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How China Was Stolen / Hyperinflation in China, 1937-1949
Bill Walker
(Feb. 3, 2005)
Once upon a time (before 1927), China had a relatively free banking system. Privately owned banks operated throughout China. The largest Chinese banks and all foreign-owned banks were headquartered in Shanghai. Banks in China issued notes that were redeemable in silver, the traditional Chinese medium of exchange. The notes from each bank circulated freely with the notes from other banks. Chinese banks did without government regulation; instead, competition prevented "inflation" (aka counterfeiting).
In 1927, the Chinese banks were trapped between Communists and Nationalists. Violence organized by Communist labor leaders crippled industry in Shanghai. Chiang Kai-shek made Shanghai banks a deal they couldn’t refuse; his forces would suppress the strikes, in return for loans to the Nationalist government.
In 1927, the first year of the Nationalist regime, these "loans" accounted for 49 per cent of government revenue. The government continued to increase its spending and debt.
In the spring of 1928, T.V. Soong (Chiang’s Triad-connected brother-in-law) forced the Shanghai banks to become dependent on high-interest "guaranteed" government bonds. Skeptical bankers were arrested. By 1932, Chinese banks located in Shanghai were stuck with between 50 per cent and 80 per cent of Nationalist government bonds.
Also in 1928 Soong founded a government "Central Bank" (patterned on the US Federal Reserve), the "State Bank of the Republic of China." Soong appointed many of the directors of private banks to a figurehead board of directors of the Central Bank. Nationalist officials who controlled the issuance of government bonds often gained seats on the boards of private banks. Just as in the US, those with inside information on Central Bank manipulations quickly became a privileged class of kleptocrats.
The final blow to the freedom of the Chinese financial system came from Franklin Roosevelt’s New Deal Administration. In 1933, the U.S. government began to purchase large amounts of silver. In June 1934 the Silver Purchase Act was passed. This Act instructed the United States Treasury to purchase silver until the world price of silver rose above $1.29 per ounce, or until the monetary value of the U.S. silver stock reached one-third the monetary value of the gold stock. (Note that this huge US government expenditure occurred at the worst time in the US Great Depression, when most ordinary Americans were struggling desperately to avoid bankruptcy).
As a result of the U.S. manipulation, from early 1933 to the middle of 1935 the price of silver had tripled. Thus, suddenly Chinese who owed silver-backed money had their debts tripled. Just as in the US paper-money deflation of 1929, businesses went bankrupt and laid off workers.
To add to the disruption, the Nationalist government imposed export controls on silver. Doubtless Soong’s Triad pals made a bundle from smuggling silver along with their previously favored opium.
The new Central Bank was granted monopoly privileges, such as exemption from the silver export controls. The Central Bank became the most profitable financial institution in China. Although it held only 11 per cent of the assets of all Chinese-owned banks, it received 37 per cent of total Chinese banking profits in 1934.
Too late, the largest private bank, the Bank of China, attempted to cut its ties to the Nationalists. The Bank of China started selling off government bonds at a loss.
On March 23, 1935, the Nationalist government seized control of the Bank of China as well as the second-largest private bank. Finance minister H. H. Kung removed the managers and replaced them with appointed officials.
In June 1935, Kung used the three government-controlled banks – the Bank of China, the Bank of Communications, and the Central Bank of China – to buy up the notes of several smaller banks in Shanghai. Then the three government banks simultaneously presented the notes for redemption. The private banks were unable to redeem all the notes at once. Kung declared the banks to be insolvent and seized direct control.
By July 1935, the Nationalist government wiped out private banking in China. All Chinese banks were looted of real assets.
On November 3, 1935 the Nationalists announced an unbacked paper money. Only notes issued by the three largest government banks – the Bank of China, the Bank of Communications, and the Central Bank of China – would be legal tender in China. All institutions and individuals who owned silver were ordered to exchange it for the new "fa-pai" currency within six months (just as Americans had been ordered by Franklin Roosevelt to turn in their gold in 1933).
Once they had a fiat currency, the Nationalists counterfeited fast and hard. Between 1935 and 1949, the price level rose by a factor of over a thousand. Nationalist government printing presses were unable to keep up with the deficits. Chinese currency printed in England had to be flown in over the Himalayas on US C-47s.
So that is how China was stolen from the Chinese people. Later the original thief was robbed by another, and had to run to Taiwan to live out his life on US foreign aid. In recent years the Chinese people have wrested some of their property back from the second thief’s bureaucratic heirs… but that is another tale.
February 3, 2005
Bill Walker [send him mail] works as a Research Associate in telomere biology at an undisclosed (thanks to legal threats from his tax-financed employer) location.
www.lewrockwell.com/orig5/walker3.html
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(Nov. 12, 2006)
Hyperinflation in China, 1937 - 1949
Till 1927, China had a free banking system through the interaction of private banks operating in various regions of the country. Privately held banks operated like any other Chinese business and competed with one another to obtain customers. Most banks issued their own notes which were redeemable in silver, the traditional medium of exchange in China. The notes from each bank circulated freely with the notes from other banks.
These Chinese banks operated largely without state regulation. A free banking system has inherent checks against inflation - primarily because customers will flee from depreciating currencies - and instances of banks' inflating their currencies were rare.
Rise of Chiang's Nationalists
Chiang Kai-shek's Nationalist Party came to power in Nanking in 1927. They initiated a long process to eliminate free banking in China. Violent strikes led by Communist labour leaders crippled industry in Shanghai. When banks appealed to the government for aid, Chiang Kai-shek struck a deal that his government would suppress the strikes in exchange for bank loans. This put the banks in the position of supporting the Nationalists to protect their loans against the Communists.
The nationalists favoured using bank loans to finance their programs instead of unpopular and administratively difficult taxation. In the first year, loans accounted for 49% of the government's revenue. (Report on the Currency System of China, 1980)
Eventually, banks became concerned about the government's ability to service its blossoming debt let alone repay. When bankers refused to loan additional funds, Chiang used the same tactics he employed against the strikers - the perpetrator was thrown in jail as a political subversive and/or had his property confiscated.
In 1928, Chiang's Chief Finance Minister and brother-in-law, T.V. Soong, formed the Central Bank of China that was effectively an extension of the Treasury. The Central Bank began to offer the private banks large quantities of bonds guaranteed and backed by government revenue from custom taxes that carried high rates of interest. These bonds did not fix the financial situation, in fact they made it much greater, but they did delay the repayment time.
In September 1931 Japanese forces seized control of Manchuria and established the puppet regime Manchukuo. The loss of Manchuria, and its vast potential for industrial development and war industries, was a blow to the Nationalist economy. The government bonds now sold for little more than 50 percent of their face value. (The History of China's Internal Loan Issues, 1980).
By 1932, Chinese banks located in Shanghai held between 50 percent and 80 percent of outstanding government bonds. (The Shanghai Capitalists and the Nationalist Government, 1927-1937, 1981)
To enhance public image, Soong appointed many of the directors of private banks to a symbolic board of directors of the Central Bank that in reality had very little power. Nationalist officials who controlled the issuance of government bonds often gained seats on the boards of private banks gaining much personal fortune in the process.
Silver Leaves China for the U.S.
In 1934, the U.S. passed the Silver Purchase Act that enabled the U.S. Treasury to buy up silver. The result was a tripling of the silver price due to the increased demand exerted by the Treasury. Massive amounts of silver flowed out of China to the U.S. sparking a deflationary recession. In 1934 the gross domestic product for China fell 26%.
The appreciation of the yuan during the deflationary period resulted in the burden of debt to become even greater. In October 1934, the Nationalist government imposed foreign-exchange controls to limit the silver exports. All this achieved was in silver being smuggled through foreign owned banks that were immune from Chinese regulations.
The Nationalist government granted the Central Bank special privileges, such as exemption from the silver export controls. Subsequently, the Central Bank became China's most profitable financial institution in 1934, earning 37 percent of all banking revenue while accounting for only 11 percent of the total banking assets in China. (The Shanghai Capitalists and the Nationalist Government, 1927-1937, 1981)
Seizure of Private Banks
In light of deteriorating finances, the Nationalists issued the Savings Bank Law which required each private bank to purchase government bonds until they represented one-fourth of total deposits.
The largest private bank, the Bank of China, decided to sever its ties with the Nationalists and began selling its holdings of government bonds at a loss. In order to prevent a wide-spread bond market collapse, the Nationalists began a propaganda campaign against the bankers. It blamed China's economic woes on the private bankers who placed their profits above those of public interest.
Public opinion persuaded the banks to form a fund from which emergency loans would be made to failing businesses. On March 23, 1935 the Nationalist government seized control over the two largest private banks - the Bank of China and the Bank of Communications. They did this by using the money collected in the emergency fund and through issuance of additional government bonds to purchase enough stock to become the majority shareholder.
They then used the resources of the three banks under their control to takeover smaller private banks. They then began a strategy where they would hoard notes of the smaller banks in Shanghai. When they had amassed a sufficient quantity, they would simultaneously present them to the targeted bank and demand redemption in silver. Since the bank was unable to redeem all the notes at once, it was deemed to be insolvent and immediately seized so that it could be managed with regard to the 'public interest'. All officials of the banks were removed and replaced with political appointees.
By July 1935, the Nationalist government had effectively ended private banking in China as it was the majority shareholder in each bank. The resources of the Chinese banks were used to finance the government through the continued purchase of government bonds.
But even with the resources of China's largest banks, the Nationalist government was barely able to remain solvent. Businesses continued to fail as more silver was smuggled out of China. The Nationalists made the smuggling of silver out of China a crime punishable by death or life imprisonment. (The New Monetary System of China, 1936)
Establishment of Fiat Currency
On November 3, 1935 the Central Bank of China announced the Currency Decree and officially took the country off the silver standard and placed the country on a fiat currency. With a complete monopoly over the money supply, the Nationalists could monetize their debt.
Only notes issued by the three largest government banks - the Bank of China, the Bank of Communications, and the Central Bank of China - were to be legal tender in China. The new currency, called the fai-pai or Chinese National Currency, was to be managed by the Central Bank of China. The notes of private banks were allowed to continue circulating in fixed amounts, although they were to be gradually phased out. All institutions and individuals who owned silver were ordered to exchange it for the new currency within six months. (The New Monetary System of China, 1936)
The move was heralded by economists around the world as a step toward a modern banking system. It was, in fact, the start of a process that would help pave the way to communist ascension in China. With an inept and corrupt government in control of the Chinese money supply inflation occurred almost immediately.
Massive monetary inflation occurred from July 1937 to September 1945 to fund the war with Japan. It is estimated that 65 to 80 percent of the annual expenditures were covered by newly printed money.
![](http://dollardaze.org/blog/posts/2006/November/12/2/chinainflation.gif)
The monetary expansion was so severe that during World War II, Nationalist printing presses were unable to keep up, and Chinese currency printed in England had to be flown in over the Himalayas. (China's Wartime Finance and Inflation: 1937-1945, 1965)
Resumption of Civil War
The end of conflict with Japan reopened the longstanding civil war between Chiang Kai-shek's Nationalist government and the large communist forces led by Mao Zedong. Mao's support had grown immensely due to the economic hardships endured by the people in response to hyperinflation. It destroyed the wealth of the middle class and drove many segments of the rural population into severe poverty. Price and wage controls imposed by the government during this time only exacerbated the problem by creating even more distortions and imbalances.
The civil war raged across China for four years and money creation continued unabated, covering some 50 to 65 percent of the government's spending.
Mao's communists were triumphant on the mainland and the remnants of Chiang's Nationalist army withdrew to Taiwan in late 1949. The new government created a new yuan to replace the old depreciated yuan at a conversion rate of three million to one bringing the total money supply to 296.8 billion yuan. However, once again the money supply grew exponentially to 8,186.3 billion by December 1948 and in April 1949, the money supply reached 5,161,240 billion yuan.
Foreign exchange markets reflected the huge devaluation of the yuan. In June 1937, 3.41 yuan traded for one USD. By December 1941, on the black-market 18.93 yuan exchanged for a USD. At the end of 1945, the yuan had fallen to 1,222. By May 1949, one USD fetched 23,280,000 yuan for anyone who cared to have some.
Sources for the above article:
- The Great Chinese Inflation by Richard M. Ebeling
- Origins of the Chinese Hyperinflation by Jay Habegger
Published on http://DollarDaze.org - Nov 12, 2006.
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© 2006 DollarDaze
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