Chinese hyperinflation

The Chinese hyperinflation was the hyperinflation in the Republic of China that lasted between 1935 and 1950. Since the Nationalist government effectively eliminated free banking in 1935, it gained a monopoly on the Chinese currency, as a result of the impact of the United States Silver Purchase act on China. However, the Nationalist government was dependent on financial deficits, leading to depreciation of the currency, a situation that was exacerbated by the Second Sino-Japanese War and the Chinese civil war.

The hyperinflation eroded popular support for Nationalists, contributing to the collapse of the Republic of China Government on Mainland China, as it destroyed the wealth of the middle class and impoverished a number of rural Chinese. To control the price hike, the government imposed price hike ban and wage control, which turned out a failure.

Origins

In 1905, the Imperial Chinese government founded the Hubu Bank, granting it the authority to issue banknotes. At the time, Chinese leaders, whether conservative or revolutionary, believed that increasing the issuance of banknotes would allow them to outspend their revenues. Although subsequent republican governments sought to unify the national currency, progress was slow by 1937 due to internal conflicts and concerns about foreign intervention, as the plan potentially required substantial foreign loans. As a result, silver bullion dominated the market, circulated and exchanged in various forms and weights without fixed ratios. Nevertheless, the rising global silver prices in the early 1930s, primarily due to the silver purchase policies in the West, led to significant deflation in China, which discouraged Chinese exports and resulting in continuous foreign trade deficit. Cheap agricultural produces flooded into China while silver flowed out. In 1935, the Nationalist government imposed a reform to replace the silver standard with the foreign exchange standard, in which a new paper currency, namely Chinese National Currency (CNC), was created. The government pledged to establish an independent Central Bank to act as the reserve bank and to create a supervisory committee with responsible members from the business community to oversee the money supply. However, none of these promises was fulfilled. Instead it paved ways for the government to expand money supply without constraints.

Second Sino-Japanese War

Free China

The Hump was the only route of imports for China in 1942-1944

Starting in July 1937, the Japanese military advanced through northern and eastern China, forcing the Chinese government to retreat inland and abandon significant manufacturing and agricultural regions, as well as key transport hubs vital for imports and exports. This retreat, combined with Japanese blockades of Chinese transport routes, led to immediate price surges in Free China. Each successive Japanese victory exacerbated the situation. For instance, the fall of Wuhan and Guangzhou in late 1938 caused import prices to rise by 72%. Similarly, the Japanese invasion of Guangxi in late 1939 nearly doubled import prices in Chongqing. In contrast, locally produced goods, including food and agricultural raw materials, maintained stable prices until 1938, supported by a robust harvest in Sichuan that year. However, from 1939 onwards, the prices of both imported and local goods began to rise in tandem as around five million refugees moved westward into Free China.

Since the start of the war, the Chinese government began funding its efforts through the issuance of war bonds, which initially enjoyed strong public support. By late 1938, government spending expanded not only for the war effort but also for reconstruction and the development of inland industries and transport infrastructure. This expansion aimed to reinforce infrastructure and sustain the war effort within the remaining Chinese-controlled territories. Consequently, government spending increased by 33%, despite the administration now managing only about half of the country. However, public confidence in war bonds waned by late 1938, leading to a decline in bond sales. Additionally, the limited new taxes introduced up to late 1939 failed to offset the government's excessive spending. As a result, the budget deficit continued to grow unchecked.

After the Pearl Harbour attack in 1941, Japan quickly seized the whole of Shanghai and, in 1942, cut off the Burma Road, a crucial supply route for China. This led to a 50% decrease in imports in 1942 compared to the previous year. Despite efforts to compensate with The Hump air transport route over the Himalayas, by 1944, China was only receiving 6% of the total imports it had in 1937. Additionally, rice production in southern China faced unfavourable outcomes, although wheat and barley production in Henan and Hebei saw slight increases. Due to administrative failures, the Nationalist government struggled to enforce price control measures, despite issuing decrees to this effect. None of the government’s strategies addressed the need to curb its own budget deficit, which continued to generate inflation. The Communist-controlled areas suffered less from the inflation as they each issued their own currencies and had a self-sufficient economy.

Occupied China

5000-yuan banknote issued by the Japanese-controlled Federal Reserve Bank of China in 1945

After the Mukden Incident in 1931, Japan established the puppet state of Manchukuo, which introduced its own currency backed by silver. Once China abandoned the silver standard, Manchukuo's currency was pegged to the Japanese yen. Following the Japanese occupation of northern China in 1937, Japan created the Federal Reserve Bank of China to issue a new currency called Lianyin Quan, replacing the banned CNC. In central China, Japan established another puppet regime known as the Reformed Government of the Republic of China. In 1939, the Huaxing Commercial Bank was founded and began issuing Huaxing Quan from 1939 to 1940, followed by Chubei Quan from 1940 to 1943. The Japanese effectively attracted deposits to these puppet banks by offering higher interest rates, allowing them to collect significant amounts of CNC for foreign exchange purposes. Additionally, from 1939 onwards, the Imperial Japanese Army’s Noborito Research Institute engaged in large-scale counterfeiting, producing approximately 4 billion yuan to bolster Japan's war efforts. However, due to stricter credit controls than the Nationalist government, the inflation in Japanese-occupied China was less severe than in Free China.

Chinese Civil War

Taiwan

In November 1945, Taiwan was returned to the Nationalist government following Japan's defeat. The government established the Bank of Taiwan to replace Japanese currency with Chinese currency. In 1946, the bank issued a new local currency, the Taiwan Dollar, which was introduced without backing reserves. The Bank of Taiwan became a major financier for the Taiwan Provincial Government, accounting for 62.8% of its total loans, and it also extended mostly unsecured loans to state-owned enterprises. Inflation gradually rose throughout 1947 and the first half of 1948, before spiking sharply in the latter half of 1948, reaching over 107% in October and November. This was partly due to the monetary reform on the Chinese mainland in 1948. Despite a deteriorating gold yuan, the exchange rate between the gold yuan and the Taiwan Dollar remained unchanged, encouraging capital inflow into Taiwan. This influx significantly increased the money supply, contributing to 86.8% of the M1 money supply growth in September 1948 and 97.9% in October. Adjustments to the exchange rate led to an 8.8-fold increase in capital outflow between October and November 1948, marking the first net outflow since the August 1948 reforms. However, December 1948 recorded a deflation rate of 9.01%, illustrating the Nationalist government's sensitivity to exchange rate policies. This temporary stabilization ended as the Nationalists' position on the mainland weakened, prompting both renewed capital flight to Taiwan and the transfer of government resources to the island. By November 11, 1948, the limit on the issuance of gold yuan notes, initially capped at 2 billion yuan, was abandoned due to rising deficits on the mainland. Economic conditions continued to worsen in mainland China, driving more capital to Taiwan. The net capital outflow of 23,277 million Taiwan dollars in November 1948 flipped to a substantial inflow of 214,495 million taipi in December, accounting for 73.4% of that month's total currency increase.

Aftermath

Transfer of gold to Taiwan

In 1949, Chiang Kai-shek ordered to transfer most of the national treasury, including 4.5 million taels of gold stored in the Bank of China in Shanghai and $384 million in foreign exchange reserves, to Taiwan. This later became a critical source of funding for Taiwan.

References

Sources

• Chang, Kia-Ngau (June 15, 1958). The Inflationary Spiral: The Experience in China 1939–1950. Cambridge, MA: Technology Press of Massachusetts Institute of Technology. ISBN 9780262532181.
• Chou, Shun-Hsin (1963). The Chinese Inflation, 1937-1949. New York, NY: Columbia University Press. ISBN 9780231892490.