Former IMF Chief Economist Eswar Prasad’s excellent book Gaining Currency – The Rise of The Renminbi starts with a fascinating chapter on China’s monetary history, the longest by far of any country. The book is ultimately a persuasive answer to the question, will the RMB become a leading international currency? His answer is yes, but only as a means of international payment and to a limited extent as a reserve currency (he estimates about 10% of global foreign reserves might be held in RMB one day). But he does not see the RMB becoming a true safe haven currency (like the US dollar, Swiss Franc and Japanese Yen) any time soon, because for that the Chinese government would need to adopt fully open capital markets, the rule of law and independent, credible institutions such as the central bank. None of these currently seem in prospect.
China debated the role of the state in money creation, centuries before the west
The United States from 1837-1862 enjoyed the “Free Banking era“, which didn’t mean low costs to customers but that any bank could issue banknotes (subject to rules of backing them with high quality securities). With the decision not to renew the charter of the Second Bank of the United States in 1836, there was no US central bank, though the dollar remained the single unit of account. Any commercial bank could issue its own bank notes (subject to backing with high quality securities). The idea was that competition, so good in most areas of economic life, applied equally to the creation of money. The experiment ended with the Civil War. A series of ever more serious financial crises led to the creation of the Federal Reserve system in 1913 and a federal state monopoly on currency issue (most money is in the form of bank deposits, which any commercial bank can create).
There are proponents today, from the libertarian and Austrian economics schools, who argue for the denationalisation of currency, allowing free competition. Bitcoin and other new crypto-currencies make this more feasible than before, though I think it’s fair to say that most economists regard the argument for competitive currencies as at best irrelevant and at worst plain daft.
China was having debates about whether the state should control currency as early as the Han dynasty, around the year 80BCE. Scholars from the mainstream Confucian tradition argued that the role of the sovereign was to provide “for the people’s welfare by not restricting the use of the natural resources of the mountains and the seas; he facilitates the use of currency by not prohibiting people from freely minting coin.” But other scholars argued that only a state monopoly could ensure the stability of the currency (ironic, when we see what follows below). The argument for state monopoly won.
China had the first paper money inflation
I think it’s widely known that among a very long list of inventions made by China, one was paper. Unsurprisingly China also invented paper money, one of many miracles that Venetian merchant Marco Polo discovered when he visited China around the year 1275. European alchemists had laboured to find a way to turn base metals such as lead into gold. Marco Polo visited the court of Kublai Khan, one of the leaders of the Yuan dynasty, in the city that would much later become known as Beijing, where he found what he regarded as a much more sophisticated form of alchemy, whereby people paid for things of value using mere paper. Moreover this currency was what we would now call a fiat currency, not backed by anything of value (all modern currencies are fiat currencies).
Kublai Khan ensured the success of the paper currency by enforcing legal tender: anybody must accept the paper as a means of payment, on pain of death. But he also limited the amount produced, to protect its credibility and value. Later emperors were not so careful. Later Yuan leaders faced a series of natural disasters (a recurring feature in China’s history) and recklessly issued too much paper currency. The collapse in the value of the currency was the first paper money inflation and was an important factor in the collapse of the Yuan dynasty, which was replaced by the Ming dynasty (1348-1644). In the fifteenth century the Ming emperor also produced too much paper money and China eventually reverted to coins for a long period. The final dynasty, the Qing, only brought back paper money when they needed to fund the suppression of the massive Tai Ping rebellion from 1850-1864. But these notes were backed by bronze and silver.
Chairman Mao’s head appeared on banknotes only from 1999
The Chinese central bank, the People’s Bank of China (PBOC), was created in December 1948, shortly before the official founding of the People’s Republic of China in October 1949. The PBOC launched a new currency called the renminbi (人民币) – the people’s currency. It was denominated in yuan, as earlier currencies were (*). There was great support for the notes to bear the face of Mao Zedong, the leader of the Chinese Communist Party and the new President of the Central People’s Government (officially the President of the People’s Republic from 1954). But he insisted it was the people’s currency and should bear images of people (and places). Ironically, in light of what happened in the 1960s and 1970s, Mao declared himself opposed to a cult of personality.
But when a new set of banknotes was planned for the 50th anniversary of the People’s Republic of China in 1999, there was new support for Mao (who died in 1976) to feature on the notes. The case was reinforced by the need for a way to protect the notes from counterfeiting. In a country which still had high illiteracy in rural areas, it made sense for a universally recognisable image. Various natural landscapes failed the test and it became clear that Mao’s face was perhaps the only one that everyone in China would recognise, making it harder for counterfeiters. From then until now, Mao’s face appears on RMB banknotes.
(*) Confusingly, the Chinese character for yuan is 元, which is the same as the symbol for the Yuan dynasty. But the unit long precedes the Yuan dynasty and comes from a different but identical sounding word, meaning circle: 圆. (Anyone learning Chinese quickly comes up against the dauntingly large number of homophones – words with the same sound.) The origin of that was circular coins, used before paper was invented. Inside this character is a radical called 贝 meaning cowrie shell. Many ancient cultures used rare shells such as cowries as currency, though I think that is a coincidence in this case, the meaning of 圆 seeming to originate in the shape of a round pot. The international currency symbol used for the Chinese currency is ¥, which is also used for the Japanese yen. There is a common linguistic origin to yuan, yen and the Korean currency won.