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that our dollar position would progressively improve and that we Page 20 199hable chance of achievinage16911997by 1952 on the basis of existing policies. The quite minor recession in the United States during the summor revealed the real weakness of our position and the complete inadequacy of our reserves. While the European countries have controllod their inflationary tendencies more effectively than we then thought likely, they have shown little or no intention of taking the steps necessary to remedy their other basic weaknesses. As the resources which we could contribute to economic union are now less than they were thought to be in January, the prospects of such a union being successful are correspondingly diminished, especially as we should have to assume leadership in it. We have also had experience during the summer of the difficulty of real co-operation in 0.E.E.C., and, as a result of the Washington talks and of the Common- wealth Finance Ministers' meeting, we have established, or are establishing, a new relationship with the United States and with the rest of the Commonwealth. Our relations with these areas take priority over our relations with Europe and for that reason alone there is a limit to the part we can play in European union.

10.

We have no doubt therefore that the policy set out in E.P.C.(49) 6 must be maintained. But if we maintain our existing policy we must still decide how within those limits we can further develop economic co-operation with other European countries.

11.

The only new proposal at present current is that relating to closer economic union between France, Italy and Benelux. The main object of this scheme is to abolish quantitative restrictions on the movement of goods and exchange control restrictions between the five countries. There would not be a Customs Union. The full details of this scheme (if they have been fully worked out) have not been disclosed to us. The five countries did not intend to bring the United Kingdom (and the sterling area) within the scheme or to extend its bene- fits to us. They would probably have preferred to include the United Kingdom in a scheme of this kind; but their suspicion that we will not come into an economic union may be one reason for their going ahead without us. The Economic Co-operation Administration, who support the scheme, also regard us as being outside its orbit, and Mr. Hoffman has discussed it with H.M. Ambassador in Washington on this basis with a view to reaching a common line towards it. On general grounds our policy has always been to encourage such co-operation between members of O.E.E.C., and we could not oppose this example of it unless it materially conflicted with our interests (e.g. by prejudicing sterling exchange rates or by establishing trade restrictions against us other than on balance of payments grounds). While taking this line we should insist as an essential preliminary that a firm proposal should be brought to 0.E.E.C. for discussion.

12.

If pressure develops for the United Kingdom to support further measures leading to 'unification' we should undertake to study any proposals that may be put forward.

13.

We thought it necessary to give the Americans some indication of our attitude to European economic union, as outlined in this paper, before Mr. Hoffman leaves for Paris in the middle of this week, and we have telegraphed accordingly to Sir Oliver Franks. A copy of the telegram is at Annex B. It will be seen that the Ambassador has been asked to explain

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