Remember the Gold Yuan of 1949? Beijing Does.

by: Sean Daly

"He who goes borrowing, goes sorrowing,"

--Cheng Siwei, PRC Standing Committee former vice-chair, quoting Benjamin Franklin

Most Americans are well aware of how Weimar-era inflation scalded the German cultural psyche, with newsreel images of wheelbarrows of cash lined up at groceries providing the general explanation for Germany’s conservative post-war monetary approach. Few, however, know of how a similar period shaped 20th century China.

In 1946, China welcomed the Nationalists with elation, but it quickly found the regime utterly incapable of managing the country’s economy. Even before the war was finished, the Nationalists had started the practice of issuing paper notes in lieu of gold reserves. These notes for Chinese dollars went from 189 billion in 1944 to 4.5 trillion in 1946.

The inflation that followed was staggering. In mid 1948, the conversion rate for a US greenback to Chinese dollar hit the one million mark; by Feb. 1949, it was six million.

Paper factories in Kwangtung allegedly found it cost effective to buy hundred yuan bills to use as a basic pulping resource for making finished paper.

As in Weimar, when people rushed each paycheck to market before the money devalued further the next day, Chinese workers in the late 1940s would spend their money the moment they were paid.

As Stella Dong, author of Shanghai: 1842-1949, has written:

To the eyes of outsiders, the Shanghainese appeared more prosperous than ever. The restaurants were full, the shop windows were full of merchandise, the average person was far better and more smartly dressed than before. Straw sandals, once ubiquitous, had virtually disappeared, replaced by leather shoes.

But this was an illusion. If ordinary people looked more rich, it was only because they had no choice but to spend every last dime on consumer goods before it lost value.

The truly rich families were busy buying all the gold and silver they could get their hands on.


I was reminded of this obscure, but pivotal moment in Chinese history yesterday, while following the events of the weekend.

On Sunday, at a hastily arranged trip to Qingdao, U.S. Treasury Secretary Timothy Geithner met with China's Vice Premier Wang Qishan. The trip was “to discuss economic relations” following the G-20 meeting of finance ministers in Seoul.

The extra trip seemed a bit obsequious. In South Korea Geithner had already fawned for Chinese media consumption earlier in the weekend:

It makes no sense for China to have monetary policies set by the Federal Reserve. They're an independent country, large economy. They need the flexibility to run their policies in a way that makes sense for China. And that requires that their exchange rate move up over time, as they're now doing.[1]

Yes, Mr. Geithner, they are a large economy. They are also clearly independently-minded. Earlier this fall, a rapid 1% gain by the yuan in one week seemed to obviate Beijing’s ability to micromanage its exchange rate. With a tactical eye for its own self-interest, the People’s Bank of China did this in an effort to stymie US congressional action. Ironically, it exhibited the very control that many U.S. legislators were saying gives the mainland an unfair trade advantage against freely convertible currencies.

In the five years since China ended its decade-long peg of 8.3 yuan per dollar (but refused to make the yuan freely convertible), its economy has gotten even bigger. It has “shaken the world” with its titanic build-out and its $1.7 trillion accumulation in foreign reserves. To slake its voracious appetite for resources, it has become the world’s top consumer of energy, building materials like concrete and steel, and foodstuffs like soybeans, rice and wheat.

As the WSJ declared earlier today, the upshot of this weekend’s G-20 meeting is that “the dollar should continue to decline in value while China and other countries should revalue.”[2]

Of course, the danger is that China’s purchasing power will expand while its tight constraints on yuan outflows will block any effort by the developed world to get direct exposure to the currency. As Adrian Ash mentioned in a thoughtful piece yesterday:

If U.S. Treasury Secretary Tim Geithner gets his wish and the Chinese yuan bears a greater share of the dollar’s global devaluation, Beijing’s purchasing power in the food, energy and mineral markets will only grow, and at the expense of today’s freely convertible currencies. Beijing likely holds some $2 trillion in the “big four” reserve currencies and Gresham’s Law says it’s more likely to spend those holdings ahead of using its own, increasingly valuable money, as it hoards ever-more food, energy and mineral resources.[3]

By keeping its own currency out of reach, it will debase the convertible currencies and provoke a further rush into hard assets like gold. Expect to see more activity in CVY, “physical” owners like GLTR, SGOL, PPLT, PALL, and even miners as diverse as BHP, FCX, GG, PAL, SWC, and CDE. Just yesterday, JPMorgan Chase (JPM) filed plans with the SEC to launch an exchange traded fund backed by physical copper. Expect a parade of similar products to continue into the winter.

China does have intentions to position the yuan as a global reserve currency. But it will do this “internationalizing” slowly, through a series of set channels. There will be a “regionalization” through Hong Kong bond offerings. There will be new products that are yuan-denominated that facilitate the trading of hard assets.

The first approach can be seen September’s action by Chinese Ministry of Finance, when said that it would issue 6 billion yuan worth of government bonds in Hong Kong. This is the first time that government bonds --comparable to U.S. Treasury securities-- were to be issued. The equivalent of $879 million, the issue was designed to “promote the yuan in neighboring countries and improve the yuan’s international status.” The sale started on September 28 and results will be announced on Oct. 22.

The other channel is to have important commodities such as gold traded in yuan. As Wang Zhenying, an official from the People's Bank of China said in May, China will likely develop more yuan-denominated gold investment products, thus utilizing the more than 30 trillion yuan in savings the country has:

A currency's international status depends on its being accepted in trade and settlement and having certain international commodities denominated in that currency helps China's goal to internationalize the yuan. Gold is a good choice to have yuan trading.

This might be a stepping stone into other yuan-denominated commodities. In September, BOC Suisse Fund Management, the Bank of China’s asset-management arm based in Geneva, said that it had received approval from the Swiss financial regulator to create a new set of funds, nearly half of them denominated in the Chinese currency.[4]

Should the yuan extend its global usage, the relative loss of purchasing power in dollars, euros, pounds sterling and yen will only accelerate further. The “big four” currencies, as a percentage of total forex reserves, have already been falling since 2005, according to the IMF.

That fall might continue in a more ragged, haphazard way. The perceivable lack of international consensus at the G-20 meeting suggests such. Yuan deposits held in local Hong Kong savings accounts totaled 130 billion yuan ($19.4 billion) at the end of August, up nearly 26% from the preceding month, according to Goldman Sachs. Many in the Chinese government and the banking sector will continue to develop ways by which investors can put those funds to use.

Ultimately, these new developments by the Bank of China are all examples of Beijing’s sure-footed, cautious process. It is an approach that will likely suck the “gravitatas” out of the convertible big four before the whole thing is over.


Getting back to that pivotal moment in history:

By the summer of 1948, grocery shops in Beijing were increasing prices several times a day or closing in the mid afternoon in order to reopen at tomorrow’s higher prices. Those wealthy families that had any money at all were converting it hand over first into gold, silver, and jade.

On August 19, 1948, Chiang announced the replacement of the old currency with a new “gold yuan” convertible from the older note at the rate of three million to one and pegged four to the US dollar. Under penalty of death, all Chinese holding gold, silver, or foreign currency were required to surrender such assets in return for “gold yuan.” Chiang Kai Shek’s son was tapped as minister of the program and initiated a terror in Shanghai to frighten people into handing over their hard assets and lifesavings. Executions and homes invasions would follow this “reform at pistol point” as trucks went from house to house pillaging hard assets.[5]

The “gold yuan” quickly dropped in the ensuing months, collapsing in value. Despite all their exhortations about more fiscal responsibility, the Nationalists had continued to print.

This, coupled with a few key military blunders in Manchuria, insured that the Nationalists would lose all the good will they initially had with the coastal bourgeois.

They would lose city after city in the North to Mao. In their final act, they would prepare for an exodus to Taiwan by stealing all bullion from the Bank of China’s vaults on the Bund. In the dead of night, in February 1949, 500,000 ounces of gold were moved out of Shanghai to awaiting ships.

On May 25, the famed “Decadent City” gained new masters.


[2] WSJ, The G-20’ Rebalancing Act, October 25, 2010



[5] Stella Dong, Shanghai, 1842-1949, HarperCollins, p 291

Author's Disclosure: long PALL, PPLT, SWC, CDE, PAL

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