Chapter 27
WAKING THE SLEEPING GIANT:
LINCOLN’S GREENBACK SYSTEM
COMES TO CHINA
The flowers had been too strong for the huge beast and he had given
up at last, falling only a short distance from the end of the poppy bed
. . . . “We can do nothing for him,” said the Tin Woodman sadly. “He
is much too heavy to lift. We must leave him here to sleep . . . .”
– The Wonderful Wizard of Oz,
“The Deadly Poppy Field”
Napoleon called China a sleeping giant. “Let him sleep,”
Napoleon said. “If he wakes, he will shake the world.”
China has now awakened and is indeed shaking the world. The
Dragon has become so strong economically that it has been called the
greatest threat to national security the United States faces, accounting
for the greatest imbalance of any country in the U.S. trade budget
deficit ($150 billion of $500 billion by 2004).1
This balance-of-trade problem is not new. The British were already
complaining of it in the early nineteenth century. Then they
discovered that exporting opium from India to China could offset their
negative trade balance and give them control of China’s financial system
at the same time. The Chinese Emperor responded by banning
the opium trade, after China started losing huge amounts of money to
England. England then declared war, initiating the Opium War of
1840. The Chinese people wound up with two sets of imperial rulers,
the British as well as their own.2
The leader of the revolution that finally overthrew 2,000 years of
Chinese imperial rule was Dr. Sun Yat-sen, now revered as the father
of modern China by Nationalists and Communists alike. Like the
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leaders of the Japanese Meiji revolution of the 1860s, he was a protegé
of a group of American nationalists of the Lincoln/Carey faction. Sun’s
fundamental principles, known as the “Three Principles of the People,”
were based on the concept presented by Lincoln in the Gettysburg
Address: “government of the people, by the people, and for the people.”
Sun was educated in Hawaii, where he built up his revolutionary
organization at the house of Frank Damon, the son of Reverand Samuel
Damon, who had run the Hawaii delegation to the American
Centennial in Philadelphia in 1876. Frank Damon provided money,
support and military training to Sun’s organization; and Hawaii
became its base for making a revolutionary movement in China.3
The Chinese Republic was proclaimed just before World War I.
After Sun’s death, the Nationalists lost control of mainland China to
the Chinese Communists, who founded the People’s Republic of China
in 1949; but the Communists retained much of the “American system”
in creating their monetary scheme, which was a Chinese variation
of Lincoln’s Greenback program. Before that, banknotes had been
issued by a variety of private banks. After 1949, these banknotes were
recalled and the renminbi (or “people’s currency”) became the sole
legal currency, issued by the People’s Bank of China, a wholly government-
owned bank. The United States and other Western countries
imposed an embargo against China in the 1950s, blocking trade between
it and most of the rest of the world except the Soviet bloc. China
then adopted a Soviet-style centrally-planned economy; but after 1978,
it pursued an open-door policy and was transformed from a centrallyplanned
economy back into a market economy.4 Private industry is
now flourishing in China, and privatization has been creeping into its
banking system as well; but it still has government-owned banks that
can issue national credit for domestic development.5
By 2004, China was leading the world in economic productivity,
growing at 9 percent annually. In the first quarter of 2007, its economic
growth was up to a remarkable 11.1 percent, with retail sales climbing
15.3 percent. The commonly-held explanation for this impressive
growth is that the Chinese are willing to work for what amounts to
slave wages; but the starving poor of Africa, Indonesia, and Latin
America are equally willing, yet their economies are languishing.
Something else distinguishes China, and one key difference is its
banking system. China has a government-issued currency and a
system of national banks that are actually owned by the nation.6
According to Wikipedia, the People’s Bank of China is “unusual in
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acting as a national bank, focused on the country not on the currency.”
The notion of “national banking,” as opposed to private “central
banking,” goes back to Lincoln, Carey and the American nationalists.
Henry C K Liu distinguishes the two systems like this: a national bank
serves the interests of the nation and its people. A central bank serves
the interests of private international finance. He writes:
A national bank does not seek independence from the
government. The independence of central banks is a euphemism
for a shift from institutional loyalty to national economic wellbeing
toward institutional loyalty to the smooth functioning of
a global financial architecture . . . [Today that means] the sacrifice
of local economies in a financial food chain that feeds the issuer
of US dollars. It is the monetary aspect of the predatory effects
of globalization.
Historically, the term “central bank” has been interchangeable
with the term “national bank.” . . . However, with the
globalization of financial markets in recent decades, a central
bank has become fundamentally different from a national bank.
The mandate of a national bank is to finance the sustainable
development of the national economy . . . . [T]he mandate of a modernday
central bank is to safeguard the value of a nation’s currency in a
globalized financial market . . . through economic recession and
negative growth if necessary. . . . [T]he best monetary policy in the
context of central banking is . . . set by universal rules of price
stability, unaffected by the economic needs or political
considerations of individual nations.7
In 1995, a Central Bank Law was passed in China granting central
bank status to the People’s Bank of China (PBoC), shifting the
PBoC away from its previous role as a national bank. But Liu says the
shift was in name more than in form:
It is safe to say that the PBoC still follows the policy directives of
the Chinese government . . . . Unlike the Fed which has an armslength
relationship with the US Treasury, the PBoC manages
the State treasury as its fiscal agent. . . . Recent Chinese policy
has shifted back in populist directions to provide affirmative
financial assistance to the poor and the undeveloped rural and
interior regions and to reverse blatant income disparity and
economic and regional imbalances. It can be anticipated that
this policy shift will raise questions in the capitalist West of the
political independence of the PBoC. Western neo-liberals will
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be predictably critical of the PBoC for directing money to where
the country needs it most, rather than to that part of the economy
where bank profit would be highest.8
Besides its “populist” banking system, China is distinguished by
keeping itself free of the debt web of the IMF and the international
banking cartel; and by refusing to let its currency float, a policy that
has fended off the currency manipulations of international speculators.
The value of the renminbi is kept pegged to the dollar; and unlike
Mexico in the 1990s, China has such a huge store of dollar reserves
that it is impervious to the assaults of speculators. In 2005,
China succumbed to Western pressure and raised its dollar peg slightly;
but the renminbi continued to be pegged to its dollar counterpart, and
the government retained control of its value.
As in Hitler’s Germany, the repression of human rights in China
deserves serious censure; but something in its economy is clearly working,
and to the extent that this is its self-contained monetary policy,
the Chinese may have the nineteenth century American Nationalists
to thank, through their student Dr. Sun Yat-Sen.
The Mystery of Chinese Productivity
In the eighteenth century, Benjamin Franklin surprised his British
listeners with tales of the booming economy in the American colonies,
something he credited to the new paper fiat money issued debt-free by
provincial governments. In a May 2005 article titled “The Mystery of
Mr. Wu,” Greg Grillot gave a modern-day variant of this story involving
a recent visit to China. He said he and a companion named Karim
had interviewed a retired architect named Mr. Wu on his standard of
living. Mr. Wu was asked through an interpreter, “How has your
standard of living changed in the last two decades?” The interpreter
responded, “Thirteen years ago, his pension was 250 yuan a month.
Now it is 2,500 yuan. He recently had a cash offer to buy his home for
US$300,000, which he’s lived in for 50 years.” Karim remarked to his
companion, “Greg, something doesn’t add up here. His pension shot
up 900% in 13 years while inflation snoozed at 2-5% per annum. How
could the government pay him that much more in such a short period
of time?” Grillot commented:
[T]he more you look around, the more you notice that no one
seems to know, or care, how so many people can produce so
much so cheaply . . . and sell it below production cost. How
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does the Chinese miracle work? Are the Chinese playing with
economic fire? All over Beijing, you find people selling things
for less than they must have cost to make.
. . . Karim and I looked over the books of a Chinese steel
company. Its year-over-year gross sales increased at a fine, steady
clip . . . but despite these increasing sales, its debt ascended a bit
faster than its sales. So its net profits slowly dwindled over time.
. . . But it also looked like the company never pays down its debt.
. . . If the Chinese aren’t paying their debts. . . is there any limit
to the amount of money the banks can lend? Just who are these
banks, anyway?
Could this be the key? . . . In the land of the world’s greatest
capitalists [meaning China], there’s one business that isn’t even
remotely governed by free markets: the banks. In the simplest terms,
the banks and the government are one and the same. Like modern
American banks, the Chinese banks (read: the Chinese
government) freely loan money to fledgling and huge established
businesses alike. But unlike modern American banks (most of them,
anyway), the Chinese banks don’t expect businesses to pay back the
money lent to them.
Evidently the secret of Chinese national banking is that the government
banks are not balancing their books! Grillot concluded that it
was a dangerous game:
[E]ven if it’s a deliberate policy, an economy can’t be deliberately
inefficient in allocating capital. Things cost money. They cannot,
typically, cost less than the value of the raw materials to make
them. The whole cannot be worth less than the sum of the parts.
. . Some laws of economics . . . can be bent, but not broken . . . at
least not without consequences.”9
Benjamin Franklin’s English listeners would no doubt have said
the same thing about the innovative monetary scheme of the American
colonies. Or could Professor Liu be right? Our entire economic world
view may need to be reordered, “just as physics was reordered when
we realized that the earth is not stationary and is not the center of the
universe.”10
How the Chinese economy can function on credit that never gets
repaid may actually be no more mysterious than the workings of the
U.S. economy, which carries $9 trillion in federal debt that nobody
ever expects to see repaid. The Chinese government can print its own
money and doesn’t need to go into debt. Before 1981, it had no federal
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debt at all; but when it opened to Western trade, it made a show of
conforming to Western practices. Advances of credit intended for
national development were re-characterized as “non-performing
loans,” rather like the English tallies that were re-characterized as
“unfunded debt” at the end of the seventeenth century. As a result,
today China does have a federal debt; but it remains substantially
smaller than that of the United States.11 China can therefore afford to
let some struggling businesses carry perpetual debt on their books
instead.
In both China and the United States, the money supply is
continually being inflated; but the Chinese mechanism may be more
efficient, because it does a better job of recycling the money. The new
money from Chinese loans that may or may not get repaid goes into
the pockets of laborers, increasing their wages and their pensions,
giving them more money for producing and purchasing goods. Like
in the early American colonies, China’s newly-created money is
increasing the overall productivity of its economy and the standard of
living of its people, promoting the general welfare by leavening the
whole loaf at once. In twenty-first century America, by contrast, the
economy keeps growing mainly from “money making money.” The
proceeds go into the pockets of investors who already have more than
they can spend on consumer goods. American tax relief also tends to
go to these non-producing investors, while American workers are
heavily taxed. Meanwhile, the Chinese government is cutting the taxes
paid by workers and raising their salaries, in an effort to encourage
more spending on cars and household appliances. The Chinese
government recently eliminated rural taxes altogether.12
Another Blow to the Quantity Theory of Money
In March 2006, the People’s Bank of China reported that its M2
money supply had increased by a whopping 18.8 percent from a year
earlier. Under classical economic theory, this explosive growth should
have crippled the economy with out-of-control price inflation; but it
didn’t. By early 2007, price inflation in China was running at only 2
to 3 percent. In 2006, China pushed past France and Great Britain to
become the world’s fourth largest economy, with domestic retail sales
boosted by 13 percent and industrial production by 16.6 percent.13 As
noted earlier, China has managed to keep the prices of its products
low for thousands of years, although its money supply has continually
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been flooded with new currency that has poured in to pay for those
cheap products.14 The “economic mystery” of China may be explained
by the Keynesian observation that when workers and raw materials
are available to increase productivity, adding money (“demand”) does
not increase prices; it increases goods and services. Supply keeps up
with demand, leaving prices unaffected.
We’ve seen that the usual trigger of hyperinflation is not a freely
flowing money supply but is the sudden devaluation of the currency
induced by speculation in the currency market. China has so far managed
to resist opening its currency to speculation; but Professor Liu
warns that it has been engaged in a dangerous flirtation with foreign
investors, who are continually leaning on it to bring its policies in line
with the West’s. China is “hoping to reap the euphoria of market
fundamentalism without succumbing to this narcotic addiction,” Liu
writes, but “every addict begins with the confidence that he/she can
handle the drug without falling into addiction.”15 He observes:
After two and a half decades of economic reform toward neoliberal
market economy, China is still unable to accomplish in
economic reconstruction what Nazi Germany managed in four
years after coming to power, i.e., full employment with a vibrant
economy financed with sovereign credit without the need to
export, which would challenge that of Britain, the then
superpower. This is because China made the mistake of relying on
foreign investment instead of using its own sovereign credit. The
penalty for China is that it has to export the resultant wealth to pay
for the foreign capital it did not need in the first place. The result
after more than two decades is that while China has become a
creditor to the US to the tune of nearing China’s own gross
domestic product (GDP), it continues to have to beg the US for
investment capital.16
Liu’s proposed solution to the international debt crisis is what he
calls “sovereign credit” and what Henry Carey called “national credit”:
sovereign nations should pay their debts in their own currencies, issued
by their own governments. Liu writes:
Sovereign debts in local currency usually do not carry any default
risk since the issuing government has the authority to issue
money in domestic currency to repay its domestic debts. . . .
[S]overeign debts’ default risks are exclusively linked to foreigncurrency
debts and their impact on currency exchange rates.
For this reason, any government that takes on foreign debt is recklessly
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exposing its economy to unnecessary risk from external sources.17
Although Liu says “the issuing government has the authority to
issue money in domestic currency to repay its domestic debts,” in the
United States today, newly-created dollars are not issued by the U.S.
Treasury. They originate with the privately-owned Federal Reserve
or private commercial banks, which create the money in the form of
loans. Like those governments that “take on foreign debt,” the U.S.
government will therefore never be able to cure its mounting debt crisis
under the current system. The only way out may be the sort of
Copernican revolution envisioned by Professor Liu, a Chinese
American economist with his feet in two worlds.
The Dragon and the Eagle
Although China has been flirting with foreign capital investment,
it has so far managed to retain the power to issue its own national
currency. It has reportedly been using that sovereign power to print
up renminbi and exchange them with Chinese companies for U.S.
dollars, which are then used to buy U.S. securities, U.S. technology,
and oil.18 Washington can hardly complain, because the Chinese have
been instrumental in helping the U.S. government bankroll its debt.
The Japanese have also engaged in these maneuvers, evidently with
U.S. encouragement. (See Chapter 40.) The problem with funding
U.S. deficit spending with fiat money issued by foreign central banks
is the leverage this affords America’s competitors. According to a
January 2005 Asia Times article, “All Beijing has to do is to mention
the possibility of a sell order going down the wires. It would devastate
the U.S. economy more than a nuclear strike.”19 If someone is going to be
buying U.S. securities with money created with accounting entries, it
should be the U.S. government itself. Why this would actually be less
inflationary than what is going on now is discussed in Chapter 39.
Ironically, the Dragon has risen to challenge the Eagle’s hegemony
by adopting a monetary scheme that was made in America. For the
United States to get back the chips it has lost in the global casino, it
may need to return to its roots and adopt the financial cornerstone the
builders rejected. It may need to do this for another reason: its debtridden
economy could be on the brink of collapse. Like for Lincoln in
the 1860s, the only way out may be the Greenback solution. We’ll
look at that challenge in Section IV, after considering one more
interesting Asian phenomenon . . . .
