A Payment History of the United States

by Kaz Nejatian

  Some historians have suggested that Madison was not just weary of states issuing paper money, he was also opposed to Congress having the power to issue paper money going as far as saying that he would only approve of Congress having the power to issue paper money if it were not considered legal tender in the United States.

  After the initial discussions about currency during the constitutional conventions, the constitutional wording in an early draft giving Congress power over money in the United States (including deletions) looked like this:

  “To regulate The exclusive right of coining money Paper prohibit no State to be perd. in future to emit Paper Bills of Credit witht. the App: of the Natl. Legisle nor to make any Article Thing but Specie a Tender in paymt of debts.”

  From reading this initial draft and the text of the debates that took place during the conventions, it is relatively clear that at least some of the drafters of the US constitution were so shocked by the inflationary effects of paper currency printed by the states that they wanted to ensure that a) no state would ever be allowed to have a say over monetary policy ever again and b) no paper money ever be issued in the United States.

  During the debates that followed, however, the majority of the convention participants opposed the express prohibition on Congress printing paper currency. Thus the final version of the US constitution, in Article 1 Section 8, giving the power to control US currency to Congress reads that [Congress shall have power] “To coin Money, regulate the Value thereof, and of foreign Coin.”

  In case this article was not clear, the US Founding Fathers added Article 1 Section 10 to the US Constitution the relevant part of which reads “No state shall … coin Money, emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts.”

  Having seen the failure of paper money issued in mass by various states, the Founding Fathers had had enough. Federal government was going to step in, as King George had once, to save the day.

  US Gold & Silver Coins

  Given the testy relations with England and the significant trade volume with Spanish colonies, the Spanish silver dollar was the most prominent coin in use in the US in the lead up to and after US independence.

  Congress, having been given the power to coin money, was generally expected to name the dollar as the basic currency of the United States. And Congress did not disappoint. Congress disappointing the American people did not become a fact of life until much later in America’s history.

  In 1792, upon the recommendation of Secretary of Treasury Alexander Hamilton, Congress passed, and President Washington signed, the Coinage Act of 1792.

  The new law established the US dollar as a gold, silver, or copper coin with specific weights for each. The most common coins issued under the law were the silver one dollar coins, the $10 gold eagle coins, the $5 golden half-eagles and the $2.50 gold quarter-eagles.

  To avoid having a shortage of money, in 1793, Congress also passed a law stating that all foreign coins in the United States would also be legal tender. This would mean that even after the introduction of the US dollar, Spanish dollar coins were by far the most popular currency in the United States. This fact bothered many Americans who viewed it as their patriotic duty to promote a US dollar.

  In 1797, President John Adams put forward a proposal to terminate the legal tender of all foreign currencies. This plan, however, was rebuffed since it was believed that it would actually lead to a shortage of currency since the US mint was incapable of producing enough US dollar coins.

  In fact, US coins were so infrequently used that in late 1790s a US congressman told the House of Representatives that “it was as difficult to find a gold as it was a flying eagle.” It was not until 1857, when the use of coins had generally decreased, that Congress passed the Coinage Act of 1857 and finally ended the life of the Spanish dollar as a legal tender in the United States.

  Free Banking

  Between 1792 and the start of US Civil War in 1861, much of the innovation in currency was done by private banks issuing private bank notes that were traded as currency. These bank notes would allow depositors to deposit their gold and silver coins with the bank and carry around with them paper money that was broadly accepted by merchants in the region who knew the bank’s reputation. Like the second generation paper notes from Massachusetts, these bank notes could be converted into gold or silver on demand by simply showing up at the bank’s office.

  One such bank was the First National Bank of the United States which issued paper currency. While the First Bank of the United State of the United States was chartered by the US government and had the US government as a shareholder, its currency was not official legal tender. In fact, its currency had no more official a position than the currency of dozens of other privately held banks, chartered by various states, that opened shop. Even after the collapse of the First Bank of the United States in in 1811, many such private banks thrived.

  In the next 50 years, in addition to the government owned banks, nearly 1,000 private banks opened up in the United States almost always serving a special group of merchants.

  Many of these banks were not really banks as much as they were lending arms of a local guild. They were usually located inside a merchant’s shop and allowed companies dealing with the merchant to buy or sell goods on credit. Many of them, however, also issued paper currency backed by their deposits of gold and silver. Some of them even issued more currency than they had gold or silver on reserve in order to expand the volume of paper currency in the economy. These banks assumed, as banks do today, that it would be very rare that 100% of all their notes would come due for gold or silver at the same time. Therefore, they could comfortably issue notes in excess of the amount of gold and silver they had on deposit.

  During this so-called “free banking” period, the United States was filled with hundreds of different currencies all with different values and different reliability. In fact, money brokers would publish books with some frequency including a list of all banks and the value of their currency compared to gold or silver.

  This created massive fraud and inflation. A merchant would have to carry in his shop a book so that he would know whether the bank whose name was printed on a piece of paper would exist by the time the merchant tried to redeem the bill for gold. This system, obviously, could not last for long. It didn’t.

  Greenbacks

  To meet the government’s financial needs during the Civil War, President Abraham Lincoln borrowed significant amounts of money. In order to pay for this debt and to avoid having hundreds of different types of currencies in the country, Congress passed the Legal Tender Act of 1862.

  The new law allowed the issuance of printed money, known as “Greenbacks” because green ink was used on the back of the paper currency. These greenbacks were the official currency of the United States and legal tender. They would be issued and accepted instead of and alongside of gold and silver coins.

  A year later, Congress passed the National Banking Act to create a single national currency. This Act placed a very high tax on any currency that was not the national currency and thus, in effect, banned private bank currencies. No one would want to buy a drink for $1 in greenbacks but $10 in some bank’s private note. Had it been successful, this law could have made the greenback the national currency of the United States replacing gold and silver dollar coins.

  Unfortunately for the greenback, however, California and Oregon refused to accept greenback as currency. Flushed with gold due to the gold rush, merchants and governments in the Western states refused to accept greenbacks. So even despite a national currency law, greenbacks could not become the national currency.

  Outside California and Oregon, greenback had other issues. Just like the early currency of Massachusetts, greenbacks were not on demand notes. They could not be easily converted to gold, so their value depended on the American population’s trust in their government’s finances.

  As the civil war went on, based on the turn of
each battle and the money required to fight it, the merchants in the United States had less and less reason to trust the central government’s ability to finance itself. Thus in their first full year in circulation, in 1862, the value of greenback against gold fell by nearly 29%. Three months later, in Spring 1863, the value of greenback against gold had fell by another 30% or so. The currency kept losings its value and at its lowest point, in July 1864 as confederate General Jubal Early led his forces within five miles of Washington, D.C., to buy something that would’ve cost $100 in gold you would have had to pay $258 in greenbacks.

  Because of these troubles, massive debt incurred during the war, and inflationary pressure on greenbacks, the US federal government stopped printing greenbacks in late 1865 and by 1879 greenbacks were completely out of circulation. Interestingly, greenbacks were topic of such political debate that they gave rise to a political party. In the 1878 elections, the Greenback-Labor Party elected 14 members of Congress. Even in as late as 2015, the old greenback had fans. A petition requesting that President Obama restate the greenback as the official currency of the United States received 14 signatures. How the mighty fall.

  Redemption of Gold

  With the death of the greenback obvious in 1866, Congress passed the Contraction Act allowing the greenbacks to be converted into gold by the US Treasury.

  Three years later, Congress passed the Public Credit Act of 1869. This law allowed the US government to pay back all civil war debt back in gold. While this law did not actually reestablish gold as the official currency of the United States, it created a political environment in which gold could be re-established as currency. It was not until 1875, when Congress passed the Specie Payment Resumption Act of 1875 (better known simply as the Resumption Act), that silver and gold once again became the national currency of the United States - though silver was practically never used and silver dollars were never minted after 1875.

  In 1877, two years after the Resumption Act, Congress passed a law making the Bureau of Engraving and Printing, which had been founded in 1862 to print greenbacks, the exclusive supplier of U.S. currency. From then until today, the Bureau of Engraving and Printing has been the exclusive printer of money in the United States.

  Federal Reserve

  By 1900, for the first time since its founding, the United States had a single currency (the US dollar), backed by a single asset (gold), and printed at a single place (the Bureau of Engraving and Printing); but this did not mean that the United States was done making significant changes to US currency.

  While the federal government had finally instituted a national banking system and a US currency, it still didn’t have much influence over how many notes were floating around the US economy. The number of notes produced was still influenced by the banks. The Treasury Department, which housed the Bureau of Engraving and Printing, merely printed the currency. It did not determine its supply which was still governed by the amount of reserves held by private banks.

  The overwhelming power of private banks over currency created problems through the late 1890s and early 1900s. The combination of bank control over the flow of US currency and fractional reserves, i.e. the ability of a bank to create more money than it has deposits or gold on hand, meant that the failure of one bank often created a so called panic. A panic could occur if a bank, for example, had only $100,000 in gold in its vault but had accepted as deposits and obligations $500,000. This bank would be fine since it is unlikely that more than 1 in 5 of its customers would demand all their money on a given day. However, if the customers of a bank believed that the bank was the on the verge of bankruptcy, then all of them would rush to the bank and create a “panic” demanding their money.

  The most famous of these panics occurred in 1907. Over the course of three weeks in October 1907, the New York Stock Exchange lost 50% of its value. This led to a deep recession that caused the failure of several banks and bankruptcies of many prominent businesses.

  Oddly enough, the Panic of 1907, which started in New York was actually caused by an event the year earlier in San Francisco.

  At 5 am on April 18, 1906, a great earthquake leveled San Francisco. The earthquake also caused a fire that destroyed nearly every building in San Francisco. Particularly hard hit were all the banks in the city because they were all located at the epicenter of the fire.

  None of the banks could open up their doors and none could get into their vaults to see whether there was anything left of their gold and currency deposits. Wells Fargo’s president, in order to avoid a run on his bank sent out a telegram to all depositors “Building destroyed. Vaults intact. Credit Unaffected”. Of course, he was only sure of the first sentence. There was no way for him to know if the vault was in fact intact or if all his credit had disappeared.

  In the aftermath of the fire, San Francisco’s two largest banks, Wells Fargo and Bank of Italy (which would go on to become Bank of America), began underwriting loans well above their gold reserves in order to rebuild the city.

  This caused a great stress on the American money supply. Virtually all the excess money from all over the country was being sucked into San Francisco. This meant that there was little money that banks could lend to each other for much of the following year.

  This would not have been cause for much concern, except that on October 16, 1907 two relatively large stock speculators in New York went bankrupt. Months of trouble in the stock market meant that these two brokers no longer had the money to cover their losses. Unfortunately for the banking world, these two stockbrokers were also connected with a handful of banks in New York and their well-publicized bankruptcy caused depositors at these banks to run to the branches asking for their money.

  Typically some other bank would have lent these troubled banks money, but so much money had gone to San Francisco that there was less than usual left in New York. The money left was not enough to cover the deposits at many banks.

  In a span of a few days, nearly a dozen prominent banks were forced to close their doors. The crisis only ended when J.P. Morgan personally stepped in to lend money to many of the banks to end the bank failures.

  In response to the Panic of 1907 and in order to get a better control over the flow of money in the country, in 1913, Congress passed the Federal Reserve Act. With this law, Congress gave the Federal Reserve, not private banks, the power to set the monetary policy of the United States; and the Federal Reserve, not the private banks, now had the power to lend as much money as it could print to banks to avoid bank failures.

  With the exception of the end of the gold standard (the discussion of which is well beyond the scope of this book), the United States has had the same basic structure when it comes to currency since the creation of the Federal Reserve.

  2 Checks in America

  Unlike government backed paper currency, checks are not a completely American invention.

  It is very likely that checks existed in one form or another during the reign of the Roman empire since the idea of checks appears in early Latin poetry. Ovid, who died in 17 AD, wrote about a day when a rich man is trying to impress his wife.

  But when she has her purchase in her eye,

  She hugs thee close, and kisses thee to buy;

  “Tis what I want, and ‘tis a pen’orth too;

  In many years I will not trouble you.”

  If you complain you have no ready coin,

  No matter, ‘tis but writing of a line;

  A little bill, not to be paid at sight:

  “Now curse the time when thou wert taught to write.”

  While they were likely invented in ancient Rome, checks became popular in Holland, where, in the 1500s, merchants and international shippers would deposit their gold and silver coins with a counterparty in exchange for a cashier’s note. This way, the gold and the silver would not have to make a long trek home and become hunted bounty for pirates.

  Between the early 1500s and the late 1600s, not much changed in the world of checking. Checks were
used with some frequency among international shippers and some merchants, but the general public and even most merchants looked at checks with suspicion.

  Boston in 1681

  That all changed in Boston in 1681. Yes. Boston, again.

  Boston, in the early 1600’s, was an odd town. It was part of the new world, yet desperately trying to be anything but new. It was ruled by the most religious puritans to land in the new world. It wanted a government, but refused to pay for it. It wanted to conquer Canada, but refused to commit to an all out assault.

  By 1681, a decade before the ill-fated attack on Canada which led to the rise of government backed currency, Boston had started modernizing and had a growing business population. The city reversed a 20-year old ban on celebrating Christmas, put in place originally to stop the dancing associated with the holiday, and began building itself as a center of both commerce and religion.