Page 4 of 5 CHINA'S DOLLAR MILLSTONE, Part 2 Developing China with sovereign credit
By Henry C K Liu
illegal private smuggling of opium into China, paid for by a massive outflow of
silver from China. What is yet to be fully recognized by economics historians
is the adverse effect on the Chinese economy from the massive outward drain of
silver from the illegal opium trade Britain and the United States imposed on
China as a result of the inability of the Qing imperial court to protect its
sovereignty and, more importantly, its independent monetary policy to forbid
free trade in silver.
The collapse of the Qing economy in the 19th century was largely a monetary
event, with similarity if not congruence with the effects of the Asian
Financial Crisis of 1997 on several of the weaker
Asian economies, notably Thailand, Indonesia, Malaysia and South Korea.
Copper, silver and gold had been the component metals in China's tri-metal
monetary regime throughout its long history. Cloth, grain, cattle, pearls and
jade, along with precious metals, had also been used as media of exchange in
ancient times. The Sung dynasty issued the first paper money in 1023. Silver
had been used increasingly widely as currency in China since the 15th and 16th
centuries with imports from the increased silver production in the Americas as
a result of a Chinese trade surplus with the West.
Around 1564, Mexican silver coins began circulating widely in Chinese coastal
trade towns such as Guangzhou and Fuzhou as payment by Portuguese traders for
Chinese exports. By the 18th century, China was operating on a de facto silver
standard monetary regime.
The 19th-century reversal of China's foreign trade from surplus to deficit was
due to Western opium smuggling starting from 1820. Up to that time, China
permitted very little foreign trade and what legitimate trade that did take
place amounted to only an insignificant portion of the Chinese economy. This
illegal opium trade was denominated in silver until China ran short of silver,
after which the legalized but immoral opium trade was denominated in porcelain
that steadily fell in price because China could produce porcelain easier than
it could produce silver, albeit Chinese export porcelain was increasingly
produced at inferior quality compared to that produced for the more
discriminating domestic market.
Monetary defacement occurred even in porcelain when it became a unit of
account.
Maria Alejandra Irigoin observes in her paper "A Trojan Horse in 19th century
China? The global consequences of the breakdown of the Spanish Silver Peso
standard", observes that until the 1640s silver trade was essentially driven by
large differences in the gold-silver ratios between Spanish America, Europe and
China, allowing a substantial arbitrage gain to be realized by intermediaries.
After 1825, China's balance of silver trade with the West became negative due
to the illicit opium trade.
According to Irigoin, between 1719 and 1833, 259 million silver pesos, or 6,321
tons of silver, entered China to pay for Chinese goods. That is the equivalent
of 421.4 tons or 135.5 million ounces of gold at the universal silver/gold
ratio of 15/1. For comparison, as of January 2007, gold exchange traded funds
held 629 tons of gold in total for private and institutional investors.
Of the 6,321 tons of silver, 62% was introduced after 1785 and a full 30% after
Spanish American independence, usually dated as 1810. Importantly, the
structure of the silver trade was different before and after 1785. Up to that
date, English intermediation accounted for about 50% of silver inflow to China
since 1719, French for 20% and Dutch for 15%. After 1785, the US became
progressively the main provider of silver to China. Around 1795, North American
merchants provided 28% of Chinese silver inflow to pay for Chinese goods. By
1799 the US share had risen to 65% and after 1807 American intermediaries
accounted for a full 97% of silver inflow into China.
This one-way trade denominated in silver grew steadily until the late 1820s. It
experienced a short-lived high point in 1834-36 after which date it declined
strongly and only staged a timid recovery after 1853. The US trade deficit with
China did not start in the 1990s. It began in 1800.
Despite Chinese discouragement of foreign trade, China had always enjoyed a
trade surplus until 1834. Chinese flow balance of silver had been positive all
through history and became negative only after 1826, 10 years later than the
inversion of the overall balance of trade of China due to the opium trade. This
was because the sliver deficit from the illicit opium trade was at first
cancelled by silver inflow from Russia in exchange for Chinese silk, porcelain
and tea. Russia earned silver in the trade boom during the Napoleonic wars.
The massive smuggling of opium led to increasing silver imbalance for China
after 1819. Similarly, Chinese silver inflow still exceeded outflow until the
mid-1820s because the US sent more silver into China than opium-smuggling
English merchants extracted from there to Bengal, Calcutta and finally to
London.
A spurt of silver demand from China occurred in the first half of the 18th
century, when the Chinese exchange rate of silver to gold was still 50% higher
than the exchange rate in Europe. This offered opportunity for European
arbitrage with China's huge population and market growth.
Irigion notes that the historiography of trade globalization has long
recognized the role of demand for silver in the Chinese economy as the
foundation in the establishment of intercontinental trade between the Americas,
Europe and Asia since the 1600s. Silver from Spanish America reached Europe
through the trade of both Spanish licensed merchants and northern European
interlopers from whence it continued to flow to China within the organized
trade of the European chartered companies, primarily the English and Dutch East
India Companies.
At the same time, a second route of silver flows was established within the
Spanish colonial trading system. This directly linked Spanish American
production areas in Peru and Mexico to Manila in the Philippines through the
famous Manila galleon, which sailed regularly from Acapulco to the East. STOP
STOP STOP The monetary changes in Spanish America in the wake of Spanish
American independence impacted upon this trade. The revolutionary wars in
Spanish America and the implosion of the Spanish empire led to a fragmentation
of the previously unified monetary regime, which resulted in the production of
coins of different quality, fineness and weight. Irigion argues that this
change, entirely exogenous to the Chinese market, resulted in falling demand
for Spanish American pesos in China.
Thus it qualifies the conventional historiography that stresses the role of
opium imports in allegedly reversing the flows of silver bullion to and from
China in the early 1800s, even though it does not altogether negate the
financial impact of opium smuggling.
Evidence supports the conclusion that monetary conditions exacerbated the
negative effect of opium smuggling on Chinese national finances. The outflow of
silver from China that began in the early 1800s coincided with the collapse of
silver prices in the international market as Western countries adopted the gold
standard and demonetized silver.
Silver was leaving China in huge quantities while the price of silver was
falling in the international market, making the Chinese trade deficit more
expensive in local currency terms. Yet while the price of silver fell in the
international market, its price rose in the Chinese domestic market in relation
to copper, accelerating and exacerbating import trade inflation in the Chinese
economy through domestic price deflation.
This monetary collapse inflicted great financial damage on China's peasantry.
While peasant income was denominated in copper coins, their tax obligation to
the imperial court was denominated in silver coins, because the imperial
government's trade deficit was denominated in silver. The scarcity of silver
created by the massive outflow pushed the domestic silver price sky-high in
terms of copper coins.
A similar monetary disadvantage is now hurting American workers, whose wages
are denominated in falling dollars with dwindling purchasing power for critical
imports such as oil. The only different is that for 19th century China, the
damage was forced on the Chinese peasantry by foreign imperialism, while in the
US, the damage on US workers was done by their own government's monetary and
trade policy.
International bimetallism greatly disadvantaged the Chinese silver-based export
economy and domestic bimetallism greatly disadvantaged the copper-based
finances of the Chinese peasantry. Chinese peasant populists would have a
similar incentive to promote a copper-based monetary regime against a silver
standard in China as the US populists did with fighting for a silver-based
monetary system against the gold standard in the US. But until the Chinese
Communist Party gained control of the governmental apparatus of the nation,
there was no official defender of the Chinese peasantry.
China suffered a protracted economic recession all through the 19th and 20th
centuries as it came into commercial contact with the West. This
two-century-long recession reduced China from being the world's richest economy
to one of the poorest. It was the result of the structural monetary double
disadvantage of international bi-metallism of gold and silver superimposed on
the silver-based monetary system of the Chinese foreign trade sector. This took
place in a world monetary regime shifting toward the gold standard, which
greatly disadvantaged the Chinese domestic bimetal monetary system of copper
and silver.
This double disadvantage fatally wounded the Chinese economy, causing the
decline of a highly developed culture with an uninterrupted history of four
millennia and halted its further development for more than seven generations
over two centuries. The bankrupt economy reduced the Qing imperial China to a
failed state unable to defend itself from aggressive Western imperialist powers
until the founding of the People's Republic, when China adopted a socialist
path for its economy.
Even after the 1911 bourgeois revolution that established the Republic of China
under the Guomindang (Nationalist Party), when China followed a petty bourgeois
free-market system, she was unable to shake off Western imperialism to free the
nation, once the most prosperous in the world, from semi-colonial economic
status.
In that sense, China is different historically from many other nations of the
Third World that had never achieved comparable prosperity, albeit many Third
World nations were much better off before falling victim to Western
imperialism. The two non-European nations that matched China's level of
socio-economic and cultural achievements were Ancient Egypt and the Ottoman
Empire, the modern descendent entities of which are but shadows of their former
greatness.
Beside economic exploitation, the British East India Company, to gain political
support from the Church of England for colonialism, also adopted aggressive
evangelistic policies on behalf of Christianity. The deep hostility between
Catholicism and Protestantism was buried within British imperialism. Many
British empire-builders were Scots, who brought with them Scottish Catholicism
to the non-white British colonies. The Act of Union of 1707 united the kingdoms
of England and Scotland and transferred the seat of Scottish government to
London. Henceforth England and Scotland were known as the United Kingdom.
The Company methodically destroyed monasteries and suppressed indigenous
culture in Buddhist Tibet, which together with the launch of the Opium Wars to
protect immoral opium smuggling, caused deep-rooted anti-Western xenophobia in
all Asia that lingers on even today and makes a travesty of belated Western
grandstanding on religious freedom, human rights and rule of law in centuries
to come.
Pound sterling and the gold standard
The pound sterling, created in 1560 by Elizabeth I, as advised by Thomas
Gresham, brought order to the monetary chaos of Tudor England that had been
caused by the "Great Debasement" of coinage that led to a decade-long
debilitating inflation beginning in 1543 when the silver content of a penny
dropped by two thirds to become mere fiduciary currency. The exchange rate of
British coins collapsed in Antwerp, where English cloth was sold in Europe.
The Bank of England was founded 1694 with the pound sterling as the currency of
account. All coins in circulation were then recalled by the Royal Mint for
re-mint at a higher standard. Sterling unofficially moved to the gold standard
from silver as a result of an overvaluation of gold in England that drew gold
from abroad in exchange for a steady outflow of silver, notwithstanding a
re-evaluation of gold in 1717 by Isaac Newton as Master of the Royal Mint.
The de facto gold standard continued until its official adoption following the
end of the Napoleonic Wars in 1816. The gold standard lasted until Britain,
along with several other trading countries, abandoned it only after World War I
in 1919. During this period, the pound was generally valued at around US$4.90.
Britain tried to restored the gold standard in 1925 without success despite
support from the US central bank, which contributed to the 1929 crash on Wall
street that immediately spread to world markets to cause a global depression.
The currencies of all other major Western countries in 1821 were either
bimetallic or specie-backed paper money. This meant that Britain operated
within a floating exchange rate system for most of the 19th century, although
for much of this time, when the silver/gold ratio stayed close to the common
mint ratio of 15.5/1, the floats were tightly constrained within a narrow band.
The 19th century gold standard was supported by government incentives and
government ability to adhere to it due to lower borrowing costs (on average 40
basis points) when loans were denominated in currency backed by gold,
especially in London, the center of international finance at the time.
Hence large borrowers, such as the newly independent US, had a strong incentive
to also adopt the gold standard. By 1870, the main core countries of the gold
standard had been deeply engaged in international trade for decades, led by
British promotion of free trade. Consequently their respective domestic price
levels were similar and their differences changed only slowly, putting less
strain on their balance of payments. Trade deficits were difficult to sustain
and trade would slow as deficits mounted until balance of payments were
restored.
British promotion of free trade under the gold standard took place in an era
when new discoveries of gold in the Americas, Australia and South Africa
allowed Britain to run a trade deficit while still funding substantial
investment in colonies overseas. This was because gold was steadily devalued on
expectation of more gold entering the market, and the resultant defacement was
expected
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