Foreign Relations of the United States, 1948, The Far East: China, Volume VIII

893.515/8–3048

Memorandum by Mr. Paul H. Nitze, Deputy to the Assistant Secretary of State for Economic Affairs (Thorp), to the Secretary of State

[Washington,] August 30, 1948.

Problem

In a desperate effort to forestall a collapse in the acceptability of the Chinese currency, upon which the power and authority of the present Government in China vitally depends, that Government initiated on August 23 a sweeping currency reform program. A new currency is being introduced at the rate of 3 million to one, and every effort is being made by the Government to establish public confidence in the new unit.

There have been recurrent reports from China that, as one step in establishing this confidence, the Government would seek a large-scale “currency stabilization” loan from the United States. No such request has yet been received, however, through official channels. (A press dispatch from China also reported an application to the International Bank for a 500 million dollar stabilization loan, but inquiry at the Bank—which obviously could not give such an application serious consideration—discloses that no such approach has been made.)

A currency stabilization loan, properly speaking, would be a loan to provide silver (or gold) for circulation in China, or to provide gold (or dollar) resources to build up the reserves held by the Central Bank against the new currency. It would be based on the hope that by assuring convertibility into “hard money”, or alternatively, handsome window-dressing at the Central Bank, the new currency would be given a prestige which would inspire public confidence.

Aside from such measures, with objectives largely or wholly psychological in nature, the Chinese might request expansion or revision of the China Aid Program with a view to combatting inflation—and protecting the value of the currency—by accelerating the flow of consumer goods to the Chinese market.

Main Features of the New Currency

The Chinese Government has commenced the introduction of a new currency called the gold yuan and described as a managed gold standard. One new yuan is being exchanged for three million old CN dollars, and the exchange rate of the new unit in terms of U. S. dollars is to be four yuan to the dollar. Assuming complete conversion of the present note issue, the initial issue of the new currency would amount to only about 230 million yuan (60 million dollars). However, an upper limit of 2 billion yuan has been authorized, apparently in recognition of the fact that the public’s need for currency for transactional purposes will be much greater if the new notes do not have the extreme velocity of circulation which characterized the old. In addition, allowance may have been made, realistically, for some continued issues to cover budgetary deficits. The Government has announced that as “backing” for the currency it holds 200 million dollars in gold, silver, and foreign exchange, and 300 million dollars in government-owned enterprises and other domestic properties. Ignoring the latter, there would still be a 40 per cent cover in bullion and foreign exchange against a 2 billion yuan note issue, although it should be noted that the Central Bank has outstanding foreign exchange liabilities amounting to more than half of these reserves. In any case, these reserves can hardly be expected to have any more effectiveness in the case of the new currency than in the case of the old.

Auxiliary reform measures include provisions for the registration and surrender of foreign assets (such as gold, silver, and foreign exchange), for the prohibition of strikes, and (to emphasize price stability) for the discontinuance of cost of living indexes and the dependence of wage rates thereon. The essential feature of the plan, however, appears to be the recognition of its dependence on immediate and radical fiscal and budgetary reforms to insure an early balancing of the budget, but no specific measures to achieve this objective have yet been announced.

Prospects for Success of the New Currency

The catastrophic progress of the inflation in China is best illustrated briefly by the rise in note circulation from about 30 trillion CN dollars at the beginning of this year to about 700 trillion CN dollars at the present time (including Northeast currency which is to be converted at 300 thousand to one). The black market exchange rate for CN dollars over the same period has depreciated from about CN$100 thousand to US$1 to CN$11–12 million to US$1. The expansion of the note issue is almost wholly associated with Government expenditures, but as confidence in the currency wanes, prices rise faster than the increase in the note issue—i.e. the velocity of circulation increases.

The movement in the black market exchange rate closely reflects the decline in the internal purchasing power of the Chinese dollar. Hence the total U. S. dollar value of the note circulation, at the black market rate of exchange, has fallen to about only US$60 million. This may have erroneously persuaded some officials of the Chinese Government that the magnitude of the currency problem was shrinking; in fact, it only demonstrates the extremity which the inflation of the old currency had reached.

The Central Bank expects an immediate favorable reaction to the currency reform in the form of restored confidence, a marked decline in the velocity of circulation and hence stability of prices until the budget can be balanced, an expansion of exports and an almost complete diversion of illegal exports and inward remittances to official channels. The lasting success of the plan will clearly depend, however, on immediate and fundamental tax and budgetary reforms probably beyond the capacity of the present Government to execute in the near future.

The magnitude of the budgetary problem is indicated by the fact that Chinese Government receipts are understood to be less than 30 percent of all expenditures, which are estimated to be at least the equivalent of US$1 billion annually (75 percent for military purposes). Moreover “receipts” include not only taxes, but proceeds of the sale of Government assets and the net proceeds from the sale of Government-owned foreign exchange. The latter item will henceforth include sales of imports financed by the ECA, but under the present program these will be no larger (and may be smaller) than imports financed in recent years by earlier aid programs and by liquidation of China’s gold and dollar reserves.

If public confidence is not rapidly established in the new currency, and it comes to be looked upon as a desperate expedient of the Government, there may be a flight from the new currency more rapid than hitherto experienced with CNC. Such a development would, of course, further impair the ability of the National Government to exert effective political and military control.

Recommended Policy on Stabilization Loans

The United States Government in accordance with previously formulated policy and in the light of existing uncertainties with respect to the program, should not now consider any new or additional assistance to the Chinese Government in the form of “currency stabilization” loans.

The China Aid Program purposely avoided any provision for currency stabilization for reasons which were explained in a memorandum submitted last March to Representative Eaton and Senator Vandenberg⁶⁶ in connection with proposals to use silver to stabilize the Chinese currency. The Department then took the position, in consultation with the Treasury Department and the Federal Reserve Board,⁶⁷ (1) that the basic cause of inflation in China was the massive budgetary deficit associated with large-scale military expenditures and financed by a “printing press” expansion of the note circulation; (2) that so long as this basic monetary disorder persisted there could be no permanent monetary stabilization; and (3) that even attempts to achieve temporary currency stabilization through loans for this purpose would represent a hazardous and uncertain venture involving large expenditures for at best limited results.

In any case, no funds for such a purpose could be made available until the new session of Congress. Conceivably, a short-term credit could be extended from the U. S. Treasury Department’s Stabilization Fund, which at present has uncommitted resources of 150–200 million dollars. However, it is extremely unlikely that the Treasury Department would even consider it, and the Department should certainly not suggest it.

Possible Redisposition of China Aid Act Funds

The Chinese Government may suggest a redisposition of China Aid Act funds to maximize the contribution these funds can make to the success of the new currency. Such a redisposition might consist of one or a combination of the following measures:

(a) Acceleration of the whole ECA program to provide maximum flow of imports to China during the next three months.

(b) Abandonment of ECA plans for new capital expenditures in favor of increased imports of food, fuel, raw materials, parts, etc. which would have a more immediate counter-inflationary effect.

(c) Diversion of 125 million dollars under Section 404(b) of the China Aid Act from military procurement to imports of such goods.⁶⁸

None of these alternatives would be attractive. The first would force the Congress (and any new Administration) to confront a serious crisis in the China Aid Program early next year. The second or third would sacrifice essential objectives of the Program. Furthermore, it should be recognized that the legislative history of the China Aid Act has the effect of limiting considerably the extent to which available funds could be diverted by the President. This is true particularly of the 70 million dollars earmarked for reconstruction and the 125 million dollars available for Chinese military procurement. Decisions with regard to these two funds could properly be made only after consultation with responsible members of Congress.

Basic to a consideration of possible Chinese proposals is the fact that a redisposition of the aid program would be likely to make a significant contribution to stabilization of the Chinese currency only if internal budgetary reforms and other supporting measures appeared to have brought currency stabilization within sight. Even then, there might be serious practical limitations on what could be accomplished by way of diversion of funds during the next few months.

66. Neither printed.
67. Statement entitled Possible Use of Silver for Monetary Stabilization in China in Connection With China Aid Program; for text, see Department of State, United States Relations With China (Washington, Government Printing Office, 1949), p. 987.
68. For correspondence regarding the $125,000,000 grant, see pp. 73 ff.