China’s devaluation of the yuan last week surprised many market observers. The yuan, which is pegged to the dollar, had been rising in tandem with the U.S. currency — in part because of expectations the Federal Reserve will increase interest rates soon. With China’s economy slowing, currency markets were pressing for the yuan to depreciate, and the Chinese government, seeking to boost competitiveness in export markets, gave in to the pressure and moved the peg.
This isn’t the first time the two countries’ monetary policies have been closely intertwined. In the Great Depression, China found itself vulnerable to the price of silver, thanks to the misguided moves of U.S. policy makers.
The Great Depression was a global crisis — almost. Every significant economy was devastated, with one notable exception: China. The reason was simple. In 1929, the U.S. and every other major nation pegged their currencies to gold. As the economic historian Barry Eichengreen has described, adherence to this standard punished countries by imposing “golden fetters” that led to crippling deflation. The fixed exchange rates of the gold standard helped transmit the monetary shocks around the world.
China, alone among the world’s major economies, operated under a silver standard in which the currency was pegged to a specific weight of that metal. This had the effect of allowing its currency to depreciate, and largely shielded it from the worst effects of the Great Depression. The economic historian Ramon Myers concluded that “China simply did not experience any national economic depression as the world depression deepened.”
As the Depression worsened in the early 1930s, the world’s biggest economies came off the gold standard, allowing them to expand their money supplies and stimulate demand. As plenty of scholars have observed, countries that did so recovered more quickly. The U.S. took the plunge in 1933, during the first year of Franklin Roosevelt’s presidency.
That was the first blow to the Chinese economy, ruining the competitive advantage it possessed when all other countries remained on the gold standard. As its currency began to appreciate, making its goods more expensive in world markets, its balance of payments turned negative, and imports exceeded exports. The worst was yet to come.
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