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| Silver-point Arbitrage and International Flows of Silver: The Chinese Silver Standard, 1902-1933 |
| ZHAO Yan, DONG Xiaoqi, ZHAO Liuyan
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School of Software & Microelectronics, Peking University;
Applied Math & Statistics, The State University of New York at Stony Brook;
School of Economics, Peking University |
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Abstract In research on the international monetary system, prominence has been given to the international adjustment of gold standard countries between the 19th and 20th centuries. One of the main issues underlying this research theme is the relative efficiency of the gold standard and its role in moderating nominal exchange rates. Tests of its efficiency revolve around consideration of the gold-point arbitrage. Although the market exchange rate fluctuated due to supply and demand shocks in the currency market, its deviation from parity was generally constrained by the so-called gold points, which refer to the cost of cross-border shipments of gold.
However, there is a relative paucity of research into the conditions of the silver standard. In the early 20th century, China was the only large country in the world adhering to the silver standard, and the operation of China's foreign exchange market is largely neglected in the literature. Silver was just another commodity in the international monetary system dominated by gold. As the price of silver in the world market was notoriously fickle, it is generally considered that the international adjustment mechanism between China and gold countries was equivalent to the floating exchange rate regime of fiat currencies. However, the Chinese silver standard shared some important characteristics with a fixed exchange rate system. Specifically, the exchange rate was determined by the world price of silver and would not adjust spontaneously according to China's international balance of payments. Thus, in adhering to the silver standard, China lost the buffer function provided by a free-floating exchange rate, which would otherwise insulate it from international shocks.
Exchange rate fluctuations and corresponding cross-border silver arbitrage played an important role in determining China's base money supply and balance of payments. They also provided a valuable perspective for measuring the relative efficiency of China's silver standard and the degree of integration in its financial market. Despite political turmoil, China gradually opened up to the outside world and underwent its first wave of industrialization and modernization. By the early 20th century, although China as a whole remained economically underdeveloped, its eastern coastal areas were significantly more developed than its inland regions. The degree of market development in modern China is a topic of debate, with some researchers arguing that the country's spatial markets were seriously segmented, whereas others consider that China's market integration had reached a substantially high level during the late Qing Dynasty. Research on this topic generally focuses on evidence from commodity markets, particularly grain markets. In recent years, the integration of monetary and financial markets has received increasing attention, and the literature on China's domestic financial integration is growing rapidly. However, there remains a lack of research on the integration of Chinese and external financial markets.
In this paper, we collect high-frequency datasets on the foreign exchange market from 1902 to 1932 and apply the silver point arbitrage mechanism and threshold autoregression models to estimate silver points between Shanghai and London, the world's major international financial center during this period. Our inferred measures of silver points are small, with estimated silver points at around 1.7% during peacetime, which match the measured costs of the silver trade derived from contemporary accounts. We observe that silver point violations and exploitable arbitrage opportunities periodically emerged, but did not persist for long. We also find a general correspondence between silver-point violations and international flows of silver, indicating that there were no significant trade barriers in cross-border silver trade. This leads us to conclude that the Chinese foreign exchange market was remarkably efficient, and that the degree of Chinese financial market integration was substantial. However, during and immediately after World War I, our estimates of the silver points increase significantly, indicating the collapse of China's links to world financial markets. As the United Kingdom was at the center of the war, the destructive effect of the war on trade and on the financial links between Shanghai and London is expected.
At the turn of the 20th century, while most countries around the world were aspiring to join the gold club, China retained its traditional silver currency, remaining the only major silver outlier. This alternative monetary system is often viewed as a reflection of China's economic and political problems. Despite political disintegration and the chaos of the regional monetary system in China, the efficiency of Shanghai's foreign exchange market was comparable with that of the gold standard system at the time. This indicates that Shanghai and the international financial markets were highly integrated, and that the eastern China market, centered around Shanghai, was deeply connected to the global economy in the early 20th century. This finding is consistent with evidence of economic growth in Shanghai's surrounding areas during this period.
In recent years, the literature on market integration in modern China has expanded rapidly, but it largely focuses on the commodity market. Financial assets are more homogeneous and have lower transaction costs than commodities such as grain and other goods. Thus, our results regarding financial integration provide an important benchmark for comparing market development in modern China and the West. It is important to note, however, that our evidence from the financial market may not necessarily apply to commodity markets because commodities such as grain, which have lower value-to-weight ratios, are less profitable to arbitrage than silver.
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Received: 18 August 2022
Published: 08 August 2023
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