Foreign Relations of the United States, Diplomatic Papers, 1942, China

893.51/7423

Document Prepared in the Department of State⁸⁶

[Washington,] February 12, 1942.

The problem is to find some way of using in whole or in part the $500,000,000 credit authorized for China to bolster up the Chinese monetary and fiscal system in spite of the disruption of commercial and financial intercourse which normally functions as the channel through which such international assistance is made effective. Whatever psychological benefit can be derived from the credit has probably already largely been realized. Broadly speaking the tangible benefits which may be realized from the foreign purchasing power made available to the Government of China would appear to derive from its use for the purchase of imports or its sale to residents of China in exchange for domestic purchasing power. China, for the foreseeable future, cannot effectively use for imports the foreign exchange resources already available to it. The only effective way of using its dollars immediately would appear to be by their sale to residents of China or as a guaranty for the repayment in dollars of the principal of an internal Chinese loan.

The first would have the advantage of promptly supplying the Chinese Government with local funds from a source other than the printing press. Such a plan might be effected by having the Stabilization Board of China through designated banks undertake sales of dollars in the open market. It might also to some extent increase the exchange value of the yuan vis-à-vis the dollar and might at least to a limited extent operate as a psychological factor against further increase in the price level. On the other hand it would in effect simply permit a flight of private capital from China—capital which no doubt has in large part been accumulated from the easy speculative profits which inhere in a highly inflationary situation. The possibilities of graft and the abuse of such a system need hardly be elaborated nor the obvious fact that if the dollars were sold merely against additional issues of yuan the net result will merely have been a complete waste of the resources made available to China to the profit of the fortunate few who were handed good American dollars as practically a free gift.

The second suggestion, the use of dollars to guaranty the Chinese internal issue may be somewhat less subject to abuse but would I believe be materially slower and technically more difficult. A plan of this type might be put into effect by placing a part of the dollars available from the credit in a special trust fund to be used for meeting the principal of Chinese internal bonds at maturity. Such a fund might in the interim be invested in interest bearing United States Government securities. Interest on the obligations might be payable in yuan of a fixed amount or might be a variable amount of yuan determined by the official rate between the dollar and the yuan. Although I do not know how it would appeal to the Oriental mind consideration might be given to the issuance of a Chinese security comparable to United States Defense Bonds; that is a security which would not bear coupon interest but which would sell at a discount from the stated amount in dollars due so many years in the future.

Both of the foregoing have the objection that Chinese nationals will come out of the war with several hundred millions of dollars of putative claims against American goods, services or investments and these largely in the hands of persons who are very probably on the whole rather indifferent to the economic welfare of China. In as much, however, as it is doubtless this class of Chinese who already possess the largest amount of yuan, any plan involving the acquisition of yuan from the public at large can hardly avoid this dilemma.

A fuller discussion of the foregoing matters is continued in the attached excerpt from a memorandum on the general problem of financial assistance to China which was prepared on December 31, 1941.⁸⁷

[Annex]

[Washington,] December 31, 1941.

III. Possible Mechanism of Assistance by the United States

The most practicable methods of assisting China to cope with its internal financial difficulties appear to be (a) some sort of guaranty of a Chinese internal loan which might permit the Chinese to acquire currency from the public rather than by adding to that already in circulation or (b) the sale of dollars by the Stabilization Board of China against yuan which could be loaned to the National Government to finance its expenditures. The first expedient has been suggested by both Arthur Young and Sir Otto Niemeyer. Sir Otto mentioned the matter to Mr. Cochran when the latter was in Chungking. Sir Otto suggested the possibility of the Chinese Government issuing an internal gold loan for a period of approximately fifteen years secured pro forma on customs revenue after existing loans; repayment to start five years hence and principal but not interest to be guaranteed as to one tranche by the British Government and as to the other by the United States Government; the amount not to exceed $40,000,000 for each tranche. Sir Otto put this forward tentatively with the remark that he might wish to submit the latter to his Government for consideration. Telegram 516 from Chungking⁸⁸ indicates that he has already done so and Sir Frederick Phillips of the British Treasury who is here in Washington has heard of it and has mentioned it to Mr. Cochran. Apparently the scheme has not been formulated in detail though perhaps this matter should be checked at once with Phillips.

Mr. Young considered an expedient of this character at some length in a memorandum which he submitted to Mr. Cochran. In his memorandum Mr. Young contended that the issuance of foreign currency debt for general subscription seemed out of the question since payment on prewar foreign currency bonds was suspended early in 1939. Free issuance of such bonds he believes would be contrary to sound credit policy. He also argued that because of American freezing regulations the public would be hesitant about buying foreign currency obligations and that the issuance of such bonds might tend further to hurt confidence in Chinese currency. For these reasons Mr. Young considered more feasible some form of obligation repayable in Chinese currency at a guaranteed rate of exchange. Thus, a bond for one thousand yuan might be payable in Chinese currency at maturity on the basis of exchange for United States fifty dollars with interest payments based on the respective rates current when interest is payable. Mr. Young recognized that in a situation such as that occupied by China at present the official exchange rates were likely to be much out of line with the internal purchasing power of Chinese currency. He thought that to some degree this situation could be safeguarded as to repayment of principal by providing that it should be paid at a free market rate or if paid at official rates these should bear a premium of a fixed percentage—say 20 per cent. A similar provision might apply to interest payments with payment at a free market rate if any exists or if not payment to be at some premium over the official rates. Mr. Young pointed out that in the past the Chinese internal obligations had sold at a yield of 12 to 13 per cent. He suggested that the bonds guaranteed by the American and British Governments might be 6 per cent bonds which he thinks could be issued at par.

It may be that some such expedient as this must be used and that the matter should be explored with Treasury and with the British. I understand, however, that the Treasury has traditionally been opposed to guarantying the issues of a foreign government. It is quite possible that the Treasury might be somewhat embarrassed by having bonds which it guaranteed carry such a high rate of interest as compared to domestic issues. On the other hand, it is possible that Chinese in Free China would buy bonds at a lower rate of interest if the interest were payable either in United States dollars or yuan at some premium above the official rate. Although the dollars would be blocked over here they would give a reasonable assurance of stability in value and the Chinese Goverment might assure purchasers of the bonds that their dollar funds could be held here indefinitely in the form of bank deposits or United States investments.

In view of the difficulties which may be encountered in attempting to work out a guaranteed loan, it is possible that primary consideration should be given to the second alternative mentioned above, namely the purchase of yuan by the Stabilization Board of China. In view of present difficulties of shipping goods to China which will probably become worse before they become any better the earlier functions of the Board from the foreign exchange point of view will doubtless be for some time to come comparatively unimportant. Under these circumstances the Board might well divert a large part of its attention to internal problems and be used as an agency for supplying the Chinese Government with yuan which it has purchased with dollars. A loan of this character could doubtless be made from the Treasury Stabilization Fund without the additional legislation that might be required in an operation such as the guaranty of an internal loan issued by a foreign government.

Since few of the dollars sold could be used to purchase imports into China it is probable that an expedient of this character would in essence amount to countering the inflationary trend in China by facilitating a flight of capital from that country. The success of the operation would appear to depend in part upon the demand in China for dollars which would be blocked under our freezing control. It is possible, of course, that many Chinese might prefer to hold blocked dollars rather than hoard commodities in China particularly if the Chinese Government should concurrently undertake vigorous action against the hoarding of commodities and speculation in commodities. At the same time some consideration might be given to the advisability of allowing some fluctation in the yuan-dollar rate and some trading in dollars in an open market in Free China. This might divert some of the speculative activity from commodities to dollars. I should think it would be possible to limit any privileges of this character to persons in Free China possibly by confining them to operations effected through certain appointed banks.

It may be noted that Dr. Kung suggested to Mr. Cochran that the United States Treasury set up in the United States a new and separate fund in dollars to constitute a reserve backing for the Chinese currency. Apparently the British Government would be asked to set up a similar fund. Dr. Kung had not thought his plan out in detail but appeared anxious that we let the world know and permit him to strengthen Chinese confidence in the yuan through the knowledge of the existence of such a fund. Kung apparently did not think it would be necessary to utilize such sums but thought that the psychological effect would be sufficient. It was not his idea that such funds should be turned over to the Stabilization Board and used in the manner in which the Board was at that time operating.

I am inclined to doubt that any mere psychological gesture of this character would be effective. However, if Treasury should be reluctant to the loan with the yuan purchase plan it might be possible to combine the two by first trying Kung’s idea and by later gradually beginning the purchase of yuan if the psychological effect appears inadequate. The objection to such a compromise is that it would do little to put the Chinese Government in immediate funds without further resort to the printing press.

It should also be noted that the Department has just been informed (telegram No. 548 from Chungking, December 30⁸⁹) that Chiang has asked for a loan of one billion dollars from this country and Great Britain. Apparently there is an intent of using this in part in some unspecified way in connection with an internal bond issue.

As pointed out above neither of the expedients suggested will be of much assistance unless the National Government and note issuing banks follow policies which do not negative the effect of United States assistance. Both of these plans, of course, are also subject to the objection that they may induce an influx of yuan from Hong Kong, Shanghai and other areas of occupied China into Free China. Such an influx can doubtless be engineered at any time by the Japanese but so long as the price level in the interior is well above that on the coast the influx will be not so easily effected as if there were also a purely financial inducement operating. The Japanese may, of course, demonetize the yuan in occupied China at any time it suits their purposes. In the circumstances it would appear desirable that China give immediate consideration to the possibility of itself demonetizing national currency in circulation in occupied China. There are, of course, considerable difficulties in effecting such a plan. Presumably outstanding notes in occupied China would have to be validated by some sort of a stamp which could not be readily copied or counterfeited. Alternatively the old currency would have to be exchanged for a new issue. In view of Sir Otto’s suggestion that the National Government assume immediate control over all bank notes and bank note paper in China, replacement of old notes by a new issue might not be feasible. There is also the further difficulty that demonetization of the yuan currency in occupied China might cause serious losses both to the native population and to foreign institutions and banks. Since the Chinese Government has long resisted to the best of its ability the supplanting of the national currency by currency issued by the invader and his puppets such a move might be politically difficult to make. I believe, however, that there are supposed to be some eight billions of yuan in the Shanghai area. If this money should pour into Free China the inflationary process would of course be greatly accelerated and this danger may well outweigh other considerations.

86. Forwarded on February 12 to the Chief of the Division of Far Eastern Affairs (Hamilton) by the Chief of the Financial Division (Livesey) with the notation, “Several copies of the attached anonymous document of unacknowledged paternity have appeared in FD and are available on request”.
87. Extract infra; original memorandum missing from Department files.
88. Dated December 21, 1941, 10 a.m., Foreign Relations, 1941, vol. v, p. 766.
89. Foreign Relations, 1941, vol. v, p. 768.