History of Money in the United States [HOMIUS] - 1.3

Private Bank Notes and Revolutionary War Finance.

Robert Morris, c. 1782 by Charles Willson Peale (1741—1827)
Oil on canvas. Independence National Historical Park, Portrait Collection (Second Bank of the United States), Philadelphia, PA.

This is the third installment of the book club discussion of Rothbard's Money and Banking in the United States. So far we have covered the book through Government Paper Money section. The previous installment can be found here:

History of Money in the United States [HOMIUS] - 1.2

As usual, will quote directly the passages I found especially interesting, including my takes here and there. The emphasis is always mine, unless stated otherwise.

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.

This is an important distinction: banks lend other people's money, while money lenders use their own.

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.

In 1638 Charles I "borrowed" £200,000 of gold from the mint. The merchants eventually were repaid, but understandably they looked for other ways of safekeeping their specie. The natural choice was to use 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.

Pseudo-warehouse receipts were not strictly necessary for fractional reserve banking. The goldsmith could lend out real gold (that belonged to the depositors.) But using warehouse receipts meant that more gold was available to meet the withdrawal demand. Which in turn meant that more could be lent out. Theoretically, the amount of loans could exceed the amount of deposits.

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...

Land banks were mentioned in the previous section. The land bank issued mortgages - loans for land as collateral. The money it issued was in the form of bank notes. I think that by "irredeemable" Rothbard means de-facto irredeemable. Because formally the notes were supposed to be redeemable at certain points in time partly in silver and partly in some commodities.

As far as I can tell from other sources I found, the main problems the bank faced were three-fold. First, it was not officially recognized or chartered. Moreover, Governor Belcher of Massachusetts, in part following the Crown's wishes, actively opposed it declaring it illegal and prosecuting the participants - not only the subscribers, but also people who accepted and passed the notes. That made people less likely to accept the bank's notes. It also meant that borrowers would seek other sources of credit first, leaving those of lesser quality to borrow from the bank.

Second, a lot of the loans that the bank made were not sound.

And third, the bank granted ample relief to the deadbeats. My feeling is that the last two problems were due in part to the local nature of the bank - it played favorites.

Another bank that came into existence as an alternative to the land bank at the same time: "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 sympathizers vainly accepting the notes.

In 1741 the Parliament outlawed both the land and the silver banks.

Rothbard notes that those banks and what he calls "other inflationary schemes" were heavily advocated and lobbied for by wealthy individuals. Since "wealthy merchants and land speculators are often the heaviest debtors" they stood to gain most from inflating their debt away.

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... 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 per usual.

The total money supply of the United States at the beginning of the Revolution has been estimated at $12 million

In five years from 1775 to 1779 Congress issued over $225 million in fiat money, called "Continental".

The result was ... a rapid price inflation in terms of the paper notes, and a corollary accelerating depreciation of the paper in terms of specie.

At the end of 1776, the Continentals were worth $1 to $1.25 in specie. By the spring of 1781, the Continentals would exchange at $168 per $1 in specie. That's where the phrase “not worth a Continental" comes from.

To top this calamity, several states issued their own paper money, and each depreciated at varying rates ... 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... 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... By the end of the war, all the wartime state paper had been withdrawn from circulation

Loan certificates were another device used by the Federal government to finance the war effort. Formally those were government bonds, i.e. government debt. In reality they were just notes issued by the government in lieu of money to purchase supplies. The merchants were forced to accept those because the government would not pay anything else.

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... the bulk [of the loan certificates] remained after the war to become the substantial core of the permanent, peacetime federal debt.

Of course the war effort had to be financed somehow. And issuing fiat notes and loan certificates was an expedient way of avoiding direct taxation. People understood the realities of the situation and discounted those government liabilities accordingly.

Rothbard contends that "the mass of federal and state debt could have depreciated and passed out of existence by the end of the war". And he thinks that such outcome should have been preferable to loan certificates being redeemed by the government. What happened, however, was that Robert Morris spearheaded the effort to make the debt of the Federal government to be redeemed at par. Rothbard, showing his bias, introduces Morris as a "wealthy Philadelphia merchant", "virtual economic and financial czar of the Continental Congress in the last years of the war", and the leader of the nationalist political forces in America.

Another way to describe him would be as one of the US Founding Fathers, the signer of all three of the America’s founding documents - the Declaration of Independence, the Articles of Confederation, and The Constitution. He also was one of the chief bankrollers of the War for Independence. And, of course, by "nationalist political forces" Rothbard means those who later called themselves the Federalists¹.

Besides his designs to redeem the debt at par Morris also advocated for federal assumption of state debt. His main purpose was fairly clear: as someone who held large amounts of the debt Morris was using his power to get repaid. Another reason, however, that Rothbard imputes to Morris was to build the case for the taxation power of Congress and the centralization of the federal government. The program that won with the adoption of the Constitution.

I am somewhat puzzled why Rothbard considers non-repayment of the war debt a good thing. As a general rule debts need to be repaid. A deadbeat government would less likely to be find financing for its projects in the future. But maybe that's precisely what an uber-Libertarian like Rothbard would want? After all, for people like him there ain't no such thing as "a good government project".

1. In this I (humbly) agree with Rothbard. Hamilton cleverly arrogated to his party the Federalist sobriquet, forcing his opponents to be described as Antifederalist. In truth it was the latter who were truer federalists.