Memorandum of Agreement With the Brazilian Representatives42

Following instructions, we yesterday afternoon put before the Brazilian technical representatives the full substance of our thoughts in regard to exchange and financial relations between this country and Brazil. It was understood that this would be reported to the Finance Minister and to Ambassador Aranha, and that then today a preliminary effort to get agreement would be made at the conference between Mr. Welles and these officials.

The main aspects of the question that were discussed are three, as follows:

(1) The question of the minimum safeguards and guarantees in the matter of exchange and financial policy that were considered by this Government adequate as part of the commercial agreement negotiations which are now being concluded between the two Governments.

It was made clear that we regarded it as essential, no matter what general plan might be developed for the better handling of the Brazilian exchange situation, that we be given now, in connection with commercial treaty negotiation, safeguards in regard to the American interests concerned. It was explained that every effort had been made by us to state these safeguards in a minimum way so as to create the least possible difficulties for Brazil in her relations with other countries; and furthermore, in framing these requirements, we had thought to put them in a form which would in no way obstruct the development and application of a general plan aimed ultimately to bring Brazil’s exchange situation into balance.

The minimum requirements were defined by us as follows:

The inclusion in the trade agreement of the article already agreed on by both parties, guaranteeing unconditional most-favored-nation treatment in exchange matters to American commerce and nationals.
A reiteration by the Brazilian Government of its intention of maintaining—vis-à-vis American investors—the terms of the present Aranha debt plan.43
That in the light of the world situation and the possible effect of various bilateral agreements to which Brazil was or might become a party, whether willingly or otherwise, it was felt necessary to ask Brazil for a minimum allotment of exchange for the payment of goods imported from the United States. We suggested as a tentative form of minimum that the Brazilian Government should promise to furnish sufficient exchange to permit prompt payment for all imports from the United States, but that in order to safeguard Brazil against a conceivable expansion in that trade so great as to disturb its whole exchange situation, a maximum amount might be specified. This maximum we suggested might be defined as a percentage of the total goods imports into Brazil (after explaining that we did not wish to put forward a definitive figure at the moment, we mentioned, as an indicative figure, that of 30 percent—which was derived from the fact that the average proportion of American goods in the total of Brazilian imports during the nine previous years was 27 percent, and the three percent was added to permit some increase).

We then continued, that as part of the minimum requirement, some small additional allotment should be made to permit the gradual reduction in the present deferred indebtedness owing to Americans and again tentatively suggested that for this purpose the maximum specified might be elevated to, say, 33 percent.

It was explained that the condition that we sought was one whereby American current trade would be assured of full and prompt payment; whether this prompt payment came from the official market or from the free market we were not seeking to dictate; that would result from the system and terms of the exchange control which Brazil operated at any given time. For example, if the present exchange regulations were maintained in force, American trade should be guaranteed the prompt provision of the 60 percent of official exchange required under present regulations, which supplemented by the 40 percent procurable in the free market would permit prompt discharge of payment; if however the Brazilian Government shifted, let us say, to 50–50, as part of a general shift applicable to the trade of all countries, then the amount of official exchange to be provided American trade would vary correspondingly; or if Brazil should limit the control of the exchanges to amounts necessary only to meet funded debt and arrange that all payment for imports should be carried through the free market, the American trade would have to look to the free market for the necessary exchange.

These then in substance were our suggestions for defining the required minimum guarantees for current trade.

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In regard to the funds to be made available to American enterprises operating in Brazil (the amount of funds provided by the Brazilian exchange control in the past to such enterprises, both American and foreign, has been an item of very considerable importance in their balance of payments—estimated to have been £15,000,000 during 1934), a promise shall be given that the treatment they are to receive in exchange matters should be no less favorable than that accorded to enterprises of any third country in Brazil.
It was understood that in order that we might have current assurance that these minimum requirements were being carried out, and that in order that we could satisfy American interests that they were being given proper protection, a plan of information and report should be put into effect between the Federal Reserve Bank of New York as fiscal agent of the American Government and the Banco do Brazil, providing for a system of full report on all transactions between Brazil and the United States.

The above made up the main substance of our statement of American requirements. The thought was that these should be embodied in notes or other suitable forms and agreed upon as part of the commercial treaty negotiations. It appears to us that they can and should be proceeded with at once; discussions regarding the other matters treated below can be continued at the same time.

(2) Discussion with the Brazilian Technical Representatives of possible General Solutions of the Exchange Control Problem.

After setting forth our minimum requirements as outlined above, and making it clear that we would expect them to apply under any plan for exchange control which Brazil might adopt, we discussed informally with the Brazilian technical representatives some possible general solutions of the Brazilian exchange problem, and we received from them a promise that they would today submit to us two alternative types of solution. These two types are

A plan for lifting the control entirely and immediately;
A plan for relaxing the control by definite stages.

Under the first plan, Brazil would require the coffee exporters or their banks to turn over to the Banco do Brazil a percentage of their coffee bills (perhaps 20 percent) at a fixed rate of exchange, a percentage sufficient to cover the public debt service under the Aranha agreement of February 1934 and of the Congelado notes of 1933,44 and in addition to provide service and gradual payment of any new credit obtained to liquidate the deferred commercial indebtedness. All other exchange would be disposed of in the free market to which all exporters to Brazil would have free and equal access. Dr. Souza Dantas now appears to prefer this solution, but advances one objection to it, namely, that with the Brazilian balance of payments now displaying a net debit of about £8,000,000 which would be increased [Page 337] to £10,000,000 if provision were made for gradual liquidation of the deferred commercial indebtedness, an immediate and complete freeing of the exchange market would result in severe depreciation of the milreis, which would not only raise prices of Brazilian imports, which might have serious social and political repercussions in Brazil, but might also result in a pronounced fall in the price of coffee. To prevent such an occurrence, he therefore suggests that an approximate balance should be assured by the reduction of the private financial remittances. These in the past year have been unduly large (£15,000,000) and appear to be a principal reason for the present collapse of the exchange control system.

We reserve judgment on the feasibility of this solution, pending Souza Dantas’ more formal presentation today, but were inclined to agree that any form of solution must include a substantial reduction of private financial remittances.

Under the second general plan there was discussed the gradual freeing of the exchanges. Brazil might still, for example, use 60 percent of control exchange and 40 percent of free exchange and then alter these percentages by definite stages so as to have a completely free market within a definite period of time (say a year). This plan would be based on:

reduction of private financial remittances;
no further accumulation of deferred commercial indebtedness;
the gradual depreciation of the milreis.

Under this plan, the arbitrary reduction of private financial remittances would be a principal safeguard both against further accumulation of deferred commercial indebtedness and undue depreciation of the milreis. Some depreciation, however, would clearly be necessary in order to provide protection against undue expansion of imports, and it is probable that a gradual depreciation would also result in some export trade expansion. Under this plan the Brazilians could control the amount and the rapidity of depreciation of milreis by adjusting the amounts of exchange placed on the free market.

Discussion of these two types of solution was general and informal, but we made it unmistakably clear that Brazil would have to accept the entire responsibility for any plan she might adopt. It was also understood that the adoption of either plan assumed a credit to clear up the deferred commercial indebtedness, and in that connection it was pointed out that the lenders would doubtless insist upon a voice in the establishment and operation of any plan which Brazil might adopt, and might well insist upon having a financial adviser or supervisor on the ground in Brazil. We also made it clear that the [Page 338] failure of any such plan to work satisfactorily as indicated, for example, by further commercial debt accumulations, would leave us free to denounce the exchange clause of the agreement and take such unilateral action as was considered necessary to safeguard the American interest.

With respect to liquidation of the deferred commercial indebtedness, it was pointed out that the lender might prefer a plan for gradual liquidation over a period of, say two years, the payments to be conditioned upon satisfactory functioning of the Brazilian exchange administration, and adjusted to the development of the situation stage by stage.

III. It must be recognized and in our discussion yesterday we made it clear to the Brazilian representatives that it was recognized that the terms of agreement and general suggestions discussed under parts I and II of this memorandum would still leave American interests exposed to a certain amount of risk and uncertainty. We were inclined to accept these risks and uncertainties for the sake of minimizing Brazil’s difficulties of adjustment vis-à-vis third countries and also with the idea of upholding, as far as circumstances permitted, the liberal approach to this problem.

Risks lay in two possibilities:

That the set of main requirements were designed in somewhat general terms and their fulfillment rested completely upon the action of the Brazilian authorities; we had avoided anything in the nature of a clearing agreement which would create a safeguarded minimum of exchange for American interests. The most complete observation of the set of main requirements would be necessary to secure for American interests the reasonable minimum we have striven to define.
In the event that Brazil, either as part of a general plan such as discussed in sub-Section II or otherwise, proceeded towards the liberation of such control, the payment which American commerce would derive from the free exchange market would naturally be subject to the rate prevailing in the free exchange market. Brazil might proceed at the same time as its exchange market is being liberated to enter into special bilateral agreements with other countries whereunder, in return for Brazilian goods, imports from these other countries would be arranged. It was by no means impossible that the extension of such special bilateral agreements might work seriously to the disadvantage of American exporters to Brazil; they would naturally depend largely upon the extent of these special agreements and upon their nature.

Such a difficulty would be quite liable to arise out of the incompatibility of a policy of free exchanges and one of direct bilateral commodity interchange arranged by governments (an incompatibility with which we are faced in the whole development of our commercial agreements program). In the event that future agreements of this kind would produce this unfavorable situation for American [Page 339] commerce we stated that we would no doubt be moved to raise the question seriously with the Brazilian Government for the purpose of seeking an adjustment that would be equitable to American interests; this might or might not involve a modification of the minimum requirements defined under sub-Section I. As a last recourse, we pointed out that the protection of American interests would lie with our right to denounce the exchange clause of the commercial agreement in sixty days and take unilateral action for that purpose.

IV. We believe one aspect of Brazilian policy might well be commented upon separately—the possible questions created by an expansion of Brazil’s military program and purchases abroad for that purpose. This is brought to the front not only by rumors that during the past year Brazil’s purchases abroad for that purpose was substantial but also by the fact that there was apparently awaiting signature in Brazil now an agreement with Italy whereunder Italy would build battleships in return for Brazilian products, and this morning’s paper carries a story to the effect that a similar arrangement with the British is under discussion.

Such transactions have a multiple bearing upon the questions discussed in the preceding. In so far as Brazil undertakes to utilize such transactions as a method of expanding exports of commodities which it is seeking to develop, such as cotton, it raises a question of possible harmful competition with our own exports of such products. Moreover, in so far as Brazil does import such supplies and pays for them with exchange, such action would aggravate the exchange disequilibrium with harmful results for American commercial and other interests in Brazil. It is difficult, for example, to see how Brazil can effect any restriction of her total import trade such as may well be necessary, if the exchange market is to be free, so long as the Government itself insists upon making large foreign expenditures for military purposes. Such a course would result either in piling up further deferred commercial indebtedness or in so severe a depreciation of the milreis as would raise Brazil’s import prices unduly and perhaps result in social and political disturbances. Whatever the result, it seems clear that American interests would be adversely affected.

  1. Prepared by Messrs. Feis, Wilson, and Williams.
  2. See Foreign Relations, 1934, vol. iv, pp. 602 ff. For text of debt funding plan embodied in decree No. 23289, February 5, 1934, see Diario Oficial, February 7, 1934, p. 2689; a translation appears in Foreign Bondholders Protective Council, Inc., Annual Report, 1934 (New York, [1935]), p. 36.
  3. Foreign Relations, 1933, vol. v, pp. 5657.