893.51/10–647: Telegram
The Ambassador in China (Stuart) to the Secretary of State
[Received October 6—8:20 a.m.]
2030. Following secret memo was handed to me by Dr. Arthur Young, financial adviser to Chinese Government, who returned to China on August 22 after an absence of 1 year. Dr. Young who has served 17 years in China is one of leading and soundest authorities on Chinese finance.
“China’s finances have deteriorated materially since departure of General Wedemeyer. Inflation has now clearly reached stage of acceleration and public are more and more inflation-conscious. While exact prediction obviously is impossible, it is advisable in my opinion to proceed upon premise that stage of violent inflation which could easily turn into collapse could begin without much warning if unfavorable events develop. Such possible events include runaway black market for foreign exchange, termination of covering balance of payments deficit because of shortage of external resources, shortage of bank notes, sharp increase of rice price and general cost of living, bad military news and strikes and Communist-caused trouble at Shanghai. Plans are being made to postpone and avert collapse as far as possible and also to deal with eventualities.
Collapse would mean some of [or] all of the following: Government could no longer finance nation-wide operations with paper money. Troops and civil offices would have to maintain themselves if at all by local requisitions where they are. There would be wholesale desertions and breakup of organizations. Regionalism would be promoted. Shock to morale would be likely to cause political crisis and drastic reorganization of Central Government with very limited authority as to area and range of activities. Anti-Communist campaign would be seriously impaired and might be suspended in many areas. Manchuria and North China might be lost. If Shanghai and other cities could not draw food and other essentials from farmers by payment with money there would be riots and bloodshed. Trade would be on barter basis and thence greatly inconvenienced and reduced. Foreign trade would be disrupted.
Total net external reserves are down to around U. S. dollars 220 millions including sterling equivalent to about U. S. dollars 15 millions. Also there is silver equivalent to about U. S. dollars 25 millions more. Government banks other than Central Bank have some external reserves but amount is exceeded by contractual commitments of Government and pre-zero import licenses now outstanding. Balance of payments deficit estimated to be at least U. S. dollars 10 millions monthly. Fall of reserves to well below U. S. dollars 200 millions would probably force revision of policy of using them to cover balance of payments deficit. This might well happen before end of year and would usher in violent inflation regardless of whether other factors have not caused an earlier crisis.
For first month under new exchange system instituted August [Page 1195] 18 the exchange market was orderly. But disturbed black market which began September 21 further hurts confidence and threatens stability. Equalization fund faces dilemma. To chase black market would put it up more and push up prices faster—Shanghai prices are up nearly 50 percent in past month. But if black market is well above open market rates, e. g. about 25 percent as now, exporters and others hold off selling exchange and export smuggling grows, thus cutting exchange receipts and draining reserves.
During first month fund committee’s receipts nearly balanced market outlay aided by considerable exports held anticipating a rate change. But in past week or two deficit has returned especially because black market rise causes exports to be held back.
Government deficit in October estimated at about dollars 3 trillions and maybe more; hence total note issue which was dollars 16.3 trillions September 26 may grow by about one-fifth. Also after settlement day which was September 29 businessmen and speculators began new plans causing faster turnover of money.
Governor Chang has denied imminent issue of larger denomination notes. Yet present deficit requires printing and issuing over 300 million pieces monthly. Larger notes must come soon despite their inflationary effect. Further large price rise would involve danger of note shortage which could have grave consequences if troops were not paid.
In order to help hold situation, equalization fund committee has urged Nanking to take immediate steps to assure Shanghai adequate rice supply, to hold back Government payments as much as feasible for a couple of weeks and to push sales of stocks of goods and of Government-owned factories. Also Central Bank is reducing and calling back credit from Government banks and enterprises. Whether sufficiently energetic action will result and whether adverse developments will offset whatever can be done is uncertain. Also agreement has been reached with Hong Kong on measures that will help control large black market there and to check smuggling. During the past month stocks of cotton yarn and edible oil have been sold to contract the money market. It has been said, ‘China is on an edible oil standard.’ But such resources are limited as stocks are reduced.
Shanghai is main danger point since prices lately have risen there more than elsewhere. Last February currency panic caused some withholding of rice and this danger could develop again. Mayor K. C. Wu is worried by strikes and states Communist agents are actively trying to cause trouble.
Some measure of American support such as help in meeting balance of payments deficit is urgently needed to strengthen confidence with view to trying to hold situation while more fundamental measures can be considered. Although basic improvement of existing financial and economic situation presents great difficulties it would be infinitely harder to build new structure after collapse and risks of passing through chaos would be incalculable.”
Main difference between Dr. Young’s analysis and that of Embtel 1967 of September 2048 is in extent of emphasis on possibility and [Page 1196] dangers of collapse. As Dr. Young rightly says, exact prediction is in nature of case impossible. Given fundamental and increasing precariousness of situation, possibility of collapse at any stage cannot be precluded though it is perhaps likely to appear greater if assessed in light of Shanghai’s hypersensitivity. As in February, mood of panic is beginning to infect high Government officials, presumably immediately caused by news from Manchuria, but again as in February Gimo still immune.
Reference in fourth sentence of first paragraph and in third paragraph of Dr. Young’s memo to possibility of termination of covering balance of payments deficit reflects not only continued depletion of Central Bank’s foreign exchange assets, but also Central Bank’s fear that Gimo may ill-advisedly and prematurely order it to cease out-payments of foreign exchange except on Government orders once official assets fall below a certain level.
With reference to silver, Gimo is still wedded to idea of using silver to pay troops with when other means of payment become unacceptable, and China is still endeavoring to obtain more silver on “credit” from Mexico. Consensus of financial opinion is that best course for China would be to dispose of her 45 million ounces of silver and that in any case if Gimo insists on retaining it there is no point in having it reminted, as old silver dollars would be more acceptable to soldiers than new silver coin and as former would be less destructive in their impact than latter.
Recommendation in first sentence of last paragraph is on the whole in line with previous Embassy recommendations to effect that judiciously timed balance of payments loans constitutes most effective method of economic aid to China.