740.5/4–1451: Telegram
The United States Deputy Representative on the North Atlantic Council (Spofford) to the Secretary of State 1
Depto 779. This is joint USDep, OSR, SUSRep, JAMAG msg, supplementing ECC message in Embtel 5242, April 4.2 Subj is use interim Finance device to activate unutilized European mil production facilities.
1. We believe such device should be very sparingly used where effect might be to ease pressure for higher Eur military budgets. In particular basic solution to problem activating production for country’s own use must be increase in country’s own defense [Page 138] appropriations. However, in field production for intra-Eur transfer, there may be more excusable reasons why production is held up, even where it is reasonably clear that items concerned will find eventual recipient among NATO countries. Potential producing Country, under stress financing requirements its own forces, may be reluctant divert limited public funds to initiation production for others. Potential recipient countries, on other hand, may be delaying placing orders because of hope receiving item free under US end-item program and/or uncertainty as to Eur supply. Former hope shld be dispelled to considerable extent by firm adoption US policies recommended by ECC in Embtels 4708 and 4709 of Mar 13 and concurred in by Todep 303 of March 14,4 and latter uncertainty shld be progessively diminished by development NATO production planning and allocation. However, determination by prospective purchasers of specific sources supply is likely lag chronically behind availability of Eur productive capacity whose output is reasonably clearly needed to meet aggregate NATO requirements. Our proposal for interim financing is intended primarily to deal with this situation. We recommend, however, that procurement for transfer be undertaken under this scheme only when we are satisfied that producing country is taking all reasonable measures utilize its productive capacity to meet its own needs for item concerned, and is not neglecting its own requirements for sake of developing export earnings.
2. Recommendation in Embtel 5242 represents adaptation technique we recommended for French ammo production, principal drawback of which is that if ammo eventually proves unsaleable (or saleable only at a loss) US will be unable present full amount of francs required under repurchase agreement and hence will lose corresponding dollars. Believe should be multilateral underwriting this risk, even though this will necessitate acceptance multilateral voice (thru DPB) in administration of fund.
3. We therefore propose adapting French ammo procedure to more general purposes as fols:
(A) Earmark portion US aid funds (say $500 million) as revolving fund to support contracts placed in Eur by US procurement agencies as agreed in DPB, and make clear to Eur countries that funds employed for this purpose wld come out of appropriated funds which might otherwise be made available to them as aid. Any actual payments required for such procurement would be made with local currency acquired against dollars under a repurchase agreement (as in French ammo case). Dollar funds committed on one order wld be freed for commitment on next as soon as contract was transferred, or [Page 139] as goods delivered under contract were resold to eventual Eur recipient and local currency proceeds were converted back into dollars. (For impact of possible losses, see (B) below.)
Comment: Note that except tor US share in eventual losses, dollars advanced under scheme wld be recovered, and hence wld not be current expenditure from US resources as in case rest of aid program. However, since purpose is to activate Eur end-item production which wld not otherwise come into existence, shld be possible justify diversion US aid funds to this program since cld be corresponding reduction in flow end-items programmed from US sources. Also note that so long as dollar funds available to back up US orders, actual outlays may be held to very moderate amount. This depends upon:
- (a)
- Extent to which contractors require progress payments, or alternatively can finance work from own resources or from bank loans issued on strength of orders placed, and
- (b)
- Extent to which contracts can be sold out to eventual recipients of equipment prior to its delivery. In any case, such dollar advances as may need to be made under procedure we propose wld be largely if not wholly immobilized in hands Eur control banks during period they were outstanding. Indeed, they wld not amount to much more than bookkeeping transactions.
(B) Seek guarantee by Eur countries (including Canada), in proportions to be agreed among them with such prodding from US as may be needed, to reimburse US for half of any losses in francs (or other local currency concerned) suffered by US from mutually-agreed interim financing operations. However, if it shld be found that this form guarantee wld require unduly large set-asides Eur funds otherwise available for current defense expenditures, or makes Eur countries inordinately cautious about approving proposed procurement operations, we wld recommend limiting losses to be borne by Eur countries to half of total losses incurred up to an agreed limit. Under this arrangement US wld take other half of losses up to agreed limit, plus an “open-end” risk in any losses in excess of that amount; latter risk cld be held in check by US thru its voice in DPB on amount and character of procurement under scheme.
Comment: Note Eur guarantee liability wld be in Eur currency obtainable through EPU: dollar advanced by US wld always be recovered thru exercise repurchase agreement except for agreed US share in losses. If Eur agree to bearing half all losses, procurement by US of $500 million wld involve theoretical Eur risk of $250 million, but obviously in practice losses wld only be fraction that amount. Wld hope Eur share in guarantee cld be implemented by initial appropriation of only fraction theoretical risk assumed, with Eur govts assuring their Parliaments that they wld limit volume and nature procurement under scheme with view to keeping actual losses within this limit while reserving right come back for further appropriations in case losses reached unforeseen size. However, if Eur govts shld feel obliged get appropriations covering full theoretical risk, we fear this might seriously reduce amount of Eur appropriations available to finance current defense expenditures. Another danger is that even [Page 140] if Eur guarantees can be implemented with only partial appropriations, Eur govts may prove inordinately cautious in approving proposed procurement operations because of fear incurring losses in excess this amount. Hence, we recommend that in either these eventualities (note that second cannot be determined until after scheme is launched) US shld be prepared accept limit on Eur guarantee liability and assume “open-end” risk itself. Thru its DPB rep, US cld itself limit total procurement to amount and character which it considered wld reduce “open-end” risk to negligible proportions. To extent losses were suffered using up Eur guarantee commitments, US might find it prudent to reduce outstanding volume of procurement or seek additional Eur commitments.
(C) In order protect each country’s financial commitment, limit US procurement under scheme to projects recommended by DPB on basis military advice as to veto-wide deficiencies in acceptable types; and its own determination appropriate efficient Eur sources supply.
Comment: Note unanimous vote in DPB wld give each country, including US, veto power over any proposed operation.
(D) Require each NAT country (including US, though wld expect this to have no practical significance) to agree in advance to purchase any equipment procured under scheme not disposed of thru normal channels, but declared by appropriate NATO mil authority suited to that country’s mil requirements, and in which country has known deficiency.
Comment: Basic purpose such provision wld be to escape losses arising from recognized tendency some Eur countries to ignore other suitable Eur sources supply in favor home production in spite resulting over-all loss efficiency. Essential idea is for all participating countries, each of which is sharing in risk of loss, to delegate proposed allocation authority to impartial arbiter. Obviously twelve-nation body in which each country wld have veto not suitable for this purpose, and although SG might seem logical candidate, nine smaller countries might have obvious reluctance accept this solution. Obligation to accept allocation designated authority cld, of course, be worded in more or less firm terms. Wld envisage allocations being made according to greatest relative need, which might involve distribution among several countries. Wld also envisage no allocation in equipment not well suited to any country’s requirements, leaving US to salvage whatever possible thru auction or otherwise with remaining loss to be distributed pursuant to guarantee arrangement. Recognize that even in absence multilateral agreement along these lines US might deliver unsaleable equipment to recalcitrant country as part its end-item program, reducing other end-item aid to country concerned correspondingly and using dollars “saved” to reimburse procurement fund. However, this procedure probably practicable only when unsaleable items reasonably substitutable for items in country end-item program. As even more severe sanction, US might reserve right reimburse fund by corresponding reduction in economic aid to country concerned, although presumably US wld resort to this measure only in extreme circumstances. Believe much better seek agreement along lines we propose, which offers excellent opportunity for practical multilateral cooperation in NATO in mutual interest participating countries.
[Page 141]5.5 Believe scheme outlined above wld have fol advantages over alternative procedures:
- (A)
- By comparison US off-shore procurement under end-item program, wld avoid rewarding producing country with dollars and making eventual recipient country free gift, with resulting disincentive effects we have all recognized. Our proposal wld conform to general system financing intra-Eur transfers through normal (EPU) payments channels.
- (B)
- By comparison system under which govt of producing country wld initially finance procurement under multilateral guarantee against eventual loss, our proposal wld avoid absorbing appropriate funds in producing country. While existence guarantee make it somewhat easier get appropriated funds, believe net effect guarantee system here referred to bound be reduction funds available in producing country for its current defense expenditures. At same time, our proposal wld leave on producing country “economic impact” of financing procurement. Dollars involved, being subject to repurchase agreement potentially exercisable at any time, wld be effectively immobilized, while any necessary payments on contracts wld in fact be made in local currency provided by producing country’s central bank. In fact what our proposal really boils down to is getting producing country to assume real burden of financing procurement by exploiting willingness its central bank provide local currency against dollars. Our proposal also wld avoid cumbersome procurement procedures of many Eur govts, although in appropriate cases US cld employ local govts as its procurement agents. In any case, multilateral agreement instituting this scheme shld include provision granting contractors filling orders under scheme same priorities, privileges, etc. as enjoyed by contractors under local govt procurement.
- (C)
- By comparison system under which each country wld contribute to general procurement fund in proportion to risk it assumed, our proposal wld avoid absorbing appropriated funds in all Eur countries. To finance initial $500 million procurement, these countries wld have to raise $250 million under this proposal—assuming 50–50 risk-sharing—as compared say with fraction that amount under ours. Again, although largely self-liquidating character of operation might make it somewhat easier get appropriated funds, believe net effect this system wld be substantial reduction funds available for current defense expenditures in countries concerned.
6. Question arises whether recipients shld be charged only at cost or (a) shld pay flat charge to cover administration costs or (b) in cases where current market price of equipment substantially exceeds cost, shld be charged something above cost in order build up reserve to offset losses on unusable items. We believe that prices will continue to rise in immediate future, making profits possible (subject to effect of escalator clauses), and would tend to favor charging prices sufficient to cover administrative costs and establish some reserve for losses especially as such procedure wld give recipients incentive for purchasing contracts promptly before prices rise. However, believe these [Page 142] matters shld be left to determination by DPB in light experience administering fund. Question also arises whether charge to recipients shld include cost raw materials embodied in items concerned and provided by US under aid program. We believe answer depends on what policy US fols in this respect on intra-Eur mil transfers generally, since prices for items procured under these arrangements shld clearly be no higher than those charged if items are bought directly by recipient govts from producers. Incidentally, however, believe wld be desirable review our present general policy in this field, and we are giving matter further study.
7. Numerous other questions of detail have occurred to us, but believe these shld be worked out in course implementation this project after basic decision reached to proceed along general lines proposed.