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Paper, silver, deficits and inflation — Chinese history version

Summary:
A history of paper money and inflation in China, from Edward Chancellor's Wall Street Journal review of Jin Xu's Empire of Silver.  In these sparse paragraphs is most of monetary (and fiscal!) theory, along with a history I was not aware of.Paper money, Ms. Xu tells us, dates back to the Tang dynasty in the ninth ...

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A history of paper money and inflation in China, from Edward Chancellor's Wall Street Journal review of Jin Xu's Empire of Silver.  In these sparse paragraphs is most of monetary (and fiscal!) theory, along with a history I was not aware of.

Paper money, Ms. Xu tells us, dates back to the Tang dynasty in the ninth century, when the authorities allowed merchants to exchange bronze coins for promissory notes, known as “flying cash.” Two centuries later, in the time of the Song dynasty, merchants in Sichuan were using private exchange notes in place of the cumbersome iron coinage. The Song emperor issued his own paper money against deposits of coin. The jiaozi, as these notes were called, proved so popular that they traded at a premium to cash.

The convenience of paper money proved its undoing, however. The first temptation was for the Song authorities to make the jiaozi inconvertible, severing the connection with metal reserves. The next step was to increase the issue of paper money, both to feed the people and, more pressingly, to fund the fight against the Mongol invaders. The inevitable outcome was inflation, followed by the collapse of the currency.

 The Mongols resurrected paper money. Marco Polo, in the late 13th century, reported that Kublai Khan, the great Mongol leader, had discovered the “secret of alchemy” by making money from the bark of mulberry trees. But in time the Mongols issued too much paper and sparked a hyperinflation, as did their successors, the Ming. From the late 14th century onward, silver replaced paper money in China.

The advantage of “white gold,” Ms. Xu emphasizes, was that it couldn’t be conjured up at the emperor’s command. The silver currency provided stability, a quality much prized by the mandarinate. But there were disadvantages. Lacking domestic reserves, silver had to be imported from abroad—first from Japan and then from the Americas. Massive inflows of silver promoted vigorous economic expansion in the late Ming era. In the 1630s, however, Spain stopped exporting American silver to the Far East. The money shortage in China that followed coincided with crop failures brought about by the Little Ice Age. Ms. Xu suggests that “silver was the fuse” for the collapse of the Ming dynasty in 1644.

Silver retained its monetary role under the Qing—the dynasty that ruled China from the mid-17th century to the early 20th—and money shortages remained. Part of the problem was that China needed to run a trade surplus in order to increase its money supply. Imports of foreign goods, which drained silver from the country, were officially discouraged.  

Paper money inflates, metallic money leaves a country dependent on trade surpluses or mining for supply. Obviously a better system is one that combines a metallic standard, recommitting the government against printing money to finance deficits, but with an ``elastic supply'' of paper and credit. 

There is no reason why silver shouldn’t have provided the base money for a modern credit system, performing a role similar to the one gold played elsewhere. The problem lay with China’s institutions...

 

John H. Cochrane
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!

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