The above referenced letter described the strains being experienced in the operations of EPU and reviewed some of the difficulties confronting efforts to find ways and means of meeting these problems. It was pointed out that the EPU Managing Board had been considering what policies it might be desirable for countries to implement in the circumstances and what revisions might be made in the structure of EPU after June 30, 1952, so that the Union would be in a better position to cope with the swings being experienced in intra-European trade. This letter reports on some of the proposals the Board has been considering.

2. As the Managing Board has not yet completed its study, the proposals are still under examination and cannot be considered as final. However, we have discussed the principal problems with a number of people associated with this work and we have been shown an early draft of the Board's report. Some of the Managing Board's final opinions we therefore know. Paragraphs 3-24 of this letter are a summary of the draft report. After dealing with the problem of settling temporary surpluses and deficits (paras. 4-11), the difficulties of settling persistent extreme positions (paras. 12-24) are discussed. In this summary the present position of the Managing Board, as far as we know it, is generally indicated concerning each point. In a few cases our comments will be found, in brackets, at the end of the paragraph. Some general comments on the problem of the persistent BLEU surplus are made in the concluding paragraphs (25-29) of this letter.

3. In spite of the increasing difficulties which have been confronting EPU the Managing Board considers, as it recorded in its first annual report (our letter No. 407 of September 7, 1951), that the Union has proved to be a satisfactory mechanism for intra-European payments during a period when convertibility was not yet possible. The principal role of the Union to serve as a clearing house has been fulfilled. With very few exceptions, country positions which followed a particular trend for some time were subsequently reversed. In the light of this experience the Managing Board has concluded that the conditions for gold and credit payments need not be radically revised. Nevertheless the Board considers that unless ways are found to cope with the difficulties arising from violent, though temporary, fluctuations, and more especially from the problem of persistent debtors and creditors, the continued functioning of the Union will become precarious. (The over-riding importance of appropriate national monetary and commercial policies in meeting these difficulties was underlined in my letter No, 40. In this connection we have been informed by Cahan that the final report of the Managing Board will state in no uncertain terms that the EPU debtors must carry the onus of responsibility for many of the current difficulties of the Union and for remedying the present unsatisfactory conditions pertaining to intra-European payments.)

B. The Problem of Settling Temporary Surpluses and Deficits

4. Having accepted that the EPU mechanism for covering temporary positions has worked satisfactorily the Board bas concluded that there need be no major changes in the mechanism of the Union. In order to reduce the violence of the recent fluctuations in payments and to enable the Union to withstand them better should they reoccur, the Board has considered whether it might in future, when examining a country's position, also look into the monetary and financial policies of other countries whose positions, without causing concern, nevertheless may have a marked effect on the position of the country in question. (When the problem of German deficit was before OEEC her economic policies were examined in detail; but whether all member countries would agree to submit to the Board and to discuss with it full information about their monetary policies is by no means certain.)

5. With regard to commercial policy, the Managing Board has noted that rapid and frequent changes in liberalization measures may tend to aggravate disequilibria and to disorganize the structure of intra-European trade. It therefore has considered suggesting that countries should resort to commercial measures only in so far as adjustments in the field of monetary and financial policies prove to be inadequate in scope or too slow in taking effect. The Board has also noted that the functioning of the Union would be facilitated if countries which have suspended liberalization measures, instead of waiting until the improvement in their position has been considerable and has been maintained for some time, would introduce some flexibility in their import controls during the period when their position in the Union has started to improve but did not yet warrant a complete return to liberalization. (At the recent special session of the OEEC Trade Committee identical views were expressed.)

6. Recent disturbances in trade have frequently been accompanied by abnormal movements in payments, principally through concealed capital transfers, which tend to aggravate the situation. The Managing Board has therefore considered whether, in an effort to limit these movements, it might be given certain information which would enable it to foresee the possible extent of the financial movements between member countries and their incidence on the accounting positions in the Union. The Managing Board has in mind that it might obtain information about the level of working capital funds in European currencies held by commercial banks and other institutions.

7. With regard to the quotas, the Managing Board does not think they need any radical revision. Arguments in favour of a general increase of quotas might be based on the growth in the volume of trade and the rise in prices but it appears to the Board that such an extension of quotas would reduce the initiative for member countries to take in good time the necessary measures to reduce their position in the Union. As far as the Board is concerned there has never been any intention of adjusting the amount of quotas to the amount of trade at any given time. Nevertheless the Board considered that the revision of some individual quotas may be necessary (presumably BLEU, Italy and Portugal are countries whose quotas might be increased).

8. The Managing Board rejects the possibility of modifying the method of settling accounting positions by making changes in the proportions between payments in gold and grants of credit as a means to restrict the rapid accumulation of surpluses or deficits. The Board does not recommend any such changes at this time for two reasons. Firstly, owing to the pressure which is already being exercised on the monetary reserves of member countries, debtors could scarcely undertake to pay the Union higher amounts in gold. Secondly, creditor countries would find it difficult to increase the credit granted owing to general inflationary trends.

9. The Managing Board has considered two possible provisions which might make it easier for the Union to settle surpluses which, without being persistent, are yet of such an extent that the country's quota is exhausted. The first provision concerns a proposal that the whole or part of the amount due to a country in respect of payments in gold should be deposited in a "convertible account" which would be opened in this country's name in the books of the Union's agent (The B.I.S.). The assets in this account would be useable only by the holder to settle a subsequent deficit in its balance of payments.

10. The second provision concerns a strengthening of the convertible assets. The Board has agreed that for several reasons the convertible assets should be increased. We understand that it considers that a minimum of 150 to 200 million additional dollars is required. In the Board's opinion the initial endowment of $350 million was barely sufficient to ensure the working of the Union within the limits of the quotas. Having regard to the gold payments already made through the Union to persistent creditors, the Board thinks that an increase in the convertible assets is especially necessary. The question of from where the resources for an increase in the assets might come was discussed in my letter No. 40. The U.S. representatives here are not only not prepared, at least at the present time, to consider the possibility of the U.S. contributing any dollars for an increase in the assets, but from our most recent conversations with them it appears that they are still not convinced that the reserves need be increased. The Managing Board argues that in the eyes of the creditor countries, the reserves constitute a partial cover for the credits they have granted; and for the public, the reserves are a sign of stability and confidence. To the latter point the U.S. representatives declare it is merely a case of understanding the EPU mechanism. To the former point they suggest that loans which creditors may make on behalf of the sterling and French franc areas should not have to be guaranteed by the U.S. putting up additional dollars.

11. A member of the Managing Board declared that it is unrealistic to expect member countries to make contributions to the convertible assets as long as they are in receipt of U.S. aid. Some dollars may accrue to the Union through U.S. assistance to structural debtors (Austria, Greece, Iceland and Turkey) but this source is too limited to bring the convertible assets up to the limit desired. Attention has also been given to the possibility of dollars from off-shore purchases being channeled into the Union. (There are various ways in which this might be done but they presuppose that the countries concerned will give up the free dollars they would otherwise gain. While a very substantial volume of dollars might be obtained in this way the U.S. has cautioned the Managing Board not to plan on this assumption. The U.S. is giving serious consideration to this idea but owing to many administrative difficulties being experienced in implementing the off-shore purchase programme the U.S. is uncertain how successful this programme may be .)

C. The Settlement of Persistent Surpluses and Deficits

12. The most fruitful development for solving the problem of persistent surpluses and deficits would be if persistent debtors accumulated surpluses outside the EPU area enabling them to pay the Union in convertible currencies. But at the present time the dollar deficit is a major problem for almost all member countries and there is no sign of the emergence of a pattern of trade making it possible to effect triangular settlements. As the Managing Board is of the opinion that the Union's liquid assets are not adequate to ensure certain settlement of the temporary surpluses and deficits (see para. 10 above) it therefore considers that the convertible currencies required to settle persistent surpluses can only come from outside sources.

13. If this analysis is accepted it follows that the only action which member countries can at present take to solve the problem of persistent positions is to reduce them to a level compatible with the convertible assets obtained from outside sources. The action principally required therefore mainly falls within the scope of monetary and commercial policy.

Monetary Measures

14. The recognition given by the Managing Board to the importance of debtor countries with inflationary situations taking appropriate measures to reduce purchasing power was referred to in paragraph 3 above. Conversely the Managing Board would like to see creditor countries without inflationary situations avoid restricting purchasing power.

Commercial Policy

15. Monetary measures by themselves can only provide a partial solution to the problems of countries which tend to be structural debtors or creditors in Europe. If a sharp reduction in the persistent positions of these countries becomes necessary, commercial measures also will be required. In the case of persistent creditors, in present circumstances when the convertible assets of the Union are inadequate, it has been suggested in the Managing Board that they should aim at simultaneously reducing surpluses in Europe and deficits outside Europe, i.e. a redirection of foreign trade. A programme of this nature would require careful study over a long period. It might require quota restrictions not only on imports but also on exports. In this connection the Managing Board has considered the usefulness of codifying the principles which should govern the application and removal of quota restrictions on exports, as has been done in the case of imports.

16. With regard to exchange control, the Managing Board has found that if a member country refrains from exercising strict control over exports of capital to the dollar area, that country attracts capital from other member countries and therefore tends to accumulate surpluses in Europe. Strict exchange control is therefore required.

D. Methods of Settlement

Debtors

17. With regard to the persistent debtors, Austria, Greece, Iceland and Turkey, the various measures described in paragraph 14 and 15 would still leave these countries with deficits to be settled by outside resources. The only source of funds is U.S. aid but in this connection the Managing Board does not yet know the size or rate of the grants which the U.S. may make. The Board is anxious, of course, to see this question settled as soon as possible as any prolonged uncertainty will tend to handicap planning for the future.

18. In the case of some countries the persistent character of their deficits in Europe would be removed if there were an inward flow of investment funds. It has been suggested that the possibility of a regular flow of long-term capital into Europe should be discussed with the I.B.R.D.

Creditors

19. The Managing Board rejects as a real solution the withdrawal or suspension of persistent creditors from the Union. While the difficulties with regard to the technical operation of the Union would be disposed of, they would continue to exist for all countries on a bilateral basis. Indeed, the solution of these difficulties might be more difficult to obtain outside the Union than inside it.

20. One proposal which has been made as a means of facilitating the settlement of the surpluses of a persistent creditor is to restore all or part of its quota by consolidating a fraction of its cumulative accounting surplus into long-term loans. The Managing Board would also like to explore the possibility of persistent debtors paying currencies of non-member countries to persistent creditors. While transfers of this nature have not been possible up to the present, the Managing Board might explore them.

21. A similar possibility is that offered by certain transactions between member countries of the Union and the International Monetary Fund. Persistent debtors might purchase from the Fund the currencies of a persistent creditor. However such transactions could only really help the efficient working of the Union if it were possible for the Monetary Fund to relax its rules of procedure. If this possibility were explored the Managing Board would of course have to enter into discussions with the I.M.F.

22. Finally, the settlement of the surpluses accumulated by persistent creditors might be facilitated by the use of any convertible currencies held by the Union over and above the amount required by it for the settlement of temporary surpluses and deficits. Additional assets of this kind might come from various sources. The Union might acquire such funds from the use of "special resources" by the structural debtors (see para. 17), or by payment through EPU of off-shore purchases. The only other possible source of funds would seem to be an additional contribution of dollars to the Union.

E. Some General Considerations Affecting the Settlement of the Surpluses of the Persistent Creditors

23. As a result of the experience with BLEU certain general principles concerning the settlement of surpluses of persistent creditors have developed, the most important of which the Managing Board has thought might be put into precise form. This is the principle of making allowance for a country's position vis-à-vis the dollar area when deciding on the amount of gold payments to be made to a persistent creditor. If the country has surpluses outside the EPU area, its surplus within the Union, in so far as it exceeds its quota, would be wholly settled by the granting of credit. The principle, in other words, is that the Union's assets in convertible currencies should not be used to strengthen a member country's monetary reserves. The Board recognizes that the equitable application of this principle would require it to examine all aspects of the dollar position of a persistent creditor, including the nature of its economy and trade, the character of its dollar deficit, and whether the country was receiving any dollars in the form of U.S. aid. (It is not certain whether all countries would be prepared to accept such an examination.)

24. One of the basic principles of EPU is that the currencies of all member countries are equally valuable. However, this has never really been the situation that existed and the problems of the Union have been aggravated for this reason. It has been suggested in the Managing Board that if the transferability of European currencies is not to be invalidated, each currency as nearly as possible should be of equal "hardness" vis-à-vis the others; and that this result could be achieved by the harmonisation of internal monetary policies and by the adoption of some degree of uniformity in member countries' policies relating to imports from the dollar area.

COMMENTARY

25. Leaving aside the problem of BLEU, it would seem that as a result of some of the adjustments in the EPU mechanism described above, and assuming that the countries concerned carry out appropriate internal policies, the operations of the Union should continue to provide a reasonably satisfactory mechanism for the settlement of intra-European balances. The two most difficult debtors, France and the U.K., have implemented programmes which in time should lead to a reversal of their recent positions. The persistent BLEU surplus is the dominating problem in planning the future of EPU. Unless a satisfactory solution is found, which must involve a substantial change in the present pattern of intra-European surpluses and deficits, EPU might well collapse. The Managing Board and M.S.A. are deeply concerned about the BLEU surplus but, from our conversations with the people concerned, it seems that they have neither unanimous views nor final opinions on the most practicable action to be taken.

26. The Belgian trade surplus in Europe can be analysed on a long-run and on a short-run basis. From the long-term point of view Belgium has tended to be a structural creditor in Europe. Before the war Belgium had a surplus in European trade and a deficit with the dollar area. In fact, much of Belgian industry is concerned with processing dollar imports and selling the products in Europe. Under this trade pattern payments settlements used to be made by obtaining dollars from some of the European countries, notably the U.K. However it is not realistic at present to expect to obtain dollars from intra-European trade. It has been suggested in the Managing Board that Belgium must therefore reorient her trade and perhaps alter the structure of her industry. This is a long-term proposition and, if accepted, it follows that in the meantime special arrangements have to be made to settle the Belgian surplus.

27. From the short-run point of view there seem to be, at least in M.S.A.'s opinion, some grounds for considering the recent Belgian surplus as abnormal. Belgium ran a deficit in EPU during the months of July to November 1950 and, it is asked, might this not happen again in the near future, The growing surplus since November 1950 had its origin in the Netherland's deficit - since corrected - and found its stature in the French and U.K. heavy buying, based in part on internal inflationary situations. Assuming that the French and the U.K. positions are corrected, and Belgium pursues a more expansionist internal policy, the Belgian surplus might disappear, at least for a few years. Uncertainty about the economic developments that can reasonably be expected in the short-run seems to be preventing agreement among the Managing Board and the U.S. representatives on the arrangements that need to be made for the future of EPU in so far as they relate to the settlement of the balances of creditors who have exceeded their quota.

28. The Managing Board tends to the opinion that BLEU is permanently above the line. MSA seems to hope that the Belgian situation will solve itself along the lines mentioned in the preceding paragraph. Discussions about the BLEU problem invariably lead to references to the policy of the Managing Board and M.S.A. concerning member countries' deficits with the dollar area. Here we find that the opinions of the Managing Board and M.S.A. are about the same. As long as BLEU cannot expect to earn dollars from her EPU partners, it is argued, it is unreasonable for Belgium to run a dollar deficit. An M.S.A. representative has even declared to us that the BLEU problem in EPU is essentially a dollar problem. As long as gold and dollars continually flow to BLEU from the Union, BLEU is as much a member of the dollar area as she is of the EPU area. What the Managing Board especially fears now is that France and the U.K. will start to regain the gold they have paid to EPU while BLEU still runs a surplus with other countries. In these circumstances the convertible assets would again start to diminish and perhaps much more seriously than heretofore. Hence the suggestion, in paragraph 24 above, that member countries might have some degree of uniformity in their policies relating to imports from the dollar area. We said that the EPU should not be permitted to become an end in itself and that any common policy towards the dollar area of the kind suggested might well move Europe even further from the goal of convertibility with European countries not "equally hard" but rather "equally soft". EPU then ceases to be a temporary mechanism but a vested interest.

29. I should be grateful to have any comments and observations you may care to make on this question and on any of the other matters raised in this letter. I expect the final report of the Managing Board will be examined by the OEEC committees with responsibilities in this field. It will also be considered at a meeting of the ministerial Council tentatively scheduled for March 24th. Should you wish us to make any comments on the questions raised we could of course do so at any of the stages of the examination of the final report of the Managing Board within the Organization.

A.R. KILGOUR
for Head of Mission