Created: 8/17/1945

OCR scan of the original document, errors are possible

Omcz or Strategic Slavics* Research and Analysis Branch



A critical currency Inflation in China, mounting steadily during eight years of war, has seriously handicapped the Chinese war effort andomplete breakdown of China's monetary system. Primary causes haveevere shortage of imported raw materials andgoods, inadequate transportation facilities, and the Chinesepolicy of resorting to printing press financing rather than Increased taxation to cover Its wartime deficits. Hoarding andhave subsequently aggravated the price spiral.94 Chinese commodity prices increasedate averaging eight to tenonthuring the winterhe rate accelerated sharply, averagingonth at Chungking andaximum ofercent between February andy5 the purchasing power of Chinese National (CN) currency had sunk to two-thousandths of7 market rates for gold. dollars, long undervalued in relation to goods, spurted upwards. Byoincident with rumors of impendinghe price rise had reverted to the earlier rate.

The effects of the inflation on tbe Chinese people, Government, and economic life have varied widely. Dissimilar local supply and demand and totally Inadequate internal transportation have resulted inprice differences as high0 percent between major urban centers. The Impact of the inflation has been more severe In cities than in rural areasubsistence economy. Unpredictable changes In raw material costs have seriously handicapped industrial production. Opportunities for speculation have diverted the attention of wholesalers and retailers from the task of distributing available supplies when and where they arc most needed.

Only the opening of normal trade routes into China can remove the basic causes of Chinese inflation. Imports of gold, textiles, or trucks by currently limited supply routes could haveuperficial remedial effect. Of recent Government measures against inflation, the land tax in kind has been considered by some to have been the most successful. Such attempted measures as price control. Government distribution of rice and cloth, gold sales, subsidies to Industry, and adnunistratlvehave substantially failed to check spiralling prices. The rise has been soits variations from commodity to commodity and from time to tune soprice control, retail rationing, and


tbe allocation of raw materials as known in the United States haveadministratively Impossible. They will remain Impossible so long as the Government relies on monetary spending, Insufficiently backed up by taxation of those with the capacity to pay, to obtain tbe goods and services it needs.

The Course of the Inflation

Tne course of the Chinese Inflation is divisible into three periods: the first and mildest stage,7he Intermediate stage1uring "which the Inflation developed Into ominous proportions; and the critical stage beginning early

7 the Japanese seizure of eastern coastal areas and port cities cut off major overseas supply routes, almost eliminated China's most Important source of revenue, her customs duties, and denied Free China the use of Infant industries which had been slowly developing in those areasorced to retreat into the ulterior of China, the Government lost not only Its customs revenue but Its principal sources of internal revenue, salt taxes and excises. Bather thannew forms of taxation to cover its wartime deficits, theembarked on an Ill-fated policy of deliberate currency Inflation. From then until tbe endhe currency in circulation expandedimes7 total.rices which bad lagged at first were already mcreaslngaster rate than currency in circulation.

Attempts to build an Industrial base In the interior to provide for military and civilian requirements were limited In their success becauseack of raw materials, transportation, and plant capacity. With the transfer of the capital to Chungking Inactories and millions of refugees migrated to western China from the middle and lower Yangtze region, new industries sprang up, and local Industrial and agricultural production increased. These developments tended at first to hold back prices. In the summerowever, the virtual Isolation of China from the outside world resulting from the Japanese occupation of Indochina and the temporary closing of the Burma roadew Impetus to the upward trend.

During the next period14 the amount of currency in circulation doubled or more than doubled each year. Commodity prices at first roseimesear and finally more than tripledoarding and speculation Intensified the shortages of food and cloth Therereakdown of any semblance of price controlidespread growth of black markets.

As prices soared money lenders and landlords began to adopt the practice of fixing loans. Interest, and rent In kind rather than In money.1 the Government itself began collecting the land tax In grain. The substitution of graineans of payment provoked growing loss of confidence in tbe currency and ledhift from money to goodsedium for saving. Buying In advance of needs, bartering, cur-

rency speculation, and hoarding of foreign exchange, particularly United States dollars, became widespread practices In the larger cities. The levy of the land tax in kind decreased the grain supplies available to the public and was partly responsible for raising the price ofout of proportion to prices of other commodities. In Chungking, for example, food prices advanced fromercent per month9 to approximatelyercent per month

The taterrnedlate stage of the inflation camelose in the fallhe westward Japanese drive in southern China and the ensuing period of uncertaintylackening in the rate of Increase In prices, although the upward trend continued. Speculators turned to gold and United States dollars as easily transportable forms of wealth. Continued Japanese advances would have made further hoarding of goods useless, and caused losses on existing hoards. Nevertheless, the threatened loss of large and valuable areas of Free China, diminution of confidence In the Government's stability, and the threatenedof the war were enough to keep prices rising, If leas rapidly than before. In Kweiyang the influx of hundreds of thousands of refugees created demand for more than the amount of goods released from hoards and drove prices above those In any other city in Free China.

Earlyhen the military situation had been more or less stabilized, the price Index resumed its spiralew average monthly rate ofercent in some cities and nearlyercent in Kunming. Although In April and Hay the monthly rate of increase tapered off somewhat, the total rise over six months was unprecedented, amounting in many placesripling of the priceontinuing rise at the new rate would haveinefold Increase in twelve months.

The most important factor behind this development was the increase in Government borrowing to foster war production and to improve army rations and pay. New demands of the Chinese War Production Board and added demands of the American and Chinese armies cut sharply Into the supply of available goods and at the same time flooded the market with more currency. For example, rice from the collection of land taxes In kind supplemented by grain purchases proved Inadequate to cover the expanded food allowances of the Chinese Army under the new ration and pay scales of4 andhe U.rmy Services of Supply in China was asked to procure localforhinese divisions at Chinese Oovemment expense. In addition to Increasing appreciably the new currency issues, thehas considerably diminished civilian food supplies

The increase In currency In the four months from4 to5 totalledillion, three times as great ai In the correspondingear earlier. New currency Issued to. Army for its expenditures representedercent of the total new currency issued4 toercent of the new currency Issues in5 resulted from Chinese

War Production Board loans. The impact ot these expenditures on market supplies and prices, naturally most severe in the immediate region of disbursement, soon spread to other urban centers.

In addition to these factors the announcement In4 that the Stilwell Road would be used only for military supplies caused renewed hoarding of scarce commodities. Speculators transferred their attention from gold and United Stales dollars back to cotton and other goods. The loss of important cotton producing areas to the Japanese4 and the deficiency of the cotton purchase program in theproducing areas had already limited the amounts available for fabrication in the cotton mills of Free China. Ineffective threats by the Oovernment to do something about price control after Its long record of failure increased public interest in hoarding. At the same time the deteriorating price relationship of raw materials to finished goodsecline In industrial activity and an aggravation of the commodity shortage.

In5 the exceptionally violent phase of price increase came to atemporary end. Both before and after this time, rumors were beard in Chungking and Kunming of an impending stabilization of the Chinese currency. The market rate in Kunming for the us. dollar had beenn February and March, lessimesate. Similarly, the Chungking market price of gold In February wasittle overn ounce, correspondingN$-US$ rate of0 torimes the prewar rate. With commodity prices0 times prewar In various cities, thereery wide margin to attract speculative interest in goldollars. Stabilization would presumably call for an upward adjustment of the relatively low gold. dollar rates and aadjustment of many commodity prices. Meanwhile thetook steps to readjust the official gold price upward in March and again in June, though both times it failed to narrow the gap between official and market prices, which had reached significant proportions as early as

The consequenceew cycle of market developments, similar in some respects to what had happenedpeculative pressure shifted first from commodities to gold and when the Governmentofficial gold sales onune from gold to. dollar. Before suspension of sales the official gold price had been raised tond the market price had reachedetweenune anduly the market rate for dollars in Chungking rose and fell fromond back again. At the lower level, this rate wasimes the prewar rate. Meanwhile the wholesale commodity price index at Chungking, whichimes the prewar level in February, advanced3 In May and well0 by the end of June.

Regardless of month-to-month shifts In the spiral of inflation, which may at times suggest somethingtabilization of commodity prices,


when compared with more violentew months earlier, it ls clear that the price trend is still strongly upwards and that inflation of the currency is continuing at an accelerating rate. The velocity ofis increasing, though the stage has not yet been reached,in agricultural areas, where the increasing rate of circulationomplete and absolute distrust of currency.

Effects of the Inflation

The character of China's economy is to someuffer against the violent Impact of the inflation. The near self-sufficiency ofcommunities, their dependence on cottage industry, and theuse of cash rather than bank deposits in the hinterland tend to curb the effects of Inflation In rural areas. The extent to which China's agrarian economy can absorb the increasing shocks of further currency depreciation depends primarily on the rapidity of depreciation. The Government's attempts to keep the inflation within bounds now appear to be relaxing In favor of rehabilitating the physical condition of the army regardless of the monetary outlay required.

Inflation at first affected the fixed salary groups and urban and industrial laborers more drastically than the entrepreneurs or large and small landowners. After the inauguration of land taxes In kind,sales and loans to the Government, and forced contributions of grain, the burden of forced saving also fell on the small landowner and tenant fanner. Loss of land to the Japanese has necessitated heavier grain collections from remaining agricultural areas. However, the provinces where the heaviest land taxes are levied are not necessarily those with the largest crop yields. More often those nearest the regional center where the Central Government's control Is strongest and those nearest the Japanese lines where army demands are heaviest bear the largest burden. As forced crop levies increased and the currencythe peasants resorted to their age-old defense of withholding surpluses and even reducing production.

The inflationisastrous effect upon the lower ranks ofemployees, the army, school teachers, and clerical and factory workers. Their real incomes had declined by the end4 to less thanercent of prewar values. Coolie laborers fared comparatively better because theyarge percentage of their wages In rice. The effects of the failure to adjust soldiers' pay and allowances to rising price indices and of Inefficient and corrupt handling of rice rations were graphically shown in the fall4 when malnutrition andin the Chinese Army prevented serious resistance to the advancing Japanese.

The entrepreneurs and the large landowners (landlords) In China may be said to haveested interest in inflation. Although many industrialistsarge portion of their Investments as the Japanese occupied the middle Yangtze and coastal cities, they set up new industrial

plants in the interior and have been able lo take advantage ol rising prices to make up their losses. Tbe lack of an adequate Chinese Income tax absolved them from contributing their share to the cost of therom the Government's point of view their knowledge, experience, and wartime fortunes were necessary to accomplish China's IndustrialThe landlords, although they received an Initial setback because of their creditor position, have benefited mcreaslngly from their controlizable share of China's agricultural production as prices continue to rise. By fixing in kind the payment of rents, interest, and tenants' guarantee deposits, the landlords have been more than able to cover their own land taxes. In many cases, because of their local political position and influence with the tax collector, they have been able to avoidof moreominal tax, and to pass the tax burden on to the small landowners and tenant farmers.

Government officials, who were drawn mainly from the landlord and entrepreneur classes, adjusted to inflation in traditional ways. If they considered their salaries and rice allowances Insufficient, theyresorted to the acceptance of rebates or commissions oncontracts, the acceptance of gifts In return for official favors, or speculation In commodities, gold, or foreign exchange with the benefit of inside knowledge.

After the rate of Increase of prices exceeded that of currency issue, the Government became aware that gains in production would beto attain and that the maintenance of production levels would require pumping currency into the economy at an increasing tempo that would accelerate the Inflation. Most of those firms which were able to take advantage of fixed raw material costs, subsidies, taxfavorable contracts, and convenient advance payments, and were consequently able to continue operations, were Government enterprises producing almost exclusively for Government or army consumption. Some of the more essential Idle plants were taken over and Integrated with Government plants. Owners of other plants found it more profitable to turn to speculation in goods. Short of complete control of supplies and pricesundamental change in the Government's inflationary policy, little could be done to correct trie inequities affecting particular industries

Counterinftationary Measures

The Chinese Government's efforts to control Inflation have been seriously hampered by the Government's technical and administrative weaknesses and its lack of revenue sources. The Chinese people,principally to small, agrarian, economically Independent village groups, have become adept at resisting tax payments of all sorts. With inadequate tax collecting machinery, taxes must be levied where they can be effectivelyexample land taxes, excises, customs duties, and revenue from Oovernment monopolies. Furthermore, the Government's political Insecurity has necessitated the appeasement of


the landlord and warlord groups,lversfled tax policy has not been developed.

7 the Government, with varying degrees of success, has tried numerous means of controlling Inflation, including tax increases, fiscal economies, administrative reforms, measures to absorb currency from circulation, measures to improve production, transportation, and distribution facilities, reorganisation of Government monopolies, and price control and rationing of essential goods.

Excises and land taxes have been increased, but their yield4 met onlyercent of budget requirements. The land tax has been considered the most effective means of countering inflationumber of reasons. It has given theeserve of grain to feed into the marketamper on rising prices. The useortion of the collection as partial salary payment to government employees and army personnel hasouble saving. It has postponed the need for salary Increases, which would necessitate Increased currency issue, and has eliminated competitive Government purchases, which would further boost prices. Not all the effects of the land tax In kind have been salutary. With the necessity of expressing monetary values In terms of grain, popular confidence in China's monetary system decreased and hoarding resulted. Tax in kind Increases were accompanied by Increased rents on land already producing at maximum capacity. Landlords with increased rent In kind collections entered the speculative market.

Administrative and policy reforms have avoided such drasticas lncreasmg tax bases, expropriating hoarded goods,essential industries for war purposes, and strengthening the Central Bank as an effective organ for monetary management. Some logical reorganizations and shifts of function among government agencies, aimed at improving operating efficiency, have taken place.

The Chinese Government in2 began to try to reduce the amount of currency In circulation through the sale 'of US. dollar-backed certificates and later through the sale of gold. Between4 and5 sales of gold worthillion brought Inillion, while the nominal total of currency in circulation Increased by approximatelyillion. However, aome of the gold found its way Into Occupied China, where It brought an even higher price. This caused an inflow of Chinese National currency which had previously been outside the economic orbit of Free China.

When the blockade of China cut the supply of goods on the market, production had to be encouraged not only so that China could wage war against the Japanese, but also to counteract the effect of competitive bidding on scarce articles, which tended constantly to drive pricesoint of control. The prewar National Resources Commission was given additional power to foster Industrial production after themoved to Chungking. But NRC-operated concerns as well as

private factories showed little Increase in heavy industry productionartly because of the obstacles created by rising costs. The inability of the NRC to coordinate production of materials and final products and the general deterioration of China's industrial fabric led to the establishment of the Chinese War Production Board inhe Board has had some success, but the Increase In production

Its net effect has been to put added pressure on prices, directly because it created additional demand for scarce materials, and Indirectly because one of its main functions was to advance new money to contracting companies for working capital. Thus the WPB, like. Army through its construction activity, hasignificant contributor to inflation.

Oovernment "monopolies" of salt, sugar, tobacco, and matches have functioned chiefly as excise tax administrations and have not been able to increase production appreciably or to attempt general rationing. Salt prices are controlled, but the tax on this article of universalyieldedercent of total tax revenue

During mostCommodity Administration" of the Ministry of Economic Affairs undertook to purchase and resell at controlled prices important consumer goods such as cloth, paper, fuel, and vegetable oil. Its success was slight and it was abolished at the end of that year.

The Government has passed many resolutions and regulations to enforce price controls, but their effect has been negligible. Theof other urban markets from Chungking and from each other has limited the influence of Central Government efforts and left to theof local food and price control committees the adjustment of local prices according to local conditions. Price ceilings may have had some moral effect in Chungking, where the Government's influence was greatest, but the merchandising operations of the Government were on toocale and confined to too small an area to mitigate the country-wide inflation.

Original document.

Comment about this article or add new information about this topic: