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What Americans may learn from China's hyperinflation in the 1940s

Almost as long as paper money has existed, unbacked paper and its inflationary implications have been around.

When the dollar was "as good as gold" and many other currencies were, economists used terms like "irredeemable," "inconvertible," "unbacked," and "fiat" to describe paper money that wasn't tied to a precious metal.

There was nothing positive about any of those adjectives.

Paper money that reflects those negative connotations is now commonplace. As they grumble about the growing prices of fiat paper, most people today do not envisage a viable alternative that is related to a metal. The streets are sodden, and it's as if we're perplexed about the source of the moisture.

The market, as if on cue, creates a way out of the government's paper quagmire. Recently, Bitcoin has even proven to be an escape route from socialist Venezuela's hyperinflation.

America’s first experiment with fiat money (Massachusetts, 1690) did not go well. A century later, the Second Continental Congress printed until its paper money became “not worth a continental.” For readers interested in those and other stories of inflation, I compiled two free eBooks, one titled When Money Goes Bad and the other titled America’s Money: A History.

In this short article, my main point is that unbacked paper and its inflationary repercussions are almost as old as the country that invented paper money—China. Its lessons are largely the same as those learned from the world's many other fiat paper experiences.

Paper money originally appeared in China in the 11th century B.C. during the Song Dynasty. It was "backed" and "redeemable" since it was made of mulberry bark and acted as a receipt or substitute for the real thing (gold and silver). Later administrations, on the other hand, misused it by over-issuing the paper and cutting it off from precious metals.

For example, legendary traveller Marco Polo recounted China's 13th-century paper inflation from personal experience. In The Travels of Marco Polo, he wrote:

All these pieces of paper are issued with as much solemnity and authority as if they were of pure gold or silver; and on every piece a variety of officials, whose duty it is, have to write their names, and to put their seals. And when all is prepared duly, the chief officer deputed by the Khan smears the seal entrusted to him with vermilion, and impresses it on the paper, so that the form of the seal remains imprinted upon it in red; the money is then authentic. Anyone forging it would be punished with death. And the Khan causes every year to be made such a vast quantity of this money, which costs him nothing, that it must equal in amount all the treasure of the world.

The greatest hyperinflation in all Chinese history occurred less than a century ago. It played a huge role in the collapse of the Nationalist government of Chiang Kai-shek and the ascendancy to power of Mao Zedong and the Chinese Communist Party in 1949. According to entrepreneur Jay Habegger,

Between 1935 and 1949, China experienced a hyperinflation in which prices rose by more than a thousandfold. The immediate cause of the inflation is easy to isolate: the Nationalist government continually injected large amounts of paper currency into the Chinese economy. The monetary expansion was so severe that during World War II, Nationalist printing presses were unable to keep up, and Chinese currency printed in England had to be flown in over the Himalayas.

The Chinese money supply stood at about 3.6 billion yuan when war broke out with Japan in 1937. By 1945, it had soared to 1,506 billion. Economist Richard Ebeling explained the price effects of this hyper-expansion:

As one very rough indicator, we can use the wholesale price index of Shanghai during this period, with May 1937 equaling 1. By the end of 1941 the Shanghai wholesale price index stood at 15.98. By December 1945 it had reached 177,088, and by the end of 1947 it was 16,759,000. In December 1948 the index had risen to 36,788,000,000, and in April 1949 it was at 151,733,000,000,000.

The government of Chiang Kai-shek desperately “fought” runaway prices by recalling and reissuing paper notes, proclaiming the new ones to be tied to gold even as it forced citizens to turn their gold in to the regime (as Franklin Roosevelt did in 1933). But the promise to pay proved little more than a renewed license to cheat, as the astronomical numbers cited above strongly suggest.

A gripping account of the hyperinflation and the communist takeover can be found in Helen Zia’s recent book, Last Boat Out of Shanghai: The Epic Story of the Chinese Who Fled Mao’s Revolution.

Money began as a medium of transaction in the marketplace. Governments, sooner or later, love to seize control, monopolize it, and then debase it to satisfy their spending appetite. In the confusion, prices rise, savings dwindle, and economies crumble.

It's a classic tale. It's a fight we're still fighting today. Neither China nor America, nor any other country, is immune to history's and economics' age-old verdict: print too much money, and it goes to hell.


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