Banking and Monetary Policy

A Brief History of Money and Banking in America

U.S. Constitution Article I Section 8
The Congress shall have Power:

  • To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
  • To provide for the Punishment of counterfeiting the Securities and current Coin of the United States;

Article I Section 10
No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.

The first colonial experience with fiat money was in the period from 1690 to 1764. Massachusetts was the first to use it as a means of financing its military raids against the French colony in Quebec. The other colonies were quick to follow suit and, within a few years, were engaging in a virtual orgy of printing “bills of credit”. There was no central bank involved. The process was simple and direct, as was the reasoning behind it. As one colonial legislator explained it: “Do you think, gentleman, that I will consent to load my constituents with taxes when we can send to our printer and get a wagon load of money, one quire of which will pay for the whole?”1

The consequences of this enlightened statesmanship were classic. Prices skyrocketed, legal tender laws were enacted to force the colonists to accept the worthless paper, and the common man endured great personal losses and hardship.1 By the late 1750s, Connecticut had price inflated by 800%, the Carolinas had inflated 900%, Massachusetts 1000%, Rhode Island 2300%.2

The situation was so out of hand that, beginning in 1751, the British Parliament stepped in and, in one of those rare instances where interference from the mother country actually benefited the colonies, it forced them to cease the production of fiat money. Henceforth, the Bank of England would be the only source.1

What followed was unforeseen by the promoters of fiat money. Amid great gloom about “insufficient money”, a miracle boom of prosperity occurred. The forced use of fiat money had compelled everyone to hoard their real money and use the worthless paper instead. Now that the paper was in disgrace, the colonists began to use their English and French and Dutch gold coins once again, prices rapidly adjusted to reality, and commerce returned to a solid footing. It remained so even during the economic strain of the Seven-Years War (1756-1763) and during the period immediately prior to the Revolution. Here was a perfect example of how an economic system in distress can recover if government does not interfere with the healing process.1

During the Revolutionary War, a form of centralized banking was adopted when the Continental Congress issued “the Continental” in 1775. Because it was not backed by anything of value, the Continental depreciated so severely that it was virtually worthless by 1781. “Not worth a Continental” became a popular slang expression.3

The onset of the Revolutionary War was the compelling motive for the colonies to return to their printing presses. The following figures speak for themselves:

  • At the beginning of the war in 1775, the total money supply for the federated colonies stood at $12 million.
  • In June of that year, the Continental Congress issued another $2 million. Before the notes were printed, another $1 million was authorized.
  • By the end of the year, another $3 million.
  • $19 million in 1776.
  • $13 million in 1777.
  • $64 million in 1778.
  • $125 million in 1779.
  • A total of $227 million in five years on top of a base of $12 million is an increase of about 2000%.
  • On top of this “federal” money, the states were doing the same in an approximately equal amount.

The immediate result of this money infusion was the illusion of prosperity. After all, everyone had more money and that was perceived as a very good thing. But this was quickly followed by inflation as the self-destruct mechanism began to roll. In 1775, the colonial monetary unit, called the Continental, was valued at one-dollar in gold. In 1778, it was exchanged for 25-cents. By 1779, just four years from its issue, it was worth less than a penny and ceased to circulate as money at all. It was in that year that George Washington wrote: “A wagon-load of money will scarcely purchase a wagon-load of provisions”.

The true nature of the inflation effect has never been more accurately perceived or more vividly described than it was by Thomas Jefferson:
“It will be asked how will the two masses of Continental and of State money have cost the people of the United States seventy-two millions of dollars, when they are to be redeemed now with about six million? I answer that the difference, being sixty-six millions, has been lost on the paper bills separately by the successive holders of them. Every one, through whose hands a bill passed, lost on that bill what it lost in value during the time it was in his hands. This was a real tax on him; and in this way the people of the United States actually contributed those sixty-six millions of dollars during the war, and by a mode of taxation the most oppressive of all because the most unequal of all.”

At the end of the Revolutionary War the nation’s first central bank – the Bank of North America – was created, with defense contractor/congressman Robert Morris implanted as its president. Centralized banking might have been ruinous for the general public, but political insiders like Morris profited handsomely. The bank was given a monopoly license to issue paper currency, and it used most of its newly created money for loans to the central government. In so doing, it inflated its currency so rapidly that within one year the market lost all confidence in the bank and it was privatized.

Alexander Hamilton was the real founding father of central banking, as the Federal Reserve Board declares in one of its publications. His Bank of the United States (BUS), established in 1791 after a momentous debate between Hamilton and Jefferson over its constitutionality, was partly intended to finance “sudden emergencies” like war, in Hamilton’s own words. Hamilton’s Bank of the United States ran up 72 percent inflation in its first five years and created such economic instability that its 20-year charter was not renewed by Congress in 1811.

The BUS was resurrected in January 1817 and empowered to create a national paper currency, purchase public debt, and receive deposits of U.S. Treasury funds. The Second Bank of the United States “launched a spectacular inflation of money and credit,” writes Murray Rothbard in his History of Money and Banking in the United States, coupled with a great deal of fraud. It promptly created the “Panic of 1819,” the first real depression in American history. For the first time there was large-scale unemployment in cities such as Philadelphia, where employment in the manufacturing of handicrafts fell from 9,700 persons in 1815 to only 2,100 in 1819.

After nearly 20 years of inflation, fraud, political corruption, and boom-and-bust cycles caused by the Second Bank of the United States, President Andrew Jackson heroically vetoed the bill to recharter the Bank in 1834, and it went out of business. But the Hamiltonian nationalists did not. They would wage a political crusade for the next two decades as members of the Whig and Republican parties to inflict central banking on the nation once again.

They finally succeeded during the Lincoln administration with the Legal Tender Act of 1862, which empowered the secretary of the Treasury to issue paper “greenbacks” that were not redeemable in gold or silver. The National Currency Acts of 1863 and 1864 created a system of nationally chartered banks that could issue bank notes supplied to them by the new comptroller of the currency. The Acts also placed a 10 percent tax on competing state bank notes to drive them out of business and establish a federal monetary monopoly.

The predictable effect was massive inflation, with the greenback dollars so devalued that within one year they were worth only 35 cents in gold. All of the negative economic effects of inflation – devaluation of private wealth, unfair redistribution of income from creditors to debtors, and hindrance to rational economic calculation – damaged the Northern war effort, but not as much as that of the South. The North funded most of the war with public borrowing; the South funded most of its wartime expenditures by printing Confederate dollars. Consequently, inflation in the Confederacy averaged more than 2,200 percent per year.

The nationalization of the money supply created an engine of inflation – and a powerful lobbying force to advocate that it keep running. Northern manufacturers realized that during periods of inflation, domestic currency tends to depreciate faster than prices are rising. A falling dollar makes domestic goods cheaper and the price of imports higher. Henceforth, they became a powerful political force in favor of an even further centralization of banking. Meanwhile, the heavily indebted railroads realized that inflation cheapened their debts, so they allied with manufacturers as a permanent lobby for inflation.

These special interests joined the political coalition that created the Federal Reserve Board in 1913, which became an important source of finance for America’s disastrous participation in World War I four years later. The Fed did not just print greenbacks, as was the case during the Civil War. It printed enough money to purchase more than $4 billion in government bonds that were used to finance the war. The amount of money in circulation doubled between 1914 and 1920 – as did prices. This was an enormous hidden war tax on the American people: wealth was cut in half, along with real wages, and just about everything consumers purchased became more expensive.

The boom created by the Fed’s war financing inevitably caused a bust – the Depression of 1920, the first year of which was even worse than the first year of the Great Depression of the 1930s. Gross domestic product declined by 24 percent from 1920-21, while the number of unemployed Americans more than doubled, from 2.1 million to 4.9 million. The Great Depression of 1920 only lasted one year, however, thanks to President Warren Harding’s inspired policy of cutting both government spending and taxes dramatically.

In the wars that have followed, central-bank financing has inflicted essentially the same kind of damage on American society: inflation, economic chaos, reduced real wages, price controls and other government interventions, and ideological attacks on capitalism rather than the real culprit, the Fed.

1 G. Edward Griffin. The Creature from Jekyll Island. Westlake Village, CA: American Media
2 Ron Paul and Lewis Lehrman. The Case for Gold. Washington, D.C.: Cato Institute, 1982
3 Thomas DiLorenzo. Inflating War: Central banking and militarism are intimately linked

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