Tuesday, March 25, 2008

The American Experience With Money

Money Matters brochure imageThe Beginnings... and Beyond

From the earliest times when commodities such as tobacco and beaver pelts were used as money, to the present when credit and debit cards are commonplace, money has always played a central role in the American experience.

Early in our history, our monetary system consisted of numerous foreign coins and paper currencies issued by the thirteen colonies and the Continental Congress. More than two hundred years later, we now have a single national currency and privately owned banks chartered by state and federal governments. Furthermore, a central bank, the Federal Reserve, has replaced gold as the regulator of the value of our money.

The evolution from a decentralized system to a more centralized system has been marked by controversy and slowed by a general suspicion of banking power. Each change has involved extensive legal debate focusing on the rights of state and federal governments and the freedom of the individual.

Another important dimension of our nation's economic development is the role of gold. Once a cornerstone of the financial system, gold has gradually but perceptibly become less important, both as a medium of exchange and as a regulator of the money supply. This process was driven by the nature of gold itself as well as by the changing needs of our modern and complex economy.

The Constitution and Money

The framers of the Constitution were apparently undecided about the form of financial system they should establish. Some preferred a centralized system with most of the power residing in the federal government. These framers wanted a national currency and a single federally chartered bank with branches throughout the country.

Others involved in developing the Constitution envisioned a decentralized financial system with principal authority resting in the states. They preferred that each state charter its own banks, and each bank issue its own bank notes-that is, its own paper currency. There would be no uniform national currency and no central bank.

After long debate, the framers of the Constitution permitted the federal government "to coin money, (and) regulate the value thereof and of foreign coins . . ." They also declared that "no state shall . . . coin money, [nor] emit bills of credit [i.e., paper currency] . . . " Significantly, no mention was made of a national currency nor federally chartered banks.

The Constitution specified little involvement for the federal government in our financial system. Congress was expressly permitted only the right to mint metal coins, regulate the percentage of precious metal in those coins, and determine the metallic content of the many kinds of foreign coins that circulated throughout the states. In other words, Congress' involvement in the financial system focused on the intrinsic value of coins, which was determined by the amount of precious metal in the coin.

Fear of Paper

Many of the framers of the Constitution opposed paper money largely because of their experience during the Revolutionary War. In 1775 the Continental Congress faced the problem of fighting a war without the means to pay for it. The British blockade of our ports limited trade, reducing revenues from tariffs, and European nations were reluctant to lend us money. Left with little alternative, the Continental Congress authorized $2 million of Continental currency. This was the first of many issuances. In total, between 1775 and the adoption of the Constitution in 1787, Congress authorized the printing of about $242 million in "Continentals."

$5 Continental bill

This $5 Continental bill was worth only 5 cents when it was redeemed in 1790.

Congress promised to pay the holders of the currency the face value of the bills in gold or silver or in Spanish coins, widely circulated at the time. However, Congress did not have enough gold or silver to make payment. In reality, there was no "backing" for the Continentals; that is, there was no mechanism, except the authority of the Continental Congress, to fix the value of Continentals or to limit the amount that could be issued. As a result, Congress issued more Continentals than the economy could handle without inflation.

The colonies experienced a rapid increase in inflation as the government printed money without restraint. The resulting oversupply of money undermined the purchasing power, and therefore value, of the Continentals.

To support the faltering currency, Congress declared that any person convicted of refusing Continentals at face value was an enemy of the country and should be "precluded from all trade . . . with the inhabitants of these colonies."

Despite such efforts to maintain the Continental's value, people paying in these notes were charged more than people paying with foreign coin of gold and silver. In other words, Continentals were discounted.

Although the printing of Continentals was an emergency measure that helped to win the war, this episode illustrated the perils of issuing too much currency.

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