841.5151/6–2249: Telegram

The Ambassador in the United Kingdom ( Douglas ) to the Secretary of State

top secret

2406. For the Secretary eyes only from Douglas. Please give this message no circulation except as indicated by the Secretary after he has seen it.

This supplements Embtel 2326 and contains further views on rapidly developing British dollar crisis.

1.
Gold and dollar expenditure, which will reach an annual rate of $3 billion during June, may not continue indefinitely at so high a level. In a few months the outgo reflecting a current tendency to assume short positions in sterling should be checked by the necessity to cover such positions. Also, the initial impact of reduced purchasing (due to cutbacks of inventory levels in the US) will give way to more normal buying for current needs, although at a lower level than in 1948. However, the prospects are sufficiently serious to call for urgent remedial action and for immediate consultation with the British. A rate of expenditure of even $2 billion a year would be intolerable in view of the scale of dollar assistance anticipated in the coming fiscal year, and the low level at which reserves will stand when that year commences on July 1. Four methods occur to us among other possibilities for attacking the fundamental inbalance reflected by the recently revealed figures.
2.
The first method is a drastic reduction of costs by direct means. This does not appear feasible in view of the considerable political manoeuvering which would be required before a really effective policy of this nature could be implemented. This would require so much time, and so much additional time before it could have results, that it could not in any case provide a sufficiently speedy solution to a problem as imminent as that which faces us.
3.
A second method would create a protected autarchic trading area, centered on London and using sterling as its basic currency. We fully appreciate what this would entail in damage to the US economy, in frustration of our political and strategic objectives in Europe and in effects on Canada. The British are not unaware of these considerations, but we anticipate that, in its efforts to deal with the imminent crisis, the UK will take many steps which would be consistent with the ultimate creation of such an area, especially if continued for a considerable time. We anticipate, for example, a plan for drastic reduction of imports from the dollar area. We are convinced, however, that the creation of an autarchy does not provide either a long-run or [Page 788] a short-run solution to the British problem. The dollar economy is so important in the economic life of the western world that it would be impossible to isolate a sterling hegemony completely. Furthermore, attempts to create such a bloc would cut across so many opposing national interests on the continent and even in the sterling area that it would be impossible to hold the group together. In any event, the creation of such an isolated sphere would take too long to provide a sufficiently prompt answer to the present problem.
4.
A third alternative would be to convince the public that the present value of sterling can and will be maintained. We foresee psychological obstacles to restoring such confidence in sterling when the facts of the present situation are revealed to the public. Even though the position may improve later, the shock to public opinion of the necessary revelation, now scheduled for July 5, will be severe. Already a crescendo of public speculation concerning an imminent dollar crisis is becoming apparent. This may, however, be a part of the solution if accompanied by other measures to restore confidence such as initial steps toward reduction UK costs and US stockpile purchases of tin, rubber, wool, etc. if money has been appropriated and this is otherwise practicable.
5.
The fourth and last alternative is devaluation of the pound, and this in our view could be effective only if accompanied by strong measures for internal economic reform and suppression of inflationary effects. We must be prepared for the economic consequences to the US of a substantial devaluation and they might be formidable. We also should not overlook the possibility that Cripps is manoeuvering toward nothing more than a 10 percent devaluation, attributing it to the US pressures for devaluation action. In our view one of the curious effects of devaluation of sterling would be to aggravate inflation in the non-dollar area and to aggravate deflation in the dollar area.
6.
The foregoing considerations lead us to be considerably concerned over the immediate future of Anglo-American relations. It has been made obvious in our conversations with Cripps that the government intends to defend the position initially by sharp curtailment of imports from the dollar area. Cripps is ostensibly strongly opposed to any proposal for a devaluation of the pound, and up to now seems prepared to stake his political position within the Cabinet and before the public on a refusal to change the present rate. We anticipate that the executive branch of the US Government will interpret the situation as requiring an immediate devaluation of sterling. At the same time British actions to cut dollar expenditures will in all probability include measures which are admittedly discriminatory, or which could be interpreted as building up an autarchy, and they would be regarded as retrograde in terms of American commercial policy. Consequently, [Page 789] we foresee the possibility of a situation in which the UK blames adverse developments on the US recession and the US blames the UK for socialist mismanagement of its affairs. Acrimonious dialectical debate over causes might make it difficult to deal with brute facts of situation and arrive at reasonable remedy.
7.
We are vitally concerned that such an acrimonious and disruptive situation be avoided. To this end we stress that what we are facing is more than a British dollar crisis—it is an Anglo-American problem, with Canada caught in the spider web, the implications of which go far beyond the question of the exchange rate of sterling and the immediate state of the British dollar reserves. The failure of our two governments to cooperate closely in the immediate future, in full appreciation that a problem of mutual concern is before us, might very well prejudice the Marshall program, the many aspects of our foreign economic and political policy which depend upon its success, and might give comfort and support to Communist and Soviet designs.
8.
We are not able to come forward with any proposal for solving the immediate problem. We strongly urge, however, that every endeavor be made to create a mechanism through which representatives of the two governments can, at the earliest possible moment (if possible before July 5 when figures will be made public), talk secretly, bluntly and frankly, in an endeavor to reach an agreed program of action. We have no firm basis for judgment as to whether discussions should take place in Washington or in London. But we feel strongly that such conversations should be initiated immediately and be conducted on a basis which recognizes how greatly our mutual interests are endangered. We suggest that Canada sit in, first because unless we are able to prevent the development of an unfortunate UK policy Canada will be compelled to decide whether to go with the UK or with the US—a question which, however resolved, would have adverse effects everywhere—and second because Canada by sitting in would find it easier to attend the meeting of Commonwealth finance ministers called for July 11 and there to play more effectively the part of amicus curiae.
9.
We mention the date of July 5 because it is then that it will be necessary to publish data revealing the adverse movements of the last three months. We mention July 11 as the date indicated to us by Cripps of meeting of Commonwealth finance ministers in London. The significance of these dates is obvious in terms of the development of a possible crisis and the initial arrangements for dealing with it.
10.
Robertson1 has been here on a secret emergency visit for two days, representing St. Laurent,2 but does not wish his presence in [Page 790] London to be known. He confirms the views expressed herein regarding Canada and confirms the general seriousness of the situation as we view it.
11.
Meanwhile, in order to keep you fully informed, we will soon forward a supplementary cable giving you the benefit of whatever observations we feel able to make on the courses of action, and the political developments in the UK, which are likely to follow from public realization of the gravity of the situation.
Douglas
  1. Norman A. Robertson, Clerk of Privy Council and Secretary to the Canadian Cabinet; former High Commissioner for Canada in the United Kingdom.
  2. Louis Stephen St. Laurent, Prime Minister of Canada.