The Origin of Paper Money 8

US one dollar bill, obverse, series 2009.jpgThis is sort an afterward or corollary to our story of paper money. This describes how we here in the United States ended up with the “Almighty Dollar.” Believe it or not, this was not present after the Revolution, but took a very long time to materialize.

The history of central banking in the U.S. is too much to get into here, but this post from the Minneapolis Fed sums it up probably better than I could: A History of Central Banking in the United States. It’s actually a good summary and a quick read. The WEA Pedagogy blog cited earlier has come out with a second post on the development of central banking in Europe in the nineteenth century: Central Bank History (2/5) 1814-1914 Hundred Years Peace

Believe it or not, at this time, aside from minted coins, there was no national paper currency in the United States. Not only that, but state governments were actually prohibited from issuing their own currency! Instead, as in other Western nations, the government permitted people to use whatever they wanted as currency. Only private banks issued banknotes:

Before the Civil War, the United States was on a bimetallic system with both gold and silver serving as the basis for money. Practically, however, gold was the de facto standard since very little silver coin was in circulation. American currency consisted of bank notes and coin, with the bank notes convertible on demand into specie: paper money was thus “backed” by gold.

The federal government issued no paper currency of its own and there were no federally chartered banks; state banks issued thier own bank notes. Thus in the 1850s the domestic monetary system was comprised of may hundreds of different state banks, each issuing its own paper currency.

This was problematic since the value of a bank note (as opposed to its face value) depended on the financial status of the issuing bank, and, with so many different banks, it was hard to know what money was worth.

Furthermore, there were no deposit insurance programs and no central bank. In contrast to the state banking system, the international gold standard served the United States well since its biggest trading partner and creditor, Great Britain, was also on the gold standard.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

In this era, banking was regulated by the states. Despite their importance to the financial system, pretty much anyone could start a bank and issue their own banknotes; all they needed was sufficient startup capital. This was called “free” banking by its proponents, but it acquired another less complimentary nickname: wildcat banking

By action of the state legislatures a bank was held to be not a corporation, which then and for many more years required a charter from the state, but a voluntary association of individuals and thus, like blacksmithing or rope-making, open to anyone. There were rules, most notably as to the hard-money reserves to be held against notes and deposits…But frequently failure to abide by regulations was discovered only after the failure of the bank made the question academic… (Galbraith, p. 88)

Although banks were required to held enough gold reserves to be albe to redeem their banknotes in specie on demand, often that could be circumvented by moving a set amount of gold around the state ahead of the regulators, as in Michigan:

…[I]n Michigan…commissioners were put in circulation to inspect the banks and enforce the requirement [of 30 per cent reserve of gold and silver against note circulation]…Also put in circulation just in advance of the commissioners, was the gold and silver that served as the reserve. This was moved in boxes from bank to bank; when required, the amount was extended by putting a ballast of lead, broken glass and (appropriately) ten-penny nails in the box under a thinner covering of gold coins. p. 88

The results, as one might expect, were not good:

by the time of the Civil War, the American monetary system was, without rival, the most confusing in the long history of commerce and associated cupidity. The coins coming to the Amsterdam bourse were simplicity itself by comparison.

An estimated 7000 different banks notes were, in greater or lesser degree of circulation, the issue of some 1600 different or defunct state banks.

Also, since paper and printing were cheap and the right of note issue was defended as a human right, individuals had gone into the business on their own behalf. An estimated 5000 counterfeit issues were currently in circulation.

No one could do any considerable business without an up-to-date guide that distinguished the wholesome notes from the less good, the orphaned and the bad. A Bank Note Reporter or Counterfeit Detector was essential literature in any significant business enterprise. (Galbraith, p. 90)

It was not a recipe for financial stability, to put it mildly. NPR’s Planet Money describes the situation on the ground during the pre-war era of wildcat banking:

So I’m looking at the Howard Banking Company’s $5 bank note. It’s…a Santa Claus note…You get a picture, I think, of the bank president up in the left-hand corner. And then right in the middle, you get a picture of Santa Claus on a sleigh.

So what basically this note will do is that if you have this note, Santa Claus and all, you’ll go to the Howard Banking Company. And they are obligated to pay you $5 in gold and silver coins if you demand it at their bank.

If you demand it at their bank, but nobody else outside that bank is required to give you gold or silver for the note or, for that matter, even to accept it at all. Sometimes people might choose to take the bill at full face value. Sometimes they might not want it. Sometimes they’ll say, yeah, I’ll accept it but it’s a $5 bill. I’ll give you $4 for it. A dollar bill was not always worth a dollar in this world.

Now, you could argue – and some people do – that this universe of 8,000 different kinds of currency is the free market at work and that this market for bank notes helped keep banks honest. But this world, it did create huge problems for people…

The Birth Of The Dollar Bill (NPR)

What kind of problems did it create?

What if you run a store? What if you run that bar in New York and some guy walks in and gives you some bill that you’ve never seen before? What do you do? Well, that’s when you take out your trusty bank note reporter, this huge book the size of a phone book. This thing, it tells you what bills are in circulation, what they’re supposed to look like and how much they might be worth.

You would take out this big…encyclopedia-looking thing…You’d look in this. You’d find the Howard Banking Company list. It would then tell you where the bank was. And then it would tell you at what discount the note was to be accepted at.

So, for instance, if this was a particularly good bank, $5 note would trade at $5. You, as a bartender, would accept it at that. If it was trading at a discount, it would also say that. If the bank had defaulted, you’d know that. And you’d know that it’s worthless and not to accept it.

And these books, new ones come out every month to keep up with the news. And you have a different book for every city. This is because a bill from, say, a Boston bank might be worth $5 in Boston but only $4 in New York. Usually, the further you get from a bank, the less its money is worth. People’s money loses value just because they’re traveling.

The Birth Of The Dollar Bill (NPR)

In fact, it could be argued that entire monetary history of the United States after the 1830’s was one long clusterfuck. Although the United States would accidentally create, for the first time, a true national paper currency due to the financing needs of the Civil War, it would undermine those innovations after the war by trying to go back on the gold standard. The use of a bimetallic (gold & silver) standard was a sort of compromise  position between gold and fiat. But back then endless debates about the true nature of money (much like today) had no clear resolution:

In the accepted, and it must be added, far from the inspired view of the monetary history of the United States, the years after 1832 were deplorable. Free banking, the resulting bank failures, then greenbacks, agitation for more greenbacks and the pressure, partly successful, for the coinage of cheap silver combined with the recurrent panics to make the financial system of the United States, as Andrew Carnegie held, ‘the worst in the civilized world.’ (Galbraith p. 85)

Greenbacks and National Banks

What brought this madness to an end was, once again, war–this time the United States Civil War. The northern and southern United States split into two separate nations who immediately went to war with each other for control of the North American continent, especially its western expansion.

The industrialized Union needed to raise funds to prosecute its war against the predominantly agrarian Confederacy. because the Confederacy was the source of nearly all the cotton for a massive sector of England’s economy, the South believed that England would intervene on their behalf to put an end to the “cotton famine.” England did not, instead finding other sources of cotton in Egypt and India.

The escalating cost of the war forced the Union government to go off of the international gold standard and–much like in the Revolutionary war—issue fiat money. And the ultimate in fiat money were the greenbacks. They were called this because they were printed in green ink (as is U.S. money today, which is often informally referred to as ‘greenbacks’, but this is something different). The U.S. government issued slips of paper and used them to pay its contractors and suppliers. It declared them to be good for payment of all domestic debts, by law (fiat). And, crucially for MMT concepts, they could be used to settle all debts with the federal government–i.e. taxes, fees and fines. Greenbacks were not good for international debts, customs duties and interest payments on the national debt. Greenbacks were not convertible into gold, and no one claimed that they were. But they were the first true national paper currency, and were useful all across the country (outside of Dixie), unlike the state bank notes. Thus, they began to circulate more broadly throughout the economy.

With the outbreak of the [Civil War], the U.S. economy was severely disrupted, and U.S. government revenues plunged as Union military expenditures soared. The fiscal crisis of the Northern state meant that it could not pay its suppliers and contractors. Moreover, speculators hoarded gold and there was a general liquidity crisis.

By the end of 1861, Northern banks had to suspend convertibility and cease to exchange specie for their bank notes. Thus, the United States went off the gold standard.

The daunting problem facing Salmon Chase, then secretary of the treasury, was a daunting one: how to fund public spending with a huge deficit and an inconvertible currency?

The first step toward a solution began in early 1862 when the government issued greenbacks, inconvertible paper money that by law was legal tender…The government also raised new taxes (including tariffs and an income tax) and borrowed to cover the deficit…By the end of the war, issuance of $450 million of greenbacks had been authorized, and the total currency more than doubled between 1861 and 1866…

Greenbacks were never thought to be a permanent solution, much less a new type of currency for the United States; rather, they were seen as a stopgap measure. It was thought that after the war, they would be replaced by “real” money, that is, money backed by gold:

…this was basically the first dollar bill issued by the U.S. government, though during the war, these dollars, they were not always worth a dollar in gold…So this was not a plan to establish a single national currency. It was a plan to fund war…

[T]he greenbacks…were seen as an emergency thing, something a government would only do in time of war. The underlying belief was that these greenbacks were temporary in the sense that we would issue them, the war would end and that…within 10 years, they’d be gone. The problem was that the consumers kind of liked them. Would you rather use a bill issued by a bank you’re not sure exists or would you want to use a bill that everyone recognizes?

Despite increased taxes and the issuance of greenbacks, the government’s costs continued to soar as the war raged on:

Thus, federal revenues grew thirteenfold…but…the national debt grew from $65 million to 2.7 billion…

To cover this national debt, the government needed to borrow. How would it do that? The usual way for governments to borrow was to sell war bonds. But the Union came up with an ingenious idea to encourage loans to the government: If one bought U.S. government bonds (which is loaning money to the government, remember), then they could use those bonds as backing to open a national bank, as opposed to a state bank. Thus, a system of national banks was created for the first time.

The national banks were different from the state banks in several crucial ways. Most notably, if you had bonds held by the U.S. government, you could issue “official” U.S. government banknotes against them. What was backing these banknotes was, of course, the government’s debt (i.e. the loans to the government). Thus, once gain we see that paper money represents the government’s liabilities. The more government debt, the more money that could be issued. This is basically the MMT conclusion: the government’s debt represents the savings surplus of the private sector.

To encourage loans to the government, a new system of nationally chartered banks replaced the old one of state-chartered banks … national banks … are regulated not by states but by the federal government. These banks are created during the Civil War and they also help raise money for the Union because in order to be a national bank, you had to buy government bonds. In other words, you had to lend money to the government.

The Birth Of The Dollar Bill (NPR)

The National Banking Act of 1863 mandated the creation of national banks whose notes were backed by government bonds. Upon deposit of federal bonds with the comptroller of the currency, investors could establish a private bank and issue national bank notes up to 90% of the value of the bonds….this made it profitable to organize national banks and thus to loan money to the government by purchasing its bonds.

The government also placed a tax on the state bank notes:

Though predictably the state banks opposed the National Bank Act, initially they did not suffer. The suspension of specie payments in 1861 relieved them of the always unwelcome need to redeem their notes in hard cash. The greenbacks … were made legal tender and served instead.

But on 3 March 1865, a mere month before Appomattox, the financial power again asserted itself. Congress was persuaded to pass additional legislation sweeping all state notes away.

A tax of 10 per cent per annum was levied on all state bank issues with effect from 1 July 1866. It was perhaps the most directly impressive evidence in the nation’s history that the power to tax is, indeed, the power to destroy.

Bank failures continued after the banning of the notes and on some years were epidemic – 140 suspensions in 1878; 496 in 1893; 155 in 1908. Most of the casualties were small state banks. For another sixty-five years these continued to be created. and the resulting loans and deposits continued to put or sustain marginal but aspiring farmers and deserving and undeserving entrepreneurs in business. (Galbraith, pp. 91-92)

Between the failures of state banks and the increasing desire to use national banks, the dollars issued by the national banks gradually took over–another manifestation of Gresham’s Law. This proves another point – that the credit that is most favored is that of the sovereign rather than that of other individuals.

Of course, you could say the the government put their thumb on the scale by taxing the state banknotes.This is often depicted by the usual suspects as a diabolical statist plan by the “evil” government to take over the money supply and crush “freedom”. While I couldn’t find the rationale for doing this, one could make the point that since the state banks were not providing funds for the war effort, the tax was an entirely justifiable way to force them to contribute to the war effort in another way.

The net effect was a decline in state banks and an increase in the importance of the national banks:

From 1860 to 1870 the number of state banks declined from 1,579 to 261, while the number of national banks went from zero to 1,612. National bank notes were legal tender in the same way that greenbacks were: payable for all public and private debts, except for import duties and the interest on the national debt. The new national banking system also helped standardize the currency, although that was not its primary intent.

For all its problems, the national banking system fulfilled its original purpose of selling government bonds and funding the war. In addition to would-be bankers, government bonds were sold directly to the public, an innovation promoted by the financier Jay Cooke. By enlisting a large sales force, advertising in the newspapers, and appealing to patriotism, Cooke was able to sell hundreds of millions of dollars worth of bonds.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

The United States had established—totally by accident—a consistent national currency for the first time after the Civil War:

So after the Civil War, the only paper money that’s circulating is the greenbacks and the bank notes issued by the national banks. And those bank notes issued by the national banks, they all start to look alike. So in the post-war years, there’s this convergence. Bills are looking more and more uniform. And for the first time, they’re all worth what they say they’re worth…So the United States at this point has kind of accidentally stumbled on an economic innovation – a $10 bill that is worth $10 in New York and in Connecticut and in New Jersey. You can take it all the way to Wyoming and it is still worth $10. And now, finally, if you’re a bartender – life is much easier…

So this really is how we got from a world of 8,000 kinds of money and of monthly guides that tell you if a $5 bill is actually worth $4 to the world basically that we know today, where if somebody gives you a $5 bill, you know it’s worth $5. This makes travel and trade much, much more efficient.

After the war, the debate was, once again, whether or not to go back on the gold standard. But there was a problem: thanks to the war, there was simply too much money floating around. Some way had to be found of reducing the amount of greenbacks in circulation. One enthusiastic goldbug even advocated a weekly bonfire of greenbacks! The problem was that such a policy would be deflationary at at time when farmers and small businessmen were hurting:

Wartime inflation had depreciated greenbacks in relation to gold, and so, for example, the value in gold of $100 of greenbacks averaged $97.00 during February 1862 but was down to $35.00 by January 1864. (I have rounded these numbers to the dollar-CH)

If greenbacks were convertible to gold, enterprising persons could buy them cheaply on the market and “sell” them at face value to the Treasury and thus make a profit. Hundreds of millions of dollars of greenbacks were in circulation, and had the government declared these paper notes convertible into specie, the Treasury would soon have exhausted its entire gold supply.

And so, if there was any hope of making money convertible into gold once again, the first step would have to be a drastic reduction of the amount of greenbacks in circulation. The government attempted to retire the greenbacks, but their timing was terrible as the nation was slipping into another recession. The contraction of the money supply especially hit debtors like small farmers. As a result of popular pressure, the power to retire greenbacks by the treasury Secretary was rescinded; only about $48 million were retired.

Resistance to…hard money policy raised the larger question or whether a return to gold was desirable and whether resumption was a suitable goal for monetary policy. Related to this was the issue of how to repay the national debt, for although the law required that interest be paid in coin (and not in greenbacks), it was unclear whether the principal also had to be repaid in coin.

To do so seemed particularly unfair to some since in the darkest days of the war the government sold its bonds for greenbacks. As a result, speculators could buy, for example, $100 in greenbacks on the market with only $35.00 in gold, and with those greenbacks purchase $100 in government bonds, hoping that both the interest and principal would be repaid in gold.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

But why retire the greenbacks at all? As Benjamin Franklin had pointed out long ago, an increase in the money supply increases economic activity. And constraining money creation with something like the gold standard severely limited the amount of money that could be issued by government, much as the hated British had done to the colonies back before the Revolution.

The debate over the gold standard shaped up along economic lines:

Farmers and other agrarian groups were heavily reliant on credit and so were hurt when money became tight. Thus, the ideas of the greenbackers found a receptive audience in American farmers who would later support the Populist movement. Greenbackism also enjoyed a brief popularity among mercantile traders, insurance brokers, capitalists of the Pennsylvania steel industry, and certain sectors of the labor movement.

Bullionism, on the other had, found support among bankers, financiers, bondholders and importers, all of whom stood to lose from inflation and gain from an appreciation of the currency.

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America (American Journal of Sociology) p. 10 (PDF)

In the 1870’s, the “hard money” position won out and the United States went back on the gold standard. The result was a general deflation and a series of painful crashes and depressions, including the “Long Depression” (which was called the “Great Depression” prior to 1929). Between the end of the Civil War and the Panic of 1907, there were a large number of financial panics, crises, depressions, etc. You can go visit Crisis Chronicles on the Liberty Street (NY Fed) blog to read about them in more detail. In brief, here are some of the major ones:

– Panic of 1873, a US recession with bank failures, followed by a four-year depression
– Panic of 1884
– Panic of 1890
– Panic of 1893, a US recession with bank failures
– Panic of 1896
– Panic of 1901, a U.S. economic recession that started a fight for financial control of the Northern Pacific Railway
– Panic of 1907, a U.S. economic recession with bank failures.

List of economic crises (Wikipedia)

The banking panic of 1907 eventually led to the creation of the Federal Reserve System, but that’s a story for another time.

The Greenback Legacy

By allowing the government to increase the money supply without worrying about convertibility to gold or increasing debt, the economy improved. After the war, many believed that the government should continue to do this: they even formed a Greenback Party to advocate for this.

Even today, some have made an argument for such a policy to be revived. Ellen Brown has written about this on her Web of Debt blog:

Helicopter money is a new and rather pejorative term for an old and venerable solution. The American colonies asserted their independence from the Motherland by issuing their own money; and Abraham Lincoln, our first Republican president, boldly revived that system during the Civil War. To avoid locking the government into debt with exorbitant interest rates, he instructed the Treasury to print $450 million in US Notes or “greenbacks.” In 2016 dollars, that sum would be equivalent to about $10 billion, yet runaway inflation did not result. Lincoln’s greenbacks were the key to funding not only the North’s victory in the war but an array of pivotal infrastructure projects, including a transcontinental railway system; and GDP reached heights never before seen, jumping from $1 billion in 1830 to about $10 billion in 1865.

Indeed, this “radical” solution is what the Founding Fathers evidently intended for their new government. The Constitution provides, “Congress shall have the power to coin money [and] regulate the value thereof.” The Constitution was written at a time when coins were the only recognized legal tender; so the Constitutional Congress effectively gave Congress the power to create the national money supply, taking that role over from the colonies (now the states).

Outside the Civil War period, however, Congress failed to exercise its dominion over paper money, and private banks stepped in to fill the breach. First the banks printed their own banknotes, multiplied on the “fractional reserve” system. When those notes were heavily taxed, they resorted to creating money simply by writing it into deposit accounts. As the Bank of England acknowledged in its spring 2014 quarterly report, banks create deposits whenever they make loans; and this is the source of 97% of the UK money supply today. Contrary to popular belief, money is not a commodity like gold that is in fixed supply and must be borrowed before it can be lent. Money is being created and destroyed all day every day by banks across the country. By reclaiming the power to issue money, the federal government would simply be returning to the publicly-issued money of our forebears, a system they fought the British to preserve.

Trump’s $1 Trillion Infrastructure Plan: Lincoln Had a Bolder Solution (Web of Debt)

And just like back in the late 1800’s, such ideas are opposed by a radical conservative movement that wishes to go back to free (wildcat) banking, abolish the central bank altogethet (just like Andrew Jackson), and go back on the gold standard. One prominent example is Gary North:

Ellen Brown is the latest in a long line of pro-fiat money, anti-gold currency, monetary statists who have infiltrated the conservative movement. They have accomplished this for over 50 years by the tactic of wrapping themselves in a flag of opposition to the Federal Reserve System. I call them false-flag infiltrators.

False-flag infiltrators are remnants of a left-wing American political movement of the late 19th century: the Greenbackers, named after the green currency issued by the North during the Civil War. These paper bills were unbacked by gold. Consumer prices rose by 75%, 1861-65.

The Greenbackers were opposed to the gold standard because it kept prices low. They wanted the government to inflate the currency, so that debtors could pay off their debts with cheap money. They had a small political party for almost two decades, the Greenback Party. It 1878, it merged with a labor Party to become the Greenback Labor Party. It went out of existence after 1888. Its main leader, James Weaver, co-founded the Populist (People’s) Party in 1891. It was a farm-bloc party that promoted fiat money in order to let farmers pay their debts with cheap money and also because they thought inflation would raise farm products’ prices more than the prices of other goods.

There was never any question of the Greenbackers’ politics. They were leftists, and openly sided with government controls on the economy…

Of course, today paper isn’t used very much anymore, and neither are coins. I’m sure most of us have used plastic debit cards and credit cards (hopefully paying it off immediately) to buy things. Money is now primarily electronic transfers between computer spreadsheets maintained by banks. Virtual money.


So what (if anything) have we learned about paper money?

Well, the first lesson, to me, is that paper money was inevitable. There was simply no amount of gold and silver anywhere in the entire world to run the kind of economy we were entering after 1700, much less today. All of the gold ever mined in human history would fit into a cube 20 meters on a side. Such a cube could easily fit on one of those giant supertankers bringing our goods over from China many times over.

When gold and silver was not enough, the quest was on for another thing to back paper money. Land was the first idea, as we’ve seen. Eventually paper money money became backed by the sovereign’s debt. Paper money became circulating government liabilities. It still is today.

Paper money was invented independently in many places, indicating to me that it must have been an inevitability. The Chinese were the first to do it, and used it on and off for about 500 years (c. 950 to 1455). Ironically, they stopped using it just at the time when the New World was being colonized by Europeans, which sent massive amounts of silver their way. But soon it was invented independently in the North Atlantic trading economies, which went on to dominate the rest of the world.

Long before “official” paper money was issued by central governments, there were things like bills of exchange, municipal bonds and annuities, and shares in joint-stock corporations. That is, much of the value transfer in the European economy was already done via paper instruments and ledgers long before paper money came on the scene, and so it’s inevitable that people made the leap. They just had to get over the cultural baggage of “money” being simply a substitute for precious metals—baggage that even today many people hold on to. Money creation was done by private banks via the stroke of a pen long before governments began issuing it. Even today, banks create most of the money in the world via keystrokes.

The first paper money were simply IOUs. Such IOU’s were issued by private individuals before governments. Eventually the government took over and issued their own IOUs, which soon changed hands as money. This is because the government’s credit is usually the most reliable. This feeds into ideas that there is a “pyramid” of what constitutes money, with the government’s money as the ultimate means of settlement at the apex.

The faith in paper money is based on the stability of the government issuing it. Just like the credit of an individual determines how much faith people have in an IOU, so too with governments. The IOUs of Zimbabwe or Venezuela are very different than those of Japan or Switzerland. Throughout history, problems with money are almost always related to political crises, and not simply to “debasement”. Debasement of currency is usually more of a signal of decline than a cause.

Another point is one I’ve made repeatedly: every major financial innovation has been created in order help states fund wars. That is, financial innovations were ways for states to aggregate and control the resources necessary to wage war. They were then later pressed into the service of trade and technological development. Paper money is a prime example of this. No country in history has decided to simply lose a war or surrender to a foreign power in order to limit their money supply or adhere faithfully to a precious metal standard.

Paper money was an instrument of revolution. How much has the modern world been affected by its creation? Would there even be a modern world without it? Without the ability to issue money in excess of the gold and silver floating around, neither the American nor French Revolutions would have succeeded. These paved the way for everything that came after—both socially and politically.

Is there a danger of uncontrollable inflation with paper money? Sure. But incomprehensibly more damage is done to the average citizen by locking your financial system into artificial handcuffs. Such systems are designed exclusively for the benefit of international merchants (who wish to have the money they make in one country’s market have the same value in their home country), while at the same time causing terrible harm to domestic populations who suffer from the resulting depressions.

As Tim Harford puts it, “While we may not always be able to trust central bankers to print just the right amount of new money, it probably makes more sense than trusting miners to dig up just the right amount of new gold.” He adds, “mainstream economists generally now believe that pegging the money supply to gold is a terrible idea. Most regard low and predictable inflation as no problem at all – perhaps even a useful lubricant to economic activity.”

In fact, it is a lack of inflation which makes debts harder to pay off. Hard-money policy has always been advocated by bankers and other big creditors, and yet the reactionary Right has somehow made this into a populist cause. Incredible!

This Reddit comment succinctly sums up the problems with tying money to gold, or anything else (I have combined two comments here):

1. Gold is scarce, and not enough of it is being found to match the increasing GDP of the world. Therefore it’s deflationary, and tends to entice people to hoard it, because simply owning the wealth makes you even wealthier as demand for it increases dramatically over supply. This chokes your economy as the poor fight over scraps and the rich do nothing. Leads to severe deflationary recessions every 5-10 years.

2. Finding a large cache of gold can royally fuck up an economy as wealth plummets overnight. There is literally nothing but luck controlling this. There’s an instance in history, of an African warlord who made a great trek to the middle east, giving out vast supplies of his wealth … during the trip, because he had so much of it, it was useless to him. He ended up crashing nearly every economy he passed through. (Mansa Musa)

3. Gold is actually very abundant on earth, but not easily accessible. There’s trillions of tons in our core, for example. And billions of tons dissolved in our oceans. Right now, gold isn’t worth the effort to extract it; but make it the driver of the worlds largest economy and people will start working on technology to get the gold out of the ocean. Pretty soon the economy will crash again.

4. In the distant future, all materials will be able to be produced in fusion furnaces. All elements were created from fusion of hydrogen during supernovas, and once fusion technology gets to the right place, we’ll be able to make any stable element we want. Gold, at that point, will become infinite. It is for this reason that we’d better figure out how to perfect fiat currencies, because we’re at the precipice of a demand-less society. One could make the argument that energy then becomes the chief currency of the world (as if it already isn’t!), but our sun provides more than enough for our civilization a billion times over.

Bottom line; basing currency on physical items is dumb and constrains us too much. It leads to crashes and gives us absolutely no ability to prevent them from happening. It’s dumb.

People … forget the single most obvious answer, which also happens to be a major reason we ditched it in the first place: it would allow any other country of sufficient size (read: China, Japan, Britain, the EU, and possibly Russia, Saudi Arabia, Australia due to their hard asset base(s)) to manipulate our currency by flooding/hoarding gold on the open markets.

Does anyone, who seriously understands international finance, think that if we handed the keys to our economy to China, that they wouldn’t use it to their ends? People that are pro-gold are a special breed of stupid.

It’s also worth noting that persistently high inflation is almost always due to other boneheaded things that governments do above and beyond simply “money printing.” In the Unites States in the sixties and seventies, we decided to ramp up a war on the other side of the world because of the “domino effect.” And we didn’t raise taxes to pay for it. We also built our entire economy around a substance whose supply ended up being controlled by countries who hated us (i.e. oil). Boneheaded!

All of this goes to say that given the history of paper money, the description of how our money system works by MMT seems basically correct. And, as MMT advocates point out, it is descriptive more than prescriptive. However, a proper understanding of what money is and how it works in modern industrial economies does lead to some policy recommendations. Perhaps the simplest one is this: any politician who claims that “we can’t afford it” should be voted out of office immediately. Another is that the low-information voters who claim to be “socially liberal but economically conservative” are just middle-of-the-road dimwits who haven’t a clue about how money and government finance work and should have their voting rights revoked.


I’ve mentioned some of the sources I’ve used throughout this series of posts, but I thought I’d list them here for convenience.

The major sources were Money: Whence it Came, Where it Went by John Kenneth Galbraith, originally published in 1975, with a revised version released in 1995 which is the the one I used. The other is The History of Money by Jack Weatherford, which came out in 1998. This one is a bit outdated, and ignores the insights of more in-depth and recent works in monetary theory.

One particularly notable one is this one: Money: 5,000 years of Debt and Power by Michel Aglietta. This is from Verso and was originally published in French.

Another major source is this article from The New Yorker: The Invention of Money

Crisis Chronicles is a series of posts by the New York Federal Reserve on its blog Liberty Street Economics:

There is a good summary of the various chapters of Glyn Davies’ History of Money on this site:

The WEA Pedagogy Blog is doing a 5-part series on the history of central banking (also accessible on the Real World Economic Review blog). Part one is available here:

The Minneapolis Fed has good history of central banking in the United States as noted above, and is available here: A History of Central Banking in the United States.

I’ve also used the following PDFs: Benjamin Franklin and the Birth of a Paper Money Economy by Owen F. Humpage

Paper Money and Inflation in Colonial America by Owen F. Humpage

The Color of Money and the Nature of Value: Greenbacks and Gold in Postbellum America by Bruce G. Carruthers and Sarah Babb

Land Bank Proposals 1650-1705 by Charlie Landale

If podcast are your preferred medium, these two are good. The first is Tim Harford’s recounting of the birth of paper money in China in his podcast 50 things that made the modern economy:

And NPR’s Planet Money podcast did a podcast on the birth of the dollar bill after the Civil War: Episode 421: The Birth Of The Dollar Bill

2 thoughts on “The Origin of Paper Money 8

  1. Kudos on an outstanding blog! I particularly appreciate the formatting (boldface and nested paragraphs) that make longreads easier to navigate.

    I don’t know why I haven’t discovered you before. Added at the top of my “weekly reading” list.

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