1. Situation. The following is my appreciation of the situation as the result of my talks in Hong Kong and to date in Shanghai.
2. Military. The main Communist threat is towards Hsuchow and Pengpu. It is possible the former has already fallen and no one expects the Nationalist Forces to resist for long as their morale is believed to have gone. The way then will be open to Nanking if the Communists wish to take it.
3. Nationalist Forces in Kalgan-Peiping-Tientsin corridor are being gradually compressed and Taiyuan in Shansi is isolated and likely to fall. Hankow front is quiet.
4. Political. Except those deeply committed to the present regime it has lost all support. The people are sick of the whole situation and want peace-they have lost all confidence in Chiang Kai-Shek.
5. Economic. The situation is chaotic and no one has any plans.
Export trade is virtually at a standstill.
6. (a). The possible ways in which the situation may develop include ... the situation may remain much as it is at present, the Central Administration discredited. The Communist strengthening their hold but avoiding occupation of big cities such as Peiping which might demoralise their troops, and pushing out into the rich rice bowl of Szechuan. Regional commanders such as T.V. Soong and Canton increasing in power and independence.
(b). The Communists continuing their advance to Nanking and Chiang retiring to possibly Nanchang or Taiwan.
(c). Chiang to give way to new administration headed by for instance, Li Tsung-Jen, which would compromise with the Communists and such semi-independent rulers as T.V. Soong. Such an administration is likely to be weak and the Communist influence would become increasingly strong.
7. Should (b) happen it would present all Governments with the early problem as to whether it would be practical to continue to recognise Chiang as the ruler of China or whether it would be necessary to open direct relations with whatever administration or administrations were controlling the bulk of China. I have reason to believe that there exist in Hong Kong an easy and reliable channel of communication with the Communists.
8. The local situation in Shanghai is for the moment better. Food is obtainable at prices much lower than a few days ago, but this situation is of a temporary nature only.