Dilemma of the Silver Standard Economies: The Case of China

[Acknowledgment]

The author thanks Boris Blagov, Michael Funke, Cheng-chung Lai, and Hao Weng for helpful discussions. The author also thanks coeditor Kent Kimbrough and two anonymous referees for their comments and suggestions. Financial support from Taiwan's National Science Council NSC99-2410-H-007-024-MY2 is acknowledged.

If the external price level is unstable, we cannot keep both our own price level and our exchanges stable. And we are compelled to choose. ... Our conclusions up to this point are, therefore, that, when stability of the internal price level and stability of the external exchanges are incompatible, the former is generally preferable; and that on occasions when the dilemma is acute, the preservation of the former at the expense of the latter is, fortunately perhaps, the line of least resistance. (Keynes 1923, pp. 154-5, 163-4)

1. Introduction

China had a silver standard until November 1935. The Chinese people accumulated silver as wealth, and banks kept their reserves in silver and also balanced interbank accounts in silver. In the cities, banknotes circulated along with silver dollars. Exchange rate commitments implied in the silver standard anchored monetary policy and the Chinese inflation rate. It was believed that the free silver standard of China acted as a natural check on the excessive issuing of notes by warlords and local governments. Excessive issuing of banknotes usually resulted in depreciations of these notes and created strong public resistance to accepting them. Reflecting on the prewar Chinese inflation experience, Chang Kia-ngau, then a leading figure in the Chinese banking, wrote, "Had it not been for the public demand for redemption in silver, the predatory attitude of government authorities toward the banks would have brought about violent inflation earlier than it finally occurred" (Chang 1958, p. 5).

Subsequent authors accept this view of the Chinese silver standard (Chen, Chou, and Tsaur 1979; Wang 1981). For example, Shiroyama (2008) emphasizes that the currency's linkage to silver limited the Chinese government's ability to manipulate the monetary system. Cho (2009) provides several examples demonstrating that government attempts to issue inconvertible notes as a means to finance deficits were repeatedly defeated by the public demand for redemption in...