Brief History of Money in America
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1. Brief History of Money and Banking in the Colonies and the United States
(Sources: McCallum, Monetary Economics; Friedman and Schwartz, A Monetary History of the United States: 1867-1960)
1. Colonial America
1. Units of account in all thirteen colonies were British denominations of pounds, shillings, and pence.
1. 1 pound =20 shillings=12 pence
2. Prices quoted and contracts specified in these units
3. Originally 1 pound = 3.871 ounces of silver. Later these units meant different amounts both in practice and legally. Pennsylvania pound (and shilling) was worth 75% as much silver as Virginia pound (and shilling)
2. Development of different units of account arose from shortage of silver which was the primary medium of exchange in the
1. Trade deficit with England had to be financed, at British insistence, with silver (or gold).
2. British pursued mercantilist view that accumulation of silver and gold was desirable policy goal. To achieve this
various restrictions imposed on colonies.
1. Prohibitions on colonists' production of goods that would compete with English exports
2. Tobacco could only be sold to England
3. With fiat money standard shortage of money impossible over long run because prices fall. Not possible under silver standard because prices of goods in terms of silver must be about same everywhere in world.
4. In attempt to attract more silver, some colonies declared an ounce of silver to be worth more shillings in the colony than elsewhere.
1. For example, in Massachusetts by 1672 an ounce of silver was worth 331/3% more shillings than in England. Idea was that silver would flow into the colony since it could buy more of the local currency.
2. Effect was that a Massachusetts shilling had a different meaning than sterling (English) shilling. Prices, in terms of Massachusetts shilling, simply rose.
3. Similar outcome in other colonies.
3. Continued need for circulating media of exchange led to bills of credit issued by colonies.
1. Debt of colonial government-promise to repay in silver at a later date.
2. Transferable without endorsement
3. Convenient denominations
4. In most cases these were declared to be legal tender-by law debts could be settled with bills of credit.
5. Effectively these became colonial currencies, paper money. Value expressed in terms of the local currencies.
Example: in Pennsylvania they were valued in terms of Pennsylvania shilling.
6. Eventually these bills of credit displaced silver and silver no longer circulated in some of the colonies as the number of bills increased substantially.
2. Revolution to Civil War
1. Problem of financing revolution
1. Continental Congress had no power to levy taxes
2. Borrowed by issuing bills of credit
1. Continental Congress issued $191,500,000 in bills from 1775 to 1779. Dollar was colonists' term for spanish peso or piece of eight.
2. States issued another $250,000,000 in same period.
3. Issues by Continental Congress and states dramatically increased stock of money thus the price level.
4. Wholesale prices in Philadelphia,1850-59 = 100
1. In 1780 Congress stopped issuing bills and asked states to accept the bills in payment of taxes at rate of 40 paper dollars = one
silver dollar (Spanish peso). After 1783 these bills were to have no legal standing.
1. 1781-1787 monetary unit was dollar or Spanish peso which contained .871 ounces of silver. Gifts and loans from France and
Spain led to a large amount of silver coins in circulation.
2. Constitution adopted in 1787-gives Congress the sole right to coin money (Article 1, Section 8). States forbidden to coin money, issue bills of credit, or make anything but gold and silver coin legal for payment of debts. Purpose was to put U.S. on bimetallic standard.
1. Coinage Act of 1792
1. Defined dollar in terms of both gold and silver
1. $1=371.25 grains of silver or 24.75 grains of gold
2. Silver to gold ratio of 15:1
2. Free coinage of gold and silver. Either could be taken to mint and minted into coins without charge.
3. Both gold and silver meant to circulate as money.
4. In world, however, silver to gold price ratio was about 15.5:1 or 31:2. Silver was relatively less valuable in nonmonetary uses. Gresham's law-bad money drives out good. Indeed, gold disappeared from circulation so that U.S. was effectively on silver standard until 1834.
2. Coinage Act of 1834 reduced the silver to gold ratio to about 16:1.
1. Gold became the 'bad' money, it was overvalued.
2. Became profitable to coin gold and melt silver. Effectively U.S. on gold standard
3. Overvaluation of gold increased when California gold discoveries in 1849 reduced the world market price of gold further.
1. States not forbidden to charter banks
1. 3 state banks by 1791 and 88 by 1811.
2. Banks issued bank notes which were ostensibly claims to specie, i.e. gold or silver. Specie holdings were a fraction of note issue.
2. Congress chartered First Bank of United States in 1791, 20 year charter. No other national banks
1. Federalists led by Alexander Hamilton, Secretary of Treasury under Washington, supported
2. Anti-Federalists led by Thomas Jefferson opposed.
3. Engaged in typical commercial bank activities such as accepting deposits, issuing notes, and making loans.
4. Also acted as central bank, governments bank
1. Provided some clearinghouse functions
2. Fiscal agent of federal government
3. Pressured state banks to keep their notes convertible. One way it could do this was federal govt. accepted state bank notes in payment for taxes. It then turned these notes over to First Bank of U.S. for collection of specie from issuing state-chartered bank.
5. Charter expired in 1811 and not renewed.
3. Second Bank of the U.S. chartered in 1816 but its president, Nicholas Biddle, became embroiled in a political battle with President Andrew Jackson and its charter was not renewed when it expired in 1836.
4. After 1836 state bank-issued bank notes were major part of nation's circulating medium.
5. Free Banking period 1838-61.
1. Formerly banks could receive a charter to operate in a state only by an act of the state's legislature.
2. Beginning with Michigan and New York, laws passed in some states which allowed persons to open a bank and issue notes provided a required quantity of state and/or federal bonds were placed on deposit with the state's comptroller.
3. Generally, these banks were regulated. Some states had reserve requirements for example.
4. Convertibility of bank notes into specie was required by law in all cases. Severe penalties for violation.
Year, Specie in Bank Notes, Bank Money Stock, Circulation, Deposits:
1842 44.8 46.4 49.3 140.5
1847 75.3 112.3 93.0 280.6
1852 208.6 175.4 137.3 521.3
1856 299.3 129.8 166.6 578.0
1859 272.6 174.3 225.4 672.3
1. Note rapid growth in money supply as well as volatility of bank notes. Also note the large increase in specie circulation associated with gold discoveries in California. Table is from McCallum
2. Civil War to WWI
1. 1862-Legal Tender Act. To finance the Civil War Congress authorized the issuance of notes which came to be called greenbacks.
1. Non-interest bearing
2. Denominated in dollars rather than specie.
3. Legal tender
4. Presumed to be convertible into specie in the future, but not at present.
5. Fiat money
6. Additional issues in 1863 and 1864 so that total issue was $450 million.
7. Some other securities issued by the Treasury had status of legal tender.
1. National Banking
2. 1863 Comptroller of the Currency began to charter national banks. Beginning of national banking system we have today.
3. Way of providing loans to federal govt. Specifically, national bank had to hold $111.11 in government bonds for each $100 in bank notes issued. Govt. bonds paid interest so this was an attractive option for banks. Recall that specie did not pay interest.
4. bank notes required to be convertible into 'lawful' money, i.e. greenbacks.
5. Capital and reserve requirements of national banks more stringent than of most state banks so some banks chose to retain only state charter.
6. 1865-In attempt to get state banks to become federally chartered Congress imposed 10% tax on newly issued state bank notes.
7. Basically ended the issuing of state bank notes and they quickly disappeared from circulation. By 1867 there were $4 million in state bank notes and $292 million in national bank notes in circulation (Friedman and Schwartz, henceforth F&S)
8. Many state banks moved into national banking system.
9. Others stayed state banks, due to less onerous restrictions, providing checkable deposits in lieu of bank notes.
1.1865-Treasury began to retire greenbacks in an effort to reduce price level and return to gold standard with gold priced at $20.67 per ounce. Use WPI transparency. Note that the price level fell each year between 1865 and 1879 except for 1872. Generally price level declined between 1865 and 1897.
10.Resumption Act of 1875-provided for resumption of convertibility into gold beginning in 1879.
11.Falling price level was not popular with all groups. Felt that convertibility to gold would continue drop in prices. This hurt debtors many of whom were farmers and Southerners or Westerners. Unanticipated inflation would have helped these groups.
12.Greenback party got 14 people elected to Congress in 1878. Opposed resumption.
13.Free Silver campaign was important part of presidential races in 1896 and 1900 with William Jennings Bryan supporting.
14.Free Silver movement
15.1834-1872 Very little silver in circulation as money although silver dollar was legal tender.
16.Mint price of silver was $1.29/ounce
17.Market price of silver was above $1.32/ounce
18.Most people sold silver on market for nonmonetary uses rather than sell it to mint for coinage.
19.Coinage Act of 1873-Silver dollar containing 371.25 grains of silver was deleted from list of coins that mint was obliged to produce. At time this attracted little attention.
20.Expanding silver production and a switch from silver to gold coins by Germany caused an increase in the supply of silver on market, driving down market price below $1.29/ounce. Now it would have been more profitable to sell silver to mint, but they were not buying it due to deletion of silver dollar from list of minted coins.
21.If silver could have been sold to mint there would have been a much larger increase in the stock of money and prices would have either fallen less or risen thus benefiting debtors.
22.Free Silver movement wanted free and unlimited coinage of silver at $1.29/ounce.
23.Movement died due to:
1.Bryan's losses in presidential races
2.Gold Standard Act of 1900.
1.declared gold dollar to be monetary unit of country
24.Set up $150 million fund in Treasury for redeeming paper money.
25.Large increases in gold supply internationally caused increases in money supply after 1897.
26.1907 Bank Panic
29.Followed bank panics in 1873, 1884, 1893 leading most to conclude that reform of banking system was needed
30.National Monetary Commission set up to study banking system. Recommendations led to Federal Reserve Act of 1913
which established the Federal Reserve System the following year.
33.12 regional banks to decentralize power
34.Each regional bank had considerable autonomy
35.Fed required by law to hold gold reserves equal to 40 percent of its outstanding Federal Reserve Notes.
36.U.S. accumulated gold from 1914-16 in payment for supplies sold to other countries. U.S. entered war in 1914.
37.Gold accumulation led to increases in price level until 1920 when Fed reduced money supply to prevent losses of gold
38.Great Depression 1929-40.
39.Money supply fell almost 30 percent 1929-33
40.Bank suspensions-closed by supervisory authorities due to financial difficulties. Most never reopened.
Year, Bank Suspensions, Deposits (mil. of $)
1929 659 231
1930 1352 869
1931 2294 1691
1932 1456 725
1933 4004 3601
1934 61 37
1.Bank failures caused by bank runs
2.Depositors attempted to convert deposits (uninsured) to currency
3.Fractional reserves meant that bank ran out of currency before depositors repaid. Bank had to close.
4.Fed had tools to prevent bank panics, loans to banks. Prevention of bank panics was one of the main reasons Fed established. Fed failed to use these tools.
5.Banking holiday-FDR (newly elected) closed all banks in March 1933. Most reopened after a week.
1.Banking Act of 1933 established FDIC. All member banks of Fed required to insure deposits, others could.
7.Banking Act of 1935
8.established Federal Open Market Committee as part of Fed
9.Allowed Fed to vary reserve requirements
11.Private holders of gold required to sell gold to Treasury at $20.67/ounce and forbidden to hold gold (other than such uses as jewelry and coin collections)
12.Price of gold, effective Feb. 1, 1934, was set at $35/ounce. Treasury would buy from anyone at this price but it would only sell gold to monetary authorities of other countries. Lasted until 1972.
13.Economy slowly recovered with interruption in 1937-38 when real GNP fell. Some have attributed this fall in real GNP to the slowing of money supply growth caused by Fed increasing reserve requirements.
14.Eventually WWII completed the recovery from Great Depression.