As noted last time, the issuance of printed money by Pennsylvania was highly successful. It increased trade and greatly expanded the economy.
One person who noticed this was a young printer by the name of Benjamin Franklin. At the age of only 23, he wrote a treatise strongly advocating the benefits of printing paper money to increase the domestic money supply.
Franklin arrived in Philadelphia the year paper money was first issued by Pennsylvania (1723), and he soon became a keen observer of and commentator on colonial money…Franklin noted that after the legislature issued this paper money, internal trade, employment, new construction, and the number of inhabitants in the province all in-creased. This feet-on-the-ground observation, this scientific empiricism in Franklin’s nature, would have a profound effect on Franklin’s views on money throughout his life. He will repeat this youthful observation many times in his future writings on money.
Franklin had noted the effects that the chronic shortage of precious metal coins had on the local economy. Something needed to be done, he thought. Franklin, of course, being a printer by trade, felt that his printing presses might be the solution to this problem.
Franklin’s proposal–and this was key–was that paper money could not be backed by silver and gold; because the lack of silver and gold was what the paper money was designed to rectify in the first place!
Franklin also noted a point that critics of the gold standard have made ever since: the value of gold and silver is not stable, but fluctuates over time with supply and demand, just like everything else! Backing one’s currency by specie was no guarantee of stable prices or a stable money supply. As was seen in Europe, a sudden influx could send prices soaring, and a dearth would send prices crashing. As we’ll see, this was a major problem with precious metal standards throughout the nineteenth century—a point conspicuously ignored by goldbugs. Instead, he proposed a land bank, which, as we saw earlier, was a very popular idea at this time. Even though the colonies didn’t have sources of previous metals—and couldn’t mint them even if they did—they did have an abundant supply of real estate, far more than Europe, in fact. Land could be mortgaged, and the mortgages would act as backing for the new government-issued currency.
Economist (and Harry Potter character) Farley Grubb has written a definitive account of Franklin’s proposal:
Franklin begins his pamphlet by noting that a lack of money to transact trade within the province carries a heavy cost because the alternative to paper money is not gold and silver coins, which through trade have all been shipped off to England, but barter. Barter, in turn, increases the cost of local exchange and so lowers wages, employment, and immigration. Money scarcity also causes high local interest rates, which reduces investment and slows development. Paper money will solve these problems.
But what gives paper money its value? Here Franklin is clear throughout his career: It is not legal tender laws or fixed exchange rates between paper money and gold and silver coins but the quantity of paper money relative to the volume of internal trade within the colony that governs the value of paper money. An excess of paper money relative to the volume of internal trade causes it to lose value (depreciate). The early paper monies of New England and South Carolina had depreciated because the quantities were not properly controlled.
So will the quantity of paper money in Pennsylvania be properly controlled relative to the demands of internal trade within the province?
First, Franklin points out that gold and silver are of no permanent value and so paper monies linked to or backed by gold and silver, as with bank paper money in Europe, are of no permanent value. Everyone knew that over the previous 100 years the labor value of gold and silver had fallen because new discoveries had expanded supplies faster than demand. The spot value of gold and silver could fluctuate just like that of any other commodity and could be acutely affected by unexpected trade disruptions. Franklin observes in 1729 that “we [Pennsylvanians] have already parted with our silver and gold” in trade with England, and the difference between the value of paper money and that of silver is due to “the scarcity of the latter.”
Second, Franklin notes that land is a more certain and steady asset with which to back paper money. For a given colony, its supply will not fluctuate with trade as much as gold and silver do, nor will its supply be subject to long-run expansion as New World gold and silver had been. Finally, and most important, land cannot be exported from the province as gold and silver can. He then points out that Pennsylvania’s paper money will be backed by land; that is, it will be issued by the legislature through a loan office, and subjects will pledge their lands as collateral for loans of paper money.
Franklin argued that the amount of money circulating would be self-correcting. If too little was issued, he said, falling prices would motivate people to mortgage their land to get their hands on more bills. If too much money was circulating, its value would fall, and mortgagees would use the cheaper notes to buy back their land, thus retiring the notes from circulation and alleviating the oversupply.
Finally, Franklin argues that “coined land” or a properly run land bank will automatically stabilize the quantity of paper money issued — never too much and never too little to carry on the province’s internal trade. If there is too little paper money, the barter cost of trade will be high, and people will borrow more money on their landed security to reap the gains of the lowered costs that result when money is used to make transactions. A properly run land bank will never loan more paper money than the landed security available to back it, and so the value of paper money, through this limit on its quantity, will never fall below that of land.
If, by chance, too much paper money were issued relative to what was necessary to carry on internal trade such that the paper money started to lose its value, people would snap up this depreciated paper money to pay off their mortgaged lands in order to clear away the mort-gage lender’s legal claims to the land. So people could potentially sell the land to capture its real value. This process of paying paper money back into the government would reduce the quantity of paper money in circulation and so return paper money ’s value to its former level.
Automatic stabilization or a natural equilibrium of the amount of paper money within the province results from decentralized market competition within this monetary institutional setting. Fluctuations in the demand for money for internal trade are accommodated by a flexible internal money supply directly tuned to that demand. This in turn controls and stabilizes the value of money and the price level within the province.
Given that the United States was the major pioneer in the Western world for a successful paper fiat currency, it is ironic that we have become one of the centers for resistance to the very idea today. This in large part due to the bottomless funding by billionaire libertarian cranks to promote shaky economic ideas in the United States, such as Austrian Economics, whereas in the rest of the world common-sense prevails. Wild, paranoid conspiracy theories about money (and just about everything else) also circulate widely in the United States, much more widely than the rest of the developed world which has far better educational systems.
Returning to the gold standard is—bizarrely—appropriated by people LARPing the American Revolution today in tri-corner hats, proclaiming themselves as the only true “patriots”. Yet, as we’ve seen, the young United States was the world’s leading innovator in issuing paper money not backed by gold–i.e. fiat currency. And this led to its prosperity. Founding Father Benjamin Franklin was a major advocate of paper money not backed by gold. This is rather inconvenient for libertarians (as is most of actual history).
The young have always learned that Benjamin Franklin was the prophet of thrift and the exponent of scientific experiment. They have but rarely been told that he was the advocate of the use of the printing press for anything except the diffusion of knowledge. (Galbraith, p. 55)
That’s right, Ben Franklin was an advocate of “printing money.” Something to remember the next time a Libertarian glibly sneers at the concept. Later advocates of “hard money”, i.e. goldbugs like Andrew Jackson, would send the U.S. economy crashing to its knees in the early nineteenth century by returning to a gold standard.
Here’s Galbraith describing the theory behind paper money:
There is very little in economics that invokes the supernatural. But by one phenomenon many have been tempted. In looking at a rectangular piece of paper, on frequent occasion of indifferent quality, featuring a national hero or monument or carrying a classical design with overtones of Peter Paul Rubens, Jacques Louis David or a particularly well-stocked vegetable market and printed in green or brown ink, they have been assailed by the question: Why is anything intrinsically so valueless so obviously desirable? What, in contrast to a similar mass of fibres clipped from yesterday’s newspaper, gives it the power to command goods, enlist service, induce cupidity, promote avarice, invite to crime? Surely some magic is involved; certainly some metaphysical or extraterrestrial explanation of its value is required. The priestly reputation and tendency of people who make a profession of knowing about money have been noted. Partly it is because such people are thought to know why valueless paper has value.
The explanation is wholly secular; nor is magic involved.
Writers on money have regularly distinguished between three types of currency:
(1) that which owes its value, as do gold and silver, to an inherent desirability derived from well-established service to pride of possession, prestige of ownership, personal adornment, dinner service or dentistry;
(2) that which can be readily exchanged for something of such inherent desirability or which carries the promise, like the early Massachusetts Bay notes, of eventual exchange; and
(3) currency which is intrinsically worthless, carries no promise that it will be redeemed in anything useful or desirable and which is sustained, at most, by the fiat of the state that it be accepted.
In fact, all three versions are variations on a single theme.
John Stuart Mill…made the value of paper money dependent on its supply in relation to the supply of things available for purchase. Were the money gold or silver, there was little chance, the plethora of San Luis Potosí or Sutter’s Mill apart, for the amount to increase unduly. This inherent limit on supply was the security that, as money, it would be limited in amount and so retain its value.
And the same assurance of limited supply held for paper money that was fully convertible into gold and silver. As it held for paper that could not be converted into anything for so long as the supply of such paper was limited. It was the fact of scarcity, not the fact of intrinsic worthlessness, that was important. The problem of paper was that, in the absence of convertibility, there was nothing to restrict its supply. Thus it was vulnerable to the unlimited increase that would diminish or destroy its value.
The worthlessness of paper is a detail. Rock quarried at random from the earth’s surface and divided into units of a pound and upward would not serve very happily as currency. So great would be the potential supply that the weight of rock for even a minor transaction would be a burden. But rock quarried on the moon and moved to the earth, divided and with the chunks duly certified as to the weight and source, though geologically indistinguishable from the earthbound substance, would be a distinct possibility, at least for so long as the trips were few and the moon rock retained the requisite scarcity. pp. 62-64
NEXT: England and France get on the paper money train. England succeeds; France fails.