Quantity Theory in Chinese History

Yesterday Yaohua Li of the Shanghai University of Economics and Finance presented her research on "The Goal of Private Pensions" at the Berkeley Economic History Lunch. After her presentation, I have a new-found tremendous admiration for anyone brave enough to study Chinese economic history. The data challenges are huge-- and so are the potential rewards for anyone diligent and resourceful enough to confront them.

Li is studying the differences in the private pension systems that arose in the United States and China in the 1920s and 30s and trying to understand why the systems developed the way they did. It is not too hard to find data about pension plans in the U.S. in that era, but for China, due to political constraints, no one has been able to collect such data before. Li is doing it totally from scratch. (As someone who has always been able to download my data straight from the Internet, I am blown away!) Her research is too preliminary for me to share results here, but she did bring up an interesting episode in monetary history that I would like to discuss.

In 1934, the United States passed the Silver Purchase Act and as a result began importing significant volumes of silver from abroad, particularly from China. China was on a silver standard, so as its silver flowed abroad, its money supply shrank. Exactly as Anna Schwarz describes, the shrinking money supply caused interest rates to rise. China was relatively unaffected by the Great Depression in 1929-- that depression rampaged the countries shackled by "golden fetters," which transmitted a monetary contraction in the United States and France around the world. But depression hit China in 1934, concurrent with the decline in its silver money supply. Just as the gold standard countries were forced off of gold in the late stages of the Great Depression, China left its silver standard in 1935.

I wanted to know more about what happened next with China's money. Research is substantially limited because of data restrictions, exacerbated by the Pacific War beginning in 1937. There is a 1954 paper by Colin Campbell and Gordon Tullock which includes as its first footnote, "The personal observations of Mr. Tullock have provided the principal data for this study. He was in Tientsin as a Foreign Service Officer from 1948 to 1950." They describe how the Nationalist, Communist, and Japanese governments in China all issued their own currencies and engaged in "monetary warfare," each prohibiting the use of the others' currency beginning around 1938.

In Free China, with the Japanese invasion in 1937, the government increased bank credit as a means of war finance. Campbell and Tullock were up on their quantity theory. From 1937 to 1938, the government was able to expand the money supply faster than prices rose. But in 1938, "people evidently began to realize that prices would rise continuously. As soon as they tried to hold smaller cash balances because they expected inflation, velocity increased sharply...In 1938-44 and in 1946-47 wholesale prices rose more rapidly than the money supply." This is a textbook-example-worthy case of Milton Friedman's distinction between the short run and long run.

In 1988, the Chinese authorities were worried about double-digit inflation and remembered how perfectly Friedman's theories described their own history before 1949. They sought Friedman's advice and apparently followed it, bringing inflation down to acceptable levels.