A History of Money and Banking in the United States: The Colonial Era to World War II (8 page)

8If Rhode Island was the most inflationary of the colonies, Maryland’s monetary expansion was the most bizarre. In 1733, Maryland’s public land bank issued £70,000 of paper notes, of which £30,000 was
given away
in a fixed amount to each inhabitant of the province. This was done to universalize the circulation of the new notes, and is probably the closest approximation in history of Milton Friedman’s “helicopter” model, in which a magical helicopter lavishes new paper money in fixed amounts of proportions to each inhabitant. The result of the measure, of course, was rapid depreciation of new notes. However, the inflationary impact of the notes was greatly lessened by tobacco still being the major money of the new colony. Tobacco was legal tender in Maryland and the paper was not receivable for all taxes.

9Roger W. Weiss, “The Colonial Monetary Standard of Massachusetts,”
Economic History Review
27 (November 1974): 589.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

operation of paper money. Despite the inflation, booms and busts, and shortages of specie caused by paper issues, the specie system worked well overall:

Here was a silver standard . . . in the absence of institutions of the central government intervening in the silver market, and in the absence of either a public or private central bank adjusting domestic credit or managing a reserve of specie or foreign exchange with which to stabilize exchange rates. The market . . . kept exchange rates remarkably close to the legislated par. . . . What is most remarkable in this context is the continuity of the specie system through the seventeenth and eighteenth centuries.10

PRIVATE BANK NOTES

In contrast to government paper, private bank notes and deposits, redeemable in specie, had begun in western Europe in Venice in the fourteenth century. Firms granting credit to consumers and businesses had existed in the ancient world and in medieval Europe, but these were “money lenders” who loaned out their own savings. “Banking” in the sense of lending out the savings of others only began in England with the

“scriveners” of the early seventeenth century. The scriveners were clerks who wrote contracts and bonds and were therefore in a position to learn of mercantile transactions and engage in money lending and borrowing.11

There were, however, no banks of deposit in England until the civil war in the mid-seventeenth century. Merchants had been in the habit of storing their surplus gold in the king’s mint for safekeeping. That habit proved to be unfortunate, for when 10Ibid., p. 591.

11During the sixteenth century, before the rise of the scriveners, most English money-lending was not even conducted by specialized firms, but by wealthy merchants in the clothing and woolen industries, as outlets for their surplus capital. See J. Milnes Holden,
The History of Negotiable
Instruments in English Law
(London: Athlone Press, 1955), pp. 205–06.

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57

Before the Twentieth Century

Charles I needed money in 1638, shortly before the outbreak of the civil war, he confiscated the huge sum of £200,000 of gold, calling it a “loan” from the owners. Although the merchants finally got their gold back, they were understandably shaken by the experience, and forsook the mint, depositing their gold instead in the coffers of private goldsmiths, who, like the mint, were accustomed to storing the valuable metal. The warehouse receipts of the goldsmiths soon came to be used as a surrogate for the gold itself. By the end of the civil war, in the 1660s, the goldsmiths fell prey to the temptation to print pseudo-warehouse receipts not covered by gold and lend them out; in this way fractional reserve banking came to England.12

Very few private banks existed in colonial America, and they were short-lived. Most prominent was the Massachusetts Land Bank of 1740, issuing notes and lending them out on real estate.

The land bank was launched as an inflationary alternative to government paper, which the royal governor was attempting to restrict. The land bank issued irredeemable notes, and fear of its unsound issue generated a competing private silver bank, which emitted notes redeemable in silver. The land bank promptly issued over £49,000 in irredeemable notes, which depreciated very rapidly. In six months’ time the public was almost universally refusing to accept the bank’s notes and land bank sympa-thizers vainly accepting the notes. The final blow came in 1741, when Parliament, acting at the request of several Massachusetts merchants and the royal governor, outlawed both the land and the silver banks.

12Once again, ancient China pioneered in deposit banking, as well as in fractional reserve banking. Deposit banking per se began in the eighth century A.D., when shops would accept valuables, in return for warehouse receipts, and receive a fee for keeping them safe. After a while, the deposit receipts of these shops began to circulate as money. Finally, after two centuries, the shops began to issue and lend out more receipts than they had on deposit; they had caught on to fractional reserve banking. Tullock,

“Paper Money,” p. 396.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

One intriguing aspect of both the Massachusetts Land Bank and other inflationary colonial schemes is that they were advocated and lobbied for by some of the wealthiest merchants and land speculators in the respective colonies. Debtors benefit from inflation and creditors lose; realizing this fact, older historians assumed that debtors were largely poor agrarians and creditors were wealthy merchants and that therefore the former were the main sponsors of inflationary nostrums. But, of course, there are no rigid “classes” of debtors and creditors; indeed, wealthy merchants and land speculators are often the heaviest debtors.

Later historians have demonstrated that members of the latter group were the major sponsors of inflationary paper money in the colonies.13, 14

13On the Massachusetts Land Bank, see the illuminating study by George Athan Billias, “The Massachusetts Land Bankers of 1740,”
University of Maine Bulletin
61 (April 1959). On merchant enthusiasm for inflationary banking in Massachusetts, see Herman J. Belz, “Paper Money in Colonial Massachusetts,” Essex Institute,
Historical Collections
101 (April 1965): 146–63; and Herman J. Belz, “Currency Reform in Colonial Massachusetts, 1749–1750,” Essex Institute,
Historical Collections
103 (January 1967): 66–84. On the forces favoring colonial inflation in general, see Bray Hammond,
Banks and Politics in America
(Princeton, N.J.: Princeton University Press, 1957), chap. 1; and Joseph Dorfman,
The
Economic Mind in American Civilization, 1606–1865
(New York: Viking Press, 1946), p. 142.

14For an excellent biographical essay on colonial money and banking, see Jeffrey Rogers Hummel, “The Monetary History of America to 1789: A Historiographical Essay,”
Journal of Libertarian Studies
2 (Winter 1978): 373–89. For a summary of colonial monetary experience, see Murray N. Rothbard,
Conceived in Liberty,
vol. 2,
Salutary Neglect, The
American Colonies in the First Half of the Eighteenth Century
(New Rochelle, N.Y.: Arlington House, 1975), pp. 123–40. A particularly illuminating analysis is in the classic work done by Charles Jesse Bullock,
Essays on the Monetary History of the United States
(New York: Greenwood Press, [1900] 1969), pp. 1–59. Up-to-date data on the period is in Roger W. Weiss, “The Issue of Paper Money in the American Colonies, 1720–1774,”
Journal of Economic History
30 (December 1970): 770–84.

A History of Money and Banking in the United States
59

Before the Twentieth Century

REVOLUTIONARY WAR FINANCE

To finance the Revolutionary War, which broke out in 1775, the Continental Congress early hit on the device of issuing fiat paper money. The leader in the drive for paper money was Gouverneur Morris, the highly conservative young scion of the New York landed aristocracy. There was no pledge to redeem the paper, even in the future, but it was supposed to be retired in seven years by taxes levied pro rata by the separate states.

Thus, a heavy future tax burden was supposed to be added to the inflation brought about by the new paper money. The retirement pledge, however, was soon forgotten, as Congress, enchanted by this new, seemingly costless form of revenue, escalated its emissions of fiat paper. As a historian has phrased it, “such was the beginning of the ‘federal trough,’ one of America’s most imperishable institutions.”15

The total money supply of the United States at the beginning of the Revolution has been estimated at $12 million. Congress launched its first paper issue of $2 million in late June 1775, and before the notes were printed it had already concluded that another $1 million was needed. Before the end of the year, a full $6 million in paper issues was issued or authorized, a dramatic increase of 50 percent in the money supply in one year.

The issue of this fiat “Continental” paper rapidly escalated over the next few years. Congress issued $6 million in 1775, $19

million in 1776, $13 million in 1777, $64 million in 1778, and $125

million in 1779. This was a total issue of over $225 million in five years superimposed upon a pre-existing money supply of $12

million. The result was, as could be expected, a rapid price inflation in terms of the paper notes, and a corollary accelerating depreciation of the paper in terms of specie. Thus, at the end of 1776, the Continentals were worth $1 to $1.25 in specie; by the fall of the following year, its value had fallen to 3-to-1; by December 1778 the value was 6.8-to-1; and by December 1779, 15Edmund Cody Burnett,
The Continental Congress
(New York: W.W.

Norton, 1964), p. 83.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

to the negligible 42-to-1. By the spring of 1781, the Continentals were virtually worthless, exchanging on the market at 168 paper dollars to one dollar in specie. This collapse of the Continental currency gave rise to the phrase, “not worth a Continental.” To top this calamity, several states issued their own paper money, and each depreciated at varying rates. Virginia and the Carolinas led the inflationary move, and by the end of the war, state issues added a total of 210 million depreciated dollars to the nation’s currency.

In an attempt to stem the inflation and depreciation, various states levied maximum price controls and compulsory par laws.

The result was only to create shortages and impose hardships on large sections of the public. Thus, soldiers were paid in Continentals, but farmers understandably refused to accept payment in paper money despite legal coercion. The Continental Army then moved to “impress” food and other supplies, seizing the supplies and forcing the farmers and shopkeepers to accept depreciated paper in return. By 1779, with Continental paper virtually worthless, the Continental Army stepped up its impressments, “paying” for them in newly issued paper tickets or “certificates” issued by the army quartermaster and commis-sary departments. The states followed suit with their own massive certificate issues. It understandably took little time for these certificates, federal and state, to depreciate in value to nothing; by the end of the war, federal certificate issues alone totaled $200 million.

The one redeeming feature of this monetary calamity was that the federal and state governments at least allowed these paper issues to sink into worthlessness without insisting that taxpayers shoulder another grave burden by being forced to redeem these issues specie at par, or even to redeem them at all.16 Continentals 16As one historian explained, “Currency and certificates were the

‘common debt’ of the Revolution, most of which at war’s end had been sunk at its depreciated value. Public opinion . . . tended to grade claims against the government according to their real validity. Paper money had
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Before the Twentieth Century

were not redeemed at all, and state paper was only redeemed at depreciating rates, some at the greatly depreciated market value.17 By the end of the war, all the wartime state paper had been withdrawn from circulation.

Unfortunately, the same policy was not applied to another important device that Congress turned to after its Continental paper had become almost worthless in 1779: loan certificates.

Technically, loan certificates were public debt, but they were scarcely genuine loans. They were simply notes issued by the government to pay for supplies and accepted by the merchants because the government would not pay anything else. Hence, the loan certificates became a form of currency, and rapidly depreciated. As early as the end of 1779, they had depreciated to 24-to-1 in specie. By the end of the war, $600 million of loan certificates had been issued. Some of the later loan certificate issues were liquidated at a depreciated rate, but the bulk remained after the war to become the substantial core of the permanent, peacetime federal debt.

The mass of federal and state debt could have depreciated and passed out of existence by the end of the war, but the process was stopped and reversed by Robert Morris, wealthy Philadelphia merchant and virtual economic and financial czar of the Continental Congress in the last years of the war. Morris, leader of the nationalist forces in American politics, moved to make the depreciated federal debt ultimately redeemable in par and also agitated for federal assumption of the various state debts. The reason for this was twofold: (a) to confer a vast subsidy on speculators who had purchased the public debt at highly depreciated values, by paying interest and principal at the least status.” E. James Ferguson,
The Power of the Purse: A History of
American Public Finance, 1776–1790
(Chapel Hill: University of North Carolina Press, 1961), p. 68.