From 1937 until 1949 China experienced a bout of inflation no less spectacular and no less fraught with social and political consequences than the hyperinflation of post–World War I Germany. The inflation began in Free China, the part of China not invaded by the Japanese, and continued until the communist government solidified control of the mainland in 1949 through 1950.
Chinese inflation falls into three eras. Between 1937 and 1939, the early war years, prices did not fully give way to inflationary pressures. Between 1940 and 1945, the war years, the Chinese people began to loose confidence in currency, and inflation accelerated. The end of World War II saw a brief lull in inflation before inflation rose to stratospheric heights, ending in the collapse of the currency system just before the nationalist government fled to Taiwan.
Japan’s invasion of China left Free China robbed of 90 percent of its industrial capacity, and the Chinese government bereft of the tax revenue of the wealthiest provinces of China. Japan’s blockade of ports serving Free China also reduced supplies of imported goods. The Chinese government sought to finance a military resistance and an industrialization of Free China without recourse to significant taxes, instead relying upon voluntary sacrifices and foreign aid. The government ran up massive deficits and expanded bank credit for industrial expansion. However, good harvests kept the prices of consumer goods down and wholesale prices increased 200 percent between December 1937 and December 1939, a modest increase in light of the inflationary pressures.
During the war years, 1940 through 1945, Japan tightened its noose around China, blocking virtually all imports into China, and crop failures further reduced the supplies of goods. China’s archaic tax system, in which revenue rose with the number of transactions rather than prices, failed to produce added revenue commensurate with the rate of inflation. Government expenditures rose with inflation but tax revenue tended to stand still, causing the budget deficit to increase fourfold from 1939 to 1941. Prices rose nearly 600 percent between December 1939 and December 1941. Between December 1941 and December 1945 the government budget deficit increased over 100-fold, and prices increased 10,000 percent. The public lost confidence in the currency, and the velocity of circulation increased, further fueling the inflation. The government made a half-hearted effort at price controls, but China had neither the administrative apparatus nor the statistical information to carry out a plan for fixing prices.
The end of the war brought a stabilizing influence to prices, which actually fell from August to December 1945. In 1946 peace negotiations with the communists broke off, and the nationalist Chinese government continued heavy military expenditures and deficit spending. In 1946 government expenditures increased threefold, and revenue covered only 37 percent of the expenditure. Between June 1946 and August 1948 prices rose 146,772 percent in Shanghai. In August 1948 the government discounted the old currency, issued a new currency at a rate of 1 unit of the new currency to 3 million of the old. The government also imposed price controls. Inflationary pressures burst through the price ceilings, and prices continued to rise at a feverish pitch. From August 1948 until April 1949 prices rose 112,390 percent. The communists occupied Shanghai in May 1949, the nationalist government was in confusion, and the compilation of price information was suspended. As the communists consolidated control of Mainland China, the nationalists’ currency became completely unacceptable.
The Chinese inflation experience adds further corroboration for Lenin’s comment that the surest way to overthrow the capitalist system was to debase the currency. The rapid inflation was probably a major factor causing the climate of cynical corruption in the nationalist government, and helped contribute to its demise.