Foreign Relations of the United States, 1969–1976, Volume E-15, Part 2, Documents on Western Europe, 1973–1976, Second, Revised Edition

259. Memorandum From Secretary of the Treasury Simon to President Ford¹

Washington, December 17, 1976.

SUBJECT

• Alternative Proposals for Dealing with United Kingdom Sterling Balances

I. Statement of the Problem

The sterling balances consist of two parts:

—The private balances, which are mainly working balances of firms and individuals, and used to finance world trade. The private balances are not the volatile portion of sterling balances, and have not been included in previous international efforts to deal with the balances.

—The official balances, now £2.5 billion (about $4 billion), held as currency reserves and investments by foreign governments, mainly OPEC. The official balances are the more volatile element, tending to increase when the U.K. economy is strong, and declining when the U.K. economy is weak. International assistance was provided on earlier occasions (1966 and 1968) to help deal with this problem.

At present, the British authorities are urgently interested in multilateral financial arrangements to deal with the sterling balance problem. The British have cited the balances as a major reason for U.K. financial difficulties—calling them “a millstone” around the U.K. neck. As seen by the British, the danger is that the balances could be offered for conversion into other currencies on a massive scale, with disruptive effects on the sterling exchange markets or on the international monetary system as a whole.

The United States is sympathetic to this desire and is prepared to participate, with others, in appropriate arrangements for dealing with the official sterling balances. The private balances are not the problem, and no official arrangements are needed for these balances. In considering the official balances, it is important—particularly at a time of widespread balance of payments difficulties in a number of countries and increasing strain on sources of official balance of payments financing—that any arrangements established deal with this recurrent problem in a responsible and lasting way. Not all arrangements would accomplish this objective, and it is essential to examine the details of alternative proposals with care.

II. Alternative Proposals

Two basic proposals for financing the sterling balances have been advanced.

One proposal, pressed by Harold Lever and certain others in the U.K. Government, is the so-called “safety-net” approach. This would provide the U.K. with credit (nominally on a short-term basis) if needed to meet conversions of official (and perhaps also private) sterling balances. This technique has been used twice before (in 1966 and again in 1968) and, in retrospect, has proved to be the wrong way to approach the sterling balance problem. While the concern has always been that the official balances are a burden to the U.K. and a source of instability in the international monetary system, the effect of such arrangements has been perverse. They have led to sharp increases in the balances—and thus to sharp increases in the potential burdens to the U.K. and in the sources of instability to the system. In essence, the international community, through these and other financial arrangements for the U.K., has provided a continuous underwriting of the sterling balances throughout the post-war period, even though that support has only been evident periodically when sterling was in severe trouble. Further repetition of this approach would not be useful or appropriate.

In reality, Lever and the proponents of the “safety-net” approach are seeking large-scale access to unconditional credit. This form of “safety-net” would apparently have no policy conditionality of its own, and could undermine the recent IMF program (which Lever vigorously opposed) by making available alternative financing. Lever would apparently like to push the sterling exchange rate up (a move we would regard as artificial and certain to fail, with serious results for Britain’s competitiveness and financial position), and he would regard large unconditional credit as helpful for this purpose.

The alternative proposal, a “comprehensive funding” approach, which the U.S. has designed, attempts to provide a comprehensive and durable solution. This alternative proposal rests on several principles which distinguish it sharply from the “safety-net” approach.

1. It supports IMF efforts to promote needed adjustment. The IMF and the U.K. have negotiated policy conditions in connection with the U.K. request for a $3.9 billion standby financing arrangement from the IMF. Actual drawings by the U.K. will be dependent on U.K. performance of these policy conditions. Such conditional financing is wholly appropriate and essential to the restoration of health to the U.K. economy and confidence in U.K. economic policy. Any financing arrangement related to the sterling balance problem must complement and support this effort, not subvert it by providing easy and possibly large-scale access to unconditional credit.

2. It recognizes the need for medium-term financing. Any new arrangement must recognize explicitly that the official balances represent a medium-term financing problem, not a short-term problem. If the U.K. is compelled to draw upon the arrangement because of large conversions of official sterling, three- or six-month money is not going to be of measurable help. To be of meaningful help, the short-term debt represented by the balances must be funded and repaid over the medium-term, as U.K. corrective policies can be expected to take effect. The “safety-net” approach provides financing nominally on a short-term basis, but permits “rollover” or extension of such financing for several years. It is a medium-term facility in short-term clothing. The comprehensive funding approach would meet the need for medium-term financing in a forthright manner.

3. It provides for sharing of responsibility for dealing with official sterling balances. Any new arrangement must recognize that, broadly speaking, three different sets of countries stand to gain from the arrangement and should contribute something to it. The U.K. gains relief from large drawdowns of the balances; official holders of sterling—the bulk of which are wealthy OPEC countries—gain what is tantamount to a guarantee that the value of their holdings will not be eroded by large conversions of sterling by others or by themselves; and other countries gain from greater stability in the international monetary system. The “safety-net” approach places obligations only on the U.S. and other creditors—to provide financing to the U.K. It does not require the U.K. to accept policy conditions or to undertake responsibility for dealing with the balances. It also provides holders of sterling with the lucrative combination of sterling interest rates and effective sterling exchange rate guarantees—and no responsibilities.

The comprehensive funding approach involves a better balance. In addition to the obligation on creditors in the arrangement to provide financing, the U.K. would be expected to offer holders of official sterling an alternative “funding” security that could help remove the threat of large conversions of sterling; and to follow policies to deal more generally with its payments problems over the medium-term. Holders of official sterling would be asked to consider investment in the “funding” securities offered by the U.K., to reduce their holdings of sterling gradually and in an orderly fashion, and, on a selective basis, to participate in the multilateral financing arrangements.

4. It provides a definitive solution—the orderly reduction of official sterling balances. Any new financing arrangement must envisage an end to the recurrent problem of the balances—an end to the officially-held balances themselves. As indicated above, the “safety-net” approach simply underpins the balances and perpetuates or increases them. It has been tested and has failed. It is not really a “safety-net” but a “trampoline” from which the balances can jump higher and higher. It is harmful rather than helpful in providing a definitive solution to the problem—or even in providing for improvement over an unsatisfactory past. The comprehensive funding approach would call for a gradual and orderly phase-out of official holdings of sterling.

Specific elements of our proposed approach are outlined in the attachment.

III. Other Countries’ Views

Our discussions with the other major creditors—Germany and Japan—indicate that they agree very strongly with certain key elements of our approach. Specifically, they support the idea that any financing should be in the form of conditional rather than unconditional credit, and the idea of assuring a phased reduction in the level of the official sterling balances over time.

There remain some differences with respect to the institutional arrangements. The Germans, in particular, seek a major role for the BIS. I feel that while the BIS can participate, it is essential that the central organization, the “umbrella” for any facility, be the International Monetary Fund. My reasons are:

—The IMF is the focal point of our international financial system, has an excellent Congressional and public reputation as a sound institution, and should be used for implementing such a structural change in the monetary system.

—The IMF alone can introduce the needed “conditionality” underpinning any financial support.

—The IMF can better attract support from non-European creditors (e.g. Saudi Arabia) who regard the BIS as a bank of the major industrial powers.

—The IMF is not tainted with inadequate earlier attempts to solve this problem, as is the BIS.

IV. Recommendation

That we press for a solution to the sterling balance problem along the lines of our alternative proposal, as described above and in the attached memorandum.

William E. Simon

1. Summary: Simon discussed alternative proposals for dealing with the UK sterling balances issue.

   Source: Ford Library, National Security Adviser, Kissinger-Scowcroft West Wing Office Files, Box 25, UK (23). Confidential. Attached but not published is an undated memorandum entitled, “Outline of a Proposed Comprehensive Multilateral Approach to Resolution of the Sterling Balances Problem.” Sent to Ford under cover of a December 18 note from Scowcroft noting that “Simon wanted you to have this paper in connection with the 2:30 meeting today.”