Economic History: FDR and Silver Greed Ruin China

I want to be more active on my blog beyond just tracking my daily habits, so I decided to add a new financial section where I plan on commenting on economic news. As I get more knowledge, hopefully my ability to predict and comment on current events will become more sophisticated. For now, here’s a classic post on economic history.

Today’s history lesson takes place at the height of the Great Depression, when the American public blamed greedy Europeans for World War I and the renewed gold standard for their deflation problems. A collection of Democrats, politicians from silver mining states, and currency speculators called for a return to bimetallism and using the silver standard to help stabilize the dollar. The gold standard was failing because too many countries were incorrectly pegged without a way to correct it; changes to currency pegs badly damaged a country’s reputation, as Argentina learned when it tried despite the warnings and ended up with massive bank runs as well as being shunned like a leper by the British Empire in trade (which made up more than 80% of Argentina’s trade).

The result of the ill-conceived new gold standard was hyperinflation in Germany (with the famous story of a guy running around with a wheelbarrow full of money to buy a loaf of bread, then being chased by a mob trying to steal his wheelbarrow) and wild deflation in Britain and the US. This is where a deep recession turns into the Great Depression because of the Federal Reserve. The Fed at the time believed that deflation could be turned if people had more disposable income from savings and decided to raise the interest rate. Incidentally, the idea of printing more money was rejected because the government was “committed” to trading gold for cash if demanded and feared bank runs if too much money circulated. Of course, the result of high interest rates was the ruin of society because people could not afford to pay the high interest rates on loans, especially in the farm sector. Employers laid off most of their workers to avoid the need to borrow more money, damaging their productivity and leaving many people without incomes.

The silver bimetallism people had been around since William Jennings Bryan nearly won the presidency on that issue in 1896, but the Great Depression was the ultimate failure of the gold standard. While silver had languished at a trading rate of 86 oz to 1 oz of gold, the silver politicians wanted it to trade at the “traditional” rate of 16 to 1 (it was traditional in the sense that this was the price written in the Constitution – like today, some thought the rule of the Constitution was absolute and the founding fathers never intended to change that price). With influential support, a bill to buy silver to the traditional rate passed in 1933 and the Fed started buying silver. President Roosevelt supported the silver legislation in a deal to push many of his New Deal reforms through an unwilling Congress. While times were great for silver between 1933-1937, the demand for silver plummeted after this short-run gain and effectively ended silver’s role as a meaningful currency because nobody wanted silver at such a high price in gold.

Where does China fit into all this? Well, China was among the few countries in the world that used a silver standard to peg its currency, since most of its gold supplies had been drained by Europeans in the unequal treaty era and many Europeans were only willing to pay for Chinese goods in silver (ironically, one reason that Europe went to the gold standard and abandoned bimetallism was the silver drain in paying for Chinese tea and silks, even with adjustments from the opium trade). When the Chinese heard that the US was paying premium prices for silver, there was a mad rush to sell every bit of silver in the country. People went so far as to melt their silver currency to sell to Americans. This crazed outflow of silver drained China of much of its reserves and caused severe deflation in that country, because now nobody had the proper silver to pay for anything in China. Of course, silver had been adjusted and pegged by the American market to be very expensive, so the Chinese government could not afford to buy back enough silver to fill its reserves.

By 1937, the Nationalist Chinese government was desperate for money because of the new Japanese and Communist threats. So they decided to abandon silver as a peg and print paper money, and just like every other n00b to print paper money from the 1778 Continental Congress in America to the Weimar Republic in Germany, they went crazy on the printing press and tried to outpace inflation by printing money faster. Even though the Chinese risked hyperinflation, it was clear in the late 1930s both that the Japanese intended to invade China and that the Chinese could not win with their current forces. The combination of brutal losses to the Japanese and the ugly effects of hyperinflation on Chinese society lost all credibility for Chiang Kai-Shek’s government and gave credence to Mao and the Communist cause.

So there you have it, FDR ruined the Chinese.