Why Can Foreign Banknotes Circulate for a Long Time in Modern China? The Competitive Currency Market in Northeast China and Its Enlightenment

Abstract

The competition between foreign currencies and domestic currencies is a phenomenon that exists in many developing countries, and it is one of the hot issues in the study of the international currency. An important feature of the currency market in modern China is the long-term circulation of foreign banknotes in China. Foreign banknotes have been circulating in China since the 1870s, while domestic banknotes gradually emerged after the 20th century. After the 1920s, they became increasingly prosperous, forming a competing situation with foreign banknotes. As the most widely circulated area of domestic banknotes, Northeast China is also popular with foreign banknotes. After the 1920s, a competitive monetary system dominated by Fengpiao issued by the official Northeast bank and Jinpiao issued by a Japanese bank was gradually formed.This paper constructs a theoretical model of currency search, and combines the theory of seigniorage, taking the Northeast currency market as an example to explore the mechanism of the currency competition between the two currencies. According to the results of the model, with the change in the exchange rate of the two currencies and the constraints of government policies, the Northeast currency market formed two different competitive equilibriums before and after 1925. Although Jinpiao was subject to the policy of Fengtian authorities in the competition with Fengpiao, it still played an important role in the Northeast currency market. The increasing circulation of Fengpiao reduced the credit of it, and replaced it with Jinpiao. This is an important reason for the continued circulation of Jinpiao in the Northeast.This paper shows that when domestic currencies face the threat of foreign currencies, if the government only restricts the circulation of foreign currencies and ignores the improvement of the credit of domestic currencies, it is difficult to prohibit the use of foreign currencies. Currency competition mainly depends on currency credit, and currency credit is subject to maximizing seigniorage. The decline in money demand is an important factor restricting the government’s issuance of banknotes. An important way to reduce the demand for domestic money is to find alternative currencies. Therefore, the government can balance the currency circulation and money demand to ensure a certain amount of seigniorage and maintain good currency credit, so that the domestic currencies can occupy a dominant position in the competition.In short, this paper mainly contributes in three aspects: First, it supplements and deepens the understanding of the reasons for the circulation of foreign banknotes and the competition mechanism, and makes up for the lack of research on the foreign currency circulation in modern China. Second, it provides empirical evidence for the theory of the currency competition, and demonstrates the important role of currency credit in competition. Third, it deepens our understanding of the current international currency competition and the internationalization of RMB, and provides strategic guidance for the internationalization of RMB. Only by upholding the long-term stability of RMB and building good government credibility, can we promote its competitiveness in various currencies.