The Case For Gold
Dr. Ron Paul & Lewis Lehrman
II. A History of Money and Banking in the United States Before the 20th Century
As an outpost of Great Britain, colonial America of course used British pounds, pence, and shillings as its money. Great Britain was officially on a silver standard, with the shilling defined as equal to 86 pure Troy grains of silver, and with silver as so defined legal tender for all debts (i.e., creditors were compelled to accept silver at that rate). However, Britain also coined gold and maintained a bimetallic standard by fixing the gold guinea, weighing 129.4 grains of gold, as equal in value to a certain weight of silver. In that way, gold became, in effect, legal tender as well. Unfortunately, by establishing bimetallism, Britain became perpetually subject to the evils known as Gresham's Law, which states that when government compulsorily overvalues one money and under- values another, the undervalued money will leave the country or dis- appear into hoards, while the overvalued money will flood into circulation. Hence, the popular catchphrase of Gresham's Law: "Bad money drives out good." But the important point to note is that the triumph of "bad" money is the result, not of perverse free-market competition, but of government using the compulsory legal tender power to privilege one money above another.
In 17th-and 18th-century Britain, the government maintained a mint ratio between gold and silver that consistently overvalued gold and undervalued silver in relation to world market prices, with the resultant disappearance and outflow of full-bodied silver coins, and an influx of gold, and the maintenance in circulation of only eroded and "light- weight" silver coins. Attempts to rectify the fixed bimetallic ratios were always too little and too late.1
In the sparsely settled American colonies, money, as it always does, arose in the market as a useful and scarce commodity and began to serve as a general medium of exchange. Thus, beaver fur and wampum were used as money in the North for exchanges with the Indians, and fish and corn also served as money. Rice was used as money in South Carolina, and the most widespread use of commodity money was tobacco, which served as money in Virginia. The pound-of-tobacco was the currency unit in Virginia, with warehouse receipts in tobacco cir- culating as money backed 100 percent by the tobacco in the warehouse.
While commodity money continued to serve satisfactorily in rural areas, as the colonial economy grew, Americans imported gold and silver coins to serve as monetary media in urban centers and in foreign trade. English coins were imported, but so too were gold and silver coins from other European countries. Among the gold coins circulating in America were the French guinea, the Portuguese "joe," the Spanish doubloon, and Brazilian coins, while silver coins included French crowns and livres.
It is important to realize that gold and silver are international com- modities, and that therefore, when not prohibited by government decree, foreign coins are perfectly capable of serving as standard moneys. There is no need to have a national government monopolize the coinage, and indeed foreign gold and silver coins constituted much of the coinage in the United States until Congress outlawed the use of foreign coins in 1857. Thus, if a free market is allowed to prevail in a country, foreign coins will circulate naturally. Silver and gold coins will tend to be valued in proportion to their respective weights, and the ratio between silver and gold will be set by the market in accordance with their relative supply and demand.
By far the leading specie coin circulating in America was the Spanish silver dollar, defined as consisting of 387 grains of pure silver. The dollar was divided into "pieces of eight," or "bits," each consisting of one-eighth of a dollar. Spanish dollars came into the North American colonies through the lucrative trade with the West Indies. The Spanish silver dollar had been the world's outstanding coin since the early 16th century, and was spread partially by dint of the vast silver output of the Spanish colonies in Latin America. More important, however, was the fact that the Spanish dollar, from the 16th to the 19th century, was relatively the most stable and least debased coin in the Western world.
Since the Spanish silver dollar consisted of 387 grains, and the English shilling consisted of 86 grains of silver, this meant the natural, free- market ratio between the two coins would be 4 shillings 6 pence per dollar.3
Constant complaints, both by contemporaries and by some later historians, arose about an alleged "scarcity of money/' especially of specie, in the colonies, allegedly justifying numerous colonial paper money schemes to remedy that "shortage/7 In reality, there was no such shortage. It is true that England, in a mercantilist attempt to hoard specie, kept minting for its own prerogative and outlawed minting in the colonies; it also prohibited the export of English coin to America. But this did not keep specie from America, for, as we have seen, Americans were able to import Spanish and other foreign coin, includ- ing English, from other countries. Indeed, as we shall see, it was precisely paper money issues that led, by Gresham's Law, to outflows and disappearance of specie from the colonies.
In their own mercantilism, the colonial governments early tried to hoard their own specie by debasing their shilling standards in terms of Spanish dollars. Whereas their natural weights dictated a ratio of 4 shillings per 6 pence to the dollar, Massachusetts, in 1642, began a general colonial process of competitive debasement of shillings. Mas- sachusetts arbitrarily decreed that the Spanish dollar be valued at 5 shillings; the idea was to attract an inflow of Spanish silver dollars into that colony, and to subsidize Massachusetts exports by making their prices cheaper in terms of dollars. Soon, Connecticut and other colonies followed suit, each persistently upping the ante of debasement. The result was to increase the supply of nominal units of account by debas- ing the shilling, inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end. Finally, the English govern- ment brought a halt to this futile and inflationary practice in 1707.
But the colonial governments had already found another, and far more inflationary, arrow for their bow: the invention of government fiat paper money.
Government Paper Money
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 1690.4-5 Massachusetts was accustomed to launching plunder expeditions against the prosperous French colony in Quebec. Generally, the expeditions were successful, and would return to Bos- ton, 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. Dis- contented soldiers are ripe for mutiny, so the Massachusetts govern- ment looked around in concern for a way to pay the soldiers. It tried to borrow 3-4,000 pounds 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. 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. As early as February 1691, the Massachusetts government proclaimed that its issue had fallen "far short" and so it proceeded to emit £ 40,000 of new money to repay all of its outstanding debt, again pledging falsely that this would be the absolutely final note issue.
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, in a year after the initial issue, the new paper pound had depreciated on the market by 40 percent against specie.
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 five 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 disappear- ance 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. Thus, in 1690, before the orgy of paper issues began, £ 200,000 of silver money was available in New England; by 1711 however, with Connecticut and Rhode Island having followed suit in paper money issue, £ 240,000 of paper money had been issued in New England but the silver had almost disappeared from circulation.
Ironically, then, Massachusetts' and her sister colonies' issue of paper 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 govern- ment expenditures and pay public debts, the government, not the public, benefited from the fiat issue.
After Massachusetts had emitted another huge issue of £ 500,000 in 1711 to pay for another failed expedition against Quebec, not only was the remainder of the silver driven from circulation, but despite the legal tender law, the paper pound depreciated 30 percent against silver. Massachusetts pounds, officially seven shillings to the silver ounce, had now fallen on the market to nine shillings per ounce. 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.
Faced with a further "shortage of money" due to the money issues, 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.
Prices rose so dramatically that the tide of opinion in Massachusetts began to turn against paper, as writers pointed out that the result of the issues was a doubling of prices in the past 20 years, depreciation of paper, and the disappearance of Spanish silver through the operation of Gresham's Law. From then on, Massachusetts, pressured by the 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.