S04: Empire of Debt

Participation

• Attendance will be taken starting today.
• One FREE absence: No question asked!
• Come prepared; expect cold calls.

Assessment changes:
Shorter, simpler, and more fun

• “The history of…”: Review an Economist article on China published this term with a historical perspective.
• “The economics of…”: A short case study on a China-related business, past or present.
• Mid-term and final exams: Written analysis on a new case.

• How to pay for debt? Financing Qing’s indemnities after the First Sino-Japanese War
• International sovereign borrowing: How to build a modern financial market? How to negotiate the best deal in an unequal system?
• Economic imperialism: What roles did foreign banks play in the development of Chinese finance?

Before mid-19th century:

• Head tax (percentage of working-age males)
• Land tax (agricultural productivity)
• Monopolies: salt, iron, jade, porcelain, customs receipts from trading ports
• Personal income
• Commercial tax

Partnership with gentry elites:

• <1% population, 25% farmland, 5-8% of agricultural income
• Preferential treatment: Taxed at 20%-50% the rate of common farmers
• Gentry wealth to pay for local administrative costs

Kangxi b. 1654-1722, r. 1661-1722

• Freeze basic land tax (1713)

Yongzheng b. 1678-1735, r. 1723-1735

• Introducing silver meltage fee
• Folding head tax into land tax

Qianlong b. 1711-1799, r. 1735-1796

• Tax reductions: lower grain assessments
• General remission of land taxes (1745)

• State involution
• Increased migration and resource competition
• Decreased agricultural productivity
• Ecological degradation: deforestation, silting of Yellow River, etc.
• Social dislocation: Talent glut

• 1694: The Bank of England founded to address fiscal crisis during wars with France.
• The Bank lent money to the state in exchange for the right to issue banknotes backed by the government’s credit.
• Trust in the state became collateral, allowing Britain to create money from promise through bonds and loans, rather than metal reserve.

Benjamin Franklin: “Rather go to bed without dinner than to rise in debt.”

Alexander Hamilton: “The necessity for borrowing in particular emergencies cannot be doubted, so on the other, it is equally evident that, to be able to borrow upon good terms, it is essential that the credit of the nation should be well established.”

• U.S. Constitution grants Congress authority over taxation and public debt, and the U.S. Treasury bond market has existed since the country’s founding.
• 1803: The Louisiana Purchase, funded by $11.25 million in bonds.
• 1868: The 14th Amendment affirmed the government’s obligation to pay its debts.

Even before the Japanese indemnity, the Qing was already struggling:

• Unequal treaty indemnities
• Rebuilding costs after Taiping and domestic rebellions
• Devolution of political and fiscal power

• How can the Qing raise more revenue, given the rise of provincial leaders?
• How can the Qing borrow more, without a central bank?

• Founded in 1865 as Hongkong and Shanghai Banking Corporation
• Created a market for China loans in Britain and managed 75% of Qing’s pre-1895 foreign borrowing
• Also acted as a link between China’s silver economy and London’s gold-based markets

• An agency of the Chinese state, but the Inspector General (initially British, then American) had sole control.
• It was a cosmopolitan civil service with its own structure, ethos, armed forces, diplomacy, and operated independently.
• The Customs Service inserted itself into niches created by weak Chinese regimes and expanding European empires.

• Robert Hart was born in Ulster in 1835 and educated in Ireland and England.
• At 19, he started as an interpreter in China Consular Service.
• He became Inspector General of the Chinese Imperial Maritime Customs Service in 1863, holding the role for 48 years.

• Qing China had no central bank, but Robert Hart created a process for Qing loans to become official debts.
• Provincial loans, upon imperial edict approval via the Zongli Yamen (Qing’s foreign office) and Customs commissioners’ signatures, became “bona fide Government loans.”
• The Qing borrowed around £16 million using this procedure before the Sino-Japanese War.

• Lijin 釐金: Internal tariff on transportation of goods, both foreign and domestic
• Context: Unequal treaties limited Qing’s ability to impose or levy external tariffs (customs)
• First introduced in 1853 to fund armies against the Taiping Rebellion.
• Became a permanent part of the Chinese tax system and a key revenue source for new militia and local governments.

• Foreign merchants opposed the internal transit tariffs, but it persisted until 1931.
• Seven provincial lijin and salt tax bureaus placed under Customs Service control as loan security.
• Bankers insisted on foreign-supervised securities due to mistrust of China’s financial management.

• The age of imperialism in East Asia: Japan gained control of Taiwan (as colony) and Korea (as protectorate; fully annexed 15 years later)
• Japan gained the right to establish industrial factories in Qing territory, opening the door to foreign investment and economic imperialism.
• Japan also acquired the Liaodong peninsula in southern Manchuria, including key ports like Dairen and Port Arthur.

Qing Treasury’s Annual Revenue:

88 million silver taels

• What was the amount and condition of the loan?
• Why did Franco‑Russian syndicate decide to underwrite it?

• Investor demand for government bonds depends on perceived risk and alternative investment opportunities.
• Factors influencing bond value include economic strength, inflation expectations, and returns from other investments.
• Government-specific factors include debt, fiscal management, taxation ability, and political stability.
• Bond prices and yields have an inverse relationship: when price falls, yield rises, and vice versa.

• What is DAB?
• When did it begin
• Why did they go to China?
• What were the main risks of doing business there?

Market:

• Rapidly growing foreign trade + Financing needs for modernization projects
• Specifically, large-scale introduction of railways, which promised plenty of opportunities for German investment.

Competition:

• Other foreign banks (HSBC, etc.)
• Local and private financial networks (such native banks, money-changing shops, and Shanxi banks)

• Operating as a foreign bank in a new market with different practices.
• Assessing China’s sovereign risk was crucial for loan negotiations. This led to Western demand for more supervision – and control – of Chinese public finance.
• Managing political risk: Popular uprisings, revolutionary movements, political fragmentation, etc.

Roles:

• Zongli yamen (Qing Foreign Office)
• Robert Hart (China Maritime Customs)
• DAB
• HSBC
• Syndicate of Russian and French banks (issuer of the 1895 £16 Million Franco-Russian 4% Gold Loan)

Discuss:

• Would you underwrite the loan? Why or why not?
• If yes, provide the bond terms: Notional amount, Coupon rate, Maturity, Issue price, Commission & expenses
• What collaterals and guarantees would you demand? Why?
• Other conditions

• China was seen as a buffer between Russia and British India.
• HSBC warned that China could become a Russian province with the Customs Service out of English hands if it received the loan.
• Robert Hart urged collaboration to pressure the Foreign Office to protect British interests and the Customs Service’s integrity.

• Were the loans a good deal for DAB and HSBC?
• Were they a good deal for China?

• After the Sino-Japanese War (1894-95), major powers sought “spheres of influence” in China.
• The US, without its own sphere, sought to equalize privileges among countries trading with China.
• On paper, support for Chinese territorial and administrative integrity: e.g. Only the Chinese government could collect taxes on trade; No power with a sphere was exempt from harbor dues or railroad charges.

• Replacement of Chinese temples with Catholic churches;
• Destruction of Chinese burial sites for German railroads and telegraph lines caused discontent.
• German shooting Chinese protestors against the railroads.

• 1898: Drought and widespread famine in North China
• Economic issues in Shandong, including foreign cotton imports, declining Grand Canal traffic, also fueled rebellion.
• 1900: Uprising led by a society society named Yihequan (“Righteous and Harmonious Fists”), which practiced certain boxing and calisthenic rituals in the belief that this made them invulnerable.

• 1900: Foreign Legation sieged. Empress Dowager Cixi declared war on all foreign powers.
• To put down the rebellion, Eight-Nation Alliance (including France, Germany, United Kingdom, Italy, Austria-Hungary, Japan, Russia, and the United States) occupied Beijing.

• Signed between China and eleven Great Powers on September 11, 1901
• 450 million silver taels as indemnity; 668 million with interest
• Entire revenue structure, except land tax, placed under foreign control
• Further erosion of national sovereignty: Japan retained troops in north China