Coined: The Rich Life of Money and How Its History Has Shaped Us

by Kabir Sehgal

  The British engaged in economic warfare by issuing counterfeit continentals to increase the money supply and erode the currency’s value. In total, the American colonists issued $200 million in continentals in four years.88 All these factors supposedly led to the considerable depreciation of continentals. In 1777, according to the Massachusetts Historical Society, $1.25 of continentals bought $1 of hard money; by 1781 it required $100 in continentals.89 But Grubb maintains that the value of continentals cratered after 1779 because Congress instituted high taxes for the redemption of the notes.90

  The poor performance of continentals wasn’t lost on the country’s founders. In 1783, Alexander Hamilton, who would serve as the nation’s first Treasury secretary, wrote about the hazards of soft money:

  Indeed, in authorizing Congress at all, to emit an unfunded paper as the sign of value, a resource, which, though useful in the infancy of this country, and indispensable in the commencement of the revolution, ought not to continue a formal part of the Constitution, nor ever, hereafter, to be employed, being, in its nature, pregnant with abuses, and liable to be made the engine of imposition and fraud; holding out temptations equally pernicious to the integrity of Government and to the morals of the people.91

  Congress stopped issuing continentals in 1779. But states continued to issue their own money using British nomenclature, which led to confusion among merchants. In 1785, at the urging of Thomas Jefferson, the government adopted the dollar as the standard unit of account. The word dollar came from thaler, a coin minted from silver in Joachimsthal, Bohemia, Germany (modern-day Jáchymov, Czech Republic). The dollar was to be parsed using a decimal system, instead of the Spanish system, which was divided into eighths. One holdover from the Spanish-American peso was its symbol, as “$” became the symbol for the American dollar.92 The Coinage Act of 1792 established the dollar as a coin that was fixed at a certain ratio of silver and gold.93 The founding fathers thought the new nation should rely on a more sound currency—hard money. They prohibited the states from making their own money but permitted the use of gold and silver as legal tender in Article I, Section 10 of the Constitution:94

  No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin Money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts.95

  By restricting the powers of the states, this clause solidified the monetary authority of the federal government.96 In addition, in Article I, Section 8 of the Constitution, the framers gave the federal government the authority to regulate the value of hard, coined money, and to borrow money, which would serve as a basis for the creation of soft money later.97 Though the dollar began as hard money, it didn’t remain that way for long. Benjamin Franklin’s vision for a unified paper currency would eventually be realized, albeit not as money backed by land. It’s only fitting that since 1914 his portrait has graced the one-hundred-dollar bill, the largest denomination of paper money circulating today in the United States.

  Getting Softer: The Civil War

  Abraham Lincoln made a difficult but necessary decision. During the Civil War, the United States desperately needed funds to finance Union troops. The nation’s finances were meager, with few sources of revenue. He supported the creation of money not backed by land or convertible into precious metals. However, like the nation’s founding fathers, Lincoln understood the perils of soft money. Left unchecked, it could lead to runaway spending, raging inflation, and financial ruin. Though he wanted hard money, he needed soft money. In his annual message to Congress in 1862, Lincoln praised the suspension of convertibility but cautioned there would be a need to return to it:

  In no other way could the payment of the troops, and the satisfaction of other just demands, be so economically, or so well provided for… A return to specie payments, however, at the earliest period… should ever be kept in view. Fluctuations in the value of currency are always injurious… Convertibility, prompt and certain convertibility into coin, is generally acknowledged to be the best and surest safeguard against them.98

  Lincoln signed the Legal Tender Act of 1862, which authorized the federal government to emit nonconvertible paper money. These “greenbacks,” printed with green ink, were mandated to be used for all debts public and private. Some $150 million of greenbacks increased the money supply and helped the government cover its expenses. Lincoln found what Law and Franklin had experienced: Paper money spurred trade and commerce.

  But as in Kublai Khan’s court and Law’s Banque Royale, the Union needed more money to cover its yawning costs: The army had swelled from sixteen thousand soldiers at the beginning of the war to one million at the conclusion, and the nation’s debt had grown to more than $2 billion. Other methods of raising capital, such as issuing war bonds and Treasury notes, helped but weren’t enough. Lincoln signed a Second Legal Tender Act and Third Legal Tender Act, which approved the issuance of $450 million in greenbacks.99 The value of this currency fluctuated with the success of Union troops. Meanwhile, the Confederacy had seen a considerable depreciation in the value of its paper notes. The Civil War was being fought with cannons, gunpowder, and paper.

  It was a difficult decision for Lincoln to sign the act, and not just because of the dangers of soft money. He risked angering a powerful constituency: bankers. Before the war, there hadn’t been a unified national paper currency. Instead, state-chartered banks issued notes backed by coins, which generated handsome profits.100 Yet these notes were risky since they depended on the credibility of the issuing bank. If a bank failed, so did its currency, thus notes typically traded below their denominated value. These “wildcat” banks were thought to be taking advantage of the public by issuing unstable, worthless notes. The term may have come from a failed bank in Michigan that had images of wildcats on its bills. Upon learning about the government’s plan for a national currency, northern banks lost even more credibility when they suspended the convertibility of notes to hard money. Without a metal anchor, the volatility of these notes spiked, and the public demanded a change. Realizing the inevitable, bankers successfully lobbied Congress to ensure that gold would still be used in interest payments owed to them. Republican congressman Thaddeus Stevens noted, “A doleful sound came up from the caverns of bullion brokers, and from the saloons of the associated banks.”101

  Despite the protests of bankers, Lincoln and the Republicans largely prevailed in reshaping the US monetary and banking system. Lincoln signed the National Bank Acts of 1863 and 1864, which instituted a tax on state bank–issued notes, resulting in banks ceasing the creation of these notes, and which gave the federal government the power to charter banks. The measures also permitted the federal government to keep its reserves in federal bonds, not just in hard money.102 State banknotes were eventually removed, but several state banks survived by creating checking accounts, which became popular.103

  With the Union victory, many bankers and creditors thought that the government would retire the greenbacks. The notes were, after all, an emergency measure, and the crisis was over. As we saw above, Lincoln had remarked on the need to return to hard money when he implemented the greenbacks. Creditors and businesses also wanted to retire the notes so that they could be repaid in more valuable hard money. But debtors wanted to keep greenbacks in circulation because of their inflationary effect. The purchasing power of the money they used to repay loans would be less.

  The creditors achieved victory in 1875 with the Specie Resumption Act, which restored convertibility of greenbacks to metal in 1879 and retired $300 million worth of greenbacks. Opposition forces organized, even creating the political Greenback Party, which sought to repeal the legislation.104 The government eventually instituted provisions that kept the greenback in circulation but backed it with hard money. In 1879, the Treasury bulked up on metal reserves in anticipation of massive redemptions, but the tidal wave of people looking to convert soft into hard money didn’t materialize. The people had come to rely on the c
onvenience of paper money, whether it was or wasn’t backed by metal. Many had faith in paper money.

  The monetary debate evolved from whether paper money should be backed by hard money to which type of metal. Debtors, including farmers and populists, advocated for bimetallism, silver and gold, because it would increase the money supply: more metal, more money, more spending, more inflation. Creditors, including businesspeople and bankers, desired the gold standard: fewer types of metal, more valuable money. In 1900, Congress passed the Gold Standard Act, which established gold as the only metal backing paper money. It would take another emergency to sever the link between precious metals and paper money again.

  Getting Softer: The Great Depression

  That emergency was the Great Depression, and it showed that the harder the times, the softer the money. During the Great Depression, 25 percent of American workers became unemployed, and many suffered drought and hunger. Trade and GDP declined almost 30 percent. This wasn’t just an American phenomenon; it was a global one. But before we examine the monetary decisions during this period, a bit of history is needed.

  From 1880 to 1914, many industrializing countries were in the “classical gold standard,” what economist Murray Rothbard calls the “literal and metaphorical Golden Age.”105 It was an era of robust international trade, price stability, economic growth, and political harmony. The United States experienced a paltry 0.1 percent inflation every year during this period. Great Britain’s exports constituted a higher percentage of GDP then, about 30 percent, versus now, 19.3 percent.106 The gold standard is straightforward and best defined by economist Michael David Bordo:

  The gold standard essentially was a commitment by participating countries to fix prices of their domestic currencies in terms of a specified amount of gold. The countries maintained these fixed prices by being willing to buy or sell gold to anyone at that price.107

  However, World War I abruptly ended this era. Several European countries left the gold standard so that they could print money to finance their military efforts. After the war, many countries returned to gold because of its prewar success.108 Yet it was a modified system known as the “gold-exchange standard,” which Rothbard explains:

  The gold-exchange standard worked as follows: The United States remained on the classical gold standard, redeeming dollars in gold. Britain and the other countries of the West, however, returned to a pseudo-gold standard, Britain in 1926 and the other countries around the same time. British pounds and other currencies were not payable in gold coins, but only in large-sized bars, suitable only for international transactions. This prevented the ordinary citizens of Britain and other European countries from using gold in their daily life, and thus permitted a wider degree of paper and bank inflation.109

  Great Britain introduced this standard at the behest of Chancellor of the Exchequer Winston Churchill. The same exchange rate that was used in leaving the gold standard was used in returning to the gold-exchange standard. But the rate didn’t account for the inflation that had occurred during the war, which overvalued the pound. Rothbard writes, “[The British] did so for reasons of… national ‘prestige,’ and in a vain attempt to re-establish London as the ‘hard money’ financial center of the world.”110 Prices plummeted some 50 percent, British exports remained uncompetitive in the global market, and unemployment skyrocketed. Churchill later regretted his decision.111

  During World War I, many European leaders realized what Abraham Lincoln understood decades before: Often during an economic emergency, a country needs more money than it has in its reserves of precious metals or cash. Officials also grasped that gold can be restrictive: When an economy bends, gold doesn’t and neither does the exchange rate. In 1929, the US market crashed and the economy spiraled downward. Several countries, including Great Britain, at first remained committed to the gold-exchange standard. These countries raised interest rates to attract investor capital, creating a more restrictive climate for borrowers and global markets. Scholars contend that they should have cut rates to make borrowing and trading easier during these difficult times.112 A gold standard, however, keeps currency exchange rates constant and forces the country to endure price deflation.113

  This doesn’t happen today. Because the dollar isn’t moored to metal, it floats against other currencies. Instead of deflation, the dollar can devalue, making exports from the United States cheaper and more competitive in the global market. Policy makers today prefer currency devaluation to price deflation. But a gold standard provides only one option in a contracting economy: deflation.

  Mired in depression, Great Britain raised rates to maintain the value of the pound, the world’s reserve currency at the time. But it reluctantly bowed to political realism: The public didn’t want to endure the bitter golden pill of deflation. Great Britain therefore abandoned the gold-exchange standard in September 1931.114 The pound lost its luster as the world’s reserve currency. Soon after, twenty-five countries also left the gold-exchange standard. Investors looked to the United States to see whether it would be next.115

  In 1933, when President Franklin D. Roosevelt took office, he realized the restrictiveness of a gold standard. He thought it was partly responsible for bank runs, as people sought to convert paper dollars into hard money, causing banks to fail.116 He instituted policies that sound as if they came from Kublai Khan’s economic playbook. He authorized Executive Order 6102, which mandated that all gold coins, bullion, and certificates (with some exceptions like jewelry and rare coins) be turned over to the government at a rate of $20.67 per ounce. The US Treasury built a bullion depository in Fort Knox, Kentucky, to house the seized gold. Gold hoarding was banned and made punishable by ten years in jail. The government also prohibited gold exports and mandated that gold mining companies sell their gold to the government.

  The Gold Reserve Act of 1934 canceled contract clauses that stipulated terms could be settled in gold. The Supreme Court upheld the cancellation of the gold clause by one vote. The act also allowed the government to adjust the exchange rate between the dollar and gold. Roosevelt increased the gold-exchange rate to $35, devaluing the dollar in an effort to kick-start inflation. There wasn’t exactly a scientific method in adjusting the gold price upward. Roosevelt once suggested on a whim that the price be increased by twenty-one cents. His adviser stated, “If anybody ever knew how we really set the gold price through a combination of lucky numbers… I think they would be frightened.”117

  During the Great Depression, the US government exercised more control over the monetary system, making it less restrictive and more flexible than under the gold standard, but at the same time bounding closer toward soft money, like the emperor in Faust. It would take one final shock to cut the metal anchor completely.

  The Final Shock

  In 1944, with World War II coming to a close, officials from forty-four nations assembled at the beautiful Mount Washington Hotel in Bretton Woods, New Hampshire, to hash out an international monetary system. The United States obtained beneficial terms in the new system since it was emerging from the war as the leading world power. One outcome of Bretton Woods was that other countries fixed their currencies to the dollar, which was fixed to gold at $35 per ounce.118 Similar to how other countries set their clocks in relation to Greenwich, England, now they had to set their currencies to the US dollar.

  The dollar was the world’s reserve currency: Other countries would hold securities denominated in dollars, and the United States paid interest for these holdings. The United States held gold. In a sense, the dollar became the new gold. However, despite having largely authored the Bretton Woods system, the United States eventually abandoned it.119

  A range of factors caused the United States to desert Bretton Woods: growing costs, burgeoning inflation, and a constraining system. During the 1960s, President Lyndon Johnson’s “guns and butter” policies—the Vietnam War and the Great Society domestic programs—required significant amounts of money. The butter, programs to help the poor,
children, and elderly, saw an increase in annual spending from $6 billion in 1965 to $12 billion in 1968.120 But these numbers were nothing compared to what was needed to finance the Vietnam War. Instead of instituting an onerous tax on the people, the US government borrowed funds to pay for the nearly two million members of the armed services involved in war efforts. More than 9 percent of America’s GDP was allocated for defense spending, and more than $100 billion (over $700 billion in today’s dollars) was spent.121 The surge in spending negatively impacted America’s fiscal situation, and deficit spending continued.122 President Johnson bemoaned, “That bitch of a war killed the lady I really loved—the Great Society.”123 It would also help to end the Bretton Woods system.

  From 1965 to 1971, the money supply increased at an average annual rate of 7.4 percent. In time, with more money came more spending and inflation. Consumer price inflation swelled from just over 1 percent at the beginning of 1965 to more than 13 percent in 1980.124 Economists debate the origin of this period known as the Great Inflation. Some contend that politicians were more concerned with achieving a target unemployment rate of 4 percent and thus used stimulative measures like deficit spending and tax cuts to boost economic activity.125 Economist Benjamin Klein contends that moving from hard money to soft helped to stoke inflation during the 1960s.126 Economist Allan Meltzer, an expert on the Federal Reserve System, asserts that because inflation is a monetary phenomenon, fault lies with those responsible for monetary policy. The Fed dithered in order to build consensus, and it finally raised rates in 1965 to tame inflation.127 But as the economy slowed down, the Fed reversed course and eased rates in 1968, which further stoked inflation.