China in the Second Sino-Japanese War

Industrial cooperatives

After Japan's 1931 invasion of Manchuria, the Republic of China began state-led industrialization policies as a response to the risk of full-scale war with Japan.^[1]: 68 In 1932, it formed a clandestine industrial mobilization government agency, the National Defense Planning Commission (renamed in 1935 to the National Resources Commission).^[1]: 68 Chinese policymakers drew inspiration from economic models used by the Soviet Union, Japan, and Germany.^[1]: 68 The ROC established another income tax system in 1936 and it remained in place (with some revisions) until the ROC's defeat in the Chinese Civil War.^{[2]: 100–101}

The Second Sino-Japanese War had quickly harmed China's economy, with one of the earliest attacks being the Battle of Shanghai in 1937. With Shanghai, being a major industrial and foreign relations port for the Chinese and now under Japanese control, the Chinese economy industry took a big hit.^[3] The Japanese Air Force carried out systematic and often indiscriminate bombings of Chinese cities. Nationalist forces applied a "scorched earth" policy in response to the invasion; destroying the productive capacity of areas they had to abandon in the face Japanese military advances.

The war brought about a massive increase in government control of industries. In 1936, government-owned industries were only 15% of GDP. In 1938, the ROC established a commission for industries and mines to control and supervise firms, as well as instilling price controls. By 1942, 70% of the capital of Chinese industry were owned by the government.^[4] In an effort to rectify this, Chinese Industrial Cooperatives (CIC) were created in 1937, under the "Gung Ho" Movement, before becoming formalized in 1938. The creation of Chinese Industrial Cooperatives allowed the Chinese people to establish smaller industry centers in small towns across China, allowing for economic and industrial production away from battle or possible Japanese invasion. In addition to supporting the economy, more immediate efforts were placed on supporting the Chinese military in producing whatever materials were needed for the war. Chinese refugees and those displaced by the war were hired by CICs to help production.^[5]

The CICs relied on foreign aid and contributions, which drew mixed reactions. Overall, the CIC program failed as they had a goal of creating 30,000 cooperatives, but only succeeded in making approximately 2,000 cooperatives instead.^[6] The name "Gung Ho" comes from the Americanization of the Chinese name for Chinese Industrial Cooperatives. The full name, "工業合作社" (gōng yè hé zuò shè) was often shortened to the term "工合" (gōng hé), which was mistaken by U.S. Marine Evans Fordyce Carlson to mean "work together". Carlson then went on to use this believed motto as his slogan throughout the war, generating that phrase "Gung Ho" that has come to be in the English language.^[7]

Hyperinflation

From the summer of 1937 through the end of 1949, the Chinese economy suffered inflation and hyperinflation.^[9]: 41 Starting in July 1937, the Japanese military advanced through northern and eastern China, forcing the Nationalist government to retreat inland and abandon significant manufacturing and agricultural regions, as well as key transport hubs for imports and exports. This retreat, combined with Japanese blockades of Chinese transport routes, led to immediate price surges in Free China. Each successive Japanese victory exacerbated the situation. For instance, the fall of Wuhan and Guangzhou in late 1938 caused import prices to rise by 72%. The Japanese invasion of Guangxi in late 1939 nearly doubled import prices in Chongqing. In contrast, locally produced goods, including food and agricultural raw materials, maintained stable prices until 1938, supported by a robust harvest in Sichuan that year. However, from 1939 onwards, the prices of both imported and local goods began to rise in tandem as around five million refugees moved westward into Free China.^[10] Tax revenues decreased drastically while military expenses remained high.^[9]: 6

Since the start of the war, the Chinese government began funding its efforts through the issuance of war bonds, which initially enjoyed strong public support. By late 1938, government spending expanded not only for the war effort but also for reconstruction and the development of inland industries and transport infrastructure. This expansion aimed to reinforce infrastructure and sustain the war effort within the remaining Chinese-controlled territories. Consequently, government spending increased by 33%, despite the administration now managing only about half of the country. However, public confidence in war bonds waned, leading to a decline in bond sales since 1938. Additionally, the limited new taxes, which were not introduced until late 1939, failed to offset the government's excessive spending. As a result, the budget deficit continued to grow unchecked.^[10] With limited tax revenue from occupied regions and no bond market, China relied on banking institutions to fund deficits, leading to monetary expansion.^[11]

Inflation, previously moderate, surged after the Pacific War began.^[11] The economic situation further worsened as China became increasingly isolated once Japan occupied British Burma and French Indochina.^[9]: 6 After the Japanese attack on Pearl Harbor in 1941, Japan quickly seized the whole of Shanghai and, in 1942, cut off the Burma Road, a crucial supply route for China. This led to a 50% decrease in imports in 1942 compared to the previous year. Despite efforts to compensate with The Hump air transport route over the Himalayas, by 1944, China was only receiving 6% of the total imports it had in 1937. Additionally, rice production in southern China faced unfavourable outcomes, although wheat and barley production in Henan and Hebei saw slight increases. Due to administrative failures, the Nationalist government struggled to enforce price control measures, despite issuing decrees to this effect. None of the government's strategies addressed the need to curb its own budget deficit, which continued to generate inflation.^[12][13] The ROC government's tried unsuccessfully to curb inflation with the introduction of new currencies and failed attempts in both 1942 and 1943 to institute a general price freeze.^[14]: 73 The efforts at price controls failed because China's agricultural economy was very concentrated, industry was declining, and exchange rates collapsing.^[8]: 73

In 1942–1943, the American Dollar Bond scandal arose.^[9]: 73 The Nationalist government of China decided to use US$200 million to absorb excess fabi in an effort to curb inflation.^[9]: 73 In theory, Chinese purchasers would use fabi to buy bonds at the official exchange rate and be paid in dollars when the bonds were redeemed following victory over Japan.^[9]: 73 The American Dollar Bonds were issued on March 24, 1942.^[9]: 73 The public response was poor, with few bond sales.^[9]: 74 In October 1943, H.H. Kung sent a secret memorandum to Chiang Kai-shek asking that the bond sales end.^[9]: 74 Subscriptions were closed on October 15, 1943, and a central bank official falsely announced that all bonds had been sold.^[9]: 74 Secretly, insiders then purchased the remaining bonds using currency acquired on the black market. The result was a windfall for Nationalist government insiders including Kung, the Soong family, Wei Daoming, Long Yun, and others.^[9]: 74 United States Treasury Secretary Henry Morgenthau Jr. reported to United States President Franklin D. Roosevelt that the US$200 million had been spent with little impact in curbing inflation.^[9]: 74 Within the Nationalist government of China, Kung was criticized for corruption, and the incident was significant in Chiang losing faith in Kung and removing him from politics.^[9]: 74

Although American shipment of gold to China played a critical role in reducing inflation,^{[15]: 33–35} China's insistence on the official exchange rate of CNC created serious tension with its major ally, the United States. The US Department of the Treasury was also unhappy with the Chinese government's handling of the sale of gold that the United States had supplied to China.^[16][15] American military operations in China also added to the financial difficulty of China. Besides providing food and lodging for US forces, China was responsible for constructing and maintaining military airfields, including costly B-29 bomber bases, which far exceeded initial budgets, costing C$79.9 billion CNC.^[11] In 1943, the US offered to cover some expenses in US dollars at an official 20:1 exchange rate, but as the Chinese currency devalued sharply, the agreement became unsustainable. By 1945, the currency's value dropped to 1/2,500 of its pre-war level, with even more severe inflation at major bases like Kunming. This led to the eventual abandonment of the 20:1 rate for payments to US forces. Payments from the US ceased after a final US$45 million settlement for late 1944, forcing China to cover expenses, which accounted for 15%–22% of its fiscal spending. From 1942 to 1945, China disbursed C$246 billion for US military aid, about 7% of its total military expenditures.^[11]

In 1944, the advance of Japan's Ichigo campaign cut the Nationalist-controlled areas of China in half.^[9]: 22 One-fourth of China's manufacturing base was destroyed in the campaign.^[9]: 22 The loss of more manufacturing, particularly in conjunction with Japanese occupation of major grain production areas, further weakened the Nationalist economy.^{[9]: 22–23} Throughout the war, but especially after the Ichigo campaign, the Nationalist government could not pay its bills.^[9]: 203

Post-war recovery and collapse

When Japan surrendered in August 1945, the KMT government was able to recover most of the economic centers lost in Second Sino-Japanese War without subjecting them to further destruction. However this ultimately made little difference given the extent of the damage caused by the war and subsequent Japanese occupation. Initially Manchuria, which Japan had transformed into the greatest industrial center in the Far East, had escaped any large scale destruction until the Soviet invasion in the final week of the war. The Red Army rapidly overran Japanese forces, commencing a 3-month occupation defined by systemic campaign of looting and destruction. Soviet Premier Josef Stalin ordered all equipment, moveable parts, tools and even material wealth plundered from private homes, shipped back to the USSR, what could not be pillaged was to be destroyed. When the Soviets withdrew in October, ^ the result was near total. What had been China's industrial epicenter was reduced to rubble, virtually all factories had been destroyed, not a single mine was operational. Manchuria had been stripped of virtually all heavy machinery and was left without even electricity as the Soviets had dismantled or destroyed all power plants, even removing the turbines from dams.^[17] Industry was severely hampered after the war by devastating conflict as well as the inflow of cheap American goods. By 1946, Chinese industries operated at 20% capacity and produced just 25% of pre-war output.^[18]

The Nationalist government seized Japanese-held businesses at the time of the Japanese surrender.^[9]: 92 The Nationalist government made little effort to return these businesses to their original Chinese owners.^{[9]: 92–93} A mechanism existed through which Chinese and foreign owners could petition for the return of their former property.^[9]: 92 In practice, the Nationalist government and its officials retained a great deal of the seized property and embezzling property, particularly from warehouses, was common.^[9]: 93 Nationalist officials sometimes extorted money from individuals in liberated territories under threat of labeling them as Japanese collaborators.^[9]: 93

Commando operations

In February 1941 a Sino-British agreement was forged whereby British troops would assist the Chinese "Surprise Troops" units of guerrillas already operating in China, and China would assist Britain in Burma.^[50] When Hong Kong was overrun in December 1941, the British Army Aid Group (B.A.A.G.) was set up and headquartered in Guilin, Guangxi. Its aim was to assist prisoners of war and internees to escape from Japanese camps. This led to the formation of the Hong Kong Volunteer Company which later fought in Burma.^[51] B.A.A.G. also sent agents to gather intelligence – military, political and economic in Southern China, as well as giving medical and humanitarian assistance to Chinese civilians and military personnel.^[52]

A British-Australian commando operation, Mission 204 (Tulip Force), was initialized to provide training to Chinese guerrilla troops.^[53] The mission conducted two operations, mostly in the provinces of Yunnan and Jiangxi. Another phase was set up with lessons learned from the first. Commencing in February 1943 this time valid assistance was given to the Chinese 'Surprise Troops' in various actions against the Japanese. These involved ambushes, attacks on airfields, blockhouses, and supply depots. The unit operated successfully before withdrawal in November 1944.^[54] Commandos and members of SOE who had formed Force 136, worked with the Free Thai Movement who also operated in China, mostly while on their way into Thailand.^[55]

Pre-war neutrality

The United States generally avoided taking sides between Japan and China until 1940, providing virtually no aid to China in this period. For instance, the 1934 Silver Purchase Act signed by President Roosevelt caused chaos in China's economy which helped the Japanese war effort. The 1933 Wheat and Cotton Loan mainly benefited American producers, while aiding to a smaller extent both Chinese and Japanese alike. This policy was due to US fear of breaking off profitable trade ties with Japan, in addition to US officials and businesses perception of China as a potential source of massive profit for the US by absorbing surplus American products, as William Appleman Williams states.^[56]

From December 1937, events such as the Japanese attack on USS Panay and the Nanjing Massacre swung public opinion in the West sharply against Japan and increased their fear of Japanese expansion, which prompted the United States, the United Kingdom, and France to provide loan assistance for war supply contracts to China. Australia also prevented a Japanese government-owned company from taking over an iron mine in Australia, and banned iron ore exports in 1938.^[57] However, in July 1939, negotiations between Japanese Foreign Minister Hachirō Arita and the British Ambassador in Tokyo, Robert Craigie, led to an agreement by which the United Kingdom recognized Japanese conquests in China. At the same time, the US government extended a trade agreement with Japan for six months, then fully restored it.

Oil embargo

Japan invaded and occupied the northern part of French Indochina in September 1940 to prevent China from receiving the 10,000 tons of materials delivered monthly by the Allies via the Haiphong–Yunnan Fou Railway line. On 22 June 1941, Germany attacked the Soviet Union. In spite of non-aggression pacts or trade connections, Hitler's assault threw the world into a frenzy of re-aligning political outlooks and strategic prospects.

On 21 July, Japan occupied the southern part of French Indochina (southern Vietnam and Cambodia), contravening a 1940 gentlemen's agreement not to move into southern French Indochina. From bases in Cambodia and southern Vietnam, Japanese planes could attack Malaya, Singapore, and the Dutch East Indies. As the Japanese occupation of northern French Indochina in 1940 had already cut off supplies from the West to China, the move into southern French Indochina was viewed as a direct threat to British and Dutch colonies. Many principal figures in the Japanese government and military (particularly the navy) were against the move, as they foresaw that it would invite retaliation from the West.

On 24 July 1941, Roosevelt requested Japan withdraw all its forces from Indochina. Two days later the US and the UK began an oil embargo; two days after that the Netherlands joined them. This was a decisive moment in the Second Sino-Japanese War. The loss of oil imports made it impossible for Japan to continue operations in China on a long-term basis. It set the stage for Japan to launch a series of military attacks against the Allies, including the attack on Pearl Harbor on 7 December 1941.

When the Imperial Japanese invaded French Indochina, the United States enacted the oil and steel embargo against Japan and froze all Japanese assets in 1941,^[58][59] and with it came the Lend-Lease Act of which China became a beneficiary on 6 May 1941; from there, China's main diplomatic, financial and military support came from the U.S., particularly following the attack on Pearl Harbor.

Military volunteers

In mid-1941, the United States government financed the creation of the American Volunteer Groups (AVG), of which one the "Flying Tigers" reached China, to replace the withdrawn Soviet volunteers and aircraft. The Flying Tigers did not enter actual combat until after the United States had declared war on Japan. Led by Chennault, their early combat success of 300 kills against a loss of 12 of their newly introduced Curtiss P-40 Warhawk fighters heavily armed with six 0.50-inch caliber machine guns and very fast diving speeds earned them wide recognition at a time when the Chinese Air Force and Allies in the Pacific and SE Asia were suffering heavy losses, and soon afterwards their "boom and zoom" high-speed hit-and-run air combat tactics would be adopted by the United States Army Air Forces.^[60]

Disagreements existed both between the United States and the Nationalists, and within the United States military, about the form of aid.^[48]: 35 Chennault contended that aid should be in the form of building on the success of the Flying Tigers and go to the US Fourteenth Air Force in China.^[48]: 35 Lieutenant General Joseph Stilwell, who was in charge of training Nationalist divisions equipped by the United States, became increasingly frustrated by the Nationalists' refusal to use them to fight the Japanese in Burma or in southeastern China.^[48]: 35

Intelligence operations

Knowledge of Japanese naval movements in the Pacific was provided to the American Navy by the Sino-American Cooperative Organization (SACO) which was run by the Chinese intelligence head Dai Li.^[61] Philippine and Japanese ocean weather was affected by weather originating near northern China.^[62] The base of SACO was located in Yangjiashan.^[63] The Sino-American Cooperative Organization^[64][65][66] was an organization created by the SACO Treaty signed by the Republic of China and the United States of America in 1942 that established a mutual intelligence gathering entity in China between the respective nations against Japan.

It operated in China jointly along with the Office of Strategic Services (OSS), America's first intelligence agency and forerunner of the CIA while also serving as joint training program between the two nations. Among all the wartime missions that Americans set up in China, SACO was the only one that adopted a policy of "total immersion" with the Chinese. The "Rice Paddy Navy" or "What-the-Hell Gang" operated in the China-Burma-India theater, advising and training, forecasting weather and scouting landing areas for USN fleet and Gen Claire Chennault's 14th AF, rescuing downed American flyers, and intercepting Japanese radio traffic.

An underlying mission objective during the last year of war was the development and preparation of the China coast for Allied penetration and occupation. Fujian was scouted as a potential staging area and springboard for the future military landing of the Allies in Japan. American and Canadian-born Chinese were recruited to act as covert operatives in Japanese-occupied China. Employing their racial background as a disguise, their mandate was to blend in with local citizens and wage a campaign of sabotage. Activities focused on destruction of Japanese transportation of supplies (signaling bomber destruction of railroads, bridges).^[67]