Hyperinflation : The Chinese Tale
Guillermo Barba / GoldSilver.com
NOVEMBER 09, 2012
History is full of examples in which foolish monetary policy has resulted in severe hyperinflation. Under such regimes there is a complete loss of confidence in the underlying currency, producing an astronomical rise in prices. A cycle quickly ensues as government prints more currency to compensate for its instant loss of value.
It is a vicious cycle triggered by the massive expansion of the currency supply, which contrary to gold and silver, can be limitlessly created.
Understood properly, it is not that prices go up, it is the value of the currency what keeps going down because of its expansion and the speed to which it is put into circulation.
As an important economic principle states, "currency may be created at will, but not wealth". If the solution were that simple, poverty could be eliminated by the distribution of currency. The limitless creation of currency would suffice to meet the demands of struggling individuals and economies. As you can see, this notion is completely absurd.
Hyper-inflationary periods typically occur under extreme geopolitical conditions such as war or civil unrest. The cost of financing these types of events is heavy, causing government to turn to cheapest alternative for funding: printing currency not backed by precious metals. The results are often catastrophic, devastating economic activity and destroying business confidence.
China's mid-twentieth century hyper inflationary feat is exemplary in providing an accurate presentation of the speed with which this process unravels. A recent study published by Steve H.Hanke and Nicholas Krus of the "Cato Institute" estimated that between October 1947 and mid-May of 1949 it took an average of 5.34 days for prices measured in yuan to double.
During the peak of the hyperinflation in April 1949, the rate of inflation was an astounding 5070%.
This occurred in midst of a bloody civil war as the Nationalists and Communists fought over control of the country. Fighting seized a month later, culminating in a communist victory and the founding of the People's Republic of China under Mao Zedong in October 1949.
Both sides attempted to finance their military costs through excessive printing. In the end, this backfired as Communists attempted to unify China under a single currency while a few currencies circulated.
It is important to note that during the decade prior to the hyperinflation, the Nationalist government had run high levels of deficit spending to finance the war with Japan which persisted from 1937 to 1945. Not coincidentally, China underwent another less drastic hyper-inflationary period from July 1943 to August 1945, during which prices doubled every 15.2 days.
It is interesting to note that during the middle of second period of hyperinflation, the Chinese government replaced outstanding notes for a new "gold" yuan at a conversion of three million to one. The word "gold" was simply inserted as a futile attempt to instill confidence in the new fragile currency, as there was no convertibility in place. These notes remained unbacked and debt-based.
The most drastic government measure was a prohibition of individual ownership of gold and silver, forcing their redemption in the newly created "gold yuan". Prices and exchange rates were frozen, imposing severe punishments on speculators and those who operated under the country's thriving black markets.
These measures are typical of governments attempting to fight off the unintended consequences of their poor policy. In the end, free markets and real money always prevail.
Chaos quickly erupted as the instituted price controls made merchants refuse the sale of their products. By November 1948, the government was forced to remove the previously instated measures.
Only the centralization of power throughout mainland China, achieved through victory of the Communists, would bring greater stability to the first quarter of 1950.
In preparation for this, the People's Bank of China (PBOC) founded in December 1948 , began issuing its privately backed notes within all areas dominated by Mao's troops, and rejected the former "gold yuan".
By July of 1949, the PBOC estimated a currency supply exceeding 60 trillion gold yuan. A few months prior in November, the currency supply was at a mere 3.4 billion.
While the value of the currency sank in China, the Kuomintang decided to distribute 40 grams of gold per person. Thousands of people came out and waited for hours to receive this amount of gold. The police, equipped with high-caliber weapons, could do little to maintain order. Ten people were crushed to death.
As we have seen, the tragic story of Chinese hyperinflation is yet another example of government testing the limits of the creation of currency.
The outcome of printing is never the creation of wealth but the proliferation of misery.
During these periods, wealth is rapidly transferred to those who own tangible assets such as gold and silver. Those who hold their wealth in fiat paper fall victim to this scheme as their wealth is virtually stolen.
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