The United States Constitution does not mention paper
money by that name. Nor does it refer to paper currency or fiat money in those
words.[1] There is
only one direct reference to the origins of what we, and they, usually call
paper money. It is in the limitations on the power of the states in Article I,
Section 10. It reads, “No State shall . . . emit Bills of Credit . . . .” Paper
that was intended to circulate as money but was not redeemable in gold and
silver was technically described as bills of credit at that time. The description
was (and is) apt. Such paper is a device for expanding the credit of the
issuer. There is also an indirect reference to the practice in the same section
of the Constitution. It reads, “No State shall . . . make any Thing but gold
and silver Coin a Tender in Payment of Debts . . . .” Legal tender laws, in
practice, are an essential expedient for making unredeemable paper circulate as
money. Except for the one direct and one indirect reference to the origin and
means for circulating paper money, the Constitution is silent on the question.
With such scant references, then, it might be supposed
that the makers of the Constitution were only incidentally concerned with the
dangers of paper money. That was hardly the case. It loomed large in the
thinking of at least some of the men who were gathered at Philadelphia in 1787
at the Constitutional Convention. There were two great objects in the making of
a new constitution: one was to provide for a more energetic general government;
the other was to restrain the state governments. Moreover, the two objects had
a common motive at many points, i.e., to provide a stronger general government
which could restrain the states.
Measures to Prevent a Flood of Unbacked Paper Money
One of the prime reasons for restraining the state
governments was to prevent their flooding the country with unbacked paper
money. James Madison, one of the leaders at the convention, declared, in an
introduction to his notes on the deliberations there, that one of the defects
they were assembled to remedy was that “In the internal administration of the
States, a violation of contracts had become familiar, in the form of
depreciated paper made a legal tender . . .”[2] Edmund
Randolph, in the introductory remarks preceding the presentation of the
Virginia Plan to the convention, declared that when the Articles of
Confederation had been drawn “the havoc of paper-money had not been foreseen.”[3]
Indeed, as the convention held its sessions, or in the
months preceding it, state legislatures were under pressure to issue paper
money. Several had already yielded, or taken the initiative, in issuing the
unbacked paper. The situation was out of control in Rhode Island, and had been
for some time. Rhode Island refused to send delegates to the convention, and
the state’s reputation was so bad that the delegates there were apparently
satisfied to be spared the counsels of her citizens. Well after the convention
had got underway, a motion was made to send a letter to New Hampshire, whose
delegates were late, urging their attendance. John Rutledge of South Carolina
rose to oppose the motion, arguing that he “could see neither the necessity nor
propriety of such a measure. They are not unapprized of the meeting, and can
attend if they choose.” And, to clinch his argument, he proposed that “Rhode
Island might as well be urged to appoint & send deputies.”[4] No one rose
in defense of an undertaking of that character.
The ill repute of Rhode Island derived mainly from
that state’s unrestrained experiments with paper money. Rhode Island not only
issued paper money freely but also used harsh methods to try to make it
circulate. The “legislature passed an act declaring that anyone refusing to
take the money at face value would be fined £100 for a first offense and would
have to pay a similar fine and lose his rights as a citizen for a second.”[5] When the act
was challenged, a court declared that it was unconstitutional. Whereupon, the
legislature called the judges before it, interrogated them, and dismissed
several from office. The legislature was determined to have its paper
circulate.
The combination of abundant paper money and Draconian
measures to enforce its acceptance brought trade virtually to a halt in Rhode
Island. A major American constitutional historian described the situation this
way:
The condition of the state during these days was
deplorable indeed. The merchants shut their shops and joined the crowd in the
bar-rooms; men lounged in the streets or wandered aimlessly about . . . . A
French traveller who passed through Newport about this time gives a dismal
picture of the place: idle men standing with folded arms at the corners of the
streets; houses falling to ruins; miserable shops offering for sale nothing but
a few coarse stuffs . . . ; grass growing in the streets; windows stuffed with
rags; everything announcing misery, the triumph of paper money, and the
influence of bad government. The merchants had closed their stores rather than
take payment in paper; farmers from neighboring states did not care to bring
their produce . . . . Some . . . sought to starve the tradesmen into a proper
appreciation of the simple laws of finance by refusing to bring their produce
to market.[6]
But there was more behind the Founders’ fears of paper
money than contemporary doings in Rhode Island or general pressures for
monetary inflation. The country as a whole had only recently suffered the
searing aftermath of such an inflation. Much of the War for Independence had
been financed with paper money or, more precisely, bills of credit.
A Surge of Continentals
Even before independence had been declared the
Continental Congress began to emit bills of credit. These bills carried nothing
more than a vague promise that they would at some unspecified time in the
future be redeemed, possibly by the states. In effect, they were fiat money,
and were never redeemed. As more and more of this Continental currency was
issued, 1776-1779, it depreciated in value. This paper was joined by that of the
states which were, if anything, freer with their issues than the Congress. In
1777, Congress requested that the states cease to print paper money, but the
advice was ignored. They did as Congress did, not what it said.
At first, this surge of paper money brought on what
appeared to be a glow of prosperity. As one historian described it, “the
country was prosperous . . . . Paper money seemed to be the ‘poor man’s
friend’; to it were ascribed the full employment and the high price of farm
products that prevailed during the first years of the war. By 1778, for
example, the farmers of New Jersey were generally well off and rapidly getting
out of debt, and farms were selling for twice the price they had brought during
the period 1765-1775. Trade and commerce were likewise stimulated; despite the
curtailment of foreign trade, businessmen had never been so prosperous.”[7]
The pleasant glow did not last long, however. It was
tarnished first, of course, by the fact that the price of goods people bought
began to rise. (People generally enjoy the experience of prices for their goods
rising, but they take a contrary view of paying more for what they buy.) Then,
as now, some blamed the rise in prices on merchant profiteering.
As the money in circulation increased and expectations
of its being redeemed faded, a given amount of money bought less and less. This
set the stage for speculative buying, holding on to the goods for a while, and
making a large paper profit on them. There were sporadic efforts to control
prices as well as widespread efforts to enforce acceptance of the paper money
in payment for debts. These efforts, so far as they succeeded, succeeded in
causing shortages of goods, creditors to run from debtors trying to pay them in
the depreciated currency, and in the onset of suffering.
Runaway Inflation
By 1779, the inflation was nearing the runaway stage.
“In August 1778, a Continental paper dollar was valued (in terms of gold and
silver) at about twenty-five cents; by the end of 1779, it was worth a penny.”
“Our dollars pass for less this afternoon than they did this morning,” people
began to say.[8] George
Washington wrote in 1779 that “a wagon load of money will scarcely purchase a
wagon load of provisions.”[9] It was
widely recognized that the cause was the continuing and ever larger emissions
of paper money. Congress resolved to issue no more in 1779, but it was all to
no avail. Runaway inflation was at hand. In 1781, Congress no longer accepted
its own paper money in payment for debts, and the Continentals ceased to have
any value at all.
A good portion of the dangers of paper money had been
revealed, and reflective people were aware of what had happened. Josiah Quincy
wrote George Washington “that there never was a paper pound, a paper dollar, or
a paper promise of any kind, that ever yet obtained a general currency but by
force or fraud, generally by both.”[10] A
contemporary historian concluded that the “evils which resulted from the legal
tender of the depreciated bills of credit” extended much beyond the immediate assault
upon property. “The iniquity of the laws,” he said, “estranged the minds of
many of the citizens from the habits and love of justice . . . . Truth, honor,
and justice were swept away by the overflowing deluge of legal iniquity . . . ”[11]
But the economic consequences of the inflation did not
end with the demise of the Continental currency. Instead, it was followed by a
deflation, which was the inevitable result of the decrease in the money supply.
The deflation was not immediately so drastic as might be supposed. Gold and
silver coins generally replaced paper money in 1781. Many of these had been out
of circulation, in hiding, so long as they were threatened by tender law
requirements to exchange them on a par with the paper money. Once the threat
was removed, they circulated. The supply of those in hiding had been augmented
over the years by payments for goods by British troops. Large foreign loans,
particularly from the. French, increased the supply of hard money in the United
States in 1781 and 1782. A revived trade with the Spanish, French, and Dutch
brought in coins from many lands as well. In addition, Robert Morris’s Bank of
North America provided paper money redeemable in precious metals in the early
years of the decade.
The Impact of Depression
By the middle of the 1780s, however, the deflation was
having its impact as a depression. Trade had reopened with Britain, and
Americans still showed a distinct preference for British imports. That, plus
the fact that the market for American exports in the British West Indies was
still closed, resulted in a large imbalance in trade. Americans made up the
difference either by borrowing or shipping hard money to Britain. Prices fell
to reflect the declining money supply. Those who had gone into debt to buy land
at the inflated wartime prices were especially hard hit by the decline in the
prices of their produce. Foreclosures were widespread in 1785-1786. This
provided the setting for the demands for paper money and other measures to
relieve the pressure of the debts. Some people were clamoring for the hair of
the dog that had bit them in the first place—monetary inflation—and several
state legislatures had accommodated them.
Though there is evidence that the worst of the
depression was over by 1787, if not in the course of 1786,[12] paper money
issues and agitations for more were still ongoing when the Constitutional
Convention met in Philadelphia. In any case, those who had absorbed the lessons
of recent history were very much concerned to do something to restrain
governments from issuing paper money and forcing it into circulation. There
were those who met at Philadelphia, too, who took the long view of their task.
They hoped to erect a system that would endure, and to do that they wished to
guard against the kind of fiscal adventures that produced both unpleasant
economic consequences and political turmoil. Paper money was reckoned to be one
of these.
The question of granting power to emit bills of credit
came up for discussion twice in the convention. The first time was on August
16, 1787. (The convention had begun its deliberations on May 25, 1787, so it
was moving fairly rapidly toward the conclusion when the question arose.) The
question was whether or not the United States government should have power to
emit bills of credit. Congress had such a power under the Articles of
Confederation, and most of the powers held by Congress under the Articles were
introduced in the convention to be extended to the new government.
Constitutional Convention Debates
Gouverneur Morris of Pennsylvania “moved to strike out
‘and emit bills on the credit of the United States’.” That is, he proposed to
remove the authority for the United States to issue such paper money. “If the
United States had credit,” Morris said, “such bills would be unnecessary: if
they had not, unjust & useless.” His motion was seconded by Pierce Butler
of South Carolina.
James Madison wondered if it would “not be sufficient
to prohibit making them a tender? This
will remove the temptation to emit them with unjust views. And promissory notes
in that shape may in some emergencies be best.” (Madison’s distinction between
bills of credit that may be freely circulated and those whose acceptance is
forced by tender laws should remind us that paper instruments serving in some
fashion as money are not at the heart of the problem. After all, private bills
of exchange had for several centuries been used by tradesmen, and these
sometimes changed hands much as money does. They are what we call negotiable
instruments, and the variety of these is large. What Madison was getting at
more directly, however, was that governments, if they are to borrow money from
time to time, may issue notes, and these may be negotiable instruments which
may take on some of the character of money in exchanges. But Madison’s
objection was overcome, as we shall see.)
Gouverneur Morris then observed that “striking out the
words will leave room still for notes of a responsible minister
which will do all the good without the mischief. The Monied interest will
oppose the plan of Government, if paper emissions be not prohibited.”
However, Morris had moved beyond his motion, which was
for removing the power, not specifying a prohibition, and Nathaniel Gorham of
Massachusetts brought him back to the point. Gorham said he “was for striking
out, without inserting any prohibition. If the words stand they may suggest and
lead to the measure.”
Not everyone who spoke, however, favored removing the
power. George Mason of Virginia “had doubts on the subject. Congress he thought
would not have the power unless it were expressed. Though he had a mortal
hatred to paper money, yet as he could not foresee all emergences [sic], he was
unwilling to tie the hands of the Legislature. He observed that the late war
could not have been carried on, had such a prohibition existed.”
Nathaniel Gorham tried to reassure Mason and others
who might have similar doubts by declaring that “The power so far as it will be
necessary or safe, is involved in that of borrowing.”
Both Positions Argued
On the other hand, John Francis Mercer of Maryland
announced that he “was a friend to paper money, though in the present state
& temper in America, he should neither propose nor approve of such a
measure. He was consequently opposed to a prohibition of it altogether. It will
stamp suspicion on the Government to deny it a discretion on this point. It was
impolitic also to excite the opposition of all those who were friends to paper
money. The people of property would be sure to be on the side of the plan [the
Constitution], and it was impolitic to purchase their further attachment with
the loss of the opposite class of Citizens.”
Oliver Elsworth of Connecticut pronounced himself of
the opposite view. He “thought this a favorable moment to shut and bar the door
against paper money. The mischiefs of the various experiments which had been
made, were now fresh in the public mind and had excited the disgust of all the
respectable part of America. By withholding the power from the new Government
more friends of influence would be gained to it than by almost any thing else.
Paper money can in no case be necessary. Give the Government credit, and other
resources will offer. The power [to emit bills of credit] may do harm, never
good.”
Edmund Randolph of Virginia still had doubts, for he
said that “notwithstanding his antipathy to paper money, [he] could not agree
to strike out the words, as he could not foresee all the occasions which might
arise.”
James Wilson of Pennsylvania favored removing the
power: “It will have a most salutary influence on the credit of the United
States to remove the possibility of paper money. This expedient can never
succeed whilst its mischiefs are remembered, and as long as it can be re sorted
to, it will be a bar to other resources.”
Pierce Butler “remarked that paper was a legal tender
in no country in Europe. He was urgent for disarming the Government of such a
power.”
George Mason, however, “was still averse to tying the
hands of the Legislature altogether. If
there was no example in Europe as just remarked, it might be observed on the
other side, that there was none in which the Government was restrained on this
head.” His fellow delegates forebore to remind Mason that except for Britain
there was hardly a government in Europe that was restrained on that or any
other head by a written constitution.
In any case, the last remarks were made by men
vehemently opposed to the power. George Read of Delaware “thought the words, if
not struck out, would be as alarming as the mark of the Beast in Revelations.”
John Langdon of New Hampshire “had rather reject the whole plan [the
Constitution] than retain the three words,” by which he meant “and emit bills.”
Denying the Power to Emit Bills of Credit
The vote was overwhelmingly in favor of removing the
authority of the United States to emit bills of credit. The delegates voted by
states, and 9 states voted in favor of the motion while only 2 opposed it. (New
York delegates were not in attendance, and Rhode Island, of course, sent none.)
It is a reasonable inference from the discussion that the delegates believed
that by voting to strike out the words they had removed the power from the
government to emit bills of credit. George Mason, who opposed the motion,
admitted as much. Moreover, James Madison explained in a footnote that he voted
for it when he “became satisfied that striking out the words would not disable
the Government from the use of public notes as far as they could be safe &
proper; & would only cut off the pretext for a paper currency, and
particularly for making the bills a tender for public or private debts.”[13]
The other discussion of paper money took place in
connection with the powers to be denied to the states in the Constitution. The
committee report had called for the states to be prohibited to emit bills of
credit without the consent of the United States Congress. James Wilson and
Roger Sherman, who was from Connecticut, “moved to insert after the words ‘coin
money’ the words ‘nor emit bills of credit, nor make any thing but gold &
silver coin a tender in payment of debts’,” thus, as they said, “making these
prohibitions absolute, instead of making the measures allowable (as in the XIII
article) with the consent of the Legislature of the U.S.”
Nathaniel Gorham “thought the purpose would be as well
secured by the provision of article XIII which makes the consent of the General
Legislature necessary, and that in that mode, no opposition would be excited;
whereas an absolute prohibition of paper money would rouse the most desperate
opposition from its partizans.”
To the contrary, Roger Sherman “thought this a
favorable crisis for crushing paper money. If the consent of the Legislature
could authorise emissions of it, the friends of paper money, would make every
exertion to get into the Legislature in order to licence it.”[14]
Eight states voted for the absolution prohibition
against states issuing bills of credit. One voted against it, and the other
state whose delegation was present was divided. The prohibition, as voted,
became a part of the Constitution.
Paper Money Rejected
Three other points may be appropriate. The first has
to do with any argument that there might be an implied power for the United
States government to issue paper money since it is not specifically prohibited
in the Constitution. Alexander Hamilton, the man credited with advancing the
broad construction doctrine, maintained the opposite view in The Federalist. While he was making a case against
the adding of a bill of rights, his argument was meant to have general validity.
He declared that such prohibitions “are not only unnecessary in the proposed
Constitution but would even be dangerous. They would contain various exceptions
to powers which are not granted; and, on this very account, would afford a
colorable pretext to claim more than were granted. For why declare that things
shall not be done which there is no power to do.”[15] In short,
the government does not have all powers not prohibited but only those granted.
Second, this point was driven home by the 10th
Amendment when a Bill of Rights was added to the Constitution. It reads, “The
powers not delegated to the United States by the Constitution, nor prohibited
by it to the States, are reserved to the States respectively, or to the
people.” The power to emit bills of credit or issue paper money was not
delegated to the United States. More, it was specifically not delegated after
deliberating upon whether to or not. The power was prohibited to the states. The
logical conclusion is that such power as there may be to emit bills of credit
was reserved to the people in their private capacities.
And third, not one word has been added to or
subtracted from the Constitution since that time affecting the power of government
to emit bills of credit or issue paper money.
Since the United States is once again in the toils of
an ongoing monetary inflation, it is my hope that this summary review of the
experience, words, and deeds of the Founders might shed light on some of the
vexing questions surrounding it.
1. Actually, the
phrase, “fiat money,” did not come into use until the 1880s. It might have
helped the Founders to specify more precisely what they had in mind to prevent,
but they had no such term.
2. E. H. Scott,
ed., Journal of the Federal Convention Kept by James Madison (Chicago:
Albert, Scott and Co., 1893), p. 47.
4. Charles
E. Tansill, ed., Formation of the Union of the American States (Washington:
Government Printing Office, 1927), p. 306.
6. Andrew
C. McLaughlin, The Confederation and the Constitution (New
York: Collier Books, 1962), pp. 107-08.
9. Quoted
in Albert S. Bolles, The Financial History of the
United States, vol. I (New York: D. Appleton, 1896, 4th ed.),
p. 132.
13. All the
discussion and quotations can be found in Transill, op. cit., pp. 556-57. While there is no way to
know if the record of the debates on this and other matters is complete,
nothing has been omitted from Madison’s notes.
14. Ibid., pp. 627-38. The committee on style
eventually reduced the number of articles in the Constitution to seven, so
there is not now an Article XIII, of course.
15.
Alexander Hamilton, et. al., The Federalist Papers (New
Rochelle, N. Y.: Arlington House, n. d.), pp. 513-14.
The Integrity of the Coinage
. . . the whole aim and intent of State intervention
in the monetary sphere is simply to release individuals from the necessity of
testing the weight and fineness of the gold they receive, a task which can only
be undertaken by experts and which involves very elaborate precautionary
measures. The narrowness of the limits within which the weight and fineness of
the coins is legally allowed to vary at the time of minting, and the
establishment of a further limit to the permissible loss by wear of those in
circulation, is a much better means of securing the integrity of the coinage
than the use of scales and nitric acid on the part of all who have commercial
dealings. Again, the right of free coinage, one of the basic principles of
modern monetary law, is a protection in the opposite direction against the
emergence of a difference in value between the coined and uncoined metal. In
large-scale international trade, where differences that are negligible as far as
single coins are concerned have a cumulative importance, coins are valued, not
according to their number, but according to their weight; that is, they are
treated not as coins but as pieces of metal.
Ludwig von
Mises, The Theory of Money and Credi
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