Money Mischief_ Episodes in Monetary History - Milton Friedman [70]
Rawski's conclusion that the money supply rose despite the export of silver is equally questionable. He constructs two alternative monetary totals, embodying different estimates of the amount of monetary silver. Both increase from 1931 to 1935—by 23 percent and 20 percent—thanks exclusively to a sharp increase in deposits in "domestic modern banks" and "foreign banks." It is highly questionable whether such deposits were relevant to domestic nonfinancial activity. Modern domestic and foreign banks were concentrated in Shanghai and served primarily the transactions activities and liquidity desires of the Shanghai financial community, domestic and international. Their lack of relevance to domestic nonfinancial activity is documented by Rawski's estimates of the ratio of currency outside of banks to the total money supply. Currency declines from 47 percent or 55 percent of the total in 1931 to only 33 percent or 41 percent of the total in 1935. Even the initial ratios are hardly credible for so underdeveloped a country as China, and the even lower final ratios are literally incredible.* By contrast, throughout the period form 1931 to 1935, currency outside banks was around 80 percent of totals that exclude the deposits of modern and foreign banks. That is much more credible for a country at China's stage of economic and financial development.†
The narrower totals, which include specie plus bank notes plus deposits in native banks, fell by 11 percent and 9 percent from 1931 to 1935, and by 13 percent and 11 percent from 1933 to 1935—so the severe decline came after the United States departed from gold and started on its silver purchase program.* I conclude that the money supply relevant to domestic nonfinancial economic activities did behave as Schwartz and I assumed.
P. H. Kevin Chang (1988), in a detailed analysis of the same period, also rejects Brandt and Sargent's explanation, on different though related grounds, namely, that "it fails to explain the sudden increase in silver exports occurring in 1934 and 1935,...the timing of the Chinese deflation does not correspond to the pattern of Chinese silver exports" ([>]). He rejects our interpretation both because he erroneously believes that it is contradicted by the new estimates that Brandt and Sargent rely on and because "we overlook the true cause of the silver outflow from China" (p. 69).
Chang argues that "America's determination to support silver prices and China's strong aversion to deflation and silver export [which Chang regards as greatly overdone], clearly pointed to an eventual suspension of the silver standard ... [which] led those holding silver within China to seek to export it," reinforcing the government's concerns and leading to the eventual departure from silver (p. 43).
Chang's explanation of the time pattern of silver exports seems convincing. The speculative response to the widespread fears of the effect of the U.S. determination to raise the price of silver may well have been the trigger for the government's decision to embargo exports of silver and subsequently to establish a fiat standard. The effects that we emphasized in Monetary History would have led to the same result, but they might well have taken a longer time to produce that result.
The differences among the interpretations are important for a full understanding of events in China between 1931 and 1936. But it is worth emphasizing that all three interpretations agree that (1) the rise in the U.S. price of silver produced a sharp deflation in China; (2) large amounts of silver were exported, both legally and via smuggling after the government embargoed exports; (3) contemporary observers saw the deflation as accompanied by severely depressed economic conditions—whether because of money illusion or because their firsthand information was more reliable than the later highly aggregated, partial, and inexact statistical data; (4) the deflation, whether solely