841.51/5–947
Memorandum by the United States Treasury Representative in the United Kingdom (Blaser)1
The Problem of the Sterling Balances
origin and growth of the balances
Prior to the war sterling balances held in London by various foreign countries ranged between one-half and one billion pounds. These were kept largely as working balances due to the importance of London as a commercial and financial center and also as a monetary reserve for certain countries which operated a sterling exchange standard.
During and after the war these balances increased each year, though at various rates, to a peak of £3,480 million at the end of 1946. This large increase represents an important method by which the United Kingdom financed its participation in the war and its postwar deficit in its international balance of payments. The following types of transactions were important in building up the balances: United Kingdom military expenditures abroad; United Kingdom purchases abroad; and the proceeds of United States dollar expenditures abroad which were acquired by the dollar pool and paid for by the United Kingdom in sterling. The rapid increase in prices due to inflationary pressure generated by these activities in the countries concerned contributed substantially to the amount of the balances. No important exchange rate adjustments were made between sterling and the other currencies which would have offset these price increases.
relation of these balances to united states–united kingdom financial agreement
Section 10 of the Financial Agreement provides that after July 15, 1947, any sterling balances released or otherwise available for current payments will be freely available for current transactions in any currency area without restriction. This means that if any country is permitted to use any portion of its accumulated sterling holdings for payments (even in the sterling area) the entire portion so released may be spent in any currency area. The correspondence between Secretary Snyder and Chancellor Dalton with reference to this point in the United Kingdom–Argentine Agreement is well known.2
What Britain must do, therefore, is to come to some agreement with each of the holders of the balances as to what portion is to be considered [Page 10] available for current payments and what portion not so available. The British must then be prepared to furnish gold, dollars, or other foreign exchange for that portion which has been released for current payments.
british position on the sterling balances question
It has been suggested in many British quarters that the problem of the sterling balances might not exist at all, and certainly not in its present magnitude if lend-lease principles had been uniformly applied, and supplies furnished by each of the allies were regarded as a contribution to the common cause. Now that the war is over the British find around their neck this financial “mill stone” which was acquired as a result of their magnificent effort in resisting the forces of aggression throughout the world.
Since these obligations do now exist, in the British view the best solution would be the cancellation of a substantial portion of the balances and the funding of the remainder over a long period of time so that the yearly burden of repayment would be as small as possible.
The conditions and methods under which these balances were built up vary considerably from country to country. These differences among the countries include their financial contributions to the war in relation to their resources, the degree of inflation experienced, and certain technical differences in the way in which the balances are held, i.e., privately or on government account. Thus, the negotiated settlements will presumably vary somewhat from country to country.
The British feel strongly that in their present difficult economic position they cannot go very far in the direction of “unrequited exports.” This was forcefully pointed out by Chancellor Dalton in his budget speech. Current British exports must be devoted to the procurement of essential imports and not applied to any appreciable extent to the settlement of past debts.
Various schemes and rates of repayment have been suggested by way of a formula to work out this problem. It is not yet clear what will be the yearly total of the obligations which will be undertaken by the British in their efforts to settle these debts. This will depend upon the individual settlements which are reached country by country. Some general indication as to the possible magnitude of the problem and its impact on the British financial position is given by the following figures. A rate of release of 2 percent per annum on the total of reported balances of £3,480 million would represent a potential annual burden of £70 million in “unrequited exports” or a corresponding loss in foreign exchange. This is a little less than 5 percent of a total import program of £1,450. The prospective balance of payments deficit for [Page 11] 1947 has been variously estimated at £350 to £400 million. It should be less in succeeding years. Gold and dollar reserves amounted to £642 at the end of 1946. In addition, considerable foreign exchange will be still available after July 15, 1947, from the unused portions of the United States and Canadian lines of credit.
british progress in negotiating settlements of accumulated sterling balances
Settlements have already been reached with Portugal, Argentina, Iran, the Netherlands, Belgium, and Italy about the treatment of all sterling balances held by each of these countries. In addition, suitable arrangements have been made with the United States and Canada, although neither of these countries emerged from the war with a sterling balance problem of the type with which this review is concerned.
Preliminary negotiations have been completed or are under way with a number of other countries which hold important amounts of accumulated sterling balances. Such countries are India, Egypt, Iraq, Brazil, Uruguay, Sweden, Switzerland, and possibly others. Negotiations are contemplated prior to July 15, 1947, with all countries holding accumulated sterling balances with which suitable arrangements have not already been made. The prospect of successfully reaching agreement with all countries concerned in the time remaining is not bright.
position taken by holders of balances
Preliminary negotiations with India (balances about £1,250 million) and Egypt (balances about £450 million), the largest creditors, have not given promise of final agreement. The political situation in both these countries is such that any settlement with Britain will be most difficult. On the economic side these countries have maintained that these balances were built up by the sale of goods and services taken from people who have a very slender margin above the base subsistence level. Military expenditures disrupted the economy of each country. The balances represent honest debts, which upon repayment will be used to buy much needed capital equipment.
Negotiations with Brazil have been protracted and their outcome is still uncertain. The Brazilians are understood to be insisting on the right to spend a larger portion of the balances which they hold than the British feel they can afford to release.
Satisfactory arrangements have been reached with Argentina and Portugal both of which hold substantial amounts of sterling.
No difficulty is anticipated in reaching agreement with Australia and New Zealand. These countries have demonstrated their good-will [Page 12] by agreeing to cancel £20 million and £10 million, respectively, of the balances which they hold.
The settlement with Italy is interesting in that it is the first agreement by a country to hold a certain minimum balance below which it will not draw down its sterling. The Argentine accepted an agreement which provided for the release of £5 million per annum for four years, but this arrangement will probably be superseded by the repatriation of the railroad securities which will wipe out all the balances.
From this brief review it is evident that the position taken by holders of the balances varies widely. Some have accepted the British proposals and others have found them completely unacceptable.
the situation on july 15, 1947
As noted above suitable arrangements have been completed or are in prospect with many of the countries holding the balances. It is probable that agreement will not be reached with other countries before Section 10 of the Financial Agreement becomes operative on July 15. The British will then be required either to take unilateral action in these latter cases or to request a postponement of the effective date of Section 10. Both of these alternatives are extremely distasteful to the British and the choice is an unpleasant one. On the one hand, unilateral action, whatever it is called, will have to be tantamount to blocking some portion of the balances. The whole concept of “blocked sterling” is something which the British are very anxious to avoid so far as possible because of the harmful effect it will have upon sterling as an international means of payment. A currency which has tendency to get itself “blocked” is not a very useful medium of exchange or a safe repository for foreign exchange reserves. These are important considerations for many reasons, not the least of which is that any increase in sterling balances represents essentially a credit to Britain which contributes to its ability to finance its deficit in current payments. British officials in discussing this problem usually object to the use of the word “blocked” in reference to the balances. They point out that they may now be used freely anywhere in the sterling area. After July 15 this will no longer be possible except for whatever portion of the balances is freed for payments anywhere.
Presumably unilateral action by the British would take the form of a statement to each country not voluntarily consenting, that from July 15 a specified portion of its balance is at its free disposition, possibly over a four year period, and that the remainder cannot be used for any purpose (blocked). Considerable administrative and mechanical difficulties will arise for the British if this unilateral [Page 13] action is taken, particularly since they probably cannot expect to have the friendly cooperation of the exchange control authorities of the other country which is so vital to effective control. Otherwise there seems to be a very fine line to be drawn between the effect of such unilateral action and a similar state of affairs set up by mutual agreement.
Perhaps one further explanation of the British reluctance to admit the use of the expression “blocked” and to “block” by unilateral action is that this definitely suggests frozen and long term. On this basis a suitable investment for the funds would be long dated, high yield, United Kingdom Government or other securities rather than the one-half percent short dated Government issues which are deemed suitable for “liquid” reserves. It is a little difficult to see how funds which may not be used until after four years, and even then probably not in their entirety, can still be considered liquid and their investment restricted to one-half percent issues. The one-half percent interest provision was, of course, agreed to by Argentina in the original settlement of balances with that country.
The other alternative facing the British, namely postponement of the effective date of Section 10, would engender strong opposition in the United States where it would be widely construed as the first in a series of moves by the British to recoil from fulfilling commitments which they made in the Financial Agreement and which were accepted by the United States in good faith.
There is no clear indication at this time as to how this dilemma will be resolved. Unilateral action in difficult cases seems more probable than an appeal to the United States for postponement of the obligation accepted under Article 10.