The global economic distortions caused by China’s state-driven economic model are becoming more severe. China’s investment has been raised to economically unprecedented levels and the country has embarked on a manic subsidized export drive to keep its GDP growth rate around 5%. That policy is reaching its limits, both through uncollectible debt in the economy and the resentment of China’s trading partners to having their manufacturing economies hollowed out. It is also keeping the skilled and hard-working Chinese people much poorer than they need to be. To prosper, China must reverse its revolution of 1949, not to the corruption and chaos of the Kuomintang era, but to the intelligent, economically sound capitalist policies of Britain’s Second Earl of Liverpool (1770-1828, Prime Minister, 1812-27).

The most important need for China is to remove the oppressive state control and cross-subsidization that has wildly distorted its economy. Ruchir Sharma’s article “China’s growth target is a global problem” in the Financial Times of March 9 sets out elegantly the difficulty with a government stressing the economy to produce an unrealistic 4.5%-5% growth target via subsidized exports that impoverish China’s neighbors and generate a gigantic Chinese trade surplus. The country’s “Belt and Road” investments in uncreditworthy countries over the past two decades are also producing huge losses and further straining China’s economy. The cost of China’s subsidies to exports and Third World investment is reflected in its overall debt, now 340% of GDP, used so inefficiently that it now takes $6 of additional debt to generate each $1 of additional GDP. With China’s workforce not growing, the government’s growth target would require productivity growth of 4.5%-5% per annum, which in China’s inefficient centrally-directed economy is economically impossible in all but the shortest run.

Instead, China must allow the price mechanism and profit motive full rein both domestically and internationally to determine which transactions are undertaken. Exports must no longer be pushed by the government even when they are made at below cost; instead export subsidies must be eliminated so that Chinese goods are sold abroad only when it is profitable for a Chinese company to do so, with no government subsidies involved. Overall, the public sector at both national and regional levels must be cut back; in particular, China must slim down its military spending, nominally 1.7% of GDP but in reality, far higher than that.

Liverpool, in his period in office after the Napoleonic Wars were won in 1815, did precisely this. He cut back the public sector rigorously, with the help of his much underrated Chancellor of the Exchequer Nicholas Vansittart (1766-1851) who made himself very unpopular and despised by intellectuals by his repeated public spending cuts, together with tax increases when they were needed to balance Britain’s distorted post-war Budget. British government expenditure, excluding debt service, fell by three quarters between 1815 and 1822, giving the private sector vastly more room to expand and after 1820 producing an unprecedented industrial boom that massively raised living standards.

Even more important than eliminating subsidies and cutting back the government’s size and control is the question of dealing with China’s mountain of government and private debt. Much of that represents malinvestment of the most egregious kind, such as apartment blocks that remain unfilled because the local citizenry cannot afford to pay an economic rent for them. The malinvestment must be dealt with, being sold at a price reflecting its value or in some cases, such as deteriorated residential housing or factories whose output is uneconomic, knocked down altogether. The Japanese example from 1991-2020 of what not to do is relevant here; allowing a mass of uneconomic assets and employment to continue ad infinitum merely diverts resources from more profitable uses and prevents economic growth and higher living standards from occurring.

Here the example of Liverpool’s government is highly relevant, not only in the innovative solution it found to a similar debt problem, but also in the extraordinarily beneficial result of that solution for the British economy in the long-term. Like China today, Britain in 1815 had a huge debt overhang of about 250% of GDP in government debt plus additional debt in the highly fragmented banking system and over-extended agriculture, both of which had grown excessively during 20 years of war, high grain prices and mild inflation. In 1815, large new debt issues for the Waterloo campaign had left British government debt a gigantic drag on the capital market, its huge size and doubts about its repayment keeping prices low and yields high and throttling other borrowing.

After 1945, the British government faced with a similar debt problem resorted to fiat currency, artificially low interest rates and inflation, reducing the burden of debt in relation to GDP at the expense of ordinary middle-class savers like my Great Aunt Nan, who had foolishly invested in War Loan trusting the government’s promises of sound money. That is similar to current Chinese policy; interest rates have been kept artificially low and debt has been serviced through the financial repression of China’s famously enthusiastic savers.

Liverpool’s solution was different. Instead of inflating the currency to reduce the real level of debt, he deflated it, announcing in advance an intention to return to the Gold Standard at the parity that had governed before 1797, when Britain had been forced to abandon it. By his 1819 legislation that accomplished this, Liverpool eliminated a gold price premium of about 30% over its parity that had existed in 1813-14, producing overall price deflation of about the same percentage over the 1814-24 decade. In response, the price of 3% Consols rose from about 55% of par in 1815 to 90% of par in 1824, producing a massive capital gain for savers who also benefited from the deflation, the opposite effect to that of Britain’s post-World War II policies.

To deflate in face of a huge debt overhang may seem counter-intuitive, but Liverpool’s policy established the pound for the next century as the universal reserve currency for world trade, bringing untold wealth to the City of London, which managed the sterling capital markets. The Gold Standard pound was universally trusted as a store of value and consequently became the instrument for almost all the world’s commerce.

China can achieve the same effect by announcing a Gold Standard for the yuan, especially easy to do currently with gold prices so high and both the Chinese government and private individuals having accumulated a large percentage of the world’s gold reserves. Whereas the yuan, despite China’s dominance in world trade, is currently distrusted by world markets, being a fiat currency of a Communist government, a gold yuan, with gold coins issued and circulating among ordinary people (like the pre-1914 Gold Standard and not the phony “Bretton Woods” standard of 1944-71) will have automatic credibility as both a unit of exchange and store of value.

Moreover, once the gold yuan has been adopted, China will be able to reduce its debt problem by issuing “consols” – irredeemable debt securities with a low interest rate that are universally accepted internationally, thereby greatly lowering debt service costs. Consols issued in a fiat currency are a simple rip-off of investors, which is why Britain was unable to continue issuing Consols or their later equivalent “War Loan” after going off the Gold Standard in 1931. Consols issued in a gold-backed currency are a reliable store of value for however many millennia they are held. If the U.S. Supreme Court in 1935 had not upheld the Roosevelt Administration’s grossly destructive retroactive abolition of already existing Gold Clauses, the U.S. could still have benefited from this, and the sad 2,274% inflation of 1935-2026 would have been greatly mitigated.

With a Gold Standard guarding the value of their money and ensuring a comfortable retirement, Chinese consumers will be able to plan their lives on a long-term basis. Another Liverpool policy, the Corn Laws, may usefully be adapted as “Rice Laws” to ensure that rural peasants receive decent prices for their farm crops and can also participate in the country’s rising living standards. China might also consider adopting yet another Liverpool policy, a limited form of democracy with votes for property owners; this would limit the propensity of fully democratic voting systems to produce governments that loot the propertied.

China’s fortunate demographic, with its population finally beginning to decline, will ensure that its greater domestic wealth is reflected in higher living standards for all, not just in the production of surplus vulgar and unattractive billionaires. There will no longer be a frothy market for “inflation-proof” shares because borrowers will pay a real cost for their money and there will be no possibility of inflation. As in 19th century Britain (albeit from a much higher starting level) industrial growth and prosperity will lead directly into better living standards, because savings will be protected and scams and leverage will result in bankruptcy, not wealth.

Chinese civilization delights in following the wisdom of ancient sages, such as Confucius. Economically, it should follow the wisdom of a sage from 200 years ago: Lord Liverpool.

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(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)