Shifting China’s Export towards the Domestic Market

Henry C. K. Liu

Part I: Breaking Free from Dollar Hegemony

Part II: Developing
China with Sovereign Credit

This article appeared in AToL on September 4, 2008


The two key factors preventing the use of sovereign credit to finance sustainable development of the domestic sector of the Chinese economy are China’s high export dependency operating under dollar hegemony and the ill-advised blanket privatization of the public sector.
The term "privatization" is generally defined as any process aimed at shifting government functions and responsibilities, in whole or in part, to the profit-driven private sector. Privatization of government responsibilities is touted by both conservatives and neoliberals as the remedy for government inefficiency and corruption. Yet the record shows that both public and private sectors, given the opportunity, have shown equally high propensity to become inefficient, corrupt and unethical, each in its own way.
In the shadow of the 1930s Great Depression and chastened by the horror of global modern war, Western societies in the 20th century sought to redefine social provision and the notion of public good. There was renewed concern with the rights of citizenship and entitlement to basic services (health care, education, public housing, subsidized mass transport and unemployment insurance) as part of a “social wage”. These programs were purposely removed from the pressure of the market, to be funded by general taxation at progressive rates for the benefit of all. The strength of the welfare state varied from one country to another. It had its weakest foothold in the United States. But the rationale was the same: social cohesion and economic progress were furthered by a shared sense of community. Forty years later ideology took an about-face. The welfare state came under attack and nowhere more so than in Britain, one of the countries where it was most advanced, led by Margaret Thatcher. Ronald Reagan jumped on the reactionary train in the US.  See my February 12, 2005 AToL article: The Privatization Wave
Privatization of the public sector, generally taking the form of sale or lease of public assets or property rights to private interests, is a path toward failed state status even for a sovereign state with a capitalist market economy. By definition the public sector exists because there are elements of the economy that the private sector cannot handle efficiently without externalizing some major costs to the economy as a whole.
Operationally, privatization of the public sector generally takes the path of corporatization of state-owned enterprises by offering shares for sale in the capital market to those who have access to money. This approach presents ideological as well as practical problems for a socialist society such as China’s, in transition towards a socialist market economy. In a socialist economy, state-owned-enterprises (SOEs) are owned collectively by all the people. Ideally, everyone enjoys all the consumable wealth he/she needs and no one needs to personally worry about savings for rainy days as excess wealth to invest. Savings in a socialist society are done collectively with the need to save socialized.
Privatization of SOEs that operate in the public sector through corporatization via initial public offerings of shares raises issues of equity and social justice, aside from the fact that it drains private capital unnecessarily from the part of the private sector that otherwise serves a legitimate economic function. This drain of private capital causes interest rates in the private sector to rise needlessly and reduces the efficiency of the entire economy.
Without an institutional framework in place to transfer state-owned property fairly to all members of the owning public with low transaction costs, the initial uneven private allocation of state-owned property and the lack of fluidity in secondary markets can and often do undermine social justice and welfare by exacerbating wealth and income inequality. A practical problem for socialist countries such as China is from whence would the potential domestic buyers with money come? Surely not from members of the proletariat class who by definition have no money for private investment, not even from latent capitalists since they were not allowed to exist before the age of reform toward market economy. Domestic buyers then must come from a small circle who are in a position to manipulated finances to gain access to bank loans collateralized by the very shares they intent to buy. Foreign buyers, albeit now still limited in the amount they can purchase, end up buying the best state-owned-enterprises at bargain prices in a buyer’s market. The problem has been the lightning rod of public complaint in past decade.
Some Eastern European transitional economies have used complicated voucher schemes in which public assets could be distributed broadly among private citizens and collectively-owned institutions with legitimate claims on them. Voucher holders could then trade these new instruments of ownership at market value as pseudo-stocks of public asset being privatized. Such voucher systems inevitably suffer from high transaction costs and other market inefficiencies caused by the unmanageably large number of individual voucher recipients, uneven market information, and the difficulties in organizing and regulating a fair market.
The net result has been to provide legal but unfair opportunities for unsavory and manipulative speculators, often foreigners with sophisticate experience and expertise in financial engineering, to buy up the dispersed vouchers at high discount and use them to subsequently acquire control of the privatized SOEs on the cheap. Such privatization processes are vivid examples of free market fairness not adding up to economic justice.
Many East European states transitioning from socialist economy to market economy thus rely on auction mechanisms to both value and privatize state-owned property. Auctions can better determine the fair market price of assets based upon a number of factors: earning history and future potential, industry trends, auction rules and process, and availability and cost of money. Restructuring of the entity before it is suitable for sale is usually necessary before an auction can proceed.
External factors affecting market value involve anticipated post-privatization contractual relationship with governmental customers, the stage of privatization within the economy, potential competitors and  market competition environment, and the degree of continuing government control of and regulation on the privatized entity, the industry and the private sector generally.
The auction process itself can influence market values by the way the state packages a SOE or parts of it for sale. Macroeconomic policies also affect enterprise market value. Bidding qualifications such as restricting auctions to buyers that meet eligibility qualifications set by the state can also affect market value. Such qualifying restriction can include buyer citizenship and other non-financial requirements to preserve socio-economic justice.
Pre-auction restructuring efforts that require management changes, layoffs, debt absorption, efficiency improvement measures, investment priorities, bridge capital and loans and adjustment in contracts with other stat-owned enterprises placed prior to the auction can raise transaction cost and lower the transaction value. For example, one determinant in pricing is the prospect of unionization of labor and workers’ right to strike against a private corporation.

Aside from the issue of social justice, transitional economies need to weigh the social cost of privatization because a privatized entity often gains operational efficiency by externalizing part of its cost to society at large. Also, state-owned-enterprises are mistakenly viewed in neo-liberal circles as inevitably failing to operate efficiently as a result of nebulous property rights, uneconomic pricing due to government subsidy and intervention in management. This view leads reformers to seek misguided blanket privatization as a cure all to stimulate more growth.
SOEs do need reform to improve their performance as a category, but privatization is not the answer. More to the point is to allow SOE salaries and wages to rise to levels competitive with private companies to retain and attract talent, to introduce meritocracy in management and to provide superior enterprise-financed training and education for career advancement. Also, SOE efficiency will improve if social benefits, such as health care, employee housing, children education, etc., are not provided by each enterprise separately but outsourced to special function SOEs that can better capture economy of scale.
Ownership and management have been separate in market economies for more than a century. In fact the separation is recognized as the most significant factor in the growth of free market capitalism.  Also, profit-based pricing often adds aggregate inflationary pressure to the economy as a whole while producing profit only to individual units to be distributed to shareholders. Subsidized food prices are a clear example of this dilemma. Further, government bailout of failed private enterprises is commonplace in free market capitalism.
In the US where free market capitalism operates as a religious faith and the private sector dominates the economy, glaring examples of failed enterprises emerge repeatedly whenever government regulation fails. The most serious giant corporate failures invariably require government bailout to prevent systemic damage to the economy. This is known as the “too big to fail” syndrome. The most recent examples in the finance sector are Fannie Mae and Freddie Mac, Bear Stearns, Countrywide and IndyMac. In recent history, the list of failed companies included Drexel Burnham & Lambert, Enron, WorldCom, Global Crossing, Pan Am Airline, Macy’s, Delphi Auto Parts, Continental Illinois National Bank and Trust Company and numerous other bankruptcies. Penn Central filed for bankruptcy and its passenger lines were nationalized as Amtrak in 1971 and its freight traffic nationalized as Conrail in 1976. Chrysler required a $1.5 billion government guaranteed loan in 1979 to avoid bankruptcy.
The case of Enron illustrates the systemic fraud on a large scale that could occur in an under-regulated market with major banks as eager participants in dubious financial manipulation. In 1985, taking advantage of a weakened antitrust regime, Enron was formed from a merger of Houston Natural Gas and InterNorth Gas of Omaha, Nebraska. By 2000, Enron had grown into the largest natural gas merchant in North America, eventually branching out from a pipeline company into a major trader of energy, electricity and other commodities such as water, coal and steel. The company attracted eager investors and its stocks rose phenomenally.
Unfortunately, Enron’s spectacular success came from its strategy of fraudulently manipulating its financials to achieve unsupported market value for its stock, resulting in the ultimate and inevitable collapse of the company as the fantasy bubble based on fraud burst and public trust in it evaporated.
A more recent example of widespread fraud is the promotion and marketing of auction rate securities (ARS), debt instruments with long nominal maturities for which the interest rate is regularly reset through a Dutch auction by bidding investors betting on money market movements. Major banks and brokerage houses market ARS as safe and liquid instruments, almost the equivalent of cash, to institutional investors, including pension funds, and charities, individuals, and small businesses, by promising to be bidders of last resort. But in early 2008, as the credit crisis that began in August 2007 caused the failure of up to 80% of the ARS market, the four largest investment banks which normally make a market in these securities (Citigroup, UBS, Morgan Stanley and Merrill Lynch) declined to act as bidders of last resort, as they had promised to do, causing losses to investors.
On August 1, 2008, New York State Attorney General Andrew Cuomo notified Citigroup of his intent to file charges over alleged Citigroup misrepresentation in the sale of troubled auction-rate securities as safe instruments. Investigators also accused Citigroup of illegally destroying relevant documents.
A week later, on August 7, in response to state and federal regulators charges, Citigroup was reported as having agreed in principle to settle the auction rate securities charges by buying back about $7.3 billion of auction-rate securities it sold to charity organizations, individual investors, and small businesses. The agreement also calls for Citigroup to use “best efforts” to make all of the US$12 billion auction-rate securities it sold to institutional investors, including retirement plans, liquid by the end of 2009. The settlement allowed Citigroup to avoid admitting or denying claims that it fraudulently sold auction-rate securities as safe, liquid investments.
On the same day, a few hours after the Citigroup settlement announcement, Merrill Lynch announced that effective January 15, 2009, and through January 15, 2010, it will offer to buy back at par auction rate securities sold by it to retail clients. Merrill’s action provided critically needed liquidity for more than 30,000 investor clients who hold municipal, closed-end funds and student loan auction rate securities. Under the plan, retail clients of Merrill would have a year-long option in which to sell back to Merrill the auction rate securities they bought at face value should the market value fall below that.
There is also the issue of the settlement’s focus on points of sale rather than on the underwriting institutions which broke their promise of making markets for the auctions, which is a much larger problem than the settlement had so far covered. Also the liquidity provided by the Fed through its discount window is accessible only to the large national investment banks but not to regional brokerage firms which acted as the large investment banks’ agents. Further, the settlement is not global in the sense that investors who bought ARS from regional firms that were not included in the settlement are not offered any buybacks.  There was also a full disclosure issue in that when the auction market first began to crack, not all potential buyers were in possession of the critical information that the market might seize up or they would not have bought ARS if they had known.
The State Attorney’s office is also probing the relationship between Fidelity Investments, the nation’s largest mutual fund manager and Goldman Sachs on the sale of ARS’s. Most of the SAS’s sold by Fidelity was underwritten by Goldman. There was a question of conflict of interest in terms of undue incentive to sell Goldman underwritten instruments to Fidelity retail customers because Fidelity was protecting its other lucrative services from Goldman, including other Goldman underwriting of private offerings of instruments Fidelity developed for accredited investors. In short, this is crony capitalism at work. What is a amazing is that this practice has been going on for years, yet it takes until now before those in charge of fair and equitable market to catch on. Better late than never, and it could have been never if a crisis had not broken out. 
In the same month, the Securities Exchange Commission’s Division of Enforcement engaged in preliminary settlements with several of the larger broker-dealers including Citigroup, JPMorgan Chase, Merrill Lynch, Morgan Stanley and UBS. The proposed settlement calls for these broker-dealers to repurchase outstanding ARS from their individual investors. Still the ARS market has remained under seizure as public trust in the market evaporated.  Goldman may be added to the list before long.
According to a new study by Greenwich Associates released on , nearly 60% of the 146 hedge funds, banks and long-only managers surveyed say they expect to see another major financial services firm collapse within the next six months as a result of the ongoing credit crisis, and another 15% think it will happen in six to 12 months. Counterparty risk in credit-default swaps is shaping up as a serious threat to global financial markets. Outstanding credit default swaps is around $45 trillion, which is 3 times larger than US GDP of $15 trillion and 300 times larger than the Bush relief plan of $150 billion. See my January 26, 2008 article in AToL: THE ROAD TO HYPERINFLATION: Fed helpless in its own crisis.

Harvard macroeconomic professor Kenneth Rogoff, former IMF chief economist, warned publicly in August, 2008 that the worst of the global financial crisis is yet to come and a large
US bank will fail in the next few months as the world’s biggest economy hits further troubles. Indications are mounting that public trust in free market capitalism appears to be in shorter supply with every passing week.
The Federal Deposit Insurance Corporation has warned repeatedly with increasing urgency that the outlook for distressed banks is bad and getting worse as a result of toxic home martgages spreading throughout the entire financial sector. By June 2008, the agency’s Q2 report showed the number of bad loans having ballooned to its highest level since 1985, which led to the 1987 crash. In Q2 2008, bank profits plunges 86% between April and June from $36.8 billion to $4.96 billion. The agency raised the number of problem banks on its list to 117, the highest since 2003. The number was 90 at the end of Q1, 2008, already bad enough.
More new tidal waves of credit crunches are approaching US and European banks as these institutions face imminent maturity of massive amount of floating-rate notes that the banks took on four years earlier to borrow money to finance their loose lending. The first wave will hit in September 2008, when banks must pay off $95 billion of matured notes. By the end of 2009, some $787 billion notes will have come due, 43% more than in the previous 16 months. This will drive up interest rates in all maturities even if the Fed keeps its overnight Fed funds rate target unchanged at 2%. A year ago in July 2007, before the current credit crisis broke out, the spread between bank floating rate notes and LIBOR  (London Interbank Offer Rate – the rate banks agree to lend to each other) was only 0.2%. In August 2008, the spread has gone up ten times to a full two percentage points for some banks. The commercial paper market seizure and the collapse of SIVs, which had been the main buyer of bank floating notes, exacerbated the problem for banks. See my AToL series: Pathology of Debt.

Choice for China

Is this the con game China wants to emulate by privatizing her public sector and opening up her financial sector to predatory global capital to allow the few to rob the many?  It would be a policy of letting the fox into the chicken coop. Is the Communist Party of China willing to lead the Chinese people to the slaughter house of finance capitalism, at a time when even the US is beset with neo-populist clamoring for a return to extensive government intervention in, and tight regulation on iniquitous abuses in the private sector? It is ironic that Hong Kong, the poster child of US free market apologists, has to repeatedly beg its socialist kin on the Mainland to give it preferential subsidy whenever it hits a bump in its supposedly productive free market. Is the Communist Party of China willing to betray the sacred trust of the masses in China to stray from unshakable faith and confidence in socialism, merely to be a belated “stakeholder” in an exploitative economic system that even the masses in the US are beginning to reject? Is China prepared to gamble away the public trust in the Communist Party earned with the blood of millions of revolutionary martyrs, to enter the dangerous minefields of deregulated markets when US public trust in unregulated free markets is evaporating faster than morning dew?
Free Market Losing Public Trust
Public trust has been recognized as critical to a vibrant capitalist market economy ever since the 12th century when the first brokers traded private debt and government securities in France. Unofficial share markets blossomed across urbanized Europe throughout the 1600s when brokers would meet outdoors or in coffee houses to make trades. The emergence of stock markets in cities contributed directly to the rise of capitalism by forming purposeful capital from the dispersed wealth held by the public at large.
Stock markets, similar to all other free markets, require government regulation to remain free. This is the socialist component in all markets. Well regulated capitalist markets share similarity in operation with socialist markets. It is ironic that the US is blaming China for unsafe imports. Many policymakers in China have been misled by US neoliberal propaganda that free markets mean no government regulation and that somehow unsafe products will be screened out by market forces. In reality, public trust in society springs from the foundation of trust in an engaged and caring sovereign government protecting the interest and welfare of all the people. Free market is an arena that operates with the principle of caveat emptor.
The distinguishing characteristic between capitalism and socialism is the ownership pattern of the means of production. Free market capitalism operates through the joint stock company for the benefit of shareholders while socialist economies operate through state-own and collectively-owned enterprises in control of the means of production for the benefit of the general population. Enlightened free marketers grudgingly acknowledge corporate responsibility to the public, but always only if it does not hamper fiduciary responsibility to shareholders. Automakers’ attitude to car safety is a clear example. Recalls within legal limits are decided on the cost of negligent litigation. A safety recall program of $100 per car covering a million cars will be launched only if the potential law suit exposure exceeds $100 million, unless criminal liability overrides the financial calculation.
Both free market capitalism and planned socialist economies are subject to fraud and abuse, albeit through different loopholes. Capitalist free markets tend to allow corporate externalization of costs to the general economy while privatizing the gains. On the other extremist socialist economies tend to place on unit enterprises social costs burdens beyond the financial capacity of individual enterprises, causing them to become inefficient or failed enterprises. Operationally, the difference lies in the attitude and reliance on the extent of government initiative on protection of the general public.
Joint Stock Companies and Colonialism
Joint stock companies are born in the manger of stock exchanges. The Amsterdam Stock Exchange, created in 1602, was the first official stock exchange when it began trading shares of the Vereenigde Oost-Indische Compagnie (VOC or United East Indies Company in English). It was the first joint stock company shares ever issued and the predecessor of the Dutch East India Company.
The parliament of the Dutch Republic (1581-1795) granted VOC a 21-year monopoly through a sovereign charter to establish trading colonies in Asia. VOC was the first transnational corporation in history. Stock-issuing transnational companies had since been closely connected to the birth of colonialism which took the form of economic conquest of foreign lands through capitalist expansion backed by political/military power. It formed the basis of Lenin’s observation that imperialism is the highest stage of capitalism. Today, modern transnational corporations continue to be linked to neo-colonialism backed by neo-imperialist government policies in the name of globalized free market fundamentalism.
Is this the game China, with a government born of revolutionary liberation, wants to emulate? Throughout her long history, China had trade with the known world for common benefit. But Chinese history never included any age of expansionist economic imperialism. When Chinese mariner Cheng He (1371-1433) sailed the oceans in 1401 in a ship three times the size of Columbus’, he did not found any colonies as Columbus and his European followers did. Cheng He reached lands in South and Southeast Asia, the Persian Gulf and Africa. Gavin Menzies claims that Cheng He’s fleet went on to reach the New World, landing on islands off the Florida coast more than half a century before Columbus. Throughout his travels, Zheng He liberally presented his hosts with Chinese gifts of silk, porcelain, tea, paper and other unique goods from Chinese civilization. In return, he received native presents from his hosts, including African zebras and giraffes that were brought back to fill Ming dynasty imperial game reserves. Zheng He and his sizable entourage paid respects to local deities and customs and adopted Islam personally. In Ceylon, Cheng He erected a three-religion monument honoring Buddha, Allah and Vishnu. The use of military force was limited to policing pirates, never on the natives on the lands Zheng He visited.
Such is the trading model China should revive in the 21th century, not helping to perpetuate exploitative Western globalization facing self-destruct. Chinese neoliberal pundits of today who mindless declare globalization an irreversible trend of world civilization are only half right.  A new trade globalization is waiting to burst out under enlighten leadership from China, the world’s most populous nation and soon to be the largest economy.  This new globalized trade will have to truly benefit all participants without the tyranny of  offshore transnational capital denominated in fiat currency like the dollar, and that benefiting only shareholders of transnational corporations. Trade should be conducted to enrich the lives of all participants, not to reap monetized profits by forcing the weak participants into perpetual poverty. That is not trade, but imperialism.
The Role of Sovereign Charters in Commerce
In England, sovereign charters historically came in the form of royal charters granted by the monarch on advice of the Privy Council, to legitimize incorporated bodies, such as cities, companies, universities, charities or such, for the betterment of the entire kingdom. A royal charter is a kind of letters patent, a legal instrument in the form of an open letter issued by the sovereign, granting an office, right, monopoly, title, or status to a legal person such as an individual of merit or a corporation, implicitly to advance the interests of the state.
In medieval feudal Europe, cities were the only place where markets could legally exist to conduct commerce, and royal charters were the only way to establish a city independent of feudal estates. The year a city was chartered is considered the year the city was “founded”, irrespective of whether there was settlement there before. Chartered cities were under the protection of the sovereign, exempt from feudal estate laws. Cities were locations where feudal estates could interact commercially as equals. Producers of different goods could not sell to each other directly within or beyond their respective feudal estates, as all assets within the estate were the property of the feudal lord.  Government authority over, and supervision of commerce, have existed from the very beginning of government in history. That government should stay out of commerce is barbaric notion.
Producers were allowed by law to bring their surplus goods to market only at designated locations in chartered cities and at scheduled times to sell them for money issued by the ruling sovereign who alone command the power of seigniorage.  Seigniorage produces monetary revenue for a sovereign when the created money has a higher face value than the intrinsic cost of producing it.
A royal charter can also create and grant special status and power to an incorporated body, such as the power to tax and to maintain a private security force and self-government over territories under its control. It is an exercise of the royal prerogative in a monarchy and a sovereign prerogative in a republic. A trading monopoly granted by British royal charter between the 17th and 19th centuries routinely possessed extraterritorial governmental powers in the colonies.
Historically, a royal charter was the only way in which an incorporated body could be formed in a monarchy. In essence, an incorporated entity is a limited collective enterprise. Other means such as the registration of a limited company are available in modern times via the commercial legal regime, which still involve the granting of sovereign prerogative by a sovereign state to entitle it to come under the protection of the state. Among the historical bodies formed by British royal charter were the British East India Company, the Hudson Bay Company, the Peninsular and Oriental Steam Navigation Company (P&O), the British South African Company and the 13 American colonies.
To facilitate the achievement of its financial goals, the VOC was granted by parliament of the Republic of the United Netherlands quasi-governmental powers on foreign soil, including the power and ability to wage war on the native peoples and governments, negotiate treaties, issue money, and establish colonies with laws independent of the homeland legal regime. This was the beginning of modern imperialism which is the conquering of foreign markets via extraterritorial property rights backed by the threat or use of force. Transnational banks were and still are all founded by sovereign charters. This fact underscores that international trade is a political extension of sovereign states. This will remain true as long as there is a world order of sovereign states.
VOC was profitable enough to pay 18% dividend annually uninterrupted for almost two centuries until its quasi-government power was interrupted in 1795 with the fall of Republic of the United Netherlands which had been allied with conservative Austrian and British interests.  The succeeding Batavian Republic, backed by the populist French First Republic, nationalized VOC assets and assumed all outstanding debt of the bankrupt VOC, making its profits payable to the state as representatives of all the people, instead of just shareholders.
The name was changed from United East Indies Company to Dutch East Indies Company. VOC territories then became the Dutch East Indies, a colony owned and administered by the Dutch state. It was expanded over the course of the 19th century to include the whole of the Indonesian archipelago. Under the decolonization policies of the victorious Allies at the end of WWII, the Dutch East Indies became the independent nation of Indonesia with 222 million people as the world’s fourth most populous country and the most populous Muslim-majority nation.  Membership in spranational institutions such as the World Trade Organiztion, the International Monetary Frnd and the Bank of International Settlements is only treaty obligations assumed by soverign states.
Britain immediately followed the Dutch example of expanding colonialism through a joint stock company. The British East India Trading Company had been granted a royal charter by Elisabeth I on December 31, 1600, two years before the founding of VOC, with the intention of bestowing upon it favorable trade privileges with India. The company was a collective enterprise of London private businessmen who banded together to make money importing spices from South Asia. The royal charter granted the newly created company a 21-year monopoly on all British trade in the East Indies. The Company through private placement quickly transformed from a private commercial trading venture to one that virtually ruled India and other Asian colonies as an imperialist overlord as it acquired auxiliary governmental and military capability. But its shares were not publicly traded until after the founding of the London stock exchange in 1801. Thereafter, the corporate structure of the British East India Company became a classic model of a successful publicly traded joint stock company. Many innovative organizational features, such as reliance of a network of highly compensated agents, known as compradors, to efficiently exploit chaotic markets, were later copied by modern transnational corporations. The comprador system reduced capital levels for the company while spread the risk away from the company. Much of the dirty exploitation was carried out by comprador agents while top management at company headquarter stayed above it all by comforting itself with having played fair according to the high-sounding principles of capitalism,
For centuries, spice trade with the East Indies relied on land routes across Asia and the Middle East, but by the sixteenth century, the superior shipping technology of the Portuguese permitted Europeans to cut out Arabic intermediaries to make far greater profits. The Spanish and Portuguese had a monopoly of the East Indies spice trade until destruction of the Spanish Armada in 1588, which permitted the British and Dutch to control this lucrative trade.  

Yet British East India Company policies in Bengal were responsible for failing to prevent the Bengal famine of 1770 which left a third of the native population of 30 million dead from starvation. As a trading entity owned and run by a foreign race, the Company’s mandate was to maximize profit by exploiting its chartered right to impose land tax over its jurisdiction and trade tariffs on imports. Land tax in Bengal
was raised five folds from 10% to 50% of the estimated value of the agricultural produce on all land in territory control by the Company, including land not directly owned by the Company.
Land tax was the key devise of the British colonial authorities of all its colonies to make the natives productive in monetary terms. Native farmers and rangers were compelled to produce more than their families needed for consumption and to sell the surplus in the market for money issued by the Company to pay land taxes. Most of the tax revenue did not stay in India or other colonies for local development. It flowed to England as dividends for British shareholders. All investments in India, and other colonies were directed toward raising trade profit for the Company, rather than to improve the welfare of the natives. As the Bengal famine approached its most severe stage in April of 1770, the Company announced a further increase of the land tax to 60% of potential production value.
The Company forbade the “hoarding” of rice at good harvest so that it could maximize profit from low prices it paid growers due to a supply glut, thus prevented traders and dealers from holding reserves for poor harvest to feed the native population during lean periods. It also paid farmers to plant opium and tea cash crops instead of rice to increase company profit. The tea that was dumped into the harbor by members of the Boston Tea Party in the American Revolution in 1773 was British East India Company property. American colonists were protesting the British East India Company’s monopoly over tea exports to the colonies. By the time of the famine, full monopoly in grain trading had been firmly established in India by the Company and its agents. The Company had no plan for dealing with the grain shortage besides measures to assure food supply for British executives and their native employees. Globally, company profit doubled in the decade of the famine.
The privileged monopoly of the Company was criticized by Adam Smith, advocate of free trade, Edmund Burke, apologist for American secessionism yet conservative critic of the French Revolution, and British home merchants locked out of the lucrative Asia trade, who protested the Company’s administrative abuses and monopolistic ineptitude. In 1833, Parliament declined to extend the monopoly of the British East India Company on trade between Britain and China. Jardine, Matheson and Company took advantage of this open market opportunity to transform itself from the position of leading agent of the British East India Company to that of a competitor to prosper in the next century.
British Trade Deficit in Silver Prompted Opium Smuggling into China
In the 18th century, England was incurring huge trade deficits denominated in silver with China under Qing dynastic rule, as silver was legal tender in China. This trade deficit was draining silver from the British Mint at a time when England was on the gold standard which undervalued silver, causing silver to leave England en mass to effectuate a inflow of gold. Thus British merchants had to buy silver in continental Europe with gold at higher prices that cost almost one moreounce of silver for every ounce of gold sold, becasue of the silver/gold ratio set by European bimetallim. The price differential of silver between England and the Continent continued until Germany demonetized silver in the 1870s. This meant silver before the 1870s was priced higher as a monetary unit in Europe than its intrinsic value as a commodity because of German seigniorage. Silver was also priced lower both commercially and monetarily in Europe than the silver/gold ratio set by the gold standard in England.
Because there was not much that China would want to buy from the West in the 18th century because China, as a more advance civilization and a wealthier economy, was producing all the goods she needed in superior quality, especially from Britain where goods produced by early industrialization were generally crude and monotonous, the British East India Company resorted to opium smuggling to China where opium trade was illegal to balance the Company's rising trade deficit.
To impose illegal opium trade on China, the Company soon found it needed to persuade the British government to adopt gunboat diplomacy to turn trade into economic and political imperialism. Beginning in early 19th century, Britain became the “Workshop of the World” of crude mass-produced products that even members of the British upperclass themselves did not find attractive and had to be exported to less cultured colonies. But Chinese markets were too cultured for these goods. Unitl opium smmugling, the British were unable to break into the huge Chinese market. Britain needed more new capital to finance its growing industries and sought it from new wealth reaped from overseas colonies. She also needed more raw materials to maintain its growing industries and more markets for the finished goods in a mercantilist trade regime. She also needed safe shipping routes between the British Isles and her far-flung colonies. Lord Palmerston (1784-1865), liberal successor to the conservative Duke Wellington as Foreign Secretary in 1830, claimed that Britain wanted only peace and prestige, a euphemism to justify his gunboat diplomacy to expand illegitimate British commercial dominance all over the world. But China remained ellusive to British colonial ambitions until the British introduced opium in her China trade.
At home, Palmerston’s expansionist foreign policy ran into conflict not only with the English landed gentry who opposed trade expansionist industrialists. The Corn Laws were passed by Parliament to protect British agriculture from cheap imports. (See my May 1, 2002 AToL article: Big Money and the Corn Laws) Palmerston also clashed with Queen Victoria who wanted British foreign policy to avoid creating situations that would weaken monarchism in Europe which was increasingly threatened by the rising revolutionary ferments of republicanism, democracy or socialism, as most royal families were her blood relatives through marriage. Her apprehension was not mere paranoia, as the German Kaiser and the Russian Czar both lost their crowns. The Kaiser went into exile in the Netherlands and lived until 1941. The Russian imperial family lost their lives through revolutionary regicide. But on imperialism on non-while peoples, the Queen and her foreign minister were of one mind.
Palmerston launched the First Opium War of 1841 against China, considered then “the sick man of Asia” by Europeans. He was advised by William Jardine, head of Jardine, Matheson and Company, who literally planned the entire military operation and drafted the proposed surrender terms to be presented to a defeated China. Easy British victory forced a poorly governed China open to Western imperialism for the next century. While the British smuggled opium to China from British India, the Forbes and Delano families of Boston smuggled opium into China with China Clippers from Turkey grown under British supervision. Much of the profit from the US opium trade went to Boston and through Boston banks to finance the expansion of the US West as investments in railroads built mostly with imported Chinese slave labor.

The Bengal famine of 1770 caused liberals in British politics to realize that private companies cannot be expected to deal effectively with socio-political issues of mercantile colonialism. For solution British liberals opted for political colonialism and passed the Government of India Act of 1858 to make the British Crown the direct ruler of India, following the so-called Indian Rebellion in 1857, in reality an independence struggle brutally suppressed by British forces. The Government of India Act of 1878 anointed Queen Victoria with the title of Empress of India. All properties of the East India Company were transferred to the Crown. Its 24,000-man private military force was incorporated into the British India Army, leaving the Company with only a shadow of the power it had wielded years earlier. The Company, without its monopoly and quasi-governmental powers, was finally dissolved on January 1, 1871 by the East India Stock Dividend Redemption Act.
The British East India Company throughout its history naturally had an interest in developing a network of fortified supply points along shipping routes from Britain to India. As early as 1620, the Company attempted to lay claim to the Table Mountain region overlooking today’s Cape Town in South Africa and later occupied it. Cape Town was a key supply point for shipping to India as Singapore was for shipping to China after the opening of the Suez Cannel in 1869. The rounding of the cape in 1488 was a major milestone in Portuguese navigational attempts to establish direct sea trade routes to the Far East.  The British East India Company also ruled St. Helena where the defeated Napoleon was kept prisoner until death under Company administration.
Elihu Yale (1649-1721), Boston born but returned with the family to England at age 4, whose widowed grandmother remarried Governor Theophilus Eaton (1590-1657) of the New Haven Colony in Connecticut, was connected to the British East India Company for two decades, becoming the second governor of Madras in 1687. Yale amassed a fortune in his lifetime, largely through secret contracts with native Madras merchants against company directive. By 1692, repeated flouting of company regulations and growing embarrassment at his illegal profiteering led to Yale’s being relieved of the post of governor.
In 1718, Cotton Mather (1663-1728), socially and politically influential New England Puritan minister and pamphleteer, a figure in the infamous Salem Witch Trials, asked Elihu Yale in 1701 to help the Collegiate School of Connecticut with money for a new building in New Haven, Connecticut. Yale sent Mather a carton of goods that the school subsequently sold for ₤560, a substantial sum in the early 1700s. In gratitude, officials named the new building Yale; eventually the entire institution became Yale University, founded initially by opium smuggling profit from the British East India Company.
Collapse of Chinese Economy in 19th Century was a Monetary Event
Over the length of two centuries, Britain devastated the economy of China, the largest nation in the world, with an ancient, highly developed civilization and the rishest economy in the world until the British came in early 19th century.

The war indemnity of the First Opium War of 1841 alone imposed on China the payment to Britain of ₤10 million, ₤3 million of which was for the destruction of confiscated opium contraband. Untold millions were subsequently collected from unequal treaties forced upon China, the first being the infamous Nanking Treaty which among preferential trade concessions granted to British interests, ceded Hong Kong to Britain. The First Opium War showed the West how weak imperial China really was behind its crumbling superpower facade and opened China subsequently to a century of foreign aggression and exploitation, draining wealth on a massive scale from China to the European powers, the United States and Czarist Russia.

In 1900, the war indemnity from an Eight-Power Coalition invasion of China as a result of the xenophobic Boxers Uprising forced China to pay 982 million taels (1 tael = 34 grams = 40.76 ounces) or 40 billion ounces of pure silver at the then British controlled market price of three taels per pound sterling, yielding ₤327 million, of which Russia received 29%, Germany 20%, France 15%, Britain 11%, Japan 7.7% and the US 7.3%.  This was three times the global trade deficit of ₤109 million incurred by Britain in 1910.  But the pound sterling was set by the Brtitish gold standard at 15 ounces of silver, and 982 million taels of silver covert to 40 billion ounces of silver or 2.6 billion, not 327 million. The sum of 2.6 billion was over 24 times the British global trade deficit in 1910. This sum and other payment obligations from subsequent unequal treaties were so large that Britain demanded and received control of Chinese maritime custom service to collect tariffs to pay Western Powers their due from unequal treaties.
The final collapse of the economy of dynastic China was caused by the advance of Western political imperialism initially via the illegal private smuggling of opium into China, paid for by a massive outflow of silver from China. What is yet to be fully recognized by economics historians is the adverse effect on the Chinese economy from the massive outward drain of silver from the illegal opium trade Britain and the United States imposed on China as a result of the inability of the Qing imperial court to protect its sovereignty and, more importantly, its independent monetary policy to forbid free trade in silver. The collapse of the Qing economy in the 19th century was largely a monetary event, with similarity if not congruence with the effects of the Asian Financial Crisis of 1997 on several of the weaker Asian economies, notably Thailand, Indonesia, Malaysia and South Korea.

Copper, silver and gold had been the component metals in China’s tri-metal monetary regime throughout its long history. Cloth, grain, cattle, pearls and jade, along with precious metals, had also been used as media of exchange in ancient times. Sung dynasty issued the first paper money in 1023. Silver had been used increasingly widely as currency in China since the 15th and 16th centuries with imports from the increased silver production in the Americas as a result of a Chinese trade surplus with the West. Around 1564, Mexican silver coins began circulating widely in Chinese coastal trade towns such as Guangzhou and Fuzhou as payment by Portuguese traders for Chinese exports. By the 18th century, China was operating on a de facto silver standard monetary regime.
The 19th-century reversal of China’s foreign trade from surplus to deficit was due to Western opium smuggling starting from 1820. Up to that time, China permitted very little foreign trade and what legitimate trade that did take place amounted to only an insignificant portion of the Chinese economy. This illegal opium trade was denominated in silver until China ran short of silver, after which the legalized but immoral opium trade was denominated in porcelain that steadily fell in price because China could produce porcelain easier than it could produce silver, albeit Chinese export porcelain was increasingly produced at inferior quality compared to that produced for the more discriminating domestic market. Monetary defacement occurred even in porcelain when it bacame a unit of account.
Maria Alejandra Irigoin in her paper: A Trojan Horse in 19th century China? The global consequences of the breakdown of the Spanish Silver Peso standard, observes that until the 1640s silver trade was essentially driven by large differences in the gold silver ratios between Spanish America, Europe and China, allowing a substantial arbitrage gain to be realized by intermediaries. After 1825, China’s balance of silver trade with the West became negative due to the illicit opium trade.
According to Irigoin, between 1719 and 1833, 259 million silver pesos, or 6,321 tons of silver, entered China to pay for Chinese goods. That is the equavelent of 421.4 tons or 135.5 million ounces of gold at the universal silver/gold ratio of 15/1. For comparision, as of January 2007, gold exchange traded funds held 629 tons or of gold in total for private and institutional investors. Of the 6,321 tons of silver, 62% was introduced after 1785 and a full 30% after Spanish American independence, usually dated as 1810. Importantly, the structure of the silver trade was different before and after 1785. Up to that date, English intermediation accounted for about 50% of silver inflow to China since 1719, French for 20% and Dutch for 15%. After the 1785 the US became progressively the main provider of silver to China. Around 1795 North American merchants provided 28% of Chinese silver inflow to pay for Chinese goods. By 1799 the US share had risen to 65% and after 1807 American intermediaries accounted for a full 97% of silver inflow into China. This one-way trade denominated in silver grew steadily until the late 1820s. It experienced a short-lived high point in 1834-36 after which date it declined strongly and only staged a timid recovery after 1853. US trade deficit with China did not start in the 1990s. It began in 1800.
Despite Chinese discouragement of foreign trade, China had always enjoyed a trade surplus until 1834. Chinese flow balance of silver had been positive all through history and became negative only after 1826, ten years later than the inversion of the overall balance of trade of China due to the opium trade. This was because the sliver deficit from the illicit opium trade was at first cancelled by silver inflow from Russia in exchange for Chinese silk, porcelain and tea. Russia earned silver in the trade boom during the Napoleonic wars. The massive smuggling of opium led to increasing silver imbalance for China after 1819. Similarly, Chinese silver inflow still exceeded outflow until the mid-1820s because the US sent more silver into China than opium-smuggling English merchants extracted from there to Bengal, Calcutta and finally to London.
A spurt of silver demand from China occurred in the first half of the 18th century, when the Chinese exchange rate of silver to gold was still 50% higher than the exchange rate in Europe. This offered opportunity for European arbitrage with China’s huge population and market growth.
Irigion notes that the historiography of trade globalization has long recognized the role of demand for silver in the Chinese economy as the foundation in the establishment of intercontinental trade between the Americas, Europe and Asia since the 1600s. Silver from Spanish America reached Europe through the trade of both Spanish licensed merchants and northern European interlopers from whence it continued to flow to China within the organized trade of the European chartered companies, primarily the English and Dutch East India Companies. At the same time a second route of silver flows was established within the Spanish colonial trading system. This directly linked Spanish American production areas in Peru and Mexico to Manila in the Philippines through the famous Manila galleon, which sailed regularly from Acapulco to the East.
The monetary changes in Spanish America in the wake of Spanish American independence impacted upon this trade. The revolutionary wars in Spanish America and the implosion of the Spanish empire led to a fragmentation of the previously unified monetary regime, which resulted in the production of coins of different quality, fineness and weight. Irigion argues that this change, entirely exogenous to the Chinese market, resulted in falling demand for Spanish American pesos in China. Thus it qualifies the conventional historiography that stresses the role of opium imports in allegedly reversing the flows of silver bullion to and from China in the early 1800s, even though it does not altogether negate the financail impact of opium smmuggling.
Evidence supports the conclusion that monetary conditions exacerbated the negative effect of opium smuggling on Chinese national finances. The outflow of silver from China that began in the early 1800s coincided with the collapse of silver prices in the international market as Western countries adopted the gold standard and demonetized silver. Silver was leaving China in huge quantities while the price of silver was falling in the international market, making the Chinese trade deficit more expensive in local currency terms. Yet while the price of silver fell in the international market, its price rose in the Chinese domestic market in relation to copper, accelerating and exacerbating import trade inflation in the Chinese economy through domestic price deflation.

This monetary collapse inflicted great financial damage on China’s peasantry. While peasant income was denominated in copper coins, their tax obligation to the imperial court was denominated in silver coins, because the imperial government’s trade deficit was denominated in silver. The scarcity of silver created by the massive outflow pushed the domestic silver price sky-high in terms of copper coins. A similar monetary disadvantage is now hurting American workers whose wages are denominated in falling dollars with dwindling purchasing power for critical imports such as oil. The only different is that for 19th century China, the damage was forced on the Chinese peasantry by foreign imperialism, while in the US, the damage on US workers were done by their own government’s monetary and trade policy.
International bimetallism greatly disadvantaged the Chinese silver-based export economy and domestic bimetallism greatly disadvantaged the copper-based finances of the Chinese peasantry. Chinese peasant populists would have a similar incentive to promote a copper-based monetary regime against a silver standard in China as the US populists did with fighting for a silver-based monetary system against the gold standard in the US. But until the Chinese Communist Party gained control of the governmental apparatus of the nation, there was no official defender of the Chinese peasantry.

China suffered a protracted two-century-long economic recession all through the 19th and 20th centuries as it came into commercial contact with the West. This two-century-long recession reduced China from being the richest economy in the world to one of the poorest. It was the result of the structural monetary double disadvantage of international bi-metallism of gold and silver superimposed on the silver-based monetary system of the Chinese foreign trade sector. This took place in a world monetary regime shifting toward the gold standard, which greatly disadvantaged the Chinese domestic bimetal monetary system of copper and silver. This double disadvantage fatally wounded the Chinese economy for two centuries, causing the decline of a highly developed culture with an uninterrupted history of four millennia and halted its further development for more than seven generations over two centuries. The bankrupt economy reduced the Qing imperial China to a failed state unable to defend itself from aggressive Western imperialist powers until the founding of the People’s Republic when China adopted a socialist path for its economy. Even after the 1911 bourgeois revolution that established the Republic of China under the Goumindang (Nationalist Party), when China followed a petty bourgeois free market system, she was unable to shake off Western imperialism to free the nation, once the most prosperous in the world, from semi-colonial economic status. In that sense, China is different historically from many other nations of the Third World that had never achieved comparable prosperity, albeit many Third World nations were much better off before falling victim to Western imperialism. The two non-European nations that matched China’s level of socio-economic and cultural achievements were Ancient Egypt and the Ottoman Empire, the modern descendent entity of which are but a shadow of their former greatness. 

Beside economic exploitation, the British East India Company, to gain political support from the Church of England for colonialism, also adopted aggressive evangelistic policies on behalf of Christianity. The deep hostility between Catholicism and Protestantism was buried within British imperialism. Many British empire-builders were Scots who brought with them Scottish Catholicism to the non-white British colonies. The Act of Union of 1707 united the kingdoms of England and Scotland and transfered the seat of Scottish Government to London. Henceforth England and Scotland are known as the United Kingdom.
The Company methodically destroyed monasteries and suppressed indigenous culture in Buddhist Tibet, which together with its launching of the Opium Wars to protect its immoral opium smuggling, caused deep-rooted anti-Western xenophobia in all Asia that lingers on even today and makes travesty of belated Western grandstanding on religious freedom, human rights and rule of law in centuries to come.
The British Pound Sterling and the Gold Standard
The pound sterling, created in 1560 by Elizabeth I, as advised by Thomas Gresham, brought order to the monetary chaos of Tudor England that had been caused by the “Great Debasement” of coinage, having caused a decade-long debilitating inflation beginning in 1543 when the silver content of a penny dropped by two thirds to become mere fiduciary currency. The exchange rate of British coins collapsed in Antwerp where English cloth was sold in Europe.
The Bank of England was founded 1694 with the pound sterling as the currency of account.  All coins in circulation were then recalled by the Royal Mint for re-mint at a higher standard. Sterling unofficially moved to the gold standard from silver as a result of an overvaluation of gold in England that drew gold from abroad in exchange for a steady outflow of silver, notwithstanding a re-evaluation of gold in 1717 by Isaac Newton as Master of the Royal Mint. The de facto gold standard continued until its official adoption following the end of the Napoleonic Wars in 1816. The gold standard lasted until Britain, along with several other trading countries, abandoned it only after World War I in 1919. During this period, the pound was generally valued at around $4.90. Britain tried to restored the gold standard in 1925 without success despite support from the US central bank which contributed to the 1929 crash on Wall street that immediately spread to world markets to cuase a global depression.
The currencies of all other major Western countries in 1821 were either bimetallic or specie-backed paper money. This meant that Britain operated within a floating exchange rate system for most of the 19th century, although for much of this time, when the silver/gold ratio stayed close to the common mint ratio of 15.5/1, the floats were tightly constrained within a narrow band. Nineteenth century gold standard was supported by government incentives and government ability to adhere to it due to lower borrowing costs (on average 40 basis points) when loans were denominated in currency backed by gold, especially in London, the center of international finance at the time. Hence large borrowers, like the newly independent US, had a strong incentive to also adopt the gold standard. By 1870, the main core countries of gold standard had been deeply engaged in international trade for decades, led by British promotion of free trade.  Consequently their respective domestic price levels were similar and their differences changed only slowly, putting less strain on their balance of payments. Trade deficits were difficult to sustain and trade would slow as deficits mounted until balance of payments were restored.
British promotion of free trade under the gold standard in an era when new discovery of gold in the Americas, Australia and South Africa allowed Britain to run a trade deficit while still fund substantial investment in colonies overseas. This was because gold was steadily devalued on expectation of more gold entering the market and the resultant defacement was expected to be corrected as the economy expanded faster than the rate of gold production. It was a classic example of the positive effects of the quantity theory of money when money supply expansion did not come from official defacement of currency even as gold was devalued. 
Key difference between Pound Sterling Hegemony and Dollar Hegemony
Earlier in the 19th century, Britain had to run a trade surplus in order to invest overseas. An increase supply of gold translated into an increase in money supply to boost economic growth globally after mid century. Overseas income in turn acted as counterbalance against temporary adverse trade flows and balance of payments and thereby reduced the need for aggressive moves in interest rates. Globally, wealth was flowing to England from the rest of the world even as England incurred persistent trade deficits.  This is the same principle behind dollar hegemony today that allows wealth to flow into the dollar economy controlled by the US even as the US incurs persistent trade and fiscal deficits. The key difference is that the dollar today is not protected by economic expansion against devaluation, since the Federal Reserve under Alan Greenspan had resorted to devaluation of the dollar as a device to stimulate serial economic bubbles. China needs to understand that there is no future in participating in a global trade regime with the dollar as reserve currency.
The ever-widening spread of a multilateral trading system also reduced the need to settle trade deficits in gold. In 1910, Britain ran a combined trade deficit of £107 million with three large regions: Continental Europe, the US and the great plain nations of Canada, Australia and Argentina. But she partially offset that deficit with a £60 million trade surplus with the non-white British colonies of India, British Caribbean and Africa. In turn, these non-white British colonies had trade surpluses of £40 million with Continental Europe, the US, and the great plain nations. British trade surplus with semi-colonial China was not included in these numbers.
US Populism and the Gold Standard
There was international consensus that the monetary discipline imposed by the gold standard ensured good policy, a belief buttressed by a general political acquiescence within the core trading economies through central bank co-ordination and capital decontrol. The exception was the US which did not have a central bank until 1913.

populists were fighting against the gold standard in favour of bimetallism in the 1860s, because the gold standard was deflationary and would and did hurt farmers with farm mortgages. Populist in the US felt that greenbacks not backed by a gold standard would allow credit to flow more freely to rural farm regions at lower interest rates where more farm credit was needed. Free silver platform also received widespread support across class lines in the Mountain states where the economy was heavily dependent upon silver mining. Western Silver Republicans became active in US politics. In the 1896 presidential election, Democratic candidate William Jennings Bryan backed the Populist opposition to the gold standard in his famous “Cross of Gold” speech. The populist Democrats lost and the gold standard prevailed because market-driven co-operation helped make central-bank intervention rates set in London remarkably effective.
Gresham’s Law of Bad Money Driving out Good
For centuries, money in Europe consisted of both silver and gold coins. When governments introduced specie-backed paper money, they specified the value of the paper currency in terms of weights of either silver or gold. A bimetal monetary system bases its money on both gold and silver at a fixed ratio, with 15 ounces of silver equaling to 1 ounce of gold set by Louis XIV France, the hegemon in Europe at the time.
As market prices of silver and gold fluctuated, as for example market price of gold rose above the ratio against silver set by the mint, making gold “good” money, gold holders could buy silver in the market and exchange the silver for gold at the Treasury, draining gold from it, forcing silver to be the only standard eventually. In United States, because the 15/1 ratio of 1792 overvalued silver as money in terms of market price of the metal because of increased silver supply from mines, silver became the standard, and the money supply in effect expanded, causing inflation. Then when the ratio was changed in 1834 to 16/1, it was gold which was overvalued so that gold became finally the standard, and the money supply shrank, causing deflation. This effect is captured by Gresham’s law which states that “bad money will drive out good”. Gresham's law applies when two forms of commodity money are in circulation as legal tenders which require their acceptance for payment of debts and taxes at face value, the undervalued good will disappear from circulation as money, and will be used as commodity to capture its higher market value.
In Napoleonic Europe, silver continued as standard as it did in the US up to 1834. The first gold coin issued in England in 1663 was the Guinea, worth one pound sterling or twenty shillings (44½ guineas would be made from one Troy pound of 11/12 finest gold, each weighing 129.4 grains). The gold used to mint the Guinea came from Guinea, Africa, hence its name. As the price of gold rose over time, a Guinea was worth as much as 30 shillings. By the 1680s the guinea had settled down to worth 22 shillings. Isaac Newton, the physicist, when acting as Master of the Mint in 1717, set the price of the British gold Guinea at 20 shillings 8 pence (which corresponded with 76 shillings 7.6 pence per 22-carat ounce of 0.9167 fine gold).
Newton’s Mint Reports [in Old English]:
On the Proportion of Gold and Silver in Value in several European Currencies (Sept. 1701).  

By the late Edicts of the French King for raising the monies in France the proportion of the value of Gold to that of Silver being altered, I humbly presume to give yr Lordps notice thereof. By the last of those Edicts the Lewis d'or passes for fourteen Livres & the Ecus or French crown for three livres & sixteen sols. At wch rate the Lewis d'or is worth 16s. 7d. sterling, supposing the Ecus worth 4s. 6d. as it is recconed in the court of exchange & as I have found it by some Assays. The proportion therefore between Gold & Silver is now become the same in France as it has been in Holland for some years. For at Amsterdam the Lewis d'or passes for 9 Guilders and nine or ten styvers wch in our money amounts to 16s. 7d. & it has past at this rate for the last five or six years.

At the same rate a Guinea of due weight, & allay is worth £ 1, 0s. 11 d.

In Spain Gold is recconed (in stating accompts) worth sixteen times its weight of silver of the same allay, at wch rate a Guinea of due weight and allay is worth 1£ 2s. 1 d. but the Spaniards make their payments in Gold & will not pay in Silver without an abatement. This abatement is not certain, but rises & falls according as Spain is supplied with Gold or Silver from the Indies. Last winter it was about five per cent.

The state of the money in France being unsetled, whether it may afford a sufficient argument for altering the proportion of the values of Gold & Silver monies in England is most humbly submitted to yor Lordps great wisdome.

On the Value of Gold and Silver in English, Irish and European Coins (Mar. - June 1712).

Gold is over-valued in England in Proportion to Silver, by at least 9d. or 10d. in a Guinea, and this Excess of Value tends to increase the Gold Coins, and diminish the Silver Coins of this Kingdom; and the same will happen in Ireland by the like overvaluing of Gold in that Kingdom.

On the Value of Gold and Silver in European Currencies and the Consequences on the World-wide Gold- and Silver-Trade (Sept. 1717).

In France a pound weight of fine gold is recconed worth fifteen pounds weight of fine silver.

In China and Japan one pound weight of fine gold is worth but nine or ten pounds weight of fine silver, & in East India it may be worth twelve. And this low price of gold in proportion to silver carries away the silver from all Europe.

Parliament modified Newton’s precise ratio and set the guinea at 21 shillings even, corresponding to 77 shillings and 10.5 pence per standard ounce 22-carat gold.

This required Newton to increase the mint price of gold by 1 shilling 2.9 pence in order to make 89 guinea coins out of two troy pounds of 22-carat gold at Parliament’s price.  In truth, Parliament had in mind more than rounding off numbers. It purposely overvalued gold to introduce the gold standard in England’s monetary regime.
French hegemony under Louis XIV had allowed the Sun King to set a silver/gold ratio at 15/1 in Europe. For English money to be at par with the same ratio, Newton recommended to Parliament that the value of the Guinea gold coin be set only 8 pence above 20 shillings. When Parliament set the value of a Guinea coin at 21 shillings (4 pence above the equilibrium price of the 15/1 ratio proposed by Newton), it was an act of deliberate policy that set off a chain reaction which ultimately led to replacing silver/gold bimetalism with the gold standard.
Silver then became the “good money” (undervalued monetarily) and gold the “bad” money in England while gold became the “good” money and silver the “bad” money in Europe. The policy of overvaluing gold drew gold to England at the expense of silver, driving silver out of its role as money in England. Because gold was thereby set to buy more silver in England than it did in continental Europe, Gresham’s Law of bad money driving out good would compel traders to buy gold with silver on the continent, sell the gold in England for silver, and take their proceeds in silver back to the continent for the next round of gold purchasing. Gresham's Law did not "invent" the gold/silver carry trade, Sir Thomas Gresham, founder of the Royal Exchange, only providing a simple explanation of it in a letter to Elizabeth I on the occasion of her accession in 1558, two years before the creation of the pound sterling. Currency carry trade has been going on since money started circulating across national borders. It had been observed by Corpernicus in his Monetae cudendae ratio written in 1526 based on an earlier report to the Prussian Diet of 1522, but published only posthumously in 1816.
Raising the exchange value of the RMB against the dollar in a freely convertible exchange regime will turn the RMB into “bad” money in Gresham’s Law and make the dollar into “good” money, even though China is a creditor nation to the US. Under such relationship, hot money denominated in fiat dollars will rush into China to change into RMB to get the benefit of higher interest rates and further exchange rate appreciation and reconvert the “carry trade” profit back into dollars, in the form of net wealth, to flow from China back into the US even when the dollar is a fiat currency and the RMB is a only a derivative currency of the dollar.
Throughout history, pressuring another country to alter the exchange value of its currency has been recognized as acts of monetary aggression. To resist this monetary aggression, China needs break away from the tyranny of dollar hegemony. To do this, a full understanding of history of monetary imperialism is necessary.

August 28, 2008

Next: History of Monetary Imperialism