No doubt one of your main London topics will be the preservation
of the present sterling area arrangement whereby we are able to
have our dollar deficits financed.

It may be that the British, with an eye to the absolute level of
their reserves, will be fearful of continuing the arrangement as
freely as we would like. They may hope to have some sort of
understanding about a ceiling on our dollar convertibility. The
Chancellor informed High Commissioners at the end of April that
one of the major lines of policy in the Marshall Aid era was to
maintain the reserves at 'the present level of about 550
million', which is necessary to commence the post-Marshall era 'in
a sound position with a strong backing for sterling.'
The United Kingdom originally expected some fall in the reserves
during the first Marshall year, and felt that the drain might
continue in the subsequent years. This of course is still
possible, but there are now stronger grounds for believing that
the Marshall aid will roughly offset the U.K. and Colonies net
deficit in dollars. (The reserves at 31St March were about 550
million; at 30th June they will be about 450 million. As there
will be 100 million unused 'drawing rights' against the E.C.A.,
the 550 million is still held at 30th June in a book-keeping
sense).

However, Marshall Aid is not intended to offset the dollar
deficits of the self governing sterling area countries, and the
Americans may expect these deficits to be reflected in falls in
the reserves. The U.K. will obviously want the resulting drain
kept to a minimum, and for this reason may desire to set
unofficial limits to the drawing rights of sterling area countries
which still have flexibility.

You will answer of course that because of our dependence on a
certain volume of dollar imports, and our vulnerability on the
export side, we want to avoid a ceiling, preferring to continue
our present flexible arrangement on the assurance that we will
conserve dollars as much as we can. But there is a point which
often occurs to me and which I have not seen in any statement or
document by the British. It is the fact that we cannot tell at
this stage what the purchasing power of 550 million in gold and
dollars will be in 1952. If dollar prices were to fall by 25%
between now and 1952 about 400 million then would be the
equivalent of 550 million now. Possibly dollar prices will be
higher in 1952, but I think they are more likely to be lower. Some
of the factors now sustaining the U.S. economy might have ceased
to be effective by 1952-e.g. building lag overtaken, other
accumulated demands met, inventory buying and spending of large
proportion of current income ceased. But whether U.S. prices fall
or rise, the additional drawings (if any) which Australia would
make under a flexible arrangement compared with a ceiling
arrangement are likely to be submerged in the movement in the real
height of the reserves caused by even a moderate change in the
dollar price level. The same would apply to New Zealand as in
neither their case nor ours, is the deficit likely to get out of
hand. But to avoid our being exposed to a policy of keeping our
imports within a fixed distance of our export values, I think it
would be worthwhile to use an argument along the above lines if
the British introduce the ceiling idea because of their desire to
have 550 million in kitty in 1952.