The history of China’s banking system in the first half of the 20th century offers powerful insights into the conduct of monetary policy and the consequences of government intrusion into banking and monetary institutions that are well worth considering today. Monetary economists and monetary historians would do well to study China’s example, and, in particular, Chang Kia Ngau’s 1958 book, The Inflationary Spiral: The Experience in China, 1939–1950. As you’ll see, sound money and sound banking matter a great deal in creating a harmonious and prosperous society.
In 1905, during the final years of the Qing Dynasty, the first government bank, the Hupu Bank, opened in Peking. It was established by the Imperial Ministry of Revenues when China was still on the silver standard to help finance government deficits by issuing paper currency (see specimen above). In 1908, the bank was renamed the Ta Ching Government Bank (Great Qing Bank), and in 1912, under a new charter, the bank became known as the Bank of China. Another government bank of issue, the Bank of Communications, was established in 1908.
The constant pressure for central and provincial governments to increase spending beyond revenues led to attempts to suspend convertibility. For example, in 1916, President Yuan Shih-kai of the Republic of China ordered the Bank of China and the Bank of Communications to halt convertibility of their bank notes, and the public was instructed to accept those irredeemable notes at par. The largest note-issuing bank, the Shanghai Branch of the Bank of China, refused to comply with the president’s order and was able to defend its notes against a bank run. The Peking Branch of the Bank of China, however, complied with the order, as did the Bank of Communications (Chang: p. 5).
In Manchuria, officials imposed the death sentence on individuals who exchanged irredeemable bank notes at less than par. Despite this severity, there were heavy discounts on provincial government bank notes “which placed a very real limit on the extent to which these issues could be increased.” By 1922 all irredeemable notes from the Bank of China and the Bank of Communications were withdrawn (Chang: p. 5). The public then slowly regained confidence in paper currency as banks recommitted to redeem their notes in silver.