Conceived in Liberty (117 page)

Creation of paper or bank money (“inflation”), therefore, confers a special privilege on some groups, at the expense of the producers and at the expense of the society’s money. The groups that benefit include the first issuers and receivers of the new money, those who sell to them, and generally those whose selling prices rise because of the inflation before a rise in the prices of the goods they have to buy. These groups gain by imposing losses on those to whom the new money is the last to trickle down, that is, those whose buying prices rise before the prices of the goods or services they have to sell. Debtors always gain from the rise in prices caused by inflation; they can then pay back their loans in money of lower purchasing power than they had borrowed. Furthermore, if the new money is loaned out by government or banks, debtors may benefit from the artificially low interest rate on the loan. Creditors, conversely, are always among the groups injured by inflation, for they receive the inferior money, and interest return on further loans is artifically lowered if the new issue appears on the loan market. Landowners generally benefit from inflation. Land prices usually rise more rapidly than most other prices, and lowered interest rates have a particularly strong impact in raising the values of an extremely durable good such as land. Since landlords, especially speculative landlords, are often debtors as well, they have a multiple incentive for favoring inflation. Land speculators who borrow to invest in large tracts of virgin land have particularly gravitated toward the vanguard of the advocates of inflation.

American historians, recognizing the interests of debtors in promoting inflation as a subsidy for themselves, have generally made a grievous error in applying this insight to the American past. They have assumed that debtors and creditors are fixed, identifiable classes and that debtors have consisted of poor farmers, and creditors of wealthy urban merchants. The fallacies in this disastrous typology are numerous.
Debtor
and
creditor
refer not to fixed occupational categories. A man is not born into the status of debtor or creditor, and anyone may shift continually from one category to the other—or to neither one. Farmers may be in debt or out of it, and may even be creditors. Merchants are notoriously creditors and debtors both—and they may shift at any time from a net-creditor to a net-debtor position, or vice versa. And debtors are not necessarily poor. Indeed, it is precisely the wealthy who generally go most heavily into debt. After all, poor people generally do not possess a very good credit rating, and therefore are not often able to borrow even if they want to. Landowners are often debtors, but they may more likely be wealthy land speculators than dirt farmers.

As befitted their undeveloped economies, the American colonies during the seventeenth century largely relied for their money on their staple and hence their most widely marketable commodities; for example, tobacco in the Chesapeake Bay colonies, rice in South Carolina, poultry and corn and other grain in the North, and wampum in trade with the Indians. There has been much lamenting among historians about the “scarcity of money” in the colonies, reflected in the various commodity monies, and imposed by the Crown’s prohibition on either colonial mints or the import of coin from England. The supply of commodity monies was, in the first place, appropriate for the low level of economic development and the limited scope of especially the internal economy of the colonies. Second, while lack of a mint was inconvenient, it was not important, for gold and silver, bullion or coin, could be bought (imported) at any time they were deemed necessary. And so they were; neither did the colonies suffer irretrievably from the imposed lack of English coin. By the late seventeenth century, abundant Spanish silver coin and Brazilian gold coin existed in the colonies, coin that was used in urban centers and in foreign trade, where wampum and the other commodities were not highly welcome as
money.
Commodity money flourished within the rural districts, where indeed much trade was carried on by simple barter without even a commodity intermediary of exchange.

While mercantilist fallacy and hoarding of specie led England to keep its specie out of the colonies, Americans continued to keep their accounts in English units. The English shilling consisted of eighty-six grains of silver, while the most popular coin in the colonies, the Spanish piece of eight, or dollar, obtained from the West Indies trade, weighed 387 silver grains. Hence, rationally, by their silver content, one pound sterling exchanged for $4.44, and one dollar exchanged for four shillings six pence of English money.

But the colonies too were prisoners of mercantilist fallacies and were also concerned to force specie to remain in the colony (that is, to force it not to be used to its best advantage in importing goods). Consequently, they decided to juggle the standards of weight of money, and debased the money. The process began as early as 1642, when the government of Massachusetts arbitrarily decreed that the Spanish dollar be valued at five shillings. Connecticut followed a year later. This meant that the Massachusetts and Connecticut shillings, as the units of account, were now arbitrarily devalued in terms of dollars. The aim of this juggling was to attract dollars into the colony; if a silver coin could be worth five shillings instead of four and a half, then coins would be attracted into the place where they were valued more highly. In short, debasement of the unit of account, as in all currency devaluations, amounted to an artificial lowering of Massachusetts and Connecticut prices in terms of dollars, so that exports from these colonies received in mercantilist fashion an artificial subsidy. If exports were encouraged by the debasement, imports from abroad were similarly discouraged and this could only injure the colonial consumers dependent on foreign goods. This sort of artificial stimulus and
burden could only be temporary, however. Soon domestic prices, stimulated by the increased demand, would increase proportionately to the fall in value and the exporters’ windfall would then be over.

As soon as one colony began the process of debasement, others followed, to avoid specie flowing elsewhere. Soon, indeed, the colonies began to engage in a disastrous competitive debasement, continually spurred to greater heights by the catching up of domestic prices—by the wearing off, in short, of the narcotizing dose.

The process, as we can see, was ruinously inflationary. The supply of money increased, to be sure, not through an increase of paper tickets or claims to money but by artificially increasing the nominal units of money in terms of actual money. In 1645 Virginia raised the value of the dollar to six shillings, and from 1671 to 1697, nine colonies advanced the dollar and—to make the matters more confusing—at varying rates. The general level was six shillings to the dollar. But New York advanced the dollar to six shillings nine pence and Pennsylvania and West New Jersey to seven shillings six pence. Virginia and Maryland had an additional incentive for debasement of the shilling: many of their planter oligarchs were in debt to English merchants and they were eager to repay shilling debts in appreciated dollars. But for similar reasons the English creditors were determined that these colonies not devalue; so Virginia and Maryland were restricted in further debasement, Virginia being forced to lower its valuation to five shillings. The result was that the tobacco colonies soon lagged behind the others and coin began to drain from there to Boston, Philadelphia, and New York. This meant, however, that Southern planters began to buy their supplies from the Northern merchants artificially favored by debasement rather than from the English merchants.

England finally decided to stop the competitive debasement and to insist on a uniform evaluation of money throughout the colonies. The English decree was, in fact, not only overdue but also excessively lenient. In 1704 the Crown proclaimed six shillings as the maximum value of Spanish dollars, thus allowing a one-third rise from the real free market value of four shillings six pence. The proclamation had no provision for enforcement, however, and so the Northern colonies and South Carolina continued to stamp a higher value on the dollar than did Virginia and Maryland. Consequently, Parliament enacted the proclamation into law in 1707 with penalties for violations.

The colonies soon found another way to juggle monetary standards fraudulently and at the same time evade the regulations. Forced to assign a certain shilling value to Spanish dollars, the colonies turned to arbitrary changes in the value of silver itself. The true sterling value of silver, gauged by the silver content of English money, was five shillings two pence per ounce of silver. At the depreciation of silver set by Parliament’s maximum of six shillings to the dollar, an ounce of silver was worth six shillings ten pence. But the colonies now began to raise the shilling value of silver, generally to eight shillings per ounce or even higher. When England properly protested this patently crude
violation of the law, the Assemblies of Massachusetts and New York refused to appropriate money for the government, except at their own proclaimed higher rates, and thus won their way. Neither did the other colonies bother to obey the law, with the exception of Maryland and Virginia, where the maximum continued to be rigorously enforced. Indeed, Virginia set silver even
lower
than the proclaimed maximum at five shillings two pence per ounce.

Jealous of the royal sovereignty and its alleged right to monopolize the mint, the Crown forbade mints in the colonies. During the Republican era, however, Massachusetts, alone of the colonies, established a mint in 1652. The mint was leased by Massachusetts to John Hull, who was allowed a fixed rate of seigniorage on each coin. In minting “pine tree” shillings, Massachusetts propelled the debasement process, coining the shilling at seventy-two grains instead of the full weight of eighty-six. This amounted to an evaluation of six shillings to the dollar. The existence of the mint was one of the Crown’s grievances against the recalcitrant Bay Colony, and in 1684 it forced the Massachusetts mint to close down.

The colonies, including Massachusetts, vainly attempted to thwart economic law by barring the export of specie, but they could not succeed even with extraordinary powers of search and such penalties as outright confiscation of estates.

It soon began to dawn on the colonists that there was a far easier way to inflate the money supply, and to a far greater extent, than by juggling the standards of weight or value of money: the creation of money out of mere paper. In 1641 the English mercantilist Henry Robinson hailed the Italian banks, able to inflate banknotes beyond the stock of specie. Nine years later, William Potter in the
Key of Wealth
argued with consistent logic that if an increase of money is beneficial, a perpetual increase would be still better. The creator of numerous such schemes, Potter would have his notes “secured” by the nation’s land. Potter failed to see that the price of land increases, along with other assets, in an inflation, so that land would hardly check a paper inflation. He also failed to see the essence of bank money and its value as a claim to standard money.

A “loan bank” to issue vast quantities of new money, particularly a “land bank” to lend on landed security, naturally enchanted leaders in New England. In 1663, Governor John Winthrop, Jr., of Connecticut urged land banking upon his fellow members of the English Royal Society. Taking the lead in proposing a land bank was the influential Reverend John Woodbridge of Newbury, Massachusetts. Woodbridge, directly inspired by Potter, proposed a bank that would issue and lend notes. Woodbridge tried the scheme abortively in 1671 and 1681, and then set forth his views in trying to organize a “fund” bank in 1682. Increased money, wrote the reverend in a nutshell, “multiplies trading; increaseth manufacture and provisions; for domestic use, and foreign return; abateth interest.”

The first land-bank proposal with a good chance of being established came
in Massachusetts in 1686. It is also a particularly instructive example of the kinds of forces behind the inflationist proposals. The originators of the scheme were emphatically
not
poor debtor-farmers. On the contrary, they were precisely the ruling oligarchy of Massachusetts.

The year 1686 saw Massachusetts ruled by Joseph Dudley and his associates in plunder. On assuming office, Dudley and his Council appointed a committee of leading merchants and other citizens to study trade conditions. The committee, led by Captain John Blackwell, reported with a proposal for a bank whose notes would be forced on the people as legal tender. The plan was to include all the leading oligarchs of the Dudley era in the directorship of the bank: Dudley himself, William Stoughton, Wait Winthrop, Simon Lynde, Elisha Hutchinson, Elisha Cooke, and others. No notes were to be issued below twenty shillings in denomination, to ensure that the bank would be largely limited to the wealthiest citizens. The bank was to have no specie capital whatever, though individual directors were to bear responsibility. The plan was abandoned with the arrival of Andros. The Glorious Revolution, in 1688, inspired new talk of the Blackwell bank, but again the proposal fell through.

Paper money finally came to Massachusetts not in the form of a land bank’s notes, but as the first issue of government paper money in the world, apart from medieval China.
*
Paper money can be issued either by government for direct spending, or by a bank, public or private, that lends out money to the public. While the former is cruder and more flagrant, it actually has less harmful repercussions on the economy. For, given the same amount of monetary issue, lending out the new money inflicts additional distortion on the loan market and interest rates, which fact generates the familiar features of the boom-bust trade cycle.
**

The fateful plunge of Massachusetts into paper money came through direct spending rather than lending. Massachusetts had engaged in an expedition of plunder against French Quebec, an expedition it hoped would more than pay for itself. But as luck would have it, the expedition failed ignominiously, and Massachusetts was faced with the grave problem of paying the salaries of its soldiers who were on the edge of mutiny. The Massachusetts government tried to borrow from three to four thousand pounds from Boston merchants, but evidently its credit rating was far too low. Proceeding upon the principle that if it could not raise money it must print its own, Massachusetts decided in December 1690 to issue 7,000 pounds in paper notes. Now the government knew that it could not simply print paper irredeemable in specie labeled
pounds; for then no one would have accepted the money. The market value of the money would then have plummeted sharply in relation to dollars or sterling. Massachusetts therefore made a twofold pledge as it issued the notes. It promised to redeem the notes in specie out of revenue in a few years and it pledged to issue no further bills. In fact, the bills continued in use for almost forty years and the pledge limit evaporated in a few months. The heady attraction of printing one’s own money is always enough to overcome initially timid limits. As early as February 1691, Massachusetts acknowledged that the emission “fell far short,” and so it proceeded to issue 40,000 pounds of new money to repay all of the colony’s debts, again pledging this issue to be the final limit.