Early Methods of Inflation Control
The People’s Republic was initially confronted by a rampant inflationary spiral that had begun under the earlier Nationalist regime. As noted in Chapter 1, when Mao Tse-tung proclaimed the People’s Republic of China on October 1, 1949, prices were skyrocketing.
There was a fourteenfold increase in the renminbi money supply, and more than tenfold increase in wholesale prices, between December 1948 and July 1949 - followed by a sevenfold increase in the money supply and a more than fivefold increase in prices over the July 1949-November 1949 period (Table 3.1). By March 1950, wholesale prices were more than two hundred times above the levels reached in June 1949, just after Shanghai fell to the Communists in the final stages of the Chinese Civil War. With little initial formal tax apparatus and no bond issuance until 1950, the surging money growth represented the only ready way by which the new regime could fund its expenditure needs. Although there was no national budget at this time, Chen Yun, who was in charge of the People’s Republic’s Committee on Financial and Economic Affairs, estimated that two-thirds of total expenditures were funded by deficit finance in 1949 (Chen, 1984, p. 77).The Communist authorities responded to inflationary pressures by direct intervention in commodity markets. Such an approach had been attempted, less successfully, by the preceding Nationalist regime (Burdekin, 2007). The basic premise behind this intervention, however, goes all the way back to practices adopted during China’s Imperial era and endorsed by Confucius as early as the sixth century b.c.e. Stabilization of grain prices became an important part of Imperial policy, and Chen (1911, p. 572) observes that in 54 b.c.e. it was formally
proposed that all the provinces along the boundary of the empire should establish granaries. When the price of grain was low, they should buy it at the normal price, higher than the market price...
When the price was high, they should sell it at the normal price, lower than the market price...The People’s Republic itself quickly established a battery of state trading units, which obtained their supplies through levying a tax-in-kind, from the output of state enterprises, and by purchase of private sector output. During the 1949-1950 inflationary spiral, these state trading companies sought to mobilize supplies of key commodities like grain and cotton cloth, and release them onto the market in the cities to combat shortages and offset the successive price jumps that arose there (Burdekin and Wang, 1999). Their operations became a key element in the Communist policy of conducting “economic warfare” against speculators (Hsia, 1953) and containing inflation in the cities. The supplies collected and put onto the market by the state trading companies represented important support for the early renminbi issues - and, according to Eckstein (1977, p. 170), the state trading companies
performed an initial distribution function, buying up surpluses and channeling them into cities and regions experiencing acute scarcities, into areas where prices of consumer goods were rising and where demand pressures were acute. In this way, they could contain speculative price rises and assure reasonable price stability.
The first nationwide intervention by the state trading companies took place in November 1949. In an attempt to bring down prices and withdraw currency from circulation, the state trading companies unloaded commodity stocks in the big cities. Sales by the state trading companies withdrew as much as 30 billion renminbi from circulation in Shanghai alone between October 10 and November 10, 1949 (Chung-kuo k’o-hsueh yuan, 1958, p. 362). Effective March 10, 1950, the state trading companies were reorganized into a full nationwide system, boosting their ability to equilibrate relative prices of commodities over the different regions and offset any local spikes in price.
Stabilization was essentially achieved by the end of March 1950, with the actions of the state trading companies aided by vigorous promotion of bond sales that appear to have funded more than one-half of the budget deficit in the first half of 1950.[39] The bond purchases by the private sector were apparently not entirely voluntary, however, and, after being “asked to subscribe to their full financial capacity... Cheap sale or sale below cost was the last resort for most businessmen to raise funds...” (Hsin, 1954, p. 15). Fiscal consolidation measures were implemented also, although significant deficit reduction was not achieved until the second half of the year (see Burdekin and Wang, 1999).In high inflation cases like China’s 1949-1950 experience, the rate of price increase typically exceeds the rate of money supply growth as individuals unload the depreciating currency faster and faster, causing the velocity of circulation to accelerate. This velocity represents the average number of times the currency changes hands over the year. Each time the currency changes hands and is spent, still more upward pressure is added to prices and so rising velocity only exacerbates the extent to which too much money is chasing too few goods. Beginning in 1949, China’s new government sought to reduce the turnover of the currency by offering bank deposit accounts that were indexed for inflation. Under the “parity deposit system” introduced by the People’s Bank of China on April 20, 1949, the value of deposits was set in terms of a commodity unit that conformed to the consumption pattern of the local population. This essentially indexed deposits to commodity prices and appears to have motivated substantial growth in bank deposits despite continued rapid inflation. In Tianjin, for example, the volume of bank deposits in June 1949 quickly rose to 20.8 times the March level (Burdekin and Wang, 1999, p. 216). In addition, after the “parity deposit system” was adopted by the Shanghai authorities on June 14,1949, a United Nations study confirmed that bank deposits grew substantially faster
Table 3.2.
Money, Prices, Output, and Velocityin China, 1950-1957| Year | Wholesale Prices | Retail Prices | Renminbi Money Stock | Net National Product | Real Money Balances | Velocity of Circulation |
| 1950 | 100.0 | 100.0 | 100.0 | 100.0 | 100.0 | 100.0 |
| 1951 | 117.8 | 111.8 | 191.6 | 131.7 | 162.6 | 69.1 |
| 1952 | 118.0 | 112.7 | 313.8 | 166.4 | 265.9 | 53.1 |
| 1953 | 116.5 | 117.4 | 418.6 | 182.3 | 359.3 | 43.8 |
| 1954 | 117.0 | 117.5 | 449.8 | 192.6 | 384.4 | 42.6 |
| 1955 | 117.7 | 119.2 | 500.2 | 202.6 | 424.9 | 40.7 |
| 1956 | 117.0 | 119.2 | 601.6 | 227.4 | 514.1 | 37.6 |
| 1957 | 117.1 | 122.0 | 595.5 | 240.6 | 508.5 | 40.1 |
Note: Real money balances are calculated by taking the ratio of the money stock to the wholesale price level (where 1950 = 100).
Source: Jao (1967-1968, p. 105).
than commodity prices over the July-October 1949 period (Hsia, 1953, p. 61).