Shifting China’s Export towards the Domestic Market – Part 2

Excerpt from Part 2 of Henry Liu’s article: Part II: Developing China with Sovereign Credit
 
 
Collapse of Chinese Economy in 19th Century was a Monetary Event
 
Over the length of two centuries, Britain devastated the economy of China, the largest nation in the world, with an ancient, highly developed civilization and the rishest economy in the world until the British came in early 19th century.

The war indemnity of the First Opium War of 1841 alone imposed on China the payment to Britain of ₤10 million, ₤3 million of which was for the destruction of confiscated opium contraband. Untold millions were subsequently collected from unequal treaties forced upon China, the first being the infamous Nanking Treaty which among preferential trade concessions granted to British interests, ceded Hong Kong to Britain. The First Opium War showed the West how weak imperial China really was behind its crumbling superpower facade and opened China subsequently to a century of foreign aggression and exploitation, draining wealth on a massive scale from China to the European powers, the United States and Czarist Russia.

In 1900, the war indemnity from an Eight-Power Coalition invasion of China as a result of the xenophobic Boxers Uprising forced China to pay 982 million taels (1 tael = 34 grams = 40.76 ounces) or 40 billion ounces of pure silver at the then British controlled market price of three taels per pound sterling, yielding ₤327 million, of which Russia received 29%, Germany 20%, France 15%, Britain 11%, Japan 7.7% and the US 7.3%.  This was three times the global trade deficit of ₤109 million incurred by Britain in 1910.  But the pound sterling was set by the Brtitish gold standard at 15 ounces of silver, and 982 million taels of silver covert to 40 billion ounces of silver or 2.6 billion, not 327 million. The sum of 2.6 billion was over 24 times the British global trade deficit in 1910. This sum and other payment obligations from subsequent unequal treaties were so large that Britain demanded and received control of Chinese maritime custom service to collect tariffs to pay Western Powers their due from unequal treaties.
 
The final collapse of the economy of dynastic China was caused by the advance of Western political imperialism initially via the illegal private smuggling of opium into China, paid for by a massive outflow of silver from China. What is yet to be fully recognized by economics historians is the adverse effect on the Chinese economy from the massive outward drain of silver from the illegal opium trade Britain and the United States imposed on China as a result of the inability of the Qing imperial court to protect its sovereignty and, more importantly, its independent monetary policy to forbid free trade in silver. The collapse of the Qing economy in the 19th century was largely a monetary event, with similarity if not congruence with the effects of the Asian Financial Crisis of 1997 on several of the weaker Asian economies, notably Thailand, Indonesia, Malaysia and South Korea.

Copper, silver and gold had been the component metals in China’s tri-metal monetary regime throughout its long history. Cloth, grain, cattle, pearls and jade, along with precious metals, had also been used as media of exchange in ancient times. Sung dynasty issued the first paper money in 1023. Silver had been used increasingly widely as currency in China since the 15th and 16th centuries with imports from the increased silver production in the Americas as a result of a Chinese trade surplus with the West. Around 1564, Mexican silver coins began circulating widely in Chinese coastal trade towns such as Guangzhou and Fuzhou as payment by Portuguese traders for Chinese exports. By the 18th century, China was operating on a de facto silver standard monetary regime.
 
The 19th-century reversal of China’s foreign trade from surplus to deficit was due to Western opium smuggling starting from 1820. Up to that time, China permitted very little foreign trade and what legitimate trade that did take place amounted to only an insignificant portion of the Chinese economy. This illegal opium trade was denominated in silver until China ran short of silver, after which the legalized but immoral opium trade was denominated in porcelain that steadily fell in price because China could produce porcelain easier than it could produce silver, albeit Chinese export porcelain was increasingly produced at inferior quality compared to that produced for the more discriminating domestic market. Monetary defacement occurred even in porcelain when it bacame a unit of account.
 
Maria Alejandra Irigoin in her paper: A Trojan Horse in 19th century China? The global consequences of the breakdown of the Spanish Silver Peso standard, observes that until the 1640s silver trade was essentially driven by large differences in the gold silver ratios between Spanish America, Europe and China, allowing a substantial arbitrage gain to be realized by intermediaries. After 1825, China’s balance of silver trade with the West became negative due to the illicit opium trade.
 
According to Irigoin, between 1719 and 1833, 259 million silver pesos, or 6,321 tons of silver, entered China to pay for Chinese goods. That is the equavelent of 421.4 tons or 135.5 million ounces of gold at the universal silver/gold ratio of 15/1. For comparision, as of January 2007, gold exchange traded funds held 629 tons or of gold in total for private and institutional investors. Of the 6,321 tons of silver, 62% was introduced after 1785 and a full 30% after Spanish American independence, usually dated as 1810. Importantly, the structure of the silver trade was different before and after 1785. Up to that date, English intermediation accounted for about 50% of silver inflow to China since 1719, French for 20% and Dutch for 15%. After the 1785 the US became progressively the main provider of silver to China. Around 1795 North American merchants provided 28% of Chinese silver inflow to pay for Chinese goods. By 1799 the US share had risen to 65% and after 1807 American intermediaries accounted for a full 97% of silver inflow into China. This one-way trade denominated in silver grew steadily until the late 1820s. It experienced a short-lived high point in 1834-36 after which date it declined strongly and only staged a timid recovery after 1853. US trade deficit with China did not start in the 1990s. It began in 1800.
 
Despite Chinese discouragement of foreign trade, China had always enjoyed a trade surplus until 1834. Chinese flow balance of silver had been positive all through history and became negative only after 1826, ten years later than the inversion of the overall balance of trade of China due to the opium trade. This was because the sliver deficit from the illicit opium trade was at first cancelled by silver inflow from Russia in exchange for Chinese silk, porcelain and tea. Russia earned silver in the trade boom during the Napoleonic wars. The massive smuggling of opium led to increasing silver imbalance for China after 1819. Similarly, Chinese silver inflow still exceeded outflow until the mid-1820s because the US sent more silver into China than opium-smuggling English merchants extracted from there to Bengal, Calcutta and finally to London.
 
A spurt of silver demand from China occurred in the first half of the 18th century, when the Chinese exchange rate of silver to gold was still 50% higher than the exchange rate in Europe. This offered opportunity for European arbitrage with China’s huge population and market growth.
 
Irigion notes that the historiography of trade globalization has long recognized the role of demand for silver in the Chinese economy as the foundation in the establishment of intercontinental trade between the Americas, Europe and Asia since the 1600s. Silver from Spanish America reached Europe through the trade of both Spanish licensed merchants and northern European interlopers from whence it continued to flow to China within the organized trade of the European chartered companies, primarily the English and Dutch East India Companies. At the same time a second route of silver flows was established within the Spanish colonial trading system. This directly linked Spanish American production areas in Peru and Mexico to Manila in the Philippines through the famous Manila galleon, which sailed regularly from Acapulco to the East.
 
The monetary changes in Spanish America in the wake of Spanish American independence impacted upon this trade. The revolutionary wars in Spanish America and the implosion of the Spanish empire led to a fragmentation of the previously unified monetary regime, which resulted in the production of coins of different quality, fineness and weight. Irigion argues that this change, entirely exogenous to the Chinese market, resulted in falling demand for Spanish American pesos in China. Thus it qualifies the conventional historiography that stresses the role of opium imports in allegedly reversing the flows of silver bullion to and from China in the early 1800s, even though it does not altogether negate the financail impact of opium smmuggling.
 
Evidence supports the conclusion that monetary conditions exacerbated the negative effect of opium smuggling on Chinese national finances. The outflow of silver from China that began in the early 1800s coincided with the collapse of silver prices in the international market as Western countries adopted the gold standard and demonetized silver. Silver was leaving China in huge quantities while the price of silver was falling in the international market, making the Chinese trade deficit more expensive in local currency terms. Yet while the price of silver fell in the international market, its price rose in the Chinese domestic market in relation to copper, accelerating and exacerbating import trade inflation in the Chinese economy through domestic price deflation.

This monetary collapse inflicted great financial damage on China’s peasantry. While peasant income was denominated in copper coins, their tax obligation to the imperial court was denominated in silver coins, because the imperial government’s trade deficit was denominated in silver. The scarcity of silver created by the massive outflow pushed the domestic silver price sky-high in terms of copper coins. A similar monetary disadvantage is now hurting American workers whose wages are denominated in falling dollars with dwindling purchasing power for critical imports such as oil. The only different is that for 19th century China, the damage was forced on the Chinese peasantry by foreign imperialism, while in the US, the damage on US workers were done by their own government’s monetary and trade policy.
 
International bimetallism greatly disadvantaged the Chinese silver-based export economy and domestic bimetallism greatly disadvantaged the copper-based finances of the Chinese peasantry. Chinese peasant populists would have a similar incentive to promote a copper-based monetary regime against a silver standard in China as the US populists did with fighting for a silver-based monetary system against the gold standard in the US. But until the Chinese Communist Party gained control of the governmental apparatus of the nation, there was no official defender of the Chinese peasantry.

China suffered a protracted two-century-long economic recession all through the 19th and 20th centuries as it came into commercial contact with the West. This two-century-long recession reduced China from being the richest economy in the world to one of the poorest. It was the result of the structural monetary double disadvantage of international bi-metallism of gold and silver superimposed on the silver-based monetary system of the Chinese foreign trade sector. This took place in a world monetary regime shifting toward the gold standard, which greatly disadvantaged the Chinese domestic bimetal monetary system of copper and silver. This double disadvantage fatally wounded the Chinese economy for two centuries, causing the decline of a highly developed culture with an uninterrupted history of four millennia and halted its further development for more than seven generations over two centuries. The bankrupt economy reduced the Qing imperial China to a failed state unable to defend itself from aggressive Western imperialist powers until the founding of the People’s Republic when China adopted a socialist path for its economy. Even after the 1911 bourgeois revolution that established the Republic of China under the Goumindang (Nationalist Party), when China followed a petty bourgeois free market system, she was unable to shake off Western imperialism to free the nation, once the most prosperous in the world, from semi-colonial economic status. In that sense, China is different historically from many other nations of the Third World that had never achieved comparable prosperity, albeit many Third World nations were much better off before falling victim to Western imperialism. The two non-European nations that matched China’s level of socio-economic and cultural achievements were Ancient Egypt and the Ottoman Empire, the modern descendent entity of which are but a shadow of their former greatness. 

Beside economic exploitation, the British East India Company, to gain political support from the Church of England for colonialism, also adopted aggressive evangelistic policies on behalf of Christianity. The deep hostility between Catholicism and Protestantism was buried within British imperialism. Many British empire-builders were Scots who brought with them Scottish Catholicism to the non-white British colonies. The Act of Union of 1707 united the kingdoms of England and Scotland and transfered the seat of Scottish Government to London. Henceforth England and Scotland are known as the United Kingdom.
 
The Company methodically destroyed monasteries and suppressed indigenous culture in Buddhist Tibet, which together with its launching of the Opium Wars to protect its immoral opium smuggling, caused deep-rooted anti-Western xenophobia in all Asia that lingers on even today and makes travesty of belated Western grandstanding on religious freedom, human rights and rule of law in centuries to come.
 
The British Pound Sterling and the Gold Standard
 
The pound sterling, created in 1560 by Elizabeth I, as advised by Thomas Gresham, brought order to the monetary chaos of Tudor England that had been caused by the “Great Debasement” of coinage, having caused a decade-long debilitating inflation beginning in 1543 when the silver content of a penny dropped by two thirds to become mere fiduciary currency. The exchange rate of British coins collapsed in Antwerp where English cloth was sold in Europe.
 
The Bank of England was founded 1694 with the pound sterling as the currency of account.  All coins in circulation were then recalled by the Royal Mint for re-mint at a higher standard. Sterling unofficially moved to the gold standard from silver as a result of an overvaluation of gold in England that drew gold from abroad in exchange for a steady outflow of silver, notwithstanding a re-evaluation of gold in 1717 by Isaac Newton as Master of the Royal Mint. The de facto gold standard continued until its official adoption following the end of the Napoleonic Wars in 1816. The gold standard lasted until Britain, along with several other trading countries, abandoned it only after World War I in 1919. During this period, the pound was generally valued at around $4.90. Britain tried to restored the gold standard in 1925 without success despite support from the US central bank which contributed to the 1929 crash on Wall street that immediately spread to world markets to cuase a global depression.
 
The currencies of all other major Western countries in 1821 were either bimetallic or specie-backed paper money. This meant that Britain operated within a floating exchange rate system for most of the 19th century, although for much of this time, when the silver/gold ratio stayed close to the common mint ratio of 15.5/1, the floats were tightly constrained within a narrow band. Nineteenth century gold standard was supported by government incentives and government ability to adhere to it due to lower borrowing costs (on average 40 basis points) when loans were denominated in currency backed by gold, especially in London, the center of international finance at the time. Hence large borrowers, like the newly independent US, had a strong incentive to also adopt the gold standard. By 1870, the main core countries of gold standard had been deeply engaged in international trade for decades, led by British promotion of free trade.  Consequently their respective domestic price levels were similar and their differences changed only slowly, putting less strain on their balance of payments. Trade deficits were difficult to sustain and trade would slow as deficits mounted until balance of payments were restored.
 
British promotion of free trade under the gold standard in an era when new discovery of gold in the Americas, Australia and South Africa allowed Britain to run a trade deficit while still fund substantial investment in colonies overseas. This was because gold was steadily devalued on expectation of more gold entering the market and the resultant defacement was expected to be corrected as the economy expanded faster than the rate of gold production. It was a classic example of the positive effects of the quantity theory of money when money supply expansion did not come from official defacement of currency even as gold was devalued. 
 
Key difference between Pound Sterling Hegemony and Dollar Hegemony
 
Earlier in the 19th century, Britain had to run a trade surplus in order to invest overseas. An increase supply of gold translated into an increase in money supply to boost economic growth globally after mid century. Overseas income in turn acted as counterbalance against temporary adverse trade flows and balance of payments and thereby reduced the need for aggressive moves in interest rates. Globally, wealth was flowing to England from the rest of the world even as England incurred persistent trade deficits.  This is the same principle behind dollar hegemony today that allows wealth to flow into the dollar economy controlled by the US even as the US incurs persistent trade and fiscal deficits. The key difference is that the dollar today is not protected by economic expansion against devaluation, since the Federal Reserve under Alan Greenspan had resorted to devaluation of the dollar as a device to stimulate serial economic bubbles. China needs to understand that there is no future in participating in a global trade regime with the dollar as reserve currency.
 
The ever-widening spread of a multilateral trading system also reduced the need to settle trade deficits in gold. In 1910, Britain ran a combined trade deficit of £107 million with three large regions: Continental Europe, the US and the great plain nations of Canada, Australia and Argentina. But she partially offset that deficit with a £60 million trade surplus with the non-white British colonies of India, British Caribbean and Africa. In turn, these non-white British colonies had trade surpluses of £40 million with Continental Europe, the US, and the great plain nations. British trade surplus with semi-colonial China was not included in these numbers.
 
US Populism and the Gold Standard
 
There was international consensus that the monetary discipline imposed by the gold standard ensured good policy, a belief buttressed by a general political acquiescence within the core trading economies through central bank co-ordination and capital decontrol. The exception was the US which did not have a central bank until 1913.

US
populists were fighting against the gold standard in favour of bimetallism in the 1860s, because the gold standard was deflationary and would and did hurt farmers with farm mortgages. Populist in the US felt that greenbacks not backed by a gold standard would allow credit to flow more freely to rural farm regions at lower interest rates where more farm credit was needed. Free silver platform also received widespread support across class lines in the Mountain states where the economy was heavily dependent upon silver mining. Western Silver Republicans became active in US politics. In the 1896 presidential election, Democratic candidate William Jennings Bryan backed the Populist opposition to the gold standard in his famous “Cross of Gold” speech. The populist Democrats lost and the gold standard prevailed because market-driven co-operation helped make central-bank intervention rates set in London remarkably effective.
 
Gresham’s Law of Bad Money Driving out Good
 
For centuries, money in Europe consisted of both silver and gold coins. When governments introduced specie-backed paper money, they specified the value of the paper currency in terms of weights of either silver or gold. A bimetal monetary system bases its money on both gold and silver at a fixed ratio, with 15 ounces of silver equaling to 1 ounce of gold set by Louis XIV France, the hegemon in Europe at the time.
 
As market prices of silver and gold fluctuated, as for example market price of gold rose above the ratio against silver set by the mint, making gold “good” money, gold holders could buy silver in the market and exchange the silver for gold at the Treasury, draining gold from it, forcing silver to be the only standard eventually. In United States, because the 15/1 ratio of 1792 overvalued silver as money in terms of market price of the metal because of increased silver supply from mines, silver became the standard, and the money supply in effect expanded, causing inflation. Then when the ratio was changed in 1834 to 16/1, it was gold which was overvalued so that gold became finally the standard, and the money supply shrank, causing deflation. This effect is captured by Gresham’s law which states that “bad money will drive out good”. Gresham’s law applies when two forms of commodity money are in circulation as legal tenders which require their acceptance for payment of debts and taxes at face value, the undervalued good will disappear from circulation as money, and will be used as commodity to capture its higher market value.
 
In Napoleonic Europe, silver continued as standard as it did in the US up to 1834. The first gold coin issued in England in 1663 was the Guinea, worth one pound sterling or twenty shillings (44½ guineas would be made from one Troy pound of 11/12 finest gold, each weighing 129.4 grains). The gold used to mint the Guinea came from Guinea, Africa, hence its name. As the price of gold rose over time, a Guinea was worth as much as 30 shillings. By the 1680s the guinea had settled down to worth 22 shillings. Isaac Newton, the physicist, when acting as Master of the Mint in 1717, set the price of the British gold Guinea at 20 shillings 8 pence (which corresponded with 76 shillings 7.6 pence per 22-carat ounce of 0.9167 fine gold).
 
Newton’s Mint Reports [in Old English]:
On the Proportion of Gold and Silver in Value in several European Currencies (Sept. 1701).  

By the late Edicts of the French King for raising the monies in France the proportion of the value of Gold to that of Silver being altered, I humbly presume to give yr Lordps notice thereof. By the last of those Edicts the Lewis d’or passes for fourteen Livres & the Ecus or French crown for three livres & sixteen sols. At wch rate the Lewis d’or is worth 16s. 7d. sterling, supposing the Ecus worth 4s. 6d. as it is recconed in the court of exchange & as I have found it by some Assays. The proportion therefore between Gold & Silver is now become the same in France as it has been in Holland for some years. For at Amsterdam the Lewis d’or passes for 9 Guilders and nine or ten styvers wch in our money amounts to 16s. 7d. & it has past at this rate for the last five or six years.

At the same rate a Guinea of due weight, & allay is worth £ 1, 0s. 11 d.

In Spain Gold is recconed (in stating accompts) worth sixteen times its weight of silver of the same allay, at wch rate a Guinea of due weight and allay is worth 1£ 2s. 1 d. but the Spaniards make their payments in Gold & will not pay in Silver without an abatement. This abatement is not certain, but rises & falls according as Spain is supplied with Gold or Silver from the Indies. Last winter it was about five per cent.

The state of the money in France being unsetled, whether it may afford a sufficient argument for altering the proportion of the values of Gold & Silver monies in England is most humbly submitted to yor Lordps great wisdome.

On the Value of Gold and Silver in English, Irish and European Coins (Mar. – June 1712).

Gold is over-valued in England in Proportion to Silver, by at least 9d. or 10d. in a Guinea, and this Excess of Value tends to increase the Gold Coins, and diminish the Silver Coins of this Kingdom; and the same will happen in Ireland by the like overvaluing of Gold in that Kingdom.

In France a pound weight of fine gold is recconed worth fifteen pounds weight of fine silver.

In China and Japan one pound weight of fine gold is worth but nine or ten pounds weight of fine silver, & in East India it may be worth twelve. And this low price of gold in proportion to silver carries away the silver from all Europe.

Parliament modified Newton’s precise ratio and set the guinea at 21 shillings even, corresponding to 77 shillings and 10.5 pence per standard ounce 22-carat gold.

This required Newton to increase the mint price of gold by 1 shilling 2.9 pence in order to make 89 guinea coins out of two troy pounds of 22-carat gold at Parliament’s price.  In truth, Parliament had in mind more than rounding off numbers. It purposely overvalued gold to introduce the gold standard in England’s monetary regime.
 
French hegemony under Louis XIV had allowed the Sun King to set a silver/gold ratio at 15/1 in Europe. For English money to be at par with the same ratio, Newton recommended to Parliament that the value of the Guinea gold coin be set only 8 pence above 20 shillings. When Parliament set the value of a Guinea coin at 21 shillings (4 pence above the equilibrium price of the 15/1 ratio proposed by Newton), it was an act of deliberate policy that set off a chain reaction which ultimately led to replacing silver/gold bimetalism with the gold standard.
 
Silver then became the “good money” (undervalued monetarily) and gold the “bad” money in England while gold became the “good” money and silver the “bad” money in Europe. The policy of overvaluing gold drew gold to England at the expense of silver, driving silver out of its role as money in England. Because gold was thereby set to buy more silver in England than it did in continental Europe, Gresham’s Law of bad money driving out good would compel traders to buy gold with silver on the continent, sell the gold in England for silver, and take their proceeds in silver back to the continent for the next round of gold purchasing. Gresham’s Law did not "invent" the gold/silver carry trade, Sir Thomas Gresham, founder of the Royal Exchange, only providing a simple explanation of it in a letter to Elizabeth I on the occasion of her accession in 1558, two years before the creation of the pound sterling. Currency carry trade has been going on since money started circulating across national borders. It had been observed by Corpernicus in his Monetae cudendae ratio written in 1526 based on an earlier report to the Prussian Diet of 1522, but published only posthumously in 1816.
 
Raising the exchange value of the RMB against the dollar in a freely convertible exchange regime will turn the RMB into “bad” money in Gresham’s Law and make the dollar into “good” money, even though China is a creditor nation to the US. Under such relationship, hot money denominated in fiat dollars will rush into China to change into RMB to get the benefit of higher interest rates and further exchange rate appreciation and reconvert the “carry trade” profit back into dollars, in the form of net wealth, to flow from China back into the US even when the dollar is a fiat currency and the RMB is a only a derivative currency of the dollar.
 
Throughout history, pressuring another country to alter the exchange value of its currency has been recognized as acts of monetary aggression. To resist this monetary aggression, China needs break away from the tyranny of dollar hegemony. To do this, a full understanding of history of monetary imperialism is necessary.

August 28, 2008

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About kchew

an occasional culturalist
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