Message LONDON, 22 December 1948

TOP SECRET
In the light of the steady deterioration in the situation of the
Nationalist Government, we have been considering the consequences
of probable Communist domination of the whole of China, or, at any
rate, down to the Yangste. The following is an outline of the
position as we see it and of the conclusions reached.

I. The situation in China
2. The Nationalist Government have virtually lost control of the
whole area north of the Yangtse, and it seems highly unlikely that
Government forces will be able to stand their ground on the
southern bank of the river in the face of determined pressure from
Communist forces. The latter have the initiative now and are
making an all out drive on Nanking, the success of which appears
to be merely a matter of time.

3. Following on the Communist occupation of the whole area north
of Yangtse, the political situation now seems likely to take one
of two courses-
(A) The disappearance of Chiang Kai-Shek, and, if the Communists
are willing, some kind of coalition between them and elements of
the Nationalist Government.

(B) An attempt by Chiang Kai-Shek to continue the war from Canton
or elsewhere in China proper. This is compatible with Chiang Kai-
Shek's present mood, but it is doubtful whether the essential
quota of Government servants would be able, or willing, to follow
him. He could only survive if he received American support on a
much more extensive scale than anything so far undertaken.

[matter omitted]

II. American Policy Toward China
7. The American policy is of course fundamental to an appreciation
of the position. We believe that the United States Government
intend to support Chiang Kai-Shek so long as he is supportable, by
hastening deliveries of such supplies as they have contracted to
make available under the Grant-In-Aid to China already voted by
Congress. Meanwhile it is difficult for the State Department (and
mutatis mutandis for the United Kingdom and other Governments) to
avoid the dilemma that any public statement calculated to assist
Chiang Kai-Shek by taking a relatively optimistic view would be
concealing the true facts, while disclosure of the true facts
would deal a possibly fatal blow to Chiang Kai-Shek's regime.

III. Political Effects
8. The political effect on neighbouring countries of Communist
domination of the whole, and in a lesser degree of the northern
portion of China would be felt in the following directions.

(i) Communist successes in China would encourage Communist
movements throughout the area;

(ii) Contacts of Chinese Communists (and hence of Moscow) with
Communists in neighbouring countries would be greatly facilitated.

Every country in the region would be affected directly or
indirectly. The United Kingdom are of course immediately concerned
with Malaya where the situation is complicated by the presence of
a large Chinese population, and with Hong Kong, which seems likely
to be the first non-Chinese territory to come into contact with
the Communists. As to foreign countries the dangers to Burma and
Siam are obvious, as are the possibilities of trouble in Indo-
China and Indonesia.

9. The effect on Japan should also be taken into account. The
spread of Communism in China would enhance the political and
strategic importance of Japan as the most important non-Communist
area in Eastern Asia, and seems certain to strengthen the
determination of the United States Government that Japan should
not fall under Communist domination.

IV. Economic Effects
10. In China it can be assumed-
(i) That there will be an immediate period of dislocation when
foreign commerce generally will be at a low ebb
(ii) That there will follow a period in which the economic
difficulties of the Communists may dispose them to be tolerant
towards foreign trading interests
(iii) That the present nationalist tendency towards foreign
investments and capital installations will thereafter be enhanced,
and that the intention to work rapidly towards the exclusion of
the foreigner will be strengthened
(iv) That there would be a tendency to subject foreign trade, both
import and export, to closer Government control.

11. The most serious economic effects of a Communist controlled
China in South
East Asia seem likely to be:

(i) The probable increase in Communist inspired labour
disturbances in South East Asia
(ii) A serious refugee problem (particularly in Hong Kong, whose
food resources would be strained to the utmost)
(iii) Further disturbances in the rice producing countries (Burma,
Siam and Indo-China) leading to a decrease in the production of
rice, which would be of grave consequence to the importing
countries of the region. A decrease in rice consumption would
provide fertile ground for Communist agitation. This, together
with general disturbances in other South East Asia industries,
would further dislocate the economy and decrease the productivity
of the area.

12. We shall be glad to learn whether our analysis accords with
your own views. It is only possible to make a very general
forecast at this stage, and each country affected will doubtless
consider the situation from its own point of view. We feel,
however, that continuing consultation on the situation will be
helpful to all.