The Great Depression and World War II

Key Pittman, a senator from the key silver-producing state of Nevada, explained the Great Depression this way: Because the price of silver was so low, Chinese could not afford to import goods from abroad, particularly from the United States. The drop in the price of silver led to a glut of products that might have been sold to Chinese consumers and a slowing of commerce. 

U.S. Senator Key Pittman of Nevada in the 1930s.

He believed that if the U.S. government took action to raise the price of silver by buying it at above-market prices, the average Chinese consumer would be able to afford the products of the world and slow economic conditions would end.

As Pittman explained in a letter to an acquaintance in the early 1930s, “If silver is stabilized at a reasonable value to satisfy the Oriental, then he will part with his silver and business will go on. If, however, the stabilized value is too low a figure, his silver will remain where it is and there will be no trade developed.”

Pittman’s explanation for the Great Depression centered on silver prices and China. His proposal, he argued, would benefit China, the world economy, and, conveniently, silver producers in his home state.

Many in China objected to Pittman’s argument. They believed that an artificial increase in the price of silver would have disastrous consequences. Silver would become more valuable as bullion on the international market than as coin in China. Under these conditions, silver would leave China. Since silver was money in China less of it would lead to deflation, exactly what China had avoided in the initial years of the Great Depression during the late 1920s and early 1930s.

Chinese protests and lobbying efforts did not prevent Congress from passing the Silver Purchase Act of June 1934. Under the Act, the Treasury Department would purchase silver until its price on the world market reached a certain level. The idea, as Pittman explained it, was to stimulate a rise in the metal’s price that would increase the purchasing power of the world, particularly of Chinese consumers. Secretary Henry Morgenthau pledged to carry out the policy and began buying silver at above-market prices later that summer.

Predictably, silver soon began to flow out of China.

By October, the Chinese minister of finance, Kong Xiangxi, a graduate of Oberlin College, asked Morgenthau to curtail the silver-buying program.

Arthur Young, one of Kong’s American advisors, surmised that the Chinese government only had a few options going forward: it could put a tax on the export of silver, which might ease things in the short term but which would undoubtedly encourage smuggling. Or, it could undertake a longer-term change to its monetary system.

In 1935, Morgenthau continued with purchases of silver and Chinese officials plotted their next move.

In November 1935, the Chinese government announced the end of the silver standard and the start of the fabi, a legal tender currency issued by the government, which promised to maintain exchange rates with the American dollar and British pound at certain levels. Everyone in China had to turn in silver for the new notes.

A 5 Yuan bank note from 1936 meant to replace silver coins. Notably, the bank note resembled the American dollar and included English words.

However, a significant problem haunted the new currency system. Most of the Chinese reserves were denominated in silver, not dollars or pounds. Now that the Chinese government had control of the nation’s silver, it sought to sell the metal for foreign currency. The Chinese minister of finance soon dispatched Chen Guangfu, a banker and University of Pennsylvania graduate, on a round-the-world trip to Washington.

The Americans did not quite know what to make of the new Chinese currency. Was it linked to the British pound or the U.S. dollar? If it was indeed linked to the British pound, Morgenthau surely could not assist the Chinese by purchasing silver. The optics would be awful. Likewise, Pittman and the silver bloc wanted to ensure that there would be at least some market for silver in China.

After several weeks of negotiations in spring 1936, Morgenthau and Chen reached an agreement concerning continued American purchases of silver. As Morgenthau told Chen, with America the largest buyer of silver and China the largest seller, the two of them could put the metal’s price anywhere they wanted.

During the next two years, the new fabi maintained its value and the move off silver went much better than many foreign and Chinese observers expected. But the Japanese invasion of China in 1937 irrevocably changed that.

As the Japanese Imperial Army swept across north and east China in 1937 and 1938, Chiang Kai-shek and the KMT government retreated deeper into the center of the country, eventually establishing a base in mountainous Chongqing. Japan set up a number of banks in areas under its control that issued their own currency and tried to undermine the value, reputation, and prestige of the fabi.

A U.S. propaganda poster from the 1940s promoting the United China Relief fund.

The Japanese invasion was a currency war as well as a military one.

The value of the fabi eroded, first gradually, and then precipitously. The KMT financed growing budget deficits through the printing press, which, the story goes, worked without interruption, needing a continuous supply of paper and ink to churn out notes. Inflation soared; it took bricks of cash to buy basic items; and uncertainty and discontent increased. After the United States entered the conflict, more financial aid arrived but the Chinese insisted it was not enough.

After the end of World War II, the conflict between the KMT and CCP resumed. The KMT tried one last effort at currency reform in 1948 but it was not successful. Deteriorating economic conditions and a series of CCP military victories made the KMT position in the mainland untenable. It soon fled to Taiwan.

The CCP announced the founding of the People’s Republic of China on October 1, 1949. In the United States, many spoke of the “Loss of China.” If only the United States had done more to support Chiang Kai-Shek and the KMT, the thinking went, the communists would have never gained power.

The People’s Republic of China and the Renminbi

The new Chinese Communist Party faced myriad challenges after the start of the PRC. Currency reform was just one of them. In the late 1940s a number of different notes circulated. The People's Bank of China began issuing the renminbi, the people's currency, in 1948 in the the territories under its control. 

Starting in 1948, the renminbi, known as the people’s currency, featured images of peasant farmers and industrial workers. From left to right: 1 Yuan Note, 5 Yuan Note, and 200 Yuan Note.

At the time, the People’s Republic of China deliberately overvalued the renminbi and put strict controls on its convertibility: it was not easy to change renminbi for American dollars or British pounds. The purpose of overvaluing the renminbi was to make it less costly to import foreign machinery to be used to produce for the domestic market.

The PRC traded with a number of countries, just not with the United States. The currency question, uncharacteristically in the history of Sino-U.S. relations, was a dormant issue, but not for long.

After President Richard Nixon’s trip to China in 1971, the death of Mao Zedong in 1976, and the economic policies of Deng Xiaoping in the late 1970s and 1980s, relations between the United States and the People’s Republic of China resumed and trade between the two countries picked up.

President Richard Nixon and Premier Zhou Enlai toasting during Nixon's historic visit in 1972.

Starting from the 1980s, the value of the renminbi declined in order to promote Chinese exports. In 1980, one American dollar could only buy about 1.5 Chinese yuan (yuan is a denomination of renminbi) but by the mid-1990s the same American dollar could buy around 8 Chinese yuan.

From the late 1990s to the mid-2000s, the People’s Bank of China maintained the value of the renminbi at a peg to the dollar. At the same time, China accumulated a growing current account surplus—it exported significantly more than it imported. Under these circumstances and over time the value of renminbi should rise. However, because the People’s Bank of China maintained the currency peg, it did not.

Because of this, in the early and mid-2000s a number of American politicians and economists sought to label China a “currency manipulator” and try to force appreciation rise in the value of the renminbi.

 

Democratic Senator Charles Schumer of New York (left) and Republican Senator Lindsey Graham of South Carolina (right).

The issue brought together unlikely political allies. In the U.S. Senate, Charles Schumer (D-NY) and Lindsey Graham (R-SC) repeatedly sponsored bills and lobbied the Treasury Department, the organization in charge of making the final decision, to pressure the Chinese currency.

In 2005, the People’s Bank of China allowed the RMB to appreciate slightly. But this change should not be totally attributed to American pressures. Plenty of figures within China disagree about how to handle the value of the RMB.

China faces what economists call the “trilemma.” In making monetary policy, a country cannot have everything it wants. It has to make choices. It cannot have a fixed foreign exchange rate, control over its own monetary policy, and free movement of capital. For example, the United States sets its own monetary policy and allows for the free movement of capital—investors can move dollars in or out of the U.S as they please—but the value of the dollar in terms of other currencies moves around.

The headquarters of the People's Bank of China in Beijing.

Different parts of the Chinese government and the Communist Party disagree about what path to pursue. If the People’s Bank of China allows the value of the renminbi to float and capital to flow in and out of China freely, that means the CCP would lose a great deal of control over the economy, something many in the party and state are likely unwilling to give up.

If it chooses the other route and tries to keep the exchange rate that moves only within a very small margin, it must maintain capital controls—limiting the amount of money people can move out or move into the country. At the moment individual Chinese citizens are only allowed to trade RMB for dollars up to the amount of $50,000 each year, though there are a number of ways to skirt this requirement and there is evidence that Chinese are moving large sums out of the country.

A label identifying a product as being made in China. The amount of Chinese-made products in the U.S. has been increasingly criticized but American consumers continue to purchase them.

Age of Uncertainty

Throughout the 2016 presidential campaign, President-elect Donald Trump accused China of manipulating its currency by keeping it too low. Yet in reality, in the face of a dramatic economic slowdown, the People’s Bank of China has recently intervened to keep the value of the renminbi artificially high.

There are a number of reasons behind this shift in economic conditions: the sense that the export-led growth model of the past 30 years is coming to an end, a declining number of viable investment opportunities, pessimism about the debt levels in China and a desire to diversify into assets outside the country.

The much-heralded Chinese currency reserves declined as people traded their RMB for dollars. Since the Chinese government promises to keep the renminbi at a certain level it has to use its dollar reserves to maintain that level. If, instead, it let the value of renminbi float on the open market, it would likely be lower than it is today.

The U.S.’s top trade partners in 2011.

In the immediate aftermath of Trump’s election, uncertainty and volatility around the world shot up and a number of markets went down: the value of the Mexican peso, for instance, was decimated. After one of the most stunning political feats in American history, commentators are rightly hesitant to make any prognostications, but here is a conservative one: the currency question in U.S.-China relations will soon reemerge.

For more than 200 years, American merchants, Qing dynasty officials, Communist party cadres, and American politicians pondered how to manage the trade and currency relations between the two countries. These debates spanned the era of Spanish silver dollars, the gold standard, the Great Depression, World War II, and the Reform and Opening of China under Deng Xiaoping. 

In past election cycles it was common for candidates to bash China during the election before changing their rhetoric when confronted with the complex, shifting and multifaceted nature of U.S.-China relations. Author James Mann calls this process the "about face." For the past 25 years, the "about face" of those presidential candidates who later became presidents became predictable and expected. 

The reliable "about face," like so much else in the world, is now shrouded in uncertainty.