decided to leave the arrangement by diversifying part of their sterling re serves. At the same time Hong Kong appears to overestimate both the difficulties of diversifying, if they chose to do so, and the extent of their ability to influence the exchange rate (and therefore their influence of HMG). They say in the memorandum for ExCo that sales of say £50 million over a few months, with the attendant publicity, could severely depress the pounds exchange rate. In my view, given the present state of the reserves and availability of foreign exchange, a diversification programme by Hong Kong of this magnitude would have little or no effect on the exchange rate. Means could also be found of handling the publicity and the danger of a decision by Hong Kong to diversify leading to a general flight from sterling by official sterling holders looks very small.
9. I see no need why we should comment on these points in replying to the Hong Kong Government since they are very jealous of their desire to take an independent judgement on these matters. However I suggest that in the reply, it is important to avoid going beyond fairly neutral terms. We should not suggest that HMG is pressing Hong Kong to accept the terms of the guarantee.
10. A suggested draft reply is attached.
W L ST CLAIR
3 May 1974
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