We are continuing with History of Money and Banking in the United States by Murray Rothbard. The previous post covered the book until Government Paper Money section.
![History of Money in the United States [HOMIUS] - 1.1](https://substackcdn.com/image/fetch/$s_!N83K!,w_280,h_280,c_fill,f_webp,q_auto:good,fl_progressive:steep,g_auto/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2Fdfb8cf3e-3e54-452b-b347-d2da42d73fe9_800x421.jpeg)
Originally I wanted the first installment of the book club to cover the text up to The Jacksonian Movement and the Bank War section. Apparently, however, given my limited time and mental resources it would take me forever to cover that much ground. Therefore I decided to be less ambitious and present the book one section at a time. Today we are doing Government Paper Money from Part I.
I will quote directly the passages I found especially interesting, including my takes here and there. The emphasis is always mine, unless stated otherwise.
Apart from medieval China, which invented both paper and printing centuries before the West, the world had never seen government paper money until the colonial government of Massachusetts emitted a fiat paper issue in 1690. Massachusetts was accustomed to launching plunder expeditions against the prosperous French colony in Quebec. Generally, the expeditions were successful, and would return to Boston, sell their booty, and pay off the soldiers with the proceeds. This time, however, the expedition was beaten back decisively, and the soldiers returned to Boston in ill humor, grumbling for their pay. Discontented soldiers are ripe for mutiny, so the Massachusetts government looked around in concern for a way to pay the soldiers. It tried to borrow £3,000–£4,000 from Boston merchants, but evidently the Massachusetts credit rating was not the best. Finally, Massachusetts decided in December 1690 to print £7,000 in paper notes and to use them to pay the soldiers.
Note how war drives governments to fiat.
Suspecting that the public would not accept irredeemable paper, the government made a twofold pledge when it issued the notes: that it would redeem them in gold or silver out of tax revenue in a few years and that absolutely no further paper notes would be issued. Characteristically, however, both parts of the pledge went quickly by the board: The issue limit disappeared in a few months, and all the bills continued unredeemed for nearly 40 years.
Same thing keeps happening over and over again: at first paper is issued with a solemn promise of redemption in specie and "this will be the last time we do this cross my heart hope to die". Then the promise is broken. Compare to what happened in France during the Revolution.
But Massachusetts found that the increase in the supply of money, coupled with a fall in the demand for paper because of growing lack of confidence in future redemption in specie, led to a rapid depreciation of new money in relation to specie. Indeed, within a year after the initial issue, the new paper pound had depreciated on the market by 40 percent against specie.
Duh!
By 1692, the government moved against this market evaluation by use of force, making the paper money compulsory legal tender for all debts at par with specie, and by granting a premium of 5 percent on all payment of debts to the government made in paper notes. This legal tender law had the unwanted effect of Gresham’s Law: the disappearance of specie circulation in the colony. In addition, the expanding paper issues drove up prices and hampered exports from the colony. In this way, the specie “shortage” became the creature rather than the cause of the fiat paper issues.
Ironically, then, Massachusetts’s and her sister colonies’ issue of paper money created rather than solved any “scarcity of money.” The new paper drove out the old specie. The consequent driving up of prices and depreciation of paper scarcely relieved any alleged money scarcity among the public. But since the paper was issued to finance government expenditures and pay public debts, the government, not the public, benefited from the fiat issue.
Depreciation proceeded in this and other colonies despite fierce governmental attempts to outlaw it, backed by fines, imprisonment, and total confiscation of property for the high crime of not accepting the paper at par.
Massachusetts decided to press on; in 1716, it formed a government “land bank” and issued £100,000 in notes to be loaned on real estate in the various counties of the province.
Land banks will play a prominent role in 1740 and shortly thereafter. Those banks would issue notes secured by land (and some commodities.)1
Prices rose so dramatically that the tide of opinion in Massachusetts began to turn against paper.
Massachusetts, pressured by the British Crown, tried intermittently to reduce the bills in circulation and return to a specie currency, but was hampered by its assumed obligations to honor the paper notes at par of its sister New England colonies.
From 1744 to 1748, paper money in circulation expanded from £300,000 to £2.5 million, and the depreciation in Massachusetts was such that silver had risen on the market to 60 shillings an ounce, ten times the price at the beginning of an era of paper money in 1690.
By 1740, every colony but Virginia had followed suit in fiat paper money issues, and Virginia succumbed in the late 1750s in trying to finance part of the French and Indian War against the French.
Here we go again - war leads to fiat.
A detailed study of the effects of paper money in New Jersey shows how it created a boom-bust economy over the colonial period. When new paper money was injected into the economy, an inflationary boom would result, to be followed by a deflationary depression when the paper money supply contracted.
British merchants did not like to be forced to accept the depreciated paper currency from colonists for payment of debts. Hence the Parliament decided to act:
in 1748, Parliament began to pressure the colonies to retire the mass of paper money and return to a specie currency ... in 1764, Parliament extended the prohibition of new issues to the remainder of the colonies and required the gradual retirement of outstanding notes.
Following the lead of Parliament, the New England colonies, apart from Rhode Island, decided to resume specie payment and retire their paper notes rapidly at the current depreciated market rate. The panicky opponents of specie resumption and monetary contraction made the usual predictions in such a situation: that the result would be a virtual absence of money in New England and the consequent ruination of all trade. Instead, however, after a brief adjustment, the resumption and retirement led to a far more prosperous trade and production—the harder money and lower prices attracting an inflow of specie.
In fact, as one student of colonial Massachusetts has pointed out, the return to specie occasioned remarkably little dislocation, recession, or price deflation.
Not being outlawed by government decree, specie remained in circulation throughout the colonial period.
To end the section Rothbard quotes Roger Weiss2 how on balance 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"
For a favorable treatment of land banks see Billias, George Athan. Massachusetts Land Bankers of 1740. University of Maine, 1959.
Roger W. Weiss. The Colonial Monetary Standard of Massachusetts. Economic History Review 27 (November 1974): 591.