Memorandum by the Assistant Chief of the Financial Division (Luthringer)

Possible Steps by This Government Which Might Contribute to the Amelioration of China’s Financial Difficulties


Recent reports from China indicate that the monetary and financial condition of that country is going from bad to worse. I do not think that anyone in this Department who was concerned with the recent extension of $500,000,000 of financial assistance to China ever had any illusions that any assistance which this country under existing circumstances could extend to China would do any more than retard the rate of deterioration of the Chinese fiscal and monetary position. It is probably inevitable that until such time as shipping and military considerations make possible closer economic contact between the United States and China this Government will be able to offer little or no real economic or financial assistance to China. The extent to which the problem can be solved will depend almost entirely on the ability of the Chinese Government itself to implement measures of [Page 510]amelioration. So far it does not appear that that Government has given much cause for optimism in this regard.

A recent telegram from Chungking states that in the two month period from the end of December to the end of February the circulation of fapi and deposits in government banks had each increased about ten per cent. During the same period the Chungking wholesale price index advanced from 2,700 to 3,000.

Recent reports from Chungking mention “the shortage of currency”, a characteristic and bad sign in a progressively inflationary situation. Apparently the Chinese are seeking to “correct” this condition by substitution of Chinese Government securities for the fapi acquired and held by the Stabilization Board against the sale of dollars. Another “corrective” measure would seem to be the putting into circulation by the Ministry of Finance of a quantity of customs gold unit notes apparently to a fapi value of 2,000,000,000 yuan. It is of course unlikely that the Chinese Government will be able to avoid securing the major part of its revenues from additional issues of fapi. I fear that the only ultimate check on this is a shortage of bank note paper referred to some months ago by Sir Otto Niemeyer51 and even this check can largely be offset by increasing the denomination of the notes.

It will be recalled that there was some hope that by using part of the financial aid from the United States as collateral the Government of China through the mechanism of dollar guaranteed savings deposits and bonds would be able to obtain some of its revenues from the savings of the people rather than from the printing press. Our reports, however, indicate that the savings deposits scheme has had very disappointing results and our Embassy is not very optimistic as to the success of the proposed special bond issue. Our Embassy has pointed out that two of the principal difficulties seem to be (a) the fact that Chinese investors do not trust their own Government to see to it that they get the dollar security which is supposed to be offered to them and (b) that the profits to be had from speculation and trade in the existing inflationary situation are so large that the supposed inducement of stability of value offered by the savings deposits appears the less attractive alternative. A further difficulty which may be shortly corrected seems to arise from the fact that the dollar secured savings deposits are purchased at the rate of 20 yuan to the dollar whereas dollars can be bought officially at 18.8 yuan to the dollar. This particular difficulty will, I believe, shortly be ironed out by lowering the official rate to 20 yuan to the dollar.

There seems to be however, considerable divergence of opinion as to the extent to which the yuan should be devalued. While it appears [Page 511]likely that the devaluation will be only to 5 cents there is apparently on the part of Kung and some others a view that the yuan should be devalued to 4 cents were it not for the fact that a devaluation of this magnitude might accentuate the rise in prices and weaken confidence in the fapi. There is also some feeling that a situation may arise in which there will be strong pressure for further devaluation from time to time to stimulate the sale of the dollar backed savings deposits and bonds.

Other difficulties seem to center around the Stabilization Board of China and the exact nature of the functions which it is supposed to perform. In part these difficulties arise from what appears to be an increasing impatience of China with respect to any form of outside control. As evidences of this attitude I would cite:

The attitude of Soong and his Government that our recent financial aid to China was completely without conditions and control by this Government of the uses to which the funds were to be put.
The alleged desire of certain officials of the Chinese Government to have our freezing control lifted with respect to China.
The reported strong tendency in certain governmental quarters to belittle the Board and reduce its functions. This appears in part to arise from the fact that the Board has exhausted its sterling assets and there has yet been no decision by the British to replenish these assets from the sterling aid recently authorized by the British for China. Hall-Patch has made a suggestion to the British Government that this be done but so far as I know no action has been taken. It may be, however, that confusion as to the future role of the Board rather than reluctance of the British is the explanation for this situation. I understand from Mr. Cochran52 who obtained the information informally from Sir Frederick Phillips53 that the British have indicated recently to the Chinese that they would be willing to make available funds from the 50,000,000 pound British credit for the purchase of goods in the sterling area. As I understood Mr. Cochran, this offer was made when the Chinese recently wished to purchase quinine and certain other products from India.
Although in the earlier stages of discussion of the use of part of the financial aid to China for dollar secured savings deposits and bonds it seemed to be generally assumed that the dollar collateral would be subject to the supervision or control of the Stabilization Board or some sort of an international group, the Chinese Government proceeded to launch the plan without requesting any specific advice from this Government and in complete disregard of any idea that the collateral would be subject to the supervision of anyone except the Chinese Ministry of Finance.

There also seems to be some question of revising the November 1 commitment of the Board to meet Chinese Governmental as well as personal and commercial demands for sterling and dollar exchange in [Page 512]excess of the exchange accruing to China from the proceeds of imports and remittances to China. It is apparently the view of the Stabilization Board (particularly of Hall-Patch) that the Board should not undertake to supply Chinese Governmental needs for sterling or dollars. I suppose this arises in part from the existence of the British and American financial aid and a feeling that Governmental needs should be met from these rather than from the funds of the Stabilization Board of China.


It is probable that under the circumstances any action which this Government can take will center around advice to the Chinese Government with a view to stimulating that Government to undertake the most energetic counter inflationary measures possible within the limits of its administrative competence. It is doubtful that from this distance we can effectively advise China in detail. However the main lines along which China should proceed seem clear and have already been indicated to the Chinese Government by various advisers in China. It may be that we can stimulate China to take further action along these lines or at least indicate to that country that the solution of its difficulties will depend primarily on China itself and that the recently granted United States aid can by no means be regarded as a substitute for energetic measures on the part of China itself.

It seems highly improbable that effective steps are being taken to prevent banks in China from financing hoarding and speculative trading. A suggestion that effective measures of control in this area be adopted was made last December by Sir Otto Niemeyer. So far as I know the Chinese Government has not actually undertaken to implement these suggestions although a recent telegram reports criticism of the banks by the Generalissimo of a vigorous but not very specific nature.

It is also not clear that the Chinese Government is doing all that it could in controlling by rationing or otherwise the use of commodities essential to the war effort or has made much progress in solving problems of hoarding. It is of course unlikely that China could adopt a very effective general price control or excess profits tax, however, I have seen little indication that anything has been done to implement Sir Otto Niemeyer’s suggestions that a report be made of available supplies of essential war materials and the use of such materials be controlled.

Both Sir Otto Niemeyer and Ambassador Gauss have suggested stimulation of small scale or handicraft production of necessary goods. It is doubtless highly desirable that vigorous action should be taken along these lines but as a counter inflationary measure the results will, [Page 513]of course, be realized slowly. Ambassador Gauss has also suggested using part of our aid to China to finance redistribution of land in accordance with a land reform which has long been contemplated. It may be that this is highly desirable from a political point of view but it is dubious that reforms of this type should be pushed now when the budgetary position of China is so unsatisfactory.

It is possible that consideration should be given to the desirability of placing the dollars securing the savings deposits and projected bond issue in the hands of trust companies or an international group of trustees. With respect to this matter, however, it must be borne in mind that so long as China has an exchange control it will always have the power to decide the rate at which residents of China may convert dollars into yuan. This being the case it is possible that the trusteeing of the dollar collateral will not afford sufficient additional protection to appeal strongly to the Chinese people particularly in the face of the highly profitable uses to which yuan can be put in China. Moreover, China already having developed and begun to put into effect its own plan it might be politically difficult both for us to approach the Chinese Government about the matter and for China itself to make any change in the indicated direction.


As suggested above China has already received plenty of sound advice as to the general type of measures which are necessary. Moreover there are doubtless several competent advisers in China (e. g. Arthur Young54) or officials in the Chinese Government itself who are in a position to make sound detailed recommendations. The Chinese, however, apparently give little weight to the advice of Mr. Young in these matters and have obviously paid little attention to the suggestions of Sir Otto Niemeyer. To put the matter bluntly, there seems to be little chance of the Chinese Government accepting suggestions of foreign advisers so long as these for political or other reasons are difficult to implement. However the chances of making effective suggestions may be to some extent increased if the advisers have considerable force of personality and are able to establish a satisfactory working basis with the Chinese. It is regrettable that in the developing crisis the American member of the Stabilization Board should be absent. It is not my understanding that Mr. Adler, who is serving as alternate to Mr. Fox, has the stature and force to serve effectively in this capacity. It may also be noted that some months ago the Chinese Government requested a central banking expert, presumably someone with federal reserve banking experience. [Page 514]Last January the Treasury indicated that it was considering this request but so far as I know no action was ever taken on the matter. It may be difficult to find a suitable person, but an able and forceful person of central banking experience might be able to do some good in China at this time providing that a suitable working basis could be established between him and Mr. Fox if the latter is to return to China.55


In view of the particular relations of the Treasury Department to most of the matters discussed above, it is doubtful that the Department would at this point wish to make any direct suggestions to the Chinese Government without clearance with the Treasury. I was informed by Mr. Southard of the Treasury Department that that Department was going to give some intensive consideration this week to the reply that should be made to some of the questions raised in recent telegrams concerning the Stabilization Board and its functions. On April 22 Treasury sent Mr. Adler a telegram56 stating that the recent cable concerning a memorandum which the Board proposed to submit to Dr. Kung is not clear and asking for Adler’s evaluation of the Board’s proposals. Treasury indicated that other questions might be answered later. It is possible, however, that if this Department asked Treasury to confer with it on the subject of the present financial situation of China we might stimulate a broader and more thorough consideration of the whole problem than would otherwise be the case. For such a conference I suggest the following as possible topics of discussion:

What should be the future role of the Stabilization Board of China.
Should we recommend to the Government of China that it delay bringing out the dollar secured bond issue until more satisfactory progress has been made with the savings deposit scheme.
Would it be desirable to suggest to the Chinese Government some means of putting in trusteeship the dollar collateral behind the savings deposits and proposed bond issue.
Should any general or specific suggestions be made to China along the lines of controlling speculation and hoarding and the use of bank credit to finance such activities.
The desirability of prompt return of Mr. Fox to Chungking.
The desirability of sending to China promptly the central banking expert requested by the Chinese several months ago.

[Page 515]


Regardless of whether or not such a conference is held with the Treasury I would like to suggest for the consideration of the Department the sending of the attached telegram to Ambassador Gauss in Chungking.56a

  1. Head of British economic mission in China.
  2. H. Merle Cochran, of the Board of Economic Operations.
  3. Of the British Purchasing Commission.
  4. American adviser to the Chinese Ministry of Finance.
  5. Notation by Alger Hiss, Assistant to the Adviser on Political Relations (Hornbeck): “I understand Fox will return as soon as he can get plane space. A. H.”.
  6. Not printed.
  7. A considerable discussion over the proposed telegram ensued between the Financial Division, the Division of Far Eastern Affairs, the Adviser on Political Relations (Hornbeck), and the Assistant Secretary of State (Berle), the idea finally being shelved on May 2 by Mr. Berle (893.51/7523, 893.51/7524, 898.51/7501a). The Department ultimately made inquiry of the Embassy in the sense of this memorandum in its telegram No. 510, June 10, 7 p.m., p. 524.