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-0 E C 'R 'fi'TTHE SEC R ET A R Y OF TH E T R EA SU R Y W A S H IN G T O N November 1 2 , /•" // 1967 M O A D M FOR THE PRESIDENT EM R N U SUBJECT: C.F. f' t' _£ r&//o S t e r lin g C r is is B r it is h C hancellor o f th e Exchequer Callaghan se n t one o f h is p r in c ip a l a id e s , S ir D en is^ R ick ett, along w ith a to p o f f i c i a l o f the^Bank o f England, t o see me y e ster d a y on s t e r lin g . The m essage was th a t th ey were a t th e end o f th e l i n e , u n le s s th ey have assurance o f s u b s ta n tia l long-term c r e d it soon. They may be forced t o devalue — perhaps w ith in a week. The B r i t is h , as you w e ll know, have come in fo r h e lp b e fo r e , but th ey have never p r e v io u s ly in d ic a te d so c le a r ly t h a t , w ithout h e lp , th ey w i l l be fo rced t o ta k e th e p lu n ge. The a u s t e r it y program imposed by th e B r it is h l a s t year brought s t e r lin g out o f i t s summer c r i s i s and v ery co n sid era b le g a in s were made in r e s to r in g B r it is h r e s e r v e s and repaying sh ort-term c r e d it s . This fa v o ra b le p ic tu r e p r e v a ile d through th e fou rth quarter o f l a s t year and in t o A p r il o f 1967 . The B r it is h p r e d ic te d a s iz a b le b a la n ce o f payments surplus fo r th e y e a r. A sharp r e v e r s a l took p la c e in May, fo llo w in g poor A p r il trad e f ig u r e s , accen tu ated by th e M id-East c r is is * The B r it is h r e se r v e s s u ffe r e d from seme movement o f M id-East fu n d s, accompanied by oth er s p e c u la tiv e f l i g h t from s t e r lin g and, more fundam entally, due t o c lo su r e o f th e Suez Canal and r e la te d a sp e c ts o f th e M id-East c r i s i s . In a d d itio n , th e hop ed -for r esu r gence in U. K. ex p o rts d id not ta k e p la c e , due, in la r g e p a r t, t o th e sta g n a tio n in Germany and slow-downs elsew h ere, in c lu d in g th e U. S . , in th e e a r ly p a r t o f th e y e a r. F in a lly , in t e r e s t a r b itr a g e r e la t io n s h ip s were turned a g a in s t th e B r it is h , as in t e r e s t r a te s in th e U nited S ta te s r o s e . The f a c t i s th a t th ey are now scrap in g th e bottom o f th e b a r r e l. They have alrea d y used $2 b i l l i o n in sh ort-term c r e d it s , which m ortgages n ea rly a l l t h e ir t o t a l r e s e r v e s . They have l e f t o n ly $600 t o $800 m illio n in sh o rt term c r e d i t s , which could go in th e attem pt t o defend th e r a te over th e next few w eeks. The market could go h e a v ily a g a in st them n e x t week, when th ey announce some v e ry bad trad e fig u r e s fo r O ctober. Everyone ex p e cts th e s e fig u r e s t o be bad because o f th e dock s t r ik e , b u t, even s o , th e impact o f th e a c tu a l numbers i s l i k e l y t o be a d v erse. DECLASSIFIED E.O. 12958, See, 3,6 NLJ ^S-ji'7 By . NAIU Date _ 77 ^ !% ] & E g-R-E-T ' - 2 - If they have to conclude that devaluation is inevitable, they would rather act now, while they still have some cash and credit left to defend a new parity rate. It might seem tempting to settle this perennial problem now and let sterling go. The arguments for this policy are: — If the devaluation were modest (10 - 15 percent). — If everybody cooperated (the Common Market, Japan, Canada, and Australia held — and few devalued). — If Wilson were able to hold his foreign commitments — Germany and East of Suez. — If, and this is the big if, Wilson can maintain his Government and the movement were not wasted because of internal British pressures. Then it might be desirable to relieve sterling's long agony and try to get the U. K. economy on a more solid basis. But the risks for us are just too great to take this gamble if we can find another alternative. -- While we believe the Common Market would hold, there is some evidence that France would try to follow the U. K. — in an effort to attack the dollar and try to force a gold price increase. Japan, Australia, and Canada probably could be held, although Japan, itself, would face great pressures. But even if all this worked out: — the dollar would come under attack; — the gold market would come under very great pressure — and might explode; — the world might not believe a "modest" devaluation would be adequate and pressure on sterling could continue. The British would prefer to hold the rate, for political and economic reasons! To do so, they tell us they need a $3 billion package of longterm help. I believe they hoped for a multi-governmental loan at long-term, .S. E C R ■ndZKTnBT - 3 but we told them that such an approach was not feasible — at least now, with all governments having budget problems. Their other proposal was for a multi-governmental (U.S., Italy, Germany) agreement to hold guaranteed sterling. This avoids any fixed date of maturity. It would have no balance of payments or budgetary effect. They said that they had some favorable response from Germany on this proposal. We suggested a package as follows: — $1.4 billion IMP credit, which technically they can get by drawing their full line; — $1 billion guaranteed sterling, if Germany and Italy would take half; — perhaps some private bank credits. Central bank governors met at Basle this weekend — their regular monthly meeting — and came up with a different approach. They believe it would be the best course to have the IMP give the U. K. a $3 billion standby commitment and announce it. This would do two things: — announce to the world that the IMP thought the present parity was right; — provide — on a standby basis — a lot of money to underwrite the present parity. These are the negative factors; — The U. K. would be drawing a lot more than its regular credit ling. This can be done technically but may cause some problems. Neither Schweitzer nor the U. K. seem to favor this approach. — This would require use of almost all GAB resources and would make it difficult for the U. S. to make a big IMP drawing if we need to. - The operational and procedural matters will require five to six weeks to clear up before a firm announcement can be made. ■ 8HB-0 R E -g___ OECRBT-- Even with an IMF standby, there may be a short-term cash problem for the U. K., since the 33® package cannot be used until it is finally approved near the end of the year. It may be necessary for the U. K. to get seme additional short-term credit soon, which could be liquidated when the IMF was drawn on. SBSould that need develop, I believe we should participate. This would involve no direct balance of payments or budget costs. It is important to understand that even the IMF standby might not hold sterling. Our judgment is that it would give them a real chance for getting through the next two months, which are crucial for them, and gives some hope that they could hold on through 1968. We believe this is an important factor. And there is at least some prospect that, if they get through 1 9 6 8 , either they could hold longer or take the plunge under better circumstances. If your schedule is manageable, I would like to go over this problem with you on Monday. We need to get your reactions to ppssible approaches/ The Federal Reserve Open Market Committee meets on Tuesday and would want to consider the guaranteed sterling question then. The situation is developing rapidly. Fred Deming will be talking to Rickett by phone at noon to get the current U. K. feeling. Schweitzer is coming to lunch with me and Bill Martin today. It would be useful to have Bill Martin (or Dewey Daane), Gene Rostow, Deming, Okun, Fried, and Walt there.