The Chinese and Hong Kong Experiences Compared

On October 15,1934, the Chinese authorities attempted to limit the outflow of silver by levying an export duty and equalization charge on all new silver exports. The duty charged was 10%, less an allowance for minting charges paid in the case of silver dollars and mint-issued silver bars.

Table 5.3. Shanghai Stock Exchange Components in 1934

Note: Totals exclude bonds and preference issues.

Source: International Center ofFinance atYale University (http://icf.som.yale.edu/sse) and author's calculations.

Table 5.1, imply that the total outflow of silver may even have been slightly higher in 1935 than in 1934. The smuggling was aided and abetted by the Japanese, who had seized China's northeastern province of Manchuria in September 1931, creating the puppet state of Manchukuo. The illegal silver flow in that area may have reached 15 million yuan a month and the Japanese authorities “were reported to have put a branch office of the Manchukuo Central Bank at the Manchurian border to pay a good price for smuggled silver” (Young, 1971, p. 216). Significant quantities ofsilverwere also smuggled out via Hong Kong. King (1957, p. 107) states:

During the first six months of 1935, the Colony exported $24,156,038 worth of silver bullion and specie; during the second six months, $150,661,908. Most of this represented re-exports, since the Colony's silver was mainly in the form of reserves against the note issue, but what free silver was in existence was exported. Coins were melted down and there was a shortage of circulating media.

After the October 1934 measures were imposed, a considerable gap opened between the foreign exchange value of China's currency and the actual value of its silver content on world markets. Young (1971, p. 217) notes that, with US silver prices near $US0.55 per ounce in October 1934, “the silver content of the Chinese dollar was worth abroad about one-fourth more than in China.” Although reduction of the equalization charge begin­ning October 19, 1934 allowed renewed appreciation of China's currency relative to the US dollar, the accelerating rise in silver prices in April-May 1935 gave rise to as much as a 50% gap between the internal and external value of China's silver (Young, 1971, p. 218). Despite the obvious stimulus

Table 5.4. Monthly Silver Outflows and Wholesale Prices in Shanghai, Tianjin, Guangzhou, and HongKong, January '934 1.

^a Denominated in thousands of Chinese yuan.

^b Formerly known as Tientsin.

^c Formerly known as Canton City.

^d Number of Hong Kong dollars per 100 Chinese yuan (fapi from November 1935).

Sources: Chung-kuo k’o-hsueh yuan (1958, pp. 109-110, 112-113); Young (1971, pp. 477-478, 480).

to smuggling activities, the Chinese policies do appear to have been effec­tive in slowing the rate of currency appreciation and, in turn, limiting the degree of deflation experienced in China. Up until the Chinese author­ities’ intervention in October 1934, the rate of exchange with the Hong Kong dollar remained steady at around 0.9 Hong Kong dollars per Chinese yuan (Table 5.4). However, the Hong Kong dollar then appreciated by 25% until the exchange rate reached 0.68 Hong Kong dollars per Chinese yuan in May 1935. At the same time, Hong Kong’s deflation worsened relative to that experienced in Shanghai and other Chinese cities (also shown in Table 5.4). Hong Kong wholesale prices dropped by 25% between October 1934 and August 1935, while Shanghaiwholesale prices droppedby just 4% over the same period - and Tianjin and Guangzhou recorded declines of approximately 1% and 10%, respectively.

The underlying problem of soaring silver prices remained unsolved, how­ever, and Chinese pleas for moderation in the scale of US silver purchases failed to bring about any significant change in US policy (cf. Young, 1971, pp. 223-229). The continued silver drain from China was reflected in British imports of over 85 million troy ounces of silver from Japan and approx­imately 73 million ounces from Hong Kong during 1935 (T’ang, 1936, p. 115). Given that Japan’s own silver production was negligible, and Hong Kong’s nonexistent, the lion’s share of this silver almost certainly originated in China¹¹ - with the United Kingdom then shipping the silver on to the United States.^{[81] [82] As if the silver drain, deflation, and business slowdown were not enough, further pressure on the government stemmed from a renewed rise in bond yields in 1935 as the sustainability of China’s financial situation became increasingly in doubt.}

China’s Minister of Finance Dr. H. H. Kung had recognized “at the outset that the remedy adopted in October 1934 could only be temporarily effec­tive; it was not a fundamental solution.”^[83] In an attempt to finally bring the deflationary silver drain and its accompanying financial pressures to an end, the Chinese government delinked its currency from silver. Under the terms of the decree of November 3,1935, all silver in circulation was nation­alized and new notes issued by the three government banks (the Central Bank of China, Bank of China, and Bank of Communications), with only limited silver backing, became legal tender. The three government banks were authorized to buy and sell foreign exchange in unlimited quantities in order to maintain exchange rate stability relative to the pound sterling and the US dollar, assisted with the boost to foreign exchange reserves arising from the sale of 50 million ounces of nationalized silver to the United States between December 21,1935 and January 7,1936 (Young, 1971, p. 241). The stability in the exchange rate with the US dollar through mid-1937 can be seen in Figure 5.2, before war with Japan initiated an ever-worsening spiral of currency depreciation.

China’s final break from the silver standard was quickly followed by Hong Kong. The Colonial Government imposed an embargo on silver exports on November 9, 1935, and, on December 5,1935,

the Hongkong Legislative Council passed an Ordinance providing for the with­drawal of all silver money in the Colony, for the creation of an exchange fund, and for the amendment of the law relating to legal tender.

Hong Kong’s note issuing banks were required to surrender all silver coin and bullion that they had been holding to back their note issue, receiving in exchange certificates of indebtedness equal to the face value of the notes covered. The currency was henceforth backed by the pound sterling rather than by silver, with the Exchange Fund holding a fixed amount of sterling credits against the issue of paper currency by HSBC, the Chartered Bank of India, Australia, and China, and the Mercantile Bank of India.^[84] The Hong Kong dollar and the new Chinese fapi were both, in fact, pegged against the pound sterling in December 1935.^[85] As shown in Table 5.4 and 5.5, the Hong Kong dollar was initially set at an approximate 10% premium to the Chinese fapi, following which the Hong Kong authorities made a series of adjustments aimed at bringing the two neighboring currencies

Table 5.5. Monthly Silver Outflows and Wholesale Prices in Shanghai, Tianjin, Guangzhou, and HongKong, January '936 june 1937

^a Denominated in thousands of Chinese yuan.

^b FormerlyknownasTientsin.

^c Formerly known as Canton City.

^d Number of Hong Kong dollars per 100 Chinese yuan (fapi from November 1935).

^e Actual value limited to +226 yuan.

Sources: Shen (1941, p. 32); Young (1971, pp. 478, 480); Chung-kuo k’o-hsiieh yuan (1958, p. 113).

closer to parity (Tamagna, 1942, p. 115). The premium was down to around 3% at year-end 1936.

Deflation ended in both China and Hong Kong soon after the abandon­ment of the link with silver. As shown in Table 5.5, Hong Kong wholesale prices, after remaining below their 1926 base of 100 throughout 1934 and 1935, finally rose above that level in March 1936 as part of an ongoing refla- tionary trend. The three Chinese cities depicted in Table 5.5 also evidenced gradual, but sustained, upward price movements between November 1935 and the outbreak of war in mid-1937. Interestingly, however, wholesale prices in Guangzhou, which is located in the southern Chinese province of Guangdong (formerly Canton) neighboring Hong Kong, appear to follow a trajectory more similar to Hong Kong’s wholesale price series than to those of the other more northerly Chinese cities. Guangzhou experienced steeper deflation than the other Chinese cities in 1934-1935, and, like Hong Kong, its wholesale price index did not return above its 1926 base until several months into 1936 - in April for Guangzhou versus March for Hong Kong.^[86]