US SECURITY AND THE BRITISH DOLLAR PROBLEM

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP78-01617A003700070002-2
• Release Decision: RIFPUB
• Original Classification: C
• Document Page Count: 16
• Document Creation Date: December 27, 2016
• Document Release Date: May 22, 2013
• Sequence Number: 2
• Publication Date: August 31, 1949
• Content Type: REPORT

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COPT NO, 172
?
? US SECURITY AND THE BRITISH
DOLLAR PROBLEM
ORE 79-49
Published 31 August 1949
This er!,zument has been
approw:.1 'For release through
the HISTi;RICAL REVIEW PROGRAM of
the Central intelligence Agancy.
Date .24.Z10.1 942,
HZIP ?41
Document
NO cliA:77:
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CENTRAL INTELLIGENCE AGENCY
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Altpmpl.B5E
US SECURITY AND THE BRITISH DOLLAR PROBLEM
SUMMARY
Apart from greatly increased US aid there
is no practicable solution for the British dollar
problem during the next two or three years
that does not involve a further downward
adjustment in the British standard of living
and investment program. Deterioration in
the standard of living will lead to some social
and political instability, which will lessen the
weight of Britain in world affairs. Though
domestic political instability will not be of a
nature appreciably to increase Communist in-
fluence, considerable political pressure will be
put upon the government to reduce the na-
tional military burdens. Such developments,
occurring to the principal ally of the United
States, will be detrimental to US security.
Nevertheless, Britain will remain an ally, and
in matters of highest strategic policy its inter-
ests will continue to be identical with those
of the US.
During the period of economic and political
readjustment in? the UK (again assuming no
increase in the presently planned scale of US
aid) British policy will frequently diverge from
that of the US in matters of less than highest
concern. In particular, the British will not
move toward the restoration of non-discrimi-
natory trade and convertible currencies, but
instead will probably try to carry further the
development of an integrated, non-dollar trad-
ing area, which would include the Common-
wealth and Empire (save Canada) , much of
Western Europe, and a few other countries
having a recalcitrant dollar problem. Insofar
as such a system might serve to free the United
Kingdom from the instability growing from re-
current dollar "crises," it would be favorable
to US security interests. It would, however, be
prejudicial to US commercial interests be-
cause of its discriminatory trade practices.
Economic stringency would also lead to greater
divergence between the UK and US in inter-
preting such agreed policies as those on East-
West trade and satellite aviation, where dif-
ferences have already appeared.
Note: The intelligence organizations of the Departments of State, Army, Navy, and the
Air Force have concurred in this report. It is based on information available to CIA
as of 15 August 1949.
19.841414313Prern
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US SECURITY AND THE BRITISH DOLLAR PROBLEM
PART I
THE DOLLAR PROBLEM
1. Introduction.
Once again international affairs have been
disturbed by a sterling area financial crisis.
On 6 July the UK Chancellor of the Exchequer
announced that the British gold and dollar
reserves were running out so rapidly as to
cause alarm and call for immediate protective
measures. A few days later the first of these
measures was made known: a cut of 25 percent
in UK dollar imports for 1949-1950. At a
hastily summoned meeting of Commonwealth
Finance Ministers convened on 13 July, it was
agreed to recommend similar cuts by the Com-
monwealth countries of the sterling area. On
25 July the UK submitted to OEEC a revised
estimate of its dollar deficit for the year begin-
ning 1 July 1949; this came to $1,578 million,
almost double the original figure. Plainly
something had gone wrong with the British
program.
The recurrence of "crises," and the contrast
between the precarious state of the British in-
ternational financial position at present and
its massive solidity in the past, still have a
tendency to startle the general public. Such
astonishment perhaps arises from a deeply-in-
grained habit, common throughout the world,
of regarding Britain as impregnably rich and
secure. This habit was formed in the nine- '
teenth century, when Britain enjoyed undis-
puted industrial and commercial supremacy,
yet even by 1914 this dominating position had
been lost. Since then the expenditures of two
world wars have hastened a relative economic
decline which would have been inevitable in
any case. Without the wars, however, the
relative economic decline would presumably
not have involved any swift impairment of the
British international financial situation.
About a quarter of the total British national
wealth, roughly estimated as of 1938 at $120
billion, was used up in fighting the second
World War. The estimated total of losses from
physical destruction, through bombing and
other means was $5.8 billion on land and
$3 billion at sea; $3.5 billion represented
the amount of internal disinvestment?the
amount by which industrial and other enter-
prises were compelled to allow arrears of nor-
mal depreciation and obsolescence to accumu-
late. Some $4.5 billion of foreign investments
were disposed of and the proceeds spent in
prosecuting the war. Nearly $12 billion were
borrowed abroad. The United Kingdom thus
emerged from the war seriously weakened;
such enormous losses could not fail to be re-
flected in the general state of the economy and
in the international financial position of the
whole sterling area. Moreover, the entire
world economy was of course disrupted, trade
channels were disturbed, markets confused,
raw material sources temporarily dried up, and
in particular the industrial communities of
Western Europe were for the time being de-
pendent to an unprecedented degree upon im-
ports from North America. Difficulties in the
British position were inevitable. Strictly
speaking it is nevertheless true that the cur-
rent crisis is an acute manifestation of the
underlying fact that the people of the United
Kingdom are maintained at a higher (though
still "austere") standard of living, and their
government is spending more resources, than
the economy of the country can support under
present circumstances.
Within its own borders Great Britain pos-
sesses no important natural resources save
coal and some low-grade iron ore. The econ-
omy is dependent upon imports of food and
raw materials; these must be paid for by ex-
ports of manufactured goods, the earnings of
various financial services and foreign invest-
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4 CONF
ments, the shipping trade and the overseas oil
industry, and the sale of certain raw materials
such as rubber, tin, wool, jute, and cocoa
which are produced in the sterling area. For
nearly a hundred years, however, the United
Kingdom has generally imported goods to a
much greater value than that of goods ex-
ported; the trade deficit was made up, and
more than made up, by surpluses in the in-
visible account (i.e., by income from shipping,
overseas investments, banking and financial
services, etc.). After the war Britain was faced
with the necessity of paying for imports almost
wholly by exports, and of doing so despite the
grave losses and dislocations of war. It was
manifestly impossible to become solvent im-
mediately, and the United States made loans
and grants to prevent a catastrophic fall in
the standard of living and productive capacity,
with a resultant lowering of British power and
stability, while the transition was being made.
Canada and the other older Dominions also
granted very great financial assistance.
Apart from foreign assistance, two things
were most necessary for the recovery of Brit-
ain: the reorganization and rehabilitation of
the industrial plant and the domestic economy
generally, and the pushing of exports, accom-
panied by a limitation of imports, so that the
balance of payments on current account could
be restored as soon as possible without foreign
help. The British set to work with great per-
tinacity, and in most respects they achieved
remarkable success. By the first quarter of
1949 the task of domestic reconstruction could
be considered complete in the sense that the
productive capacity of the United Kingdom
had been restored; in fact industrial produc-
tion had reached a point nearly 30 percent
above the prewar level. The armed forces
were reduced close to probable peacetime lev-
els, and manpower returned to normal pur-
suits; an extensive program of housing was
carried out; full employment was achieved
and maintained; the inflationary potential
was successfully held in check, and a very
comprehensive and expensive system of social
services was not only kept in being but greatly
ENTIAL
extended. Meanwhile the volume of exports
from the United Kingdom increased until in
March 1949, it reached 162 percent of the
1938 figure, while imports were kept at about
80 percent of the prewar volume. At this
point much optimism was felt.
2. The Dollar Problem.
Successful as the UK export drive was, the
increases were principally in sales to coun-
tries and dependencies of the sterling area,
and to OEEC countries. The problem of pay-
ing for imports from the United States, Can-
ada, and other dollar areas was still unsolved,
for the surplus earned in trade with OEEC
countries could not under postwar conditions
be converted to dollars, while that earned
from the sterling area was, of course, in Brit-
ain's own currency. A large dollar deficit per-
sisted, and has come to constitute the core of
the whole British international financial prob-
lem.
In 1947 the UK bought 33.3 percent of its
imports from dollar countries; in 1948 this pro-
portion dropped to about 22 percent, which
was virtually the same as that of 1938 and
may therefore perhaps be considered "nor-
mal." But these imports were far from being
paid for by exports to the dollar area; in 1948
the United Kingdom alone had a deficit of
$1.2 billion in its dollar account. Further-
more, although exchange of goods and services
between the United Kingdom and the Western
Hemisphere results in the greatest single item
in the dollar deficit, it is by no means the only
source of disequilibrium. The rest of the ster-
ling area has its own dollar deficit, which to
the extent not covered by outside aid must
eventually be settled out of the reserves for
the area, which are held by the UK. Sub-
stantial payments are also made in dollars
to non-dollar countries?especially to Belgium
and Switzerland?in accordance with agree-
ments made with those countries. The follow-
ing table gives the net dollar deficit for the
whole sterling area, arising from all its various
transactions, and shows the manner in which
this deficit has been met since 1946.
CONVENTIAL
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CONIZENTIAL 5
Sterling Area Gold and Dollar Reserve
$ Million
Years
and
Quarters
Net
Deficit
FINANCED BY:
US and
Canadian
Credits
Purchases
from
IMF
South
African
Gold
Loan
ERP
Change
in
Reserves
Reserves
at end of
Period *
1946
904 1116
+212 2656
1947
4,096 3248
240
?608 2048
1948:
I
588 340
88
320
+160 2208
II
428 8
16
88
?316 1892
III
304
. ? .
160
?144 1748
IV
372
24
428
+80 1828
Total 1948
1692 348
128
320
676
?220 1828
1949:
328 28
32
324
+ 56 1884
II
628 28
340
?260 1624
* Including Canadian dollars.
This table shows why the British, upon con-
templating the figures for the last half of
1948 and the first quarter of 1949, were able
momentarily to hope that even their recalci-
trant dollar problem was on the way to solu-
tion. After such results as these, the adverse
turn occurring during the second quarter of
1949 came as a bitter disappointment.
It had long been foreseen that the rapid in-
crease in British exports to foreign markets
would not be easy to maintain when the era
of postwar spending, came to an end; when
other countries began to -fill their own domes-
tic demand and to compete with Britain in
the markets of the world. But the turn of the
tide came somewhat earlier than expected.
UK exports, after their record of 162 percent
in March 1949, fell in April to 140 percent of
the 1938 volume. The May figures showed
improvement to 151 percent of 1938, but with-
in that increase the all-important exports to
dollar countries further extended their decline,
while imports remained very high. The dollar
deficit of the sterling area, which during the
first quarter of 1949 had been $328 million
(excluding ERP assistance and other external
credits offsetting the loss), was $628 million
for the second quarter. Despite ERP assist-
ance and drawings on the Canadian loan, the
gold and dollar reserves fell to a figure nearly
$400 million under the $2 billion which had
been announced as the acceptable minimum.
Sir Stafford Cripps explained to the House
of Commons that this was far from constitut-
ing a "crisis" in the sense of August 1947;
perhaps even less did it compare with the situ-
ation when Lend-Lease was terminated in
1945. It is still too early to be entirely certain
whether the adverse developments during the
second quarter of 1949 represented a perma-
nent change of direction. Nevertheless the
situation was considered bad enough to call
for emergency cuts in dollar imports, and it
was treated by the press as a genuine crisis.
The reasons for its occurrence are not wholly
clear, and in particular it is not yet certain
which among them should be considered most
important. But it appears plain that among
the contributing factors were:
CONF ENTIAL
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6 CONVINTIAL
(a) A falling off in receipts from sales to
the United States, both of goods from the
United Kingdom, and of the raw products of
the sterling area. This falling-off was not
compensated for by reduced imports.
(b) Widespread rumors of a corning devalu-
ation of sterling, which caused many custom-
ers to refrain from placing new orders for
British goods and to postpone payment for
filled orders.
(c) The fact that Britain did not yet derive
substantial benefits from lower world prices
of food and raw materials, because these goods
were still largely coming in under long-term
bulk contracts, some of which had been nego-
tiated at a higher price than that prevailing
in the spring of 1949. The terms of trade thus
continued unfavorable to the United King-
dom.
(d) The occurrence during the second quar-
ter of unexpectedly large payments in dollars
to Belgium, Switzerland and Iran, and the
drawing by India of $45 million from the ster-
ling dollar pool.
(e) The drawing down of sterling balances
by US holders as a consequence of persistent
rumors of devaluation; this capital flight
amounted to at least $60 million in the second
quarter.
It is apparent that all these factors might
prove to be superficial and temporary. The
matter of sales to the US, however, was crucial,
for there was no possibility that a favorable
turn in the other factors could offset a con-
tinuing failure to earn more dollars by exports
of goods and services. And the prospect for
increased sales was poor; not only were the
effects of receding business in the United
States felt, but the British Government and
all responsible authorities agreed that the
price of British goods was too high, their cost
of production too great, to permit them to
compete favorably in hard-currency markets.
Whatever the conditions which had produced
a "crisis," it was plain that the dollar problem
was not on the way to permanent solution.
ERP aid, moreover, began in July to operate
on the 25 percent lower schedule of the new
fiscal year. Sir Stafford Cripps indicated in
the House of Commons that there must be
sought "a long-term remedy for the stubborn
problems of the balance of trade between the
Western Hemisphere and the rest of the world
of which the sterling area forms so important
a part."
CONVENTIAL
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PART II
PROBABLE DEVELOPMENTS AND SOLUTIONS
1. Short-term Measures.
The dollar deficits on current account will
be alleviated by the cut of 25 percent in im-
ports by the United Kingdom, the Common-
wealth, and the dependencies. Such cuts are
painful both to sterling area consumers and
to US exporters. They are furthermore un-
desirable because, by reducing the British
standard of living, they tend to depress the
morale of the working population; to the ex-
tent that they involve cuts in the import of
raw materials they may directly affect British
industrial production. As imposed at present,
therefore, they are stated to be temporary
emergency measures; as such they will be tol-
erable for a short time, probably without any
marked adverse effect upon production.
A remedy much talked of is devaluation of
the pound sterling, which indubitably is being
Maintained at a figure ($4.03) above its equi-
librium level. Rumors of devaluation have
already done much harm to British exports,
as mentioned above, and these rumors may yet
force the step actually to be taken; but it is
extremely unlikely that devaluation could, as
an emergency measure, quickly help the
United Kingdom in its most pressing need:
the earning of more dollars. Any possible in-
crease in exports to the dollar area, even if not
threatened by retaliatory tariff boosting,
would be insufficient substantially to offset
the reduced dollar price which the goods
would bring. Furthermore, devaluation would
increase the sterling cost of British imports
and this increase would be reflected in a
higher cost of living. If this could be ab-
sorbed without wage increases _leading to
higher costs of production, it would be help-
ful in a solution of the dollar problem. It ap-
pears extremely unlikely, however, that a suf-
ficient proportion of the higher costs of living
would be so absorbed; the pressure from wage-
earners for compensatory pay raises would
not be resisted. The British Government will
therefore postpone devaluation as long as pos-
sible; nevertheless, devaluation will probably
occur eventually as a part of a general Euro-
pean scheme.
2. Longer-term Measures.
Underlying all serious consideration of per-
manent solutions for the British problem is
one virtually inescapable proposition: that the
costs of production in the UK must be lowered,
and the effectiveness of British marketing
practices increased, until a sufficiency of Brit-
ish products can be offered in world markets
at prices low enough to find buyers, to earn
foreign exchange, and so to pay for the im-
ports required. With this general statement
probably no one disagrees, and the British
Labor Government has long been urging its
implications upon the citizenry. Nor is it
doubted that most British prices are now too
high. Concerning the implementation of a
program of reduction of costs and increased
sales abroad, especially in the long run, there
is much to be said that lies outside the scope
of this paper; for example, about the particu-
lar lines of products on which UK manufac-
turers might best concentrate their efforts for
export; the height of tariff walls over which
British traders may have to compete; the dif-
ficulties connected with Socialism; the modi-
fications in the British educational system
which might be required in order to furnish
an adequate supply of technicians, production
engineers, industrial designers, and the like.
These are questions of detail, or of long range.
It is unnecessary to investigate them all in or-
der to arrive at an estimate of whether an
increase of sales through lowering of costs
presents a reasonable hope of solving the Brit-
ish problem within the next two or three
years.
The dimensions of the dollar problem, it
must be remembered, are truly formidable. If
the British standard of living is to be main-
CON/F ENTIAL 7
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8 CONTANTIAL
tamed at approximately its present level, and
the government is to keep up its current com-
mitments, the rate of purchases from dollar
areas must continue to be large; there is no
possibility of quickly doing without or buying
elsewhere or developing within the sterling or
soft-currency areas new sources of the food-
stuffs, tobacco, raw materials, and machinery
which now come from the United States,
Canada, and other dollar countries. But in
1948, an extremely good year for British ex-
ports, there was a dollar deficit of $1.7 billion,
before outside aid. If other factors were
favorable, the size of this deficit might be ex-
pected to taper off in coming years, but its
immediate tendency is to increase rather than
to diminish. Thus the sum to be found will
be something of the order of $1.7 billion per
year, and it is plain that there is no practical
possibility of reducing British costs and selling
enough goods abroad during the next two or
three years to meet such a deficit. Unless the
United States lends or grants, or otherwise
makes available large additional amounts of
dollars, therefore, the British standard of liv-
ing is destined to undergo a further downward
adjustment, and that fairly soon. The impli-
cations of this for US security are discussed in
Section III.
The only way of reducing costs of produc-
tion without reducing the standards of living
is to increase productive efficiency mainly
through investment in new machinery, but
also by the improvement of managerial and
labor techniques. Increase of productive effi-
ciency is certainly a desirable procedure,
permitting as it does a maintenance and
eventually an improvement in the standard of
living. It is a stated goal of the British Gov-
ernment, which has planned to devote 20 per-
cent of the annual gross product to capital
investment. If all goes well, it will perhaps
solve the problem in years to come, but it will
not do so soon because progress is far too slow.
There is another difficulty. Even if the
British, by some miracle, should raise to a suf-
ficient degree their efficiency and productivity,
the extent to which they would benefit from
it would depend upon the extent to which
other nations refrained from measures to
"protect" themselves against British "compe-
CON
tition." It would also depend upon a reason-
able degree of prosperity in the world. A
characteristic of the British economy is that
its successful functioning rests as much on
the economic condition of and the policies fol-
lowed in the rest of the world as it does upon
the domestic efforts of the British themselves.
A depression in the United States, a political
disturbance in some raw-material-producing
area, but most particularly the raising of tar-
iffs or the adoption of other restrictive trade
practices by the UK's important foreign cus-
tomers, all have immediate and detrimental
effects on the British economy. It will never
be sufficient that the British should work
harder and produce more; there must also be
favorable world conditions for their trade.
Like an increase of productivity and of sales
abroad, the gradual restoration of non-dis-
criminatory trade and convertibility of cur-
rencies is widely advocated as a most impor-
tant and desirable goal of public policy. It is
frequently reiterated by British Government
spokesmen, and is in accord with the present
policies and interests of the United States.
Nevertheless, it is entirely dependent upon the
successful development of low-cost production
in Britain, and is therefore out of the question
during the next few years for the reasons al-
ready noted. It may be expected that the
British will continue to resist all urgings to-
wards an early abandonment of discrimina-
tory trade practices; the most that can be ex-
pected is an occasional minor relaxation when
such will not imperil the gold and dollar re-
serves.
It is far more probable under the circum-
stances that Britain will attempt to protect
itself by the deliberate furtherance of dis-
criminatory practices. Certain authorities,
more particularly of the British Conservative
Party, are already arguing that since a return
to multilateral trade depends almost entirely
upon long-continued, large-scale buying and
lending by the United States, it would be pru-
dent to seek an alternative less dependent
upon the sentiments of the US Congress.
They therefore recommend the expansion of
an integrated, non-dollar trading area, within
which "multilateral" trade would flourish, but
which would perforce be discriminatory
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CONF,ENTIAL
against the dollar area. Such a system might
include much of Western Europe and all the
Commonwealth and Empire save Canada, to-
gether with such nations of the Middle East
or Latin America (for example, Argentina) as
have a serious dollar problem. To none of
the members would this association seem
ideal; all would be virtually forced into it by
their shortage of dollars and by the success of
sterling as a second-best international cur-
rency. Yet complete escape from it would be
impossible as long as the dollar resources of
these countries remained inadequate to bal-
ance their accounts.
The maintenance of such an exclusive non-
dollar trading area would be out of accord
with the principles of free trade which served
Britain so well in the nineteenth century,
with the terms of the US Loan Agreement,
and with the expressed policy of the Labor
Government. Nevertheless, it would fit the
predilection of many British businessmen for
exclusive cartels and well-protected high-cost
trade associations. It would please die-hard
champions of Empire, such as Lord Beaver-
brook. It would, furthermore, offer certain
positive attractions, both economically and
politically. To the extent that American
products were removed from competition in
the trading area, and that dollars remained
short, British products would occupy a favor-
9
able position, and sterling would be the prin-
cipal currency for international transactions.
The United Kingdom would thus become the
head of a very respectable agglomeration of
economic and political power; an economic
"Third Force." It must not be forgotten that
the United Kingdom still is the world's best
market for foreign goods; as such, it is never
wholly without bargaining power.
It is of course virtually unthinkable that a
trading area wholly insulated from US goods
would ever be established; certainly it would
be very undesirable. The UK and its part-
ners will continue to buy as much as they can
from the United States, but it will not be pos-
sible for the UK either to buy all it may desire,
or to support US policies of multilateral trade
and currency convertibility, without extensive,
long-term loans or grants or investments of
dollars, and a generous US import policy.
The British are wholly familiar, from their
own experience, with the manner in which
foreign trade policy must be conducted by the
most powerful and wealthy nation in the
world, and the greatest creditor. They will
not sacrifice their chances of dominating a
"Third Force" in the world economy in order
to pursue a premature attempt at multi-
lateralism, in the course of which the last of
their gold and dollar reserves would probably
vanish.
CONF/ENTIAL
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CONF
ENTIAL
PART III
IMPLICATIONS FOR US SECURITY
Everywhere in the world outside the West-
ern Hemisphere and Northeast Asia British
power is an essential component in the pres-
ent structure of US security. It is accepted
that with respect to the gravest matters of in-
ternational relations the interests of the two
nations are identical, despite all differences in
political techniques and attitudes, and in eco-
nomic and social outlook. In consequence the
United States has counted on the British,
sometimes pursuant to formal agreement but
more generally by implication, to assume pri-
mary responsibility for the management of
affairs in accordance with the common inter-
est in several highly important areas of the
world, notably the Middle East, South and
Southeast Asia, and most of Africa. It is also
clear that Britain is by far the most weighty
member of those associations?the Brussels
Pact, the OEEC, the Council of Europe?upon
which the United States must place greatest
dependence for the furtherance of its security
interests in Europe. Likewise the British
Commonwealth and Empire is the only world-
wide association both strong enough and
friendly enough to constitute a reliable source.
of support and security to the United States.
In short, Britain is the only powerful ally the
US possesses.
It is not necessary to prove that the power
and influence of the United Kingdom depend
in great part upon its commercial, industrial,
and financial health; this is taken as axio-
matic. It is therefore plain that from the
point of view of US security British economic
vigor is favorable and weakness unfavorable.
This has in fact been demonstrated: already
the United States has had to take over com-
mitments in Greece and Turkey, and a share
of naval responsibility in the Mediterranean,
because the United Kingdom could not afford
to maintain these functions. Such an in-
crease of US burdens could well go further;
even before the current crisis the British were
complaining that their responsibilities in
Libya were too costly. Ever since Yalta, in
fact ever since August 1914, the free world
has been distressed and the United States fre-
quently embarrassed or endangered as a conse-
quence of overestimating British material
capabilities. Britain is now strained as
nearly to capacity as any great democratic
nation has ever been in peacetime. Little
increase of economic stringency can be borne
without reflection in a decline of national
power. Since increased economic stringency
will shortly be felt (assuming no considerable
increase in direct US aid), a decline in na-
tional power must follow, and the security of
the United States will thereby be unfavorably
affected.
An immediate adverse effect on US security
would be felt if the British should decide sub-
stantially to reduce their foreign military and
political commitments and to cut expendi-
tures for their armed forces. Strong voices
from the left wing of the Labor Party have
long urged such measures; Communists and
fellow-travelers have demanded them. When
the need for "economy" and increased auster-
ity becomes acute, there will be a great temp-
tation for the government to make savings
in this way instead of by cutting the food
subsidies, or the social services, or other popu-
lar expenditures of the national budget.
The slashing of military expenditures, how-
ever, would have little directly remedial effect
on the dollar shortage, because the mainte-
nance of the military establishment depends
much more on sterling than on dollars. It is
undeniable that if the men and materials de-
voted to the armed forces were available for
other employment some strengthening of the
economic situation would result; there would
be more labor and more raw materials for the
export trade, for instance. Yet the loss in
British power and prestige if the armed forces
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12 CONF
are reduced, would be great, and these will be-
come important elements in any campaign for
independence from dollar "domination."
Therefore it is unlikely that the Forces will
be very much cut, or foreign commitments
very substantially reduced, in the near future.
It is virtually certain, however, that there will
be sharp debate within the Labor Party on
this question, and that some reductions will
be made.
The real weakening of the British position
will come about rather more subtly than by
open reduction of overseas commitments.
Any really effective measures taken to stabi-
lize the British international financial position
(except for renewed and increased US subsi-
dies), will bring about a lowering of the Brit-
ish standard of living. The reduction will not
necessarily be catastrophic, but it will come
soon, and will inevitably impair the stability
and power of the United Kingdom, for a time.
The middle and upper classes, which have al-
ready suffered greatly from war and postwar
austerities, will have to put up with new de-
privations. The great masses of the popula-
tion will lose some part of the considerable
gains which they have made since prewar
days. For this they will hold the government
accountable. Though all modern states have
accepted a degree of responsibility for the pub-
lic welfare which would have been inconceiv-
able a generation ago, no government in the
western world has to such a degree as the
British made itself the custodian of the gen-
eral social and economic well-being. Hence
the government cannot disclaim responsibil-
ity for a cut in the standard of living. It will
not be taken by the populace as a part of the
order of nature, which the government does
not control. It will cause resentment, and
this will lead to political instability.
There is no reason to suppose that political
instability in Britain will go to the point of
revolt or domestic violence, or even that it
will be sufficient to permit an appreciable in-
crease in Communist influence. It will take
other forms: the supporters of the Labor Gov-
ernment will lose their enthusiasm; perhaps
Labor will be replaced by a Conservative ad-
ministration which will have to cope with the
antagonism as well as the disappointments of
ENTIAL
the working classes. What is even more
likely is that at the coming election neither
party will gain a sufficiently solid parliamen-
tary majority to be able to govern with confi-
dence and decision. This sort of political in-
stability bears in the present situation a very
important relationship to the maintenance of
British power abroad. For the British posi-
tion at a dozen critical points is upheld not
by the immediate weight of British resources
in men and money, or even by the general
knowledge that those resources would be ul-
timately brought into play by an overtly hos-
tile act, but by the decisiveness and sureness
of touch of British administrators and diplo-
mats in dealing with individual challenges as
they arise. To do this successfully the re-
sponsible British official must be under no
doubt whatsoever as to whether or not his
government will back him up.
With respect to trade policies, it must be
expected that if the British should attempt an
early restoration of non-discriminatory trade
and convertibility of currencies between
pound and dollar they will be subject to re-
current "crises" such as the present one, and
they will require frequent emergency bolster-
ing with dollars. They will be extremely
sensitive to US economic policies and to the
general condition of world trade. Under such
circumstances Britain would presumably re-
main a faithful but frequently disgruntled
ally.
If on the other hand the British resort to
increasingly discriminatory trade practices in
order to expand a non-dollar trading area, the
consequences will assuredly be damaging to
US commercial interests and trade policies,
but not otherwise prejudicial to US security.
In matters of the highest political import
Britain would remain a dependable ally, and
the prospect of dominating an economic
"Third Force" and becoming independent of
dollar aid might strengthen British morale,
impaired as it would be by a reduced living
standard. In matters of less than highest
import, however, it would happen that as eco-
nomic policies diverged there would be a ten-
dency for other policies to do likewise. For
example, the temptation for the British to
promote extensive trade with the USSR and
CONFI / ENTIAL
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444001444-14NE414-24'""'
the satellites would certainly be greater, and
security grounds would not always be suf-
ficient to stop sales of marginal commodities
or to restrict the operations of Eastern Euro-
pean civil aviation. The very establishment
of discriminatory trade regulations would cer-
tainly be attended with some acrimony be-
tween Britain and the US. The intimacy of
the connection between the two countries
13
would doubtless diminish. The UK, less de-
pendent economically on the US, would be
somewhat less cooperative; but the UK would
remain at least as dependent as at present for
strategic support, its military assumptions
would not change and it would therefore
stand firmly with the US on fundamental west-
east issues.
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Document No.
NO CHANGE _,
71(k DRCLASSIa
Fl
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U. S. GOVERNMENT PRINTING OFFICE
4119-STATE-1949
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