Paper money’s inauspicious start in the US
Many Americans assume the use of paper money in the North America didn’t begin until the 1770s, when the Continental Congress issued Continental currency in a desperate bid to finance the Revolutionary War.
However, nearly a century earlier the colonial government of Massachusetts became the first governing body in the western hemisphere to issue paper money, beginning in 1690.
Massachusetts, at that time an English colony, was accustomed to launching plunder expeditions against the prosperous French colony in Quebec.
“This time, however, the expedition was beaten back decisively, and the soldiers returned to Boston in ill humor, grumbling for their pay,” according to Rothbard. “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 late 1690 to print £7,000 in paper notes and to use them to pay the soldiers.
To quell concerns about accepting paper money in lieu of specie, the government said it would redeem the notes in gold or silver out of tax revenue in a few years and that absolutely no further paper notes would be issued.
Not surprisingly, 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, Rothbard stated.
“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 absolute final note issue,” he wrote.
If that weren’t bad enough, Massachusetts found that the increase in the supply of money, coupled with a fall in the demand for paper money because of growing lack of confidence in future redemption in specie, had led to a rapid depreciation of the new money.
Within a year after the initial issue, the new paper pound had depreciated on the market by 40 percent against silver coinage.
By 1692, the Massachusetts government tried to counteract this market phenomenon 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,” according to Rothbard. “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,” he added.
Prices rose as paper money depreciated in value. But not everyone was hurt by the impact of paper money on the colony. Since the paper was issued to finance government expenditures and pay public debts, the government benefited from the fiat issue.
Massachusetts churned out another huge issue of paper money in 1711, £500,000, to pay for another failed expedition against Quebec. The end result was to drive the remainder of the silver from circulation and further depreciate the paper pound against silver.
Depreciation proceeded in Massachusetts 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, Rothbard writes.
In addition, the notes were easy to counterfeit.
“Most colonial notes were poorly printed and anti-counterfeiting measures were generally notional, no more sophisticated than the motto on a New Jersey 30 shilling note that read ‘To counterfeit this bill is DEATH,’” according to a 2009 article in The Telegraph. “And with each colony issuing its own paper, counterfeiters in New York, for example, could produce fake Virginia notes – and if they passed at a discount as ‘foreign’ exchange, who cared?”
Faced with a further “shortage of money” due to the money issues, Massachusetts decided to press on. By 1716, it had 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 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,” according to Rothbard.
“From then on, 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,” he added.
In 1744, another losing expedition against the French led Massachusetts to issue an enormous amount of paper money over the next several years.
Between 1744 and 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, 10 times the price at the beginning of an era of paper money less than 60 years before.
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.
Similar consequences – dramatic inflation, shortage of specie and massive depreciation despite compulsory par laws – ensued in each colony.
In addition to Massachusetts’s depreciation of 11-to-1 of its notes against specie compared to original par, Connecticut’s notes had sunk to 9-to-1, the Carolinas’ were at 10-to-1 and the paper of Rhode Island had risen to 23-to-1 against specie by 1740.
Even the least-inflated paper, that of Pennsylvania, had suffered an appreciation rate of 80 percent over par.
(HT: Mises Economics Blog)