Foreign Relations of the United States, Diplomatic Papers, 1944, China, Volume VI

893.51/7755

Memorandum of Conversation, Prepared in the Department of State

[Washington,] February 29, 1944.

Participants:	Mr. Bell, Under Secretary of the Treasury, Mr. Harry White and Mr. Irving Friedman of the Treasury Department
	Major General Lucius Clay and Colonel Eugene Foster of the War Department
	Messrs. Vincent, Hiss, Collado and McGuire of the Department of State

At the request of Mr. Bell, a meeting of the above-mentioned persons was held in Mr. Bell’s office this afternoon.

General Clay read a telegram from General Hearn in which it was stated that the Chinese Government had made further advances of Chinese currency to the United States Army over and above the initial advance of one billion yuan of which we had been informed on February 14. General Clay said that the United States Government had not yet credited any United States dollars to China’s account against these advances, and he felt that we should immediately deposit at least U. S. $25,000,000, the amount mentioned in the President’s last message to the Generalissimo as our contemplated monthly dollar expenditures for military operations in China. In making the advances of Chinese currency, Dr. Kung had agreed that the exact yuan-dollar ratio be determined through negotiations now in progress. General Clay suggested that continued Chinese advances were a hopeful indication that the Chinese were weakening in their stand on the official 20–1 exchange rate. He also pointed out that as the amount of the advances increased, the Chinese would be increasingly anxious to reach a settlement on the dollar-yuan ratio, and that General Hearn had had this in mind when he asked Dr. Kung to make the advances. In General Hearn’s message he stated that prospects had improved for a successful conclusion of negotiations, and that he hoped they would be concluded within thirty days.

State and Treasury representatives agreed that U. S. $25,000,000 should be deposited by the Army to Chinese account with the Chase National Bank immediately.

General Clay continued reading from General Hearn’s telegram. Dr. Kung had requested that the Army transport to India U. S. $20,000,000 in U. S. currency of large denominations. U. S. $5,000,000 of this would be shipped into China for use by the Central Government for an experiment in control of the black market rate for U. S. currency in China. The U. S. currency would be sold for yuan in the black market, exerting a downward pressure on the yuan-dollar rate, which has recently soared to 195–1 at certain points. It was hoped that reversal of this trend would have a favorable psychological effect upon commodity prices. Also, the Chinese Government could use the yuan obtained through dollar sales to meet part of our Army’s yuan demands, thus reducing the necessary amount of new note issue. This would have direct deflationary effects. General Hearn recommended this procedure, pointing out that any favorable commodity price repercussions would reduce Army expenditures. If the experiment with sale of U. S. $5,000,000 appeared to be successful, the U. S. $15,000,000 balance held in India could be made available promptly to the Chinese Government.

Mr. White said it was interesting to note that the Chinese were now willing to have U. S. currency introduced into China. They had opposed the Treasury’s plan for letting our Army obtain yuan by sale of U. S. currency and gold. Of course, under the present proposal, the profits from the yuan premium on U. S. currency would accrue to the Chinese Government rather than to the U. S. Army. We would give them dollars, which they would sell for 195 yuan per dollar, and they would then sell the yuan back to us at the official rate of 20 yuan per dollar, (or 30 yuan per dollar, under their most recent offer). This would not reduce our Army’s high dollar costs due to the artificial exchange rate, though it might check commodity price increases and thus be of some indirect benefit to our Army. Dr. White could see an additional practical advantage, through making possible the utilization of hoards of yuan already in China, thus reducing the amount of new yuan notes which would otherwise have to be flown into China, taking up valuable cargo space.

In further discussion it developed that General Hearn felt that acceding to this Chinese request would assist the American negotiators in pressing for a more reasonable exchange rate. It would be a friendly gesture, a “sweetening of the kitty.” A very small amount was involved in the experiment, and once the exchange rate negotiations were concluded, we could perhaps find some excuse for dropping the experiment, such as shortage of shipping space for U. S. currency.

Mr. White said that of course five, or even twenty-million dollars, was a small amount relative to the amounts at stake in the exchange controversy. If it would help our negotiations to get a substantial exchange rate concession, it should be done. However, if it was to develop into a continuing procedure, much thought would have to be given to it. There would be a flow of currency into occupied China, in exchange for hoards of fapi still held there by Japanese and puppet interests, thus increasing the fapi in circulation in Free China. To prevent enemy interests from using the U. S. currency, the notes might have to bear a “gold seal,” like the notes used by invasion troops in North Africa and Sicily. And a public scandal might develop in the United States if it became known that we were allowing the Chinese to use our currency to accumulate yuan which were later sold back to us at a tremendous dollar profit. Dr. White felt that we would eventually have to ask the Chinese to split the profits with us.

(Note: The possibilities of this in connection with the exchange-rate controversy are interesting. Suppose that U. S. $150,000,000 could be sold in the black market at an average rate of 100 yuan to a dollar, the yuan proceeds amounting to 15 billion yuan. We would give the Chinese Government the necessary U. S. 150,000,000, and they would give us one-half of the yuan proceeds. We would get seven and one-half billion yuan at a cost of U. S. $150,000,000, equivalent to a 50–1 rate. If our total needs were, say, thirty billion yuan, and we obtained the additional twenty-two and one-half billion through the official exchange facilities, at a rate of say 30–1—a dollar cost of U. S. $750,000,000—then our total yuan needs of thirty billion yuan would have cost us a total of U. S. $900,000,000 equivalent to an average exchange rate of 33–1. The advantages to the Chinese Government would be that fifteen billion of the thirty billion yuan supplied to our Army would have been obtained from yuan in circulation, i. e., the necessary new note issue would have been cut by fifty percent. Prices would rise somewhat less than if the whole thirty Million yuan had been a new note issue, and the net result for our Army might be about as favorable as an outright 40–1 exchange rate.)

After this discussion, State and Treasury representatives signified their approval of the Army’s plan to ship U. S. $20,000,000 in currency to India, for experimental use in China. However, Dr. White said he hoped the Army would find some excuse, such as lack of shipping space, to delay the actual shipment. The promise to ship might be a sufficient friendly gesture for the moment, and during the next thirty days many developments might take place which might make this particular operation unnecessary. Or, on the other hand, the idea might turn out to be an important key to a solution of the exchange-rate controversy, and the operation might be carried out on a much bigger scale.

General Clay was then asked whether the Joint Chiefs of Staff had reached a decision as to the necessary scale of United States military operations in China. The General said they had not. He said he felt that the high costs due to the artificial exchange rate were weighing heavily in their considerations, but that they hated to make a definite decision to curtail.

The General said that General Hearn was informing the Chinese of the vastly increased scale of operations involved in recent Army plans. Both the Embassy and the Department of State have expressed fear that the Chinese economy cannot support such operations without danger of drastic inflation and perhaps complete collapse. The War Department and Treasury experts have inclined to the view that since the chief Chinese contribution will be labor, of which they believe China has a surplus, these fears are not warranted. However, at this meeting, Mr. Vincent, Chief of the State Department’s Division of China Affairs, said that in his opinion it would be highly advisable to consider asking Chiang Kai-shek to use his soldiers and labor battalions on construction work on the American airports. Use of these standing troops, who must be fed and paid whether active or idle, would reduce the number of new laborers which must be diverted from agriculture and other pursuits by the offer of high wages by United States army contractors. High wages increase army expenditures, increase the total amount of currency in circulation, increase the purchasing power of the workers and hence their demand for consumers’ goods, while the supply of such goods is not increased, and, in fact, declines, if the workers were formerly employed in consumer goods production.

All present agreed that the inflationary impact of military construction projects could be greatly reduced if Chiang would give us the use of his soldiers and labor battalions. (We would reimburse Chiang for the cost of their upkeep according to Chinese pay and subsistence standards.) But General Clay said it was not customary to require Chinese soldiers to do manual labor, and he did not believe Chiang would ask them to. A complicating factor is that many of the soldiers not engaged in active fighting are under the direct command of war-lords over whom Chiang has only tenuous control.

At the conclusion of the meeting, Dr. White handed to General Clay a list of possible economic sanctions which might be applied against China if the Chinese Government failed to cooperate in attempting to arrive at a reasonable solution of the Army’s exchange difficulties. General Clay had asked Dr. White to prepare such a list. Dr. White promised to send a copy⁷⁴ to the Department.

74. Not found in Department files.