Thursday, March 29, 2012

Not Worth a Continental

In The Perils of Paper Money, I introduced David Wolman's article A Short History of American Money, From Fur to Fiat, which appeared in The Atlantic in early February.

In that essay, I explained briefly how money, once disconnected from any objective standard of value, has historically devalued over time. This is starkly illustrated by the story of the Continental Currency issued during the American Revolution. This tale, relegated to two brief paragraphs in The Atlantic article, is central to our understanding of the concept of money. It provides an important cautionary tale concerning our existing Federal Reserve System and the peril of money grounded in nothing but the full faith and credit of any government.

Starting in 1690 with the Province of Massachusetts Bay, the colonies issued Bills of Credit, usually not exchangeable for gold or silver, but accepted for payment of taxes, at which time the Bills would be retired. When they issued too many or failed to tax them out of circulation, inflation resulted. We'll let Wikipedia pick up the story for a bit.
This depreciation of colonial currency was harmful to creditors in Great Britain when colonists paid their debts with money that had lost value. Adam Smith criticized colonial bills of credit in his famed 1776 work The Wealth of Nations. According to Smith, the inflationary nature of the currency was a "violent injustice" to the creditor; "a scheme of fraudulent debtors to cheat their creditors." As a result, the British Parliament passed several Currency Acts to regulate the paper money issued by the colonies. The Currency Act of 1751 restricted the emission of paper money in New England. It allowed the existing bills to be used as legal tender for public debts (i.e. paying taxes), but disallowed their use for private debts (e.g. for paying merchants).
Naturally, the colonies were not happy about such restrictions. After much lobbying, Parliment relented and the printing presses started up again. Once the Revolutionary War began, the printing presses went into high gear. The Continental Congress began issuing paper money known as Continental Dollars, or Continentals. During the revolution, Congress issued almost a quarter-billion dollars worth of Continentals, while the states themselves also continued issuing "Bills of Credit." Congress and the states lacked the will or the means to retire the bills from circulation, either through taxation or the sale of bonds, so they continued to circulate in the economy. The British got into the act (this was war, remember) by counterfeiting Continentals on a large scale.

The end result was not pretty.
By the end of 1778, Continentals retained from 1/5 to 1/7 of their face value. By 1780, the bills were worth 1/40th of face value. Congress attempted to reform the currency by removing the old bills from circulation and issuing new ones, without success. By May 1781, Continentals had become so worthless that they ceased to circulate as money. [Ben] Franklin noted that the depreciation of the currency had, in effect, acted as a tax to pay for the war. In the 1790s, after the ratification of the United States Constitution, Continentals could be exchanged for treasury bonds at 1% of face value.
Note the bolded sentence. If there's one lesson that the government learned from this fiasco, it's right there in black and white. And it's a lesson they've never forgotten. It's worth noting that Ben Franklin's had argued for Bills of Credit in A Modest Enquiry into the Nature and Necessity of Paper Currency, published in 1729. His essay contained basically the same argument that established John Maynard Keynes as the darling of government two hundred years later. "If we need more money, we'll just print it, because it will get the economy humming again."

Let's look at what really happened during that time. The inflationary effect of printing money with no increase in real goods (wealth) to back it up meant that the real goods got more expensive when valued in pieces of paper. That's inflation; a deflation in the value of currency against other goods and services, although the politicians generally try to blame it on this or that producer "unfairly" raising prices. Nice try on their part, but inflation is simply an increase in the money supply, and it's generally done to pay for promises they can no longer afford to keep without a dose of new paper. Make more of anything faster than the growth rate of the economy, and it gets cheaper. Witness what's been happening in electronics for the last three decades. When it's real goods, like electronics, the economy thrives. When it's the medium of exchange itself, we have inflation.

Since the politicians got to call for the printing of all that new money and spend it on war supplies, they got the advantage of prices that were stable. But as people realized that there was more and more of the stuff, it became less valuable in their eyes. The forever fate of fiat money.

The rest, as they say, is history. Soon, the Continental Dollar was worth essentially the same as the German Mark in July 1924. Nothing. Here's another story worth reading. Note particularly the chart on the right-hand side. We'll see something similar shortly.

In summary, the Continental Dollar collapsed and damn near took the new nation with it. The painful experience of the runaway inflation and collapse of the Continental dollar prompted the delegates to the Constitutional Convention to severely limit both federal and state governments when it came to defining money.

Article 1, Section 8 of the Constitution includes two clauses pertaining to money on the federal level.
To borrow money on the credit of the United States;

To coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures;
Article 1, Section 10, Clause 1 deals with the states.
No State shall... coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts...
Both federal and state governments repeatedly tried to get around those restrictions, culminating with the Supreme Court ruling in 1871 that consigned those clauses and the lessons of the Continental Dollar to the dustbin of history.

In Knox v Lee, 79 U.S. 457 (1871), the Court ruled that paper money was not unconstitutional. First they reinterpreted the term "coin" to include the term "print," with the statement "The Constitution nowhere declares that nothing shall be money unless made of metal." The Court then condescendingly noted the arguments of the Framers against "emitting bills" and countered them by simply declaring that the Framers couldn't have anticipated all of government's needs, and anyway, the Constitution allowed the Congress to do what was necessary and proper to carry out its powers. The stage was set for a repeat of the Continental debacle.

In 1913, Congress under the Woodrow Wilson administration created the Federal Reserve Bank. Seven years later, the first Fed-fueled collapse occurred, but since nobody had figured out quite how to play the game yet, it was over in about a year.

Nine years after that, after pumping money into the economy recklessly and encouraging wild speculation in the stock market (dot-com bubble, anyone?) the whole thing went south in a big, big way. This time, though, government stepped in to fix things, passing one massive spending program after another, creating make-work jobs in an effort to get the economy running again. In 1933, FDR was so desperate he made it illegal for citizens to own gold and confiscated what they had, then devalued the worth of the dollar from 1/20th of an ounce of gold, to 1/35, by decree, in international trade. The average joe had lost almost half his purchasing power in the world market virtually overnight. The trend was already established. The government was spending the people's wealth faster than it could be covered up.

While WWII got the "GDP" humming again, with everyone involved in the war effort there was no way for the standard of living to increase. The money simply went to the war manufacturers for guns and bombs. Nobody had much to eat, but the numbers looked good. The Great Depression droned on until massive cuts in government spending and the release of twelve million troops into the economy in 1945. (Fun version)

It's eerily reminiscent of the period from 2009 'til now, when the numbers say we're not in a recession, but unemployment rates are persistently bad. This time around, the money went directly to the bankers through bailouts. They didn't need to create any make-work jobs to get it from the government into their hands. Nobody has much to eat, but the numbers look good.

In 1971, Nixon realized that FedGov could no longer afford both guns and butter in the amounts the politicians needed to get re-elected, so he removed us internationally from the gold standard, and the dollar was allowed to float against gold. Ben Franklin's lesson of inflation as a war tax went into full effect, fueling the last four decades of expanding Empire and free stuff for everyone.

Today, forty years later, the dollar is worth 1/1700 of an ounce of gold. It lost 98% of it's value in 40 years. And unless your investments, your income, and your home have outpaced that rate of depreciation, by increasing in dollar value faster than the dollar sank, you're poorer than you were in 1971, even if those items represent more dollars than they did then. The Continental Mark II is well under way.

This was way too long, so I'll wrap it up with a nifty chart that tells the story more concisely -- now that you know the rest of the story.


Today, a bag of pre-1971 silver coins with a face value of $1,000 sells for around $20,000 in irredeemable paper money. It’s just a stark reminder of what the statists have done with their unconstitutional, immoral, paper-money, Federal Reserve scheme.

Just remember the Continental the next time you notice that your dollar's not buying what it was just a few months ago.

...and that's all I have to say about that.
Author's Note: this is a very complex story told in short form, but the broad strokes are there. It's worthwhile to dig deeper into the story if you're so inclined. The Keynesians and Krugmanites will be happy to point out this minor detail or that minor detail that supposedly negates the whole story. Keep the broad strokes in mind, and you won't lose the big picture while they're nit-picking the color of the villains' eyes.

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