Please convey the following to the Prime Minister [1] for his Most
Secret and Personal information. BEGINS.

CHINA
Chiang Kai Shek [2] indicated in putting forward Anglo-Chinese
proposals set out in my telegram Circular Z. 350 [3] that effects
of Japanese air raids this summer and of price inflation in China
are so serious that unless he could receive assistance from the
United States and us, he would be unable to maintain his
resistance to Japan beyond the end of this year and that China
would then have to extract herself from her difficulties as best
she could.

2. Our financial commissioner in the Far East [4] considers that
the seriousness of the price situation has not been overstated.

The likelihood of Chiang's giving in soon is difficult to assess
but we believe his supply situation to be deteriorating and we
know that Japan is endeavouring to detach Russia and to get into
direct negotiation with Chiang Kai Shek. It would seem therefore
that a gesture of support is in fact needed to hearten the Chinese
resistance.

3. Chiang Kai Shek's proposals have accordingly been
sympathetically considered by Cabinet. It was agreed that in view
both of increasing pressure on Indo China (see Circular Z. 364
[5]) and of other indications that Japanese may be preparing for a
move southwards against British and Dutch territory, it was in our
vital interest that Chinese resistance should be maintained. From
this it follows that our policy should be to give China as
extensive help as we can consistent with our own war effort and
without provoking Japan prematurely into war.

4. As regards Chiang Kai Shek's specific proposals, our views are
as follows:-

5. Paragraphs (1) (2) and (3) of my Circular Z. 350: Similar
proposals have now been made to United States (see my Circular
telegram Z. 365 [6]) and we shall wish to discuss them with them
when more exact details are known and the United States Government
have had time to consider them. We cannot expect, however, that
the United States will be willing to enter into definite
commitments at this stage and this seems to rule out anything in
the nature of an alliance. Some joint or parallel declarations may
well be possible but as they are bound to cover ground which has
on several occasions been covered by statements of the United
States Government and ourselves, we feel it is better in the first
place to work out such concrete help as may be feasible.

6. (a) in last paragraph of Circular Z. 350: Loan sums as large as
those mentioned by Chiang Kai Shek would be beyond our capacity,
although the United States may be willing to add to previous
credits on a larger scale than hitherto. We have, however,
received more limited proposals through the Chinese Ambassador in
London [7] for a currency stabilization loan up to 5 million and
additional export credits of the same amount for purchases
anywhere in the sterling area. It is evident that Chinese desire
these credits in the first place for political reasons as a token
of our support of China's cause. Having regard among other
considerations to the fact that assistance has been given to China
by us in this form already and that it is at the same time a
measure of assistance to Far Eastern interests generally, we
consider reactions in Japan are likely to be less than to any
other form of direct assistance, especially as the United States
have also given credits and may give more. Cabinet have therefore
decided in principle to grant China a loan for currency purposes
and a credit for sterling purchases, subject to the views of the
Dominion Governments and satisfactory overcoming of technical
difficulties.

7. Since China is long of sterling at present, the Treasury view
is that to give her more sterling unconditionally would result in
increased sales of sterling on Shanghai market and a fall in
sterling-United States dollar rate there, which would result in
increased evasion of our control through Shanghai, to the
detriment of our exchange position. This would also react on the
Chinese dollar. As regards export credits to cover purchases in
sterling area, position is that export credit of three million
pounds granted in 1939 for purchases in the United Kingdom has not
been fully expended owing to difficulty in meeting Chinese
requirements from the United Kingdom without detriment to our own
war effort. It would seem however that important, even if less
urgent, requirements could be met from sterling area as a whole. A
fuller list of requirements is therefore being sought from Chinese
in order to determine whether this would be feasible.

8. To meet exchange difficulty, Treasury contemplate making in
agreement with the Chinese Government, arrangements under which
sterling held by Chinese residents will be available for
expenditure in sterling area only. If this can be done, financial
assistance could be given to China without weakening our exchange
position. Subject to this condition and to the further examination
of Chinese requirements, the idea we have in mind is to make a
further advance to stabilisation fund not exceeding five million
pounds and to agree to export credits for Chinese purchases in
sterling area with a maximum of three million pounds or possibly
five million pounds.

9. (b) in last paragraph of Circular Z. 350: We are not in a
position to provide aeroplanes (except possibly a few of
obsolescent type as to which we are making enquiries). Almost all
United States production of up to date types is absorbed either by
United States or by ourselves. It is possible however that the
United States might be able to supply obsolescent types which
would be of little use to ourselves but might be of use against
the Japanese. There is the further point that the Chinese have
placed orders in the United States of which they have not yet been
able to obtain delivery. These points will be discussed with the
United States Government in due course.

10. (c) in last paragraph of Circular Z. 350: If financial
assistance is granted to China it might be of advantage to follow
it up with an economic mission or by providing technical experts,
but we think it better that these should not precede concrete
help. Meanwhile we are proposing to Chinese Government that a
mission should go to Chungking from Burma to discuss the problems
directly affecting Burma. We do not propose for the present that a
military mission should be sent, though we are considering the
creation of a nucleus of such a mission to be held in readiness in
case we were involved in hostilities in the Far East. Meanwhile we
are also considering replacing our Military Attache in China by a
more senior officer and strengthening his staff. Through this
channel unobtrusive discussions can be held with the Chinese of a
technical character.

11. We should welcome your views before proceeding with the
proposals outlined above.