circumstances.

Why was the U.S. performing so poorly, relatively, in economic terms by the later 1960s? The assistant to the president for international economic affairs, Peter Peterson, had some ideas as well as some thoughts on how to address them. In a thought-provoking and insightful essay, he laid out for Richard Nixon his prescription for the future: "we should think through whether the rapidly changing economic, technological, and social world we are living in doesn't require more systematic approaches to projecting the future development of our economy in order to understand more clearly the long-term choices for public policy. We are making these choices today, if only by inaction, but in some ways we are making the choices in the dark." (9)

Clearly, the United States was living in a much more competitive world than at any time since 1945, trying to outdo a number of countries that devoted a great deal of time and effort to shaping their futures, like Japan and West Germany. It seemed that the traditional U.S. method of "planning," that is, relying on the private sector and market mechanisms, was limited in its effectiveness and Peterson was urging the Nixon administration to re-evaluate the role of government in the planning process. This memorandum to the president, notable in its analysis of the strengths and weaknesses of the American economy and for its suggestions as to how to escape its economic morass, suggested a different path to the future.

There were also other reasons for changing U.S. attitudes. Nixon's appointments to certain key positions favored those who espoused a "tough love" approach to allies. John Connally, a man with experience in neither international finance nor diplomacy, reflected this hardening American position. Named as the administration's second secretary of the treasury in late 1970, his elevation had stunned foreign financial capitals and impaired the American relationship with a number of countries. (10) Along with Henry Kissinger, the president's assistant for national security affairs, he thought that the devaluation of the U.S. dollar would not be catastrophic, the opposite of the view held by the previous Democratic regime as well as by other countries. Also, the new treasury secretary felt that foreigners were becoming more, not less, protectionist. As one adviser later recalled, "Connally was 'vociferous about how the United States was getting the short end of the stick in trade matters,' delivering 'an unbelievable diatribe' against the European Community and Japan in one Cabinet-level meeting with the President." (11) He was convinced that in order to effect a major international realignment, it was necessary to Shock American allies. He wanted, he said, to use "a baseball bat to get the mule's attention." And that was largely caused by the fact that the U.S. had it first balance of trade deficit since 1893. (12) The North American commercial relationship was about to enter a new phase.

The sharp turn of that new path, epitomized by Nixon's New Economic Program, took American trading partners by surprise. It had also shocked some American officials who had also not been told of this most significant policy change. Peter Towe, the Canadian minister at the embassy in Washington, told Mitchell Sharp, Canada's secretary of state for external affairs, that the "content of the package put together at Camp David seems to have come as a surprise even to senior USA officials left in Washington." (13) Most of these officials, and especially those from the State Department, would have been opposed to the Nixon plan. As the president had earlier pointed out as a rationale for excluding State, "that agency [only] represented the interests of] foreign governments[!]" (14) At Camp David, the solitary voice of the chair of the federal reserve board, Arthur Burns, put the opposing case, objecting that the type of program suggested "would squander the valuable good will of foreign governments, and he warned of retaliation. Connally responded: "We'll go broke getting their good will ... So other countries don't like it. So what? ... Why do we have to be 'reasonable'? Canada wasn't [when it imposed import quotas in 1962] ... Let 'em [retaliate]. What can they do?" (15)

Almost immediately following the president's announcement, Connally went on NBC's Today show to say that there would be no exemptions from this legislation, singling out the northern neighbor:

    [The Canadians are] going to come down and complain and ask that
    they be exempt from the imposition of the surcharge. We're going to
    be cooperative ... but I'm going to point out that when they imposed
    a surcharge in 1962 we went up there to ask for relief for American
    products, they said no. I'm going to point out to them that in 1965
    when they had real economic problems, we entered into an automotive
    agreement with them. At that time, we had a surplus trade balance
    with Canada of US$650 million per year. Last year, we had a deficit,
    a negative trade balance of US$1.6 billion, so we had a net change
    of US$2.3 billion in our trade with Canada in the last five years. I
    must say that I don't think that their bargaining position is as
    strong as it might be. (16)

Still, a ministerial delegation, led by Minister of Finance Edgar Benson and Minister of Industry Jean-Luc Pepin, to plead the country's case had been dispatched as soon as Nixon's broadcast was finished. When Canadian requests for negotiation were turned aside, petitioners in late August, this time led by Simon Reisman, the deputy minister of finance, traveled to Washington for talks. When it was reiterated that there would be no deals this time around, he asserted that Ottawa would "look to its defenses and what Canada might have to do might not please the U.S." (17)

The element that most exercised Canadians was the ten percent import surcharge, described by one senior banker in Toronto as "a nuclear warfare type of tax" which threatened Canadian prosperity and employment by restricting the flow of goods to the U.S. (18) It was estimated that it would affect about 25 percent of Canada's sales to the United States and the dollar figures were stark--out of a total export bill to the U.S. of CDN$10.6 billion, it would touch on something on the order of CDN$2.5 billion and was forecast to cost 90,000 jobs if it remained in force for one year. The only redeeming feature from the Canadian point of view was that it would not apply to imports then entering the U.S. duty free or under a mandatory import quota program, like oil and autos. The intent of the surcharge was, as Connally spelled out in a press conference, "to provide a means and a time where American industry and American workmen can regain their competitive spirit and their competitive capabilities." (19) As well, he suggested that as a condition for the removal of the surcharge there should "be substantial progress toward the dismantling of specific trade barriers" to be named later by American officials.

Connally had a general sense of the Canada-U.S. trade relationship, and was correct in his assessment that the former's balance on merchandise trade with the United States remained in surplus. However, there is little evidence to suggest that he was fully aware that Canada's overall current account balance remained in deficit to the tune of CDN$845 million in 1969, CDN$165 million in 1970, and CDN$282 million in 1971. That reflected a U.S. surplus in non-merchandise trade from 1969 to 1971 of CDN$1.317 billion, CDN$1.286 billion and CDN$1.491 billion. The United States actually benefited from its Canadian connection, and that was only possible so long as Canada ran a merchandise trade surplus. Americans were not then of a mind to heed these arguments.

However, even if it wanted to, as Katz told Towe, the U.S. could not practice discrimination in the application of the import surcharges for legal reasons reflecting commitments made under the General Agreement on Tariffs and Trade. Still, Washington would, he thought, "be more disposed to consider the special problems created for 'cooperative trading partners.'" (20) One way for Canada to become so was to make quick progress on modifying those elements of the Autopact, signed in 1965 by President Johnson and Prime Minister Pearson, that remained a sore point with the Nixon administration and Congress. Indeed, Connally had clearly identified the Autopact as "a specific barrier to trade," even though it had been freely negotiated by the previous administration. (21) The secretary wanted changes in the safeguards--the "floors" under Canadian value added and the production-sales ratio as set out in letters to car companies, guaranteeing a certain level of Canadian production in Canadian-made vehicles. The International Trade Commission later went on record noting that Canada had not complied with the letter and spirit of the agreement in that it had not phased out these transitional provisions. (22)

The U.S. certainly wanted action on that agreement--at first its abrogation, but the administration was convinced to remove that from consideration at the last minute. In the end, the White House wanted Canada to agree to remove the transitional safeguards noted above, and to Ottawa's limitation on duty-free entry to bona fide car manufacturers. (23) It also wanted some changes to the Defence Production Sharing Agreement, having been alarmed over a cumulative surplus in trade account on defense purchases of more than US$500 million in Canada's favor. As well, the newly-established Michelin tire plant in Nova Scotia drew some fire from U.S. officials. They had focused on the government assistance provided to the French company which had resulted in its location in the Maritimes. Michelin had received a CDN$5 million grant from the province and a Department of Regional Economic Expansion grant approaching CDN$10 million, plus a commitment that the company be allowed to import into Canada duty-free steel cord radial tires of a class not yet produced in Nova Scotia. Approximately 60 percent of the tires produced at the plant were to be exported to the U.S. in direct competition with American firms. Finally, Washington wanted reciprocity in tourist allowances.

Ottawa completely rejected this position, the refrain of which they heard over the autumn of 1971. Canada did not maintain unfair trade barriers against the United States, and should not be expected to pay for the removal of U.S. restrictions which in the view of Canadian policymakers should not have been applied in the first place. But even given what they regarded as needless provocation, negotiations were necessary; "it [made] sense to see what could be done in the short term to deal with these issues and thereby facilitate prompt removal of the U.S. surcharge." (24)

It also made sense because of the new breezes blowing through the halls of American decision-making. For example, Paul Volcker, the undersecretary of the treasury for monetary affairs, had told Canadians on a few occasions that his country was "at the end of the line" and "on the short end of the stick" in a number of trading arrangements around the world. Such innovations as the Domestic International Sales Corporation proposal reflected its effort to emulate programs in other countries that practiced trade discrimination. In terms of foreign commercial policies, the E.E.C.'s preferential system and its common agricultural policy, as well as Japanese trade barriers, were the most important issues. Canada fitted in here as well with the Autopact, and if the protectionist pressures that were building in the U.S. were to be defeated, Ottawa would have to help Washington in its efforts to redress the imbalance, particularly in trade in autos and parts.

The Canadians continued to be perplexed as to why they did not fit into a special category as they had in the past, especially as their condition vis-a-vis the U.S. had not changed since the 1960s. Moreover, to lump Canada in with the E.E.C. and Japan was, in their view, ludicrous. Certainly they figured that they had done their best for the United States; a memorandum prepared for Trudeau suggested that the country had met the test of good neighbor and trading partner. The Canadian dollar had been allowed to float in 1970 and it had appreciated in value against the American dollar by about eight percent. As well, Canada did not maintain any discriminatory or unfair trade restrictions against U.S. imports, and it had unilaterally accelerated the recently-negotiated GATT Kennedy round tariff reductions which had helped American exports to the country. The take-no-prisoners American approach was suggestive of a changing relationship between Canada and the U.S.

The effects of the program were also thrashed out with others in the G-10, a group comprised of Canada, the largest European economies, Japan and the United States. These meetings provided a forum in which to compare experiences and "purge" emotions as well as let the Americans know precisely what others thought of the Nixon Shock. They met first to discuss that file in London on September 15-16, in Washington on the 26th of that month, and in Rome in late November.

At the London meeting, discussions were heated as participants went around the table itemizing their disagreements with U.S. policy. Connally was a major reason why the talks became acrimonious given his pressuring of Europe to do something to help the U.S. with its balance of payments problems. In response to a point raised by the head of the U.K. delegation, that Connally state the specific conditions necessary for the removal of the import surcharge and that the U.S. make a contribution in currency realignment through a devaluation of the dollar in terms of gold, the secretary exploded:

    I thought I covered that. I find it passing strange that it should
    be constantly suggested that the U.S. acted heinously in imposing
    its surcharge ... The people most critical of it have the most
    experience with surcharges.... I have been asked time and time again
    for clarification. Well, I thought I said that the surcharge was
    temporary, unlike many actions by others to impose import and border
    taxes and subsidies. But I said that the U.S. has no disposition to
    remove the surcharge until it has some answers from others. I could
    put it another way, perhaps more negatively: If we take the
    surcharge off today, what are you prepared to do? What are you
    prepared to do? (25)

Connally continued that the U.S. would not talk in terms only of a currency realignment. First, it wanted a productive discussion on defense burden sharing which could be done collectively or bilaterally. When ministers had suggested that it would take a great deal of time to deal appropriately with trade restrictions, his reply was "It's not that tough if governments are really prepared to settle." And if other delegations believed that the solution now rested with the U.S., it did not:

    We don't have a plan--we've acted. If people want to see the U.S.
    engage in self-flagellation, we've done that. For 25 years we have
    tried to "contribute something." We have already made the strongest
    political moves. We have taken unprecedented monetary, economic and
    political risks at home. We have humbled ourselves at home and
    abroad by saying we're broke ... we've done our penance.

With respect to gold, he said "you well know our policies. I have not been authorized by the President to alter our position one iota." As well, the surcharge was "less onerous than restrictions imposed by nations around this table on a continuing basis." Canada's finance minister, Edgar Benson, the chair of the meeting, was desperate to end it and was also put off by this demonstration of American "arrogance" and "ignorance." A compromise in the communique allowed him to adjourn with a minimum of delay. It had been a very trying day for international cooperation.

Benson had also had discussions with Connally earlier in the day. The secretary had claimed that "Other countries are using the U.S. as the whipping boy, and we are entitled to better treatment than that." (26) The minister demurred, suggesting that others were prepared to do a great deal to help; indeed, even the French were softening their stand on a change in the franc. He did not, however, know how quickly progress could be made on the trade front as others were not nearly as concerned about the surcharge as Canada, and the Japanese "did not even know what DISC is." Almost alone among the G-10, Canada, Benson pointed out, did not like the surcharge and the DISC was even worse. He was also concerned about the danger of nationalist reactions if progress on dismantling the American program was not made quickly; "barriers to trade and payments will build up and we will lose what we have gained in the past 30 years." The American wanted progress too, but not by giving up, noting that "The Common Agricultural Policy [was] an unconscionable evil [and] Japan does unbelievable things to keep our goods out." The Europeans greatly irritated Connally. The U.S. had asked them to make a gesture on "day to day agricultural decisions," but the E.E.C., taking the hard-line French position as its own, had declined. Indeed, the Community's reaction was strongly colored by "resentment and suspicion of U.S. intentions." Moreover, there seemed to be little reason to rush into any sort of negotiation as both the Community and Japan were adjusting relatively well to the surcharge, thereby diminishing, according to Kiyoaki Kimura, Tokyo's G-10 representative, "U.S. bargaining power." (27)

Benson also raised the issue of a possible U.S. countervail of the Canadian assistance program overseen by the Canadian Department of Regional Economic Expansion to help Canadian exporters through the crisis. It involved a subsidy of exports, at least from the U.S. point of view, and Canadian protestations that it was to maintain employment by helping firms increase their sales in the domestic market fell on deaf ears. Connally understood that "the assistance [was] only available to firms which export to the U.S. It seems to me that there is an export subsidy as long as they continue sending any of their production to the U.S." (28) He hoped that Washington would not take action. Connally's matter-of-fact response was "We probably will." That would leave the Canadians with few options. A possibility raised by Benson was a reduction of oil and gas exports to the United States. That also did not seem to make any impression on the secretary. Indeed, it almost seemed as if he relished a fight:

      We gave careful thought to the possibility that our action would
      lead to a trade war. We hope that it will not happen but we have
      to find a remedy for our own problem. You in Canada have, of
      course, special relationships with the United Kingdom; perhaps.
      we are going to have to think about new forms of relationship
      between Canada and the U.S.... in the trade and economic
      fields. (29)

The failure of the Trudeau government to obtain the surcharge exemption, however, and concern about the DISC program and the Buy American provisions of U.S. investment credits in face of rising unemployment in Canada, (7.1 percent by October, the highest rate in a decade), focused public attention on U.S.-Canada relations. As a Toronto Globe and Mail editorial noted: "We have lately learned, and are still learning, that Canada's economic and political dependence on the United States is not as easy, secure, or undemanding as Canadian complacency has tended to assume in the past." (30) It advocated the government investigate the development of closer ties with the rest of the world, and while the newspaper could not claim total credit, it was somewhat influential in terms of encouraging a change of policy in the months ahead.

Certainly the Liberals were keen on alternatives to the U.S., and the prime minister had suggested the possibility of a fundamental policy reassessment if Washington permanently raised barriers to Canadian manufacturers thereby relegating Canada to the role of a supplier of raw materials. Sharp confirmed in October 1971 that, as a prudent step in the face of uncertainty, he was encouraging public debate on this issue to prepare for "any necessary changes in direction." (31) Indeed, the whole issue brought out another perspective on Canadian economic development, one which would move to the forefront in the years immediately ahead. For the first time since 1945, at least in a serious and coordinated way, Ottawa began thinking of a commercial world in which the U.S. did not bulk so large. A briefing document prepared for Trudeau prior to his visit to Washington on December 6 laid out two possibilities: the first was "to move closer [to the U.S.] with an increasing economic relationship while the second was "to move further away and to decrease proportionately the percentage of its dependence on the United States economy." (32) This was, of course, the precursor to the government's economic diversification program, the Third Option policy, sketched out by Mitchell Sharp in the autumn of 1972.

For the present, however, officials from various departments continued their meetings with Americans on the immediate fall-out from the Nixon Shock. Most of these became constructive and friendly over the months. A group led by Reisman went for talks in Washington in late October, while others met in Paris with U.S. members of their OECD delegation. These Paris discussions were cordial, although the Canadians were very gloomy about Canada's prospects; the August 15 measures had caused considerable speculation on the country's ability to achieve its growth and employment targets in 1972. (33)

As well, there was a series of meetings started in Ottawa between U.S. and Canadian officials to discuss the implications and ramifications of the continental relationship after the events of August 15. The first was held in the office of A.E. Ritchie, undersecretary of state for external affairs, in early November, where the assistant secretary of state, Phillip Trezise, laid out a possible agenda that his side would like to address during future meetings:

     A. Autopact, where U.S. desires removal of residual safeguards;
     B. Canadian embargo on used cars;
     C. Canadian embargo on used aircraft;
     D. Duty free allowances for returning tourists;
     E. Defense production sharing;
     F. Michelin, and;
     G. "Artificial Stimulation" of business operations in Canada by
        U.S. firms. (34)

After talking around these issues in two sessions, the Ritichie-Trezise meetings lapsed in late November, the two leaders unable to get firm instructions from their political masters on how to proceed.

Finally, the Americans themselves had undertaken a comprehensive study of the U.S.-Canada relationship under the auspices of the Council on International Economic Policy. It was tasked with examining trade and investment issues involved in continental economic relations, and to make recommendations for U.S. policy. The embassy in Ottawa made suggestions of its own to help the research along. In terms of overall policy development, the objective was quite simple as the embassy pointed out: "The continuation of Canada as a national political entity not hostile to our interests." (35) There were a number of other "motherhood" resolutions as well, such as "the continuation of Canada as a Free World ally," the "continued responsible participation by Canada in world affairs generally," and "the continuation, in a form which at least meets our minimum requirements, of Canadian cooperation in continental defense." As well, Canada was important to the U.S. but what should the United States government use as a guide in its relations? Embassy officials laid out five indicators: it was strategically important; it was "an immense storehouse of natural resources for which our need will inevitably grow"; Canada was the United State's biggest customer; American private investment was greater than in all of Europe and more than one-third of total U.S. world investment outside the United States, and; "Canadians are not Americans and don't want to be."

The political log-jam that had become Canadian-American relations began to respond to treatment with a visit by Trudeau to the Nixon White House, although it would take Connally's retirement from public life in May 1972 before discussions became civil. Given the context, it came as a surprise that things went so well, with the president demonstrating an unexpected sensitivity and empathy for Canadian interests. Indeed, in the prime minister's briefing book, one of his primary tasks was "To dissipate any impression in the President's mind that the present Canadian government is anti-American or pro-Soviet (pro-Communist)." (36) The need even to mention that point demonstrated how far the relationship had deteriorated, and how anti-Canadian the White House might be. Instead, Nixon went on record as saying that "'as regards Canada, we don't want to gobble you up.' Quite the contrary: the United States did not intend to use its trade relations with Canada to accumulate a surplus with which to buy up what remained of the country." (37)

Despite some tough bargaining and tougher words, progress was also made on an altered exchange rate regime with the gathering of the G-10 at the Smithsonian Institution in Washington on December 17, 1971. Connally had convened the meeting to discuss exchange rates and what other G-10 members were prepared to do to help the U.S., primarily, he hoped, by revaluing their currencies. According to Louis Rasminsky, governor of the Bank of Canada and a member of the Canadian delegation, Connally ran the show like an auction, trying to push up the bids as he moved around the table. Rasminsky, a seasoned official, had never seen anything like it before. It also fell to him to make the main Canadian presentation as the finance minister, the nominal head, had been recalled to Ottawa on government business. He rejected the treasury secretary's demands; Canada had done pretty much all it could, and that had not been insubstantial.

Canada's currency had appreciated eight percent against the U.S. dollar since it floated in May 1970, which made its exports eight percent more expensive and imports from the U.S. eight percent cheaper. Moreover, this action was taken when it did not fit the needs of the Canadian economy then characterized by high unemployment. And while Canada's merchandise trade balance with the U.S. had improved remarkably, much of that was due to temporary factors, such as the steel strike in the United States. By later 1971, with the economic recovery of Canada, its imports were up and the current account surplus had been falling continuously since the fourth quarter of 1970. Now, if Canada responded favorably to the American demand that its currency appreciate a further five percent as Connally had demanded, it would create havoc in its international accounts. Rasminsky would have none of that: "There is nothing that the Canadian Government or its advisors can see in neither the domestic position nor international payments position to justify this proposal." (38) Indeed, the Canadians completely rejected the secretary's demand.

Some Americans had also begun to see Connally's interventions as counter-productive. As early as November 1971 the initiative to correct the American imbalance in international receipts and trade, to date supervised by Connally alone, was broadened to include Henry Kissinger, the president's assistant for national security affairs. His intervention in the conversations reflected Washington's turf wars--he felt that Connally was monopolizing the president's time and that his advice was not being heard. (39) As well, the secretary's failure to work more favorable deals with various parties and his harsh negotiating tactics with other countries probably marked him as a department head with limited time remaining. Indeed, with respect to the latter, even Americans began to complain. For example, Helmut Sonnenfeldt and Robert Hormats, NSC staffers with some responsibility for Canadian affairs, sent a memorandum to Kissinger entitled "A Tough Treasury Position on Canada--A Pointless Crisis," alerting him to the stark deterioration in Ottawa-Washington relations and urging him "to moderate Connally before an unnecessary foreign policy crisis with adverse domestic implications arises." (40) A few days later, Sonnenfeldt again wrote to Kissinger about the deadlock in negotiations between Canada and Treasury, placing the blame squarely on that department's secretary. He called it "a crashlanding now in prospect." (41) Similarly, Assistant Secretary of Commerce Harold Scott was scathing in communicating to Kissinger on April 25, 1972 his version of U.S. negotiations with Canada since August 15, 1971: For starters, "the U.S. never had an agreed-upon position or objective," looking for unilateral Canadian concessions. (42) Moreover, despite provocation, the Canadians were "conciliatory and courteous [with a] desire to be helpful without abandoning their traditionally tough negotiating stance and their awareness of their domestic political climate." As historian Robert Bothwell has pointed out, the secretary's antics were also spilling over into other areas; Connally's "trade theatrics were interfering with progress on disarmament, on detente, on China." (43) Almost of greater importance, Connally's program was now meeting with opposition from labor leaders and others who openly voiced criticism of the new economic policy, especially the attempt to control prices and wages. That was very worrying for an administration bent on re-election and facing a date with the people in November 1972.

The Canadians were also becoming less concerned over the effects of the Nixon Shock on their economy. Indeed, it seemed to have shrugged off the NEP's worst elements and was growing. The Bank of Canada's dry prose suggested just how well it was doing; "In real terms, the Gross National Product has been rising at an average rate of 6 percent a year since the third quarter of 1970--a rate in excess of the long-term growth path of the Canadian economy. This is a considerable achievement." (44) This allowed Ottawa the latitude to increase its efforts to diversify markets, to find new sources other than the U.S. for technology and capital, to add value to raw materials and generally to broaden and strengthen Canada's industrial base. Given the Nixon program, Minister of Industry Jean-Luc Pepin had told the Canadian Exporter's Association on October 18 that they "would have to try even harder at industrial and trade diversification in an attempt to decrease the degree of vulnerability of the economy." For the present, the skies cleared when the U.S. lifted the application of the import surcharge against Canada on December 21. It was quite a Christmas present. As the U.S. embassy noted, following that announcement, "the mood in business [in Canada was] buoyant." (45)

Still, with Connally in control at Treasury and continuing to have Canada in his sights, trade relations between the two could not be normal. While they now generally eschewed inflammatory rhetoric and were focused on discussing more mundane matters, like the tariff status of agricultural machinery and used aircraft or the duty on new aircraft, defense production sharing and the ubiquitous question of uranium, they remained uneasy. As well, the U.S. made continuing demands of Ottawa, as it had of the E.E.C. and Japan. It wanted its largest trading partners to take unilateral action by agreeing to a package deal with a view toward helping the U.S. correct its balance of payments deficit. Those negotiations began in early 1972 and were carried on for the better part of two months. The E.E.C and Japan settled quickly with the U.S., but Canada did not. Washington had some specific requests of its northern neighbor: increase tourist exemptions from CDN$25 to CDN$100; do away with the ten percent preference in favor of domestic suppliers for military equipment built under the Defence Production Sharing Agreement; and, abrogate the safeguards under the Autopact. These had been consistent demands made by the U.S., but with Connally again in full flight, they had taken on added importance. By February 1972, the relationship had deteriorated (once more) to the point where one of the most continentalist ministers in government, Mitchell Sharp, went to New York City to complain in a speech to the American Management Association about U.S. policy, suggesting that "narrow and self-destructive economic nationalism [was] not restricted to countries outside the United States, but [could] be found within the U.S. as well." (46)

Paul Volcker spoke for the administration in dismissing Sharp's and Canadian concerns. In a condescending speech at the Johns Hopkins University School of Advanced Studies, (which the governor of the Bank of Canada called "a very ill-tempered and tendentious piece"), he said that he was "confused and irritated ... when I see some reports from Canada that the whole program of ours launched on August 15 seems to be aimed at stealing jobs from Canada. This was not exactly in the forefront of our minds, I assure you. The idea of the United States stealing a few jobs from Canada hadn't quite occurred to me, but is seems to have added to the emotional tone of the argument." (47)

Indeed, the tone was emotional and it was caused largely by the American demands. It seemed so clear to Washington that Canada, running a substantial balance of payments surplus similar to those of the E.E.C and Japan, should be subject to the same scrutiny. And that, Volcker noted, did not sit well in Ottawa which thought there should be special treatment for Canada: "When we look at those arrangements, not only did we say to ourselves not only was there no excuse for a special position to Canada in this case, but hadn't the time come to repair some of the special provisions made in the past?" Volcker only held out the vision of "a more mature special relationship" which must not be so one-sided in favor of Canada.

What was Volcker thinking about? As noted above, his "repair" list included the Autopact, the defense production sharing agreement (which, he interpreted, "quite specifically [said] the United States will import all it can from Canada and Canada should not import much from the United States"), tourist allowances ("where in a period of Canadian difficulty they screwed down the tourist allowance pretty hard, and when they got into a strong position the screws have not been relaxed"), and Canadian access to U.S. capital markets.

These topics were formalized in a document distributed around the White House by Peter Flanigan. The problem was that the U.S. negotiations with Canada for the purpose of developing a package of trade measures similar to those arrived at with the E.E.C. and Japan by February 1972 had not been fruitful, in large part "because the Canadians had objected vigorously to the unilateral positions and pressure tactics of the United States, and behind this posture of objection Canada refused to participate in meaningful talks." (48) That obstinacy had greatly surprised Connally who had believed that the Canadians would eventually cave in. He was after a shift of some US$9 billion in the U.S. trade balance, of which Canada's share was US$1.7 billion, to be paid for via concessions on those very trade and payments policies which were under discussion and on which Ottawa had refused to yield. (49) Canada was perceived by some influential Americans to be an "obstinate loner that refused to play the game of 'restoring world order'" as well as a "free rider." (50) The problem, from the Canadian point of view, was the American insistence on some measure of reciprocity in any trade package. The word "package" came to be synonymous in Ottawa with a new and more difficult United States.

There was one major issue on which Canada refused to budge even despite American insistence: it would not scrap the Autopact provision that restricted the duty-free import by ordinary Canadians of U.S.-made cars. It did, however, agree to do away with the first two, the guarantee of a minimum Canadian production in both cars and auto parts and the limitation of duty-free import privileges into Canada to qualified manufacturers. The Canadian government also insisted that the major car companies in the U.S. be precluded from making use of DISC, which granted qualifying firms tax deferral privileges on the additional export earnings generated by expanded manufacturing operations within the United States. As well, it would not permit used car imports into Canada.

Obviously, under these circumstances agreement was impossible and Ottawa began an evaluation of where that would leave the country. Certainly the ramifications were very serious; as the Globe and Mail's Ross Munro wrote, "The breakdown of the talks between the United States and Canada may have set the stage for the worst period of relations between the two countries in a decade." (51) He reported a key U.S. official as saying that he thought they were "in a situation that borders on catastrophe ... These damn things [trade issues] have been discussed ad nauseum. There are going to be people on both sides who're going to say 'it's a waste of time.'" Connally himself believed that the negotiations were over as did Pepin.

In short, the Canadian government felt that it could not move much more than it already had. Both sides agreed that the issues were far more political than they were economic. Munro was surely correct when he noted that "The consensus is that the Liberal Government of Pierre Trudeau sees itself hemmed in by the forces of economic nationalism.... The Trudeau government feels that it will be attacked and badly hurt by the opposition parties for making any significant trade concessions to the United States." The Liberals had earlier been very shaken by the popular reaction to leaked documents containing possible negotiating positions on the Autopact, defense production sharing and tourist allowances. The nationwide response had been extremely critical led in large part by the new Ontario Premier, William Davis, who perhaps saw in his mind many of those automobile jobs in Windsor, St. Catharines, and Oshawa disappearing. The premier of Quebec, Robert Bourassa, had also voiced his intense displeasure. For his part, Connally told anyone who would listen that Canada had to knuckle under or else. The Liberals were seemingly caught between a rock and a hard place with the threat of American retaliation hanging like the sword of Damocles over their heads if the government did not bow to administration wishes. (52)

That was where matters lay as Richard Nixon traveled to Ottawa in May 1972 at the invitation of the Trudeau government to sign the Great Lakes Water Quality Agreement, and to lay out his vision of the new sort of North American relationship that had developed since August 1971. In an address to a joint session of Parliament, Nixon came directly to his point, suggesting that the two negotiate a new future:

    Canadians and Americans [must] move beyond the sentimental rhetoric
    of the past. It is time for us to recognize that we have very
    separate identities; that we have significant differences; and that
    nobody's interests are furthered when these realities are
    obscured.... Our policy toward Canada reflects [a] new approach we
    are taking in all of our foreign relations, an approach that has
    been called the Nixon Doctrine. That doctrine rests on the premise
    that mature partners must have autonomous independent policies; each
    nation must define the nature of its own interests; each nation
    must decide the requirements of its own security; each nation must
    determine the path of its own progress. (53)

That was true, and Canadians took Nixon at his word. Alone among the E.E.C and Japan, Canada stuck to its guns, and did not negotiate a new package deal, even following Connally's departure from the Treasury in May. It was also true that Nixon returned to Washington with a reinforced dislike of Ottawa, Trudeau, and most things Canadian. He told his chief of staff, H.R. Haldeman, that he had "to put it to these people for kicking the U.S. around after what we did for that lousy son of a bitch [Trudeau]. Wasting three days up there. That trip we needed like a hole in the head." (54)

In September, perhaps reflecting its new relationship with the U.S., Mitchell Sharp articulated a new vision, the Third Option, which had been percolating in the Canadian policy mix for some months, where the objective was to diversify Canada's foreign linkages abroad, away from the United States. It was almost as if key cabinet members had re-read Claude Julien's 1965 book, Canada: Europe's Last Chance. As he had then noted, "the key question for the European is ... will Canada allow itself to be colonized by the United States or will it strengthen its ties with Europe and help to balance the power of the United States?" (55) The Third Option suggested the latter route, although Canadians themselves seemed unsure. Polling data showed that when asked the best path for Canada, 42 percent chose the first option (the status quo), 18 the second (develop closer ties with the U.S.), and only 30 percent chose the third. (56) Still, the government was committed to its new policy.

The so-called special relationship between the two North American countries had been dealt a body blow by the Nixon Shock. It was not a knock-out punch, however, and it was revived in later years, between Jimmy Carter and Trudeau and again during the Ronald Reagan-Brian Mulroney years. It remained, however, that President Nixon's parliamentary address set a new tone for the relationship between Canada and the United States. Never again did Ottawa take Washington for granted, as it arguably did in the 1960s, while the U.S. did not tender the same favor to Canada that it had. Autopacts and defense production sharing agreements were now definitely things of the past.


1. Not much has been written about the NEP in a sustained and analytical way. Certainly all newspapers in Canada carried stories on its announcement in August 1971 and the hardships that would be visited upon the country if an exemption was not secured. However, their coverage quickly moved on to other events. Similarly, Canadian historians, with a few exceptions, have not dealt with the NEP as it affected Canada in the months after its implementation in much detail. Of more importance to them was Ottawa's reaction, which became the Third Option policy of September 1972, and what flowed from that. This article is an attempt to begin the process of sketching in the detail surrounding President Nixon's program as it affected Canada, and the Canadian response, the Third Option. For historians writing on this topic, see Robert Bothwell, "Canada-United States Relations," International Journal (Winter 2002-03); J.L. Granatstein and Robert Bothwell, Pirouette: Pierre Trudeau and Canadian Foreign Policy (Toronto: University of Toronto Press, 1990); J.L. Granatstein and Norman Hillmer, For Better or for Worse: Canada and the United States to the 1990s (Toronto: Copp Clark Pitman, 1991); John Herd Thompson and Stephen J. Randall, Canada and the United States: Ambivalent Allies (Montreal: McGill-Queen's University Press, 1994); forthcoming, Bruce Muirhead, Dancing Around the Elephant: Creating a Prosperous Canada in an Era of American Dominance, 1957-73 (Toronto: University of Toronto Press, 2005). This field has been better covered by political scientists, at least in terms of the analysis. See, for example, Peter C. Dobell, "Negotiating with the United States," in J.L. Granatstein, ed., Towards a New World: Readings in the History of Canadian Foreign Policy (Toronto: Copp Clark Pitman, 1992); Peter Dobell, "Reducing Vulnerability: the Third Option, 1970s," in Don Munton and John Kirton, eds., Canadian Foreign Policy: Selected Cases (Scarborough, Ont.: Prentice-Hall, 1992); Harald von Riekhoff, "The Third Option in Canadian Foreign Policy," in Brian W. Tomlin, ed., Canada's Foreign Policy: Analysis and Trends (Toronto: Methuen, 1978); Bruce Thordarson, Trudeau and Foreign Policy: A Study in Decision-Making (Toronto: Oxford University Press, 1972); Tom Keating, Canada and World Order: The Multilateralist Tradition in Canadian Foreign Policy (Toronto: McClelland and Stewart, 1993).

2. The IET, if fully applied to Canada, would have increased the cost of borrowing money in the United States by about one percent. Dependent upon foreign loans for economic development and to balance its international current account, Canada would have been badly off. Canada was also exempted from the 1965 Johnson guidelines relating to the patriation of profits to the U.S. of American firms operating overseas, as well as the 1968 program. Similarly, in the late 1950s, President Eisenhower gave the Canadian government what amounted to a veto over U.S. sales of wheat in some markets.

3. For an excellent discussion of the various points of the special relationship, see Stephen Clarkson, Uncle Sam and Us: Globalization, Neoconservatism and the Canadian State (Toronto: University of Toronto Press, 2002), pp. 22-5.

4. Bank of Canada Archives, Ottawa, Canada, Louis Rasminsky Papers, LR76-374-1, Prime Minister's Meeting with the President of the United States, 6 December 1971.

5. National Archives, Washington, D.C., Nixon CF, BE-Bus/Econ, (1971-1974), Peterson to the President, 12 July 1971.

6. The U.S. trade surplus with Canada had grown progressively smaller following the signing of the Autopact Agreement in early 1965. The table tells the story and must have been quite unsettling for some American policymakers.

U.S. Trade Surplus (Deficit) with Canada, 1964-72 (CDN$) ('000)

   Exports                Imports           Surplus/(Deficit)

1964 5,164,285           4,271,059               893,226
1965 6,044,831           4,840,456             1,204,375
1966 7,135,611           6,027,722             1,107,889
1967 8,016,341           7,088,490               927,851
1968 9,048,372           8,922,526               125,846
1969 10,312,638         10,215,400                97,238
1970 9,904,919          10,652,713              (747,794)
1971 10,950,727         12,024,761            (1,074,034)
1972 12,878,259         13,963,363            (1,085,104)

Source: Canada Year Book for 1972 (Ottawa: Statistics Canada, 1972), p.

7. Dobell, "Reducing Vulnerability," p. 237.

8. Globe and Mail, 16 August 1971, p. 2.

9. The following discussion comes largely from Nixon CF, BE--Bus/Econ, (1971-1974), Peterson to the President, 12 July 1971. John Kenneth Galbraith, Harvard professor, former U.S. ambassador to India, and erstwhile Canadian, had put the U.S. attitude to planning best when he noted that proposing such a plan in Washington would not get one invited to any parties in the capital. See James Laxer, Reckoning series, video.

10. John S. Odell, "The U.S. and the Emergence of Flexible Exchange Rates: An Analysis of Foreign Policy Change," International Organization 33 (1979): 67. See also Peyton Lyon, "Canada-United States Relations," in H. Edward English (ed.), Proceedings of the Academy of Political Science 32, no. 2, New York, 1976, p. 18.

11. Odell, p. 69.

12. See Theodore H. Cohn, Global Political Economy: Theory and Practice (Toronto: Longman, 2000), p. 149.

13. Rasminsky Papers, LR76-373-3, Washington D.C. to External, 15 August 1971.

14. Foreign Relations of the United States. Vol. III: Foreign Economic Policy; International Monetary Policy, 1969-1972 (Washington: USGPO, 2001), p. 454.

15. See Odell, p. 74. For a personal account of the process leading up to Camp David and its aftermath, see Robert Solomon, The International Monetary System, 1945-1976: An Insider's View (New York: Harper and Row, 1977), pp. 176-215. Connally had noted, in his defense of American interests, that "foreigners are out to screw us. Our job is to screw them first." Bothwell, "Canada-United States Relations," p. 76.

16. Rasminsky Papers, LR76-373-12, Treasury Secretary Connally on the Today show, NBC-TV. See also Dobell, p. 244. In more colloquial language, Dobell records that Connally told Canada's minister of industry, Jean-Luc Pepin that "he had decided to shake the world. And that, brother, includes you!"

17. Rasminsky Papers, LR76-373-14, Washington to External, 26 August 1971.

18. Globe and Mail, 16 August 1971, p. 2.

19. United States Information Service, John Connally, "Press Conference," 16 August 1971.

20. Rasminsky Papers, LR76-373-3, Washington to External, 16 August 1971.

21. Rasminsky Papers, LR76-373-3, Washington to External, 16 August 1971.

22. 94th Congress, 1st Session, Ninth Annual Report of the President to the Congress on the Operation of the Automotive Products Trade Act of 1965, Will E. Leonard, Chair, International Trade Commission to Russell Long, Chair, Senate Committee on Finance, 22 January 1976.

23. Rasminsky Papers, LR76-374-1, Prime Minister's Meeting with the President of the United States, "Trade Discussions," 2 December 1971.

24. Rasminsky Papers, LR76-374-1, Prime Minister's Meeting with the President of the United States, "Trade Discussions," 2 December 1971.

25. Rasminsky Papers, LR76-299-20, D.J. Orchard to Reisman, 20 September 1971. President Nixon said something similar; "We have too long acted as Uncle Sugar and now we've got to be Uncle Sam." Granatstein and Bothwell, Pirouette, p. 61. See also John Holmes, Life With Uncle: The Canadian-American Relationship (Toronto: University of Toronto Press, 1981), p. 59. "Americans [were] now more inclined to see themselves as victims of their own generosity to other countries and Canada as a rich hoarder of resources and industrial competition rather than a junior partner deserving particular consideration in the mutual interest."

26. Rasminsky Papers, LR76-299-19, "Notes of a Conversation between Mr. Benson and Secretary Connally," September 1971.

27. Rasminsky Papers, LR76-299-26, Geneva to Rome (Delegation to G-10), Pepin's Talks re: U.S. Surcharges, 27 November 1971.

28. Rasminsky Papers LR76-299-19, "Notes of a Conversation...."

29. Rasminsky Papers LR76-299-19, "Notes of a Conversation...."

30. Globe and Mail, 16 October 1971, p. 6.

31. Department of State Records, Box 730, file: E-1-CDN-U.S., 1/1/70, U.S. Embassy Ottawa to Secretary of State, 28 October 1971.

32. Rasminsky Papers, LR76-575, "Canada-U.S. Relations: Some General Perspectives," 30 November 1971.

33. Department of State Records, Box 726, file: E-2 CDN 1/1/70, U.S. Mission OECD to Secretary of State, 15 October 1971. The U.S. delegation, on the other hand, thought the Canadians too pessimistic and suggested that their "pall of doom" was wildly overstated.

34. Department of State Records, Box 730, file: E-1-CDN-U.S., American Embassy Ottawa to Secretary of State, 6 November 1971.

35. Department of State Records, Box 730, file: E-1-CDN-U.S., American Embassy Ottawa to Secretary of State, 24 December 1971.

36. Rasminsky Papers, LR76-374-2, Prime Ministers Meeting with the President of the United States, 6 December 1971.

37. Granatstein and Bothwell, p. 70.

38. Rasminsky Papers, LR76-299-35, G-10, Washington, 17 December 1971. For a full account of Rasminsky's role and the Canadian position at the Smithsonian talks, see Bruce Muirhead, Against the Odds: The Public Life and Times of Louis Rasminsky (Toronto: University of Toronto Press, 1999), pp. 289-293.

39. Odell 74-5. As Odell writes, "Until this time Kissinger had not participated at all in this issue. He admitted that he was not interested in economic matters, but he became concerned that this conflict could interfere with other diplomatic efforts. Kissinger and Nixon were arranging a series of summit meetings with key allied governments preparatory to Nixon's 1972 trips to Peking and Moscow, when Britain's Prime Minister Edward Heath refused to meet Nixon until the United States took steps to end the monetary crisis. One close observer has hypothesized that Kissinger suggested this tactic to the British in order to provide himself with the tool he needed for pulling Nixon away from Connally.... The effort succeeded ... by influencing the President, for whom military-political issues were most salient." See also "Foreign Economic Policy Lights Up," The Economist, 7 October 1972, p. 53 for an analysis of Kissinger and his new role.

40. Nixon, NSC, County File--Europe, Box 671, file: Canada Volume III, Sonnenfeldt and Hormats to Kissinger, 4 February 1972.

41. Nixon, NSC Files, Country File--Europe, Box 671, file: Canada Volume III, Sonnenfeldt to Kissinger, "Canadian Ambassador Anxious to See You," 7 February 1972.

42. Nixon, NSC Files, Country Files--Europe, Box 671, file: Canada Volume III, Robert Hormats to Kissinger, 25 April 1972.

43. Bothwell, p. 79.

44. Bank of Canada, Annual Report of the Governor to the Minister of Finance and Statement of Accounts for the Year 1971 (Ottawa: Bank of Canada, 1972), p. 5.

45. Department of State Records, Box 730, file: E-1-CDN-U.S., 1/1/70, American Embassy Ottawa to Department of State, 24 December 1971.

46. See R.B. Byers, "External Affairs and Defence," in John Saywell (ed.), Canadian Annual Review for 1971 (Toronto: University of Toronto Press, 1972), p. 259.

47. Rasminsky Papers, LR76-373-25-2, Paul A. Volcker, "Canada and the U.S.: The New Crunch," 16 February 1972. See also The Economist, 11 December 1971, p. 55.

48. Harald B. Malmgren, "The Evolving Trading System," in H. Edward English (ed.), Canada-United States Relations, Proceedings of the Academy of Political Science 32, no. 2, New York 1976, p. 125.

49. However, the Autopact proposals would not do much to help the U.S. As Kissinger told the president, "The U.S. companies say that removal of safeguards would have little economic effect and have asked that the U.S. government place a low priority on their removal. However, some influential members of Congress are highly critical of trade trends and price differences since the agreement has been in effect, and they assume the safeguards are responsible." Nixon, NSC Files, VIP Visits, Box 912, file: Canada--Trudeau, 12/6/71.

50. Globe and Mail, 4 February 1972, p. B-3.

51. Ross Munro, "Slump in U.S. Relations Likely," Globe and Mail, 11 February 1972, 1. also as #56, Alexandra Gill quote.

52. Part of this conundrum was represented by the Foreign Trade and Investment Act, commonly known as the Hartke-Burke Bill, which would impose quotas on most imports to the U.S.

53. Canada, House of Commons Debates 14 April 1972, p. 1327.

54. See Alexandra Gill, "Nixon's Bushy-Haired 'Bastard' Bites Back," Globe and Mail, 23 March 2002, p. 1.

55. Claude Julien, Canada: Europe's Last Chance trans. Penny Williams, (Toronto: Macmillan, 1968), p. 6.

56. J. Alex Murray and Lawrence Leduc, A Cross-Sectional Analysis of Canadian Public Attitudes Toward US Equity Investment in Canada, Working Paper No. 2/75, June 1975, p. 27. Almost 5,000 Canadians were polled. As has been documented elsewhere, the entire Third Option strategy failed miserably for a number of reasons, chief among them Canadian political challenges (the election of the sovereigntist Parti Quebecois in 1976 and continuing federal-provincial discord), waning prime ministerial attention, and a stark disinterest in exploring the possibilities of the European market demonstrated by Canadian business. It was declared officially dead in 1982 by the minister of international trade, Gerald Regan. Still, it did reflect the Canadian search for counterweights to the U.S. For an account of the rationale of the Third Option, see Byers (1974), pp. 221-4. For an account of its failure, see, for example, Granatstein and Bothwell, Pirouette, pp. 175-7, 379; Roy Rempel, Counterweights: The Failure of Canada's German and European Policy, 1955-1995 (Montreal: McGill-Queen's University Press, 1996), pp. 81-8; Thomas Axworthy, "A Singular Voice: The Foreign Policy of Pierre Elliot Trudeau," in C. David Crenna (ed.), Lifting the Shadow of War (Edmonton: Hurtig, 1987).

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