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

893.50/11–1047: Telegram

The Ambassador in China (Stuart) to the Secretary of State

Nanking, November 10, 1947—4 p.m.
[Received 6:01 p.m.]

2223. Following memorandum was handed me today by Arthur Young and contains his thoughts on the critical economic situation in China and suggestions for remedial measures. It is Young’s idea that he would endeavor to persuade Chinese Government to propose measures outlined. We will comment in separate telegram⁵⁹ but meantime would appreciate Department’s reaction to Young’s proposals.

“China’s Financial Emergency and Measures To Deal With It

In this memorandum I shall summarize the main facts, set forth the nature and extent of China’s needs for external financial and economic aid, and outline certain repeated measures and action on the part of China that are necessary if TEC [aid] is to achieve the aim desired, namely, to promote stability and to further the development of a strong and independent China. In analyzing these measures and actions I have had in mind both the conditions that the American Government and American opinion may deem it wise to fix if aid is granted, and the conditions that would be in the interest of both China and the U. S. and that the Chinese Government and Chinese opinion may be prepared to accept.

I. Summary of the facts:

(1) External reserves. The position has lately become graver than China’s leaders seem to realize. Total Central Bank external reserves are below U. S. $200,000,000 for the first time, comprising as of November 8 U. S. $182,000,000 gold and U. S. $15,000,000 equivalent of sterling, total U. S. $197,000,000. Besides there is silver in China worth about U. S. $25,000,000. Other Government banks have some external holdings but the amount is exceeded by contractual commitments and pre-zero licenses outstanding plus the commitment to allow import of accumulated unlicensed goods whose value may reach U. S. $40,000,000 to $50,000,000. The estimated deficit of foreign currency receipts and payments through official channels on commercial account averages about U. S. $12,000,000 monthly. Government payments for civil and military needs have been of similar proportions. But I have just been informed of commitments for military needs totalling around U. S. $50,000,000 before the end of this year. As matters now stand it looks as if external reserves might fall to around U. S. $125,000,000 by the year end. In view of the prospective pressing need for further supplies of ammunition and gasoline, et cetera, there is growing danger the Government may stop meeting the deficit on commercial account. This would not only disrupt foreign trade but the public would take it to mean the near exhaustion of reserves. Such action may be expected to lead to panic conditions in the markets. It would be the prelude to imminent financial collapse. Moreover financial secrets are no longer well guarded and knowledge of the reserve position may leak out and cause great harm.

(2) The internal financial position. The situation is now highly vulnerable and inflation is in the dangerous stage. Prices throughout China have risen more than tenfold in the past year. The deficit covered by inflation was about $3.5 millions in each of the last 2 months, or about two-thirds of total expenditure, and is growing. Note issue exceeded $22 trillions on November 8 and increased 7 percent during the preceding week. At present the shortage of notes on hand is perhaps the most effective check on fresh issues. In such conditions the state of confidence is crucial. For the past 3 weeks hope of American aid has buoyed confidence. But fresh large supplies of money are flooding Shanghai and there are signs that a further price spurt is starting. The black market which usually snaps prices upward reached on November 8 its former top of 93,000. When rates reach 100,000 which may happen soon, that figure may have a bad psychological effect. Without careful handling of the situation and without American aid a financial collapse is unavoidable although no exact time prediction is possible.

(3) The balance of payments on commercial account. For the year ending September 30, 1948 it is estimated that the minimum deficit in foreign currency receipts and payments through official channels on commercial account will be U. S. $125 to $150 millions. The actual deficit may be larger. Imports and other out payments are figured on a basis of austerity and cannot be reduced without damage to China’s economy. Attainment of the export target depends upon promotion efforts and upon a fairly orderly foreign exchange situation and no material worsening of internal economic conditions during the period.

(4) Progress in balancing international payments on commercial account. Immediate financial difficulties obscure the fact, which is not generally realized, that in the past year China has made much progress toward a more balanced trade position. As to imports, although administration of the controls ought to be improved there is nevertheless an effective limitation of trade to essentials on a basis of austerity. As to exports China at last has a foreign exchange policy under which they can move in good volume. This policy under the regulations of last August is working fairly well so that maintenance of more realistic rates of foreign exchange is now feasible. The deficit in the trade balance is due primarily to need for abnormally large imports of raw cotton, tobacco and fuel to replace former domestic production. This production notably of cotton was cut to a fraction of the pre-war level during the war partly to prevent the enemy from getting it and partly because food crops were substituted. Then after the war the Communists were in control of important areas producing cotton, tobacco and coal. If they can be cleared from these areas and communications be restored, there is good prospect of restoring balance in China’s international transactions without much delay. Furthermore, the restoration of Manchuria’s soya bean exports, worth many tens of millions yearly, contains the possibility of providing substantial funds abroad to cover service of China’s debts and to finance a program of development. Finally, private Chinese assets abroad, which it is difficult if not practically impossible to marshal under unstable conditions, will tend to be repatriated gradually if the situation improves.

II. China’s needs for financial aid:

These needs fall under four main heads:

1. A commodity credit to meet the deficit in the balance of China’s commercial account;

2. External aid in checking inflation while internal counter-inflationary measures are being put into operation;

3. A limited number of urgent reconstruction projects; and

4. The external cost of a military program. I shall only touch upon the latter since it is predominantly military and political rather than a financial matter.

(5) Need for a commodity credit. In my opinion such a credit is the first priority to meet the emergency that is not far ahead. The Chinese Government 1 understand has not made any recent specific proposal adapted to meeting the immediate emergency because of awaiting clarification of the position in Washington. The proposed tobacco credit of about U. S. $30,000,000 would meet part of the need. But at least U. S. $100,000,000 to $125,000,000 more are needed to cover purchases of goods from the U. S. during the next 12 months. It is desirable that the proportion of expenditures for various items be elastic within agreed limits that could be worked out in negotiations, and that the credit be immediately available to meet current dollar requirements. It now appears that the main items other than tobacco and the amounts needed in the next 12 months would include: (in U. S. dollars millions)

Raw cotton	80
Petroleum products (for non-military use)	50
Timber and paper	10
Dyes and chemicals	12
Machinery and parts for current maintenance	20
Total	172

Inasmuch as it will take some time to bring the financial situation under control, even under relatively favorable conditions, the duration of any credit should be as long as feasible and early payments should be light. I may add that China has made good record in its repayment of borrowing from American Government agencies. Out of about U. S. $208,000,000 borrowed since 1931, apart from the war-time credit of U. S. $500,000,000 and lend-lease transactions about U. S. $115,000,000 or over half have been repaid to date together with all interest due thereon.

As to cotton, the estimates have been checked with Mr. Dawson, the American Agricultural Attaché. They cover payment for part of the third quota which is in course of arriving in China, part of a “top-off” of perhaps 50,000 bales needed early in 1948 by mills that will be short of specific grades, and estimated imports of about 350,000 bales beginning in April or May 1948. The Export-Import Bank in a recent communication⁶⁰ to the Chinese Embassy in Washington has indicated doubt as to China’s needs for cotton in the near future. A more detailed explanation of the cotton situation will be supplied to them as soon as the text of their communication is received here.

(6) Aid in checking inflation. Since inflation has been in progress for 10 years it is in an advanced stage. But it is essential to check it if any program in China is to be effective. Naturally no fundamental reform is possible while active and large-scale civil war continues. Nevertheless, with proper internal policies and certain external aid, inflation can be kept within manageable limits, even in spite of civil war, and the way prepared for later stability. The added confidence resulting from the act of a program of American aid would in itself tend to slow down the inflation.

The cost of an anti-inflation program would be additional to the proposed balance of payments credit—since the latter would only permit continuation of essential imports now being partly paid for from reserves. It might be advisable that funds for checking inflation be obtained as an advance against China’s share of the undistributed property looted by Japan.

Use of external funds to prevent a calamitous fall of the foreign exchange value of the currency or runaway prices should necessarily be limited, and funds should be used with care as a brake on the situation when circumstances warrant. But it is clear that at certain stages of the inflation sales of imported goods might be used to advantage as a two-edged weapon—to add to the supply of goods on the market, and to withdraw money and contract the currency. The present budget deficit is equivalent to roughly U. S. $40 millions monthly. The program outlined below calls for reducing the deficit both by economies and by development of taxation—as to which latter China has been making a not-too-bad record by covering about a third of expenditures by taxes and other non-inflationary means, not counting substantial receipts in kind (rice, wheat, et cetera). If funds averaging about U. S. $15 millions monthly could be available for use as required, it should suffice to prevent a runaway situation. It would be desirable to have available about U. S. $150 millions for 1948 for checking inflation. The need for such funds would diminish as the effects of the program of reforms would be felt—especially if the military situation improved.

(7) Reconstruction projects. These should be limited to what is essential, such as the Shanghai power development scheme and urgent railway restoration, until the finances are substantially stabilized. The cost of essential reconstruction projects may be estimated tentatively at perhaps U. S. $50 to 60 millions for 1948. This is apart from railway reconstruction in connection with a military program.

(8) Cost of a military program. Here the case might be partly for items available in the U. S. that might be “declassified” and would thus depend upon the valuation placed on them. But in addition there are current items such as gasoline. No estimate is here made as to the cost of a military program.

(9) Summary of external costs. To estimate total costs for an extended period is impossible unless an assumption is made as to the duration of the civil war. It is difficult at present to look beyond 1948. Apart from the cost of a military program, the cost to the end of 1948 of meeting the balance of payments deficit on commercial account, of a program of checking inflation, and of minimum essential reconstruction would be of the order of U. S. $350 millions. Part of this might be gotten from the undistributed property looted by Japan.

If a program like that outlined below were put into effect, it would be possible after a few months to make better estimates of the cost and duration of further aid. But costs should be on a declining scale.

The question should be considered, as is being done as regards American aid to Europe under the Marshall Plan, whether part of the aid should be non-repayable.

III. Internal measures and conditions of aid:

(10) No external program could hope to succeed unless accompanied by wise and firm internal measures. Some of the measures needed run counter to unsound but well-entrenched economic and financial ideas, and others run counter to strong vested interests. It is clear that these measures can only be taken if they go hand in hand with external aid, and if the extent and nature of external aid is coordinated with and dependent upon adoption and execution of such measures. In particular it is vitally important to reform the present military system. It is hardly necessary to stress the connection between civil war and this system, on the one hand, and the public finances and currency, on the other. In relation to immediate emergency aid, point “a” below is of special importance. The Chinese Government, however, after consideration of the entire program might be prepared to propose giving effect to it as a means of improving the situation and of best utilizing further aid. The program outlined below is partly American and, in keeping with the spirit of the United Nations, is also partly international. It is in the interest of both the United States and China, my judgment, that the program have such an international aspect.

(11) Clearly it is desirable that China adopt a program of internal measures on the following lines:

a. Foreign trade. To promote exports and improve the administration of import controls. To that end the Chinese Government to inform the American Government that it wishes to appoint an American nominated by the latter to participate in the work of the Export-Import Board. The Chinese Government should undertake to reduce gradually governmental trading, and to remove such restrictions as those on export of oil seed and oils and on private export of mineral products. While probably it would not be expedient to make any formal condition as to opening Hankow and Nanking to direct foreign trade, China should be informally urged to do this as a matter of self-help on the ground that limiting cabotage to Chinese vessels can be justified but that restricting these ports to local vessels goes beyond the general practice of nations and is a form of extreme economic nationalism that China cannot afford.

b. Taxation. It is vitally important to improve the system of taxation. The Chinese Government to constitute a Chinese-Foreign group of tax experts to devise means to improve tax laws and administration. Such a group, on the foreign side, should be international and might be nominated by an agency of the United Nations. This group should deal comprehensively with national, provincial and local taxation, including the land tax. The group should include an expert on land policy, to deal with beginning introduction of a system of land registration. Special attention should be given also to the practicability of means to tax newly-made wealth.

c. Civil expenditures. Similarly, a Chinese-Foreign group should be constituted to deal comprehensively with the system of national, provincial and local expenditures, and to devise means of reorganization on a basis of greater efficiency and economy. Economy in foreign currency expenditures should be included. This field also includes as a major item the problem of personnel training.

d. Military expenditures. Clearly any plan for military reorganization should provide for control of payments and supplies, and specific means for reforming the present military system and bringing its eventual cost to a level that China can afford. As a temporary measure, so long as civil war continues, it is important to determine what military payments are essential and how they may be met with the least damage to the financial and economic situation. Financial and economic experts should participate in determining policy in this regard.

e. Credit policy and banking. It is an elementary measure of self-help that there should be a strict control of granting of credit. Promiscuous giving of credits on the basis of political considerations and favoritism should stop, as should also the use of financial institutions like the Central Trust for primarily political ends. A survey of the position of Government banks and other financial institutions should be made in order to devise a definitive policy for the future, and with a view to gradually putting the recommendations into effect. Here also a Chinese-Foreign group should be named.

f. Currency and foreign exchange. The present foreign exchange equalization fund committee is in a strategic position to become the agency primarily responsible for current policy concerning currency and foreign exchange, and to plan and in due course to give effect to fundamental measures as conditions permit.

g. Land policy and agricultural reform. A Chinese-Foreign group should be named to work out means for introduction of such of the recommendations of the recent Chinese-American Agricultural Mission as are suitable for early introduction. Stress upon the land question and improvement of rural conditions is important as part of a program of combating communism.

h. Industry and communications. Likewise there should be a Chinese-Foreign group to consider the more urgent problems in these fields. Any large-scale program, however, clearly would have to await the ending of civil war and stabilization of the national finances.

i. Legal system. It is further important that China develop an improved system of law and public administration. Also there should be a Chinese-Foreign group working in this field.

j. Coordination. All of the above major heads involve problems of the budget. There has to be close coordination so that different groups do not work at cross purposes. Hence there should be a central organization, e. g., a commission on economic and financial affairs. Each group working on a particular field should have one or two representatives on such a commission. The commission should be in constant touch with the leaders of the Government and should coordinate the work of the groups. The commission would be headed by an outstanding Chinese, with an outstanding American as co-chairman.

(12) In conclusion I would emphasize that the foregoing is put-forward by me personally and not in any way for or on behalf of the Chinese Government.”

Stuart

59. Infra.
60. Dated October 23, p. 1199.