Foreign Relations of the United States, 1947, The Far East: China, Volume VII

893.00/7–1847

The Director of the Office of Far Eastern Affairs (Vincent) to the Secretary of State

Washington, July 18, 1947.

Dear General Marshall: The real purpose and body of the attached memorandum is to be found in the 5th and final Section, Currency Reform; and the specific problem raised is that of a reintroduction of silver into China as a medium of exchange. This Section of the memorandum adds nothing to what we already know. As a matter of fact, we have much more precise information from Sol Adler in Nanking. The Treasury experts continue to take a dim view of the project. They do not consider it feasible. As a layman I am still for it and wish that some way could be worked out to put it into effect. I find also that most of the old China business hands with whom I have talked favor the proposal. Some form of American supervision would be necessary if we gave China a large silver credit to assure that it did not fall into the hands of large speculators and hoarders in Shanghai but actually went into the interior to loosen up the flow of goods to the seaports. Jenkins of Treasury, who is accompanying Wedemeyer,¹² will no doubt report on the matter.

I am of course in hearty disagreement with the statement in Section 1 (c) that “one and a half year’s time was lost to these futile efforts to prevent civil war in this country”. I am quite sure that conditions in China would have been much worse had there not been during 1946 a relative lull in military activity. Although little has been done, the Chinese Government is more alive now than it was then to the need for putting its house in order. Had there been active civil war in the early part of 1946, I seriously doubt that the 250,000 Russian soldiers in Manchuria would have withdrawn. And, unless we were prepared for total involvement in the civil war on the side of Chiang, I do not believe he was any more capable then than he is now of eradicating the Chinese Communist army from north China.

With regard to Section 2, I would comment that Chiang’s popularity is decreasing. Butterworth supports this view. But it does not follow that he should be replaced. Disintegrative forces in China are always stronger than integrative. Chiang has been fighting a losing battle primarily because he has been, it seems to me, playing the wrong game with the wrong cards. I do not believe he realizes the extent to which the relative unity achieved by him before and during the war was due to two factors: (1) the pressure exerted by Japan and (2) the healthy financial and economic situation which made it possible to attract provincial loyalty. The financial strength of the Nanking Government, which it used to bring unity, has always been in the Yangtze River area. Outlying areas have been, generally speaking, liabilities. If Chiang goes, the disintegrative trend will be speeded up because there is no strong man or group to succeed him. If he stays he may be able, with our assistance, to improve his position in the Yangtze River area from a financial and economic standpoint and cut some of his liabilities in outlying areas. There is a somewhat oblique approach to a solution of this kind in Section 4 (a) of the memorandum which suggests that in the area south of the Yangtze “greater power should be vested in provincial governments so that governors may have a freer hand to improve their fiscal administration, to balance their budgets, to make necessary agrarian reforms, etc.”

I agree with the main thesis in Section 3 that “the prospect of peace with the Communists is not very hopeful” and I might add one more reason to those given; namely, the inability of the National Government to visualize the problem in terms of a social as well as a military contest.

With regard to general policy on the question of economic aid to China I tend more and more to the belief that, while continuing efforts to contain the spread of Communism in China without becoming directly involved in the civil war, the grass roots and strength of our relations with China over the past 100 years derive from American commercial and cultural activities in the country. With this thought in mind, I believe we should do all that we reasonably can to strengthen American business and cultural enterprise in the country. Specific projects should be considered in the light of their relation to strengthening American business in places where we may reasonably expect operations not to be completely at the mercy of the vicissitudes of civil war or of the vagaries of the present National administration. If we can build up enclaves of increasing American influence in such places as Shanghai and Tsingtao, the effect might gradually spread and be beneficial to wider areas and perhaps lead the way to more extensive economic assistance which we would then be able to justify in the eyes of the American people as sound American policy. This will take time; and the question is whether time is on our side; whether we have time. I am inclined to think we have because the Russians do not seem anxious to move aggressively and precipitately into the morass of China. They may realize the difficulties of playing hockey in a marsh.

Manchuria, of course, is a more urgent problem. There is no need crying over the mistakes of the past. But I believe that if Chiang would modify his desire to achieve unity based upon the complete authority of the National Government and would make a practical and sincere attempt to gain the support of the old Manchurian leaders and the Manchurian population, he could at least move in the direction of improving the situation in Manchuria. After all, Chang Tso-lin¹³ may have been a thorn in the side of intramural Chinese Governments for 20 years because of a semi-autonomous position; but he was also able to operate in a manner which modified the aggressive tendencies of the Japanese and the Russians and which maintained him in control.

J[ohn] C[arter] V[incent]

[Enclosure—Memorandum]¹⁴

1. Factors leading to the present chaos:

(a) Privation as the result of eight years of war against the Japanese.

(b) Development of the Red influence in North China in the course of the war.

(c) Too much optimism after the war. Peace negotiations during Marshall’s mission, the preparations for the National Assembly and the Coalition Government, etc. held many things in abeyance and prevented the Government from paying necessary attention to such important problems as the improvement of Government administration, finance and monetary policy. About one and a half year’s time was lost to these futile efforts to prevent civil war in this country.

2. Factors essential to stability in China:

Political unity, maintenance of the social economy and of regular economic relations with countries abroad are the three most important requirements for a peaceful and stable China.

Towards the objective of political unity, which is most important not only to China herself but also to the Far East as a whole, the Chiang regime has made an important contribution. There has been two versions with respect to the present regime. Although some think that the absence of the Generalissimo from the Government may improve conditions in China, the majority of the Chinese people believe that, before the completion of the constitutional machinery, Chiang’s absence will bring greater chaos to China, with peace to be regained only after a long period of turbulence. Without the Generalissimo, there will likely be a united Communist regime in North China vis-à-vis a disunited non-Communist government in the South.

Thanks to the agrarian system in China, the economic system of the country has never been impaired despite the repeated changes of dynasties. But the situation is somewhat different under the present conditions where a system of managed curency is used.

When the people loses confidence in the currency, their confidence in the Government will also be lost. The loss of confidence among the rural populace will mean interruption of trade between cities and rural areas. There will be no agricultural supplies for the metropolitan areas and little trade with countries abroad.

3. Peace with Communists:

The prospect of peace with the Communists is not very hopeful because of (1) the different ideology of communism, (2) the deep-rooted hatred between the Communists and the Kuomintang Party, and (3) the dominance of the Soviet influence over the Reds in China.

A temporary truce with the Communists might be attained if, and only if,

(a) China can meet the demands of Soviet Russia, particularly an exclusive interest in Sinkiang and Manchuria, or

(b) the Central Government can win a few strategic victories so as to ensure a definite superiority over the Reds, or

(c) the Central Government can yield unconditionally to the terms of the Communists.

4. Will the Chiang Government be able to prevent the expansion of the Communists in China?

The bulk of the people in China is in favor of the Central Government because (1) they are afraid of a radical revolution and (2) the experience of those who have been in the Communist areas have not been pleasant.

In order to consolidate its position among the people, there will also be several important conditions which the Central Government must fulfill:

(1) On the political and military side, the Government must adopt a bold and determined policy. This will include the following points:

(a) The area south of the Yangtze River will be designated as an area for economic reconstruction and industrial development under the following conditions:

(i) Civil personnel will take charge of the provincial governments to replace the military men who are now holding a great number of these posts.

(ii) Greater power should be vested in the provincial governments so that governors may have a freer hand to improve their fiscal administration, to balance their budgets, to make necessary agrarian reforms, etc.

(iv) [(iii?)] Peace and order in this area will be maintained by militia and police forces rather than regular combat units.

(b) The area north of the Yangtze will be designated as a pacification area, in which more power should be given to the military personnel before the Communists are cleared up. In the meantime, it will also be imperative to make these areas adequately provided with food and clothing so that the allegiance of the northern provinces to the Central Government may be ensured, despite the continuance of the civil war in these provinces.

(2) On the economic side, currency reform and measures to reduce the budgetary deficit are imperative:

(a) The currency reform must be undertaken in the next few months, before a total collapse in the present economic system becomes a reality.

(b) The budgetary deficit must gradually be reduced by improving the tax system as well as curtailing government expenditure. To reduce military expenditure, it will be helpful to divide the nation’s military forces into two sections: the combat units and the local militia. The former units must be well trained and fully equipped for their duty, but their number may be reduced since the areas south of the Yangtze will mainly be guarded by the militia and police forces.

5. The Currency Reform

(a) In order to ensure the flow of indigenous agricultural supplies from the rural districts and in view of the waning confidence in the paper notes among the rural populace, the use of metallic coins will probably be imperative if the currency reform is to be successful. A limited amount of gold coins and a sizeable amount of silver money will be put into circulation in the course of monetary reform. Gold and silver certificates duly backed by metallic reserve may also be used, if the technical difficulties involved in coinage prevent the use of metallic coins at the early stage of the reform or when conditions prevent the circulation of a new paper money. The size of the gold circulation will be predicated on the supply of the metal that China will be able to obtain. The coins will not be used to meet the Government deficit, but to pay wages of industrial workers and to buy agricultural supplies from the rural areas.

(b) The conversion ratio between the old fapi notes and the new money will be fixed in accordance with the market conditions at the time of the monetary reform.

(c) A currency reserve board consisting of representatives of the Ministry of Finance, the Central Bank of China, the Ministry of Audit of the Control Yuan, the Bankers’ Association, the Chamber of Commerce and other relevant associations or institutions will be established to supervise the issuance and the reserve of the new currency. Foreign advisors may also be invited to participate in the supervision.

(d) At present, the volume of the note circulation in China is about nine trillion yuan. Assume that the circulation needed after the monetary reform will double the present volume of circulation, the conversion ratio between the old notes and the new money is about 25000:1, and 50% of the new circulation is composed of hard coins and the rest of the money notes backed by a metallic reserve of 50%, the amount of silver needed will be approximately 302,400,000 ounces. At US$1.29 per ounce, the official price for silver in the United States, about US$390,096,000 will be required; and at the market rate of US$.70 about US$211,680,000 will be required.

(e) To undertake the monetary reform it will be necessary to have a loan of 302,400,000 ounces of silver from the United States. The loan may be repayable in silver in the course of a thirty-year period beginning five years after the loan is granted. To ensure the servicing of the loan, China will specify a few commodities to be exported to the United States and the proceeds derived therefrom will be used to purchase the silver for the payment of the interest and amortization of the loan.

(f) To replenish China’s depleting exchange reserve, short-term commodity loans amounting at least to US$200,000,000 will also be imperative besides the silver loan previously mentioned. In the past year, commodities valued at about US$300,000,000 totaling about three-fourths of China’s entire imports, were from the United States. They included fuel, cotton, wheat, flour, dyestuff, fertilizers, metals, pharmaceuticals, machinery and machine parts. In order to continue such imports, it is necessary to arrange commodity credits with either the Export-Import Bank or other financial institutions of the United States. These credits will have a term of not more than five years and will be strictly on a business basis and repayable, like some of the previous loans from the proceeds of specified exports from China. It is hoped that these commodity credits will be repaid before the servicing of the silver loan is started.

The above scheme of monetary reform is designed so as to:

(1) Minimize the drain of gold, which is precious in the United States or the dollar fund, which is scarce in the world market.

(2) Increase the demand for silver, which is relatively abundant in the United States.

(3) Prevent the collapse of the social economy of China.

(4) Guard through the Currency Reserve Board the credit granted by the United States from being mis-used.

It is hoped that through this monetary reform, the confidence of the people in the currency as well as political unity of the country may be restored.

12. Lt. Gen. Albert C. Wedemeyer; for correspondence on his mission to China, see pp. 635 ff.
13. Ruler of Manchuria until his death in June 1928.
14. Sent by the Secretary of State to Mr. Vincent on July 3 with a note asking for his comment on this memorandum which had come “from a very high Chinese source”.