Government Paper Money
Apart from medieval China, which invented both paper and printing centuries before the West,
the world had never seen government paper money until the colonial government of Massachusetts admitted a fiat paper issue in 1690.
Massachusetts was accustomed to launching plunder expeditions against the prosperous French colony in Quebec.
Generally, the expeditions were successful, and would return to Boston, sell their booty, and pay off the soldiers with the proceeds.
This time, however, the expedition was beaten back decisively, and the soldiers returned to Boston in ill humor, grumbling for their pay.
Discontented soldiers are ripe for mutiny, so the Massachusetts government looked around in concern for a way to pay the soldiers.
It tried to borrow 3,000 to 4,000 pounds from Boston merchants, but evidently the Massachusetts credit rating was not the best.
Finally, Massachusetts decided in December 1690 to print 7,000 pounds in paper notes
and to use them to pay the soldiers.
Suspecting that the public would not accept irredeemable paper, the government made a
two-fold pledge when it issued the notes, that it would redeem them in gold or silver
out of tax revenue in a few years, and that absolutely no further paper notes would be
issued.
Characteristically, however, both parts of the pledge went quickly by the board.
The issue limit disappeared in a few months, and all the bills continued to unredeem for
nearly 40 years.
As early as February 1691, the Massachusetts government proclaimed that its issue had fallen
far short, and so it proceeded to emit 40,000 pounds of new money to repay all of its outstanding
debt, again pledging falsely that this would be the absolute final note issue.
But Massachusetts found that the increase in the supply of money, coupled with a fall
The fall in the demand for paper because of growing lack of confidence in future redemption in specie led to a rapid depreciation of new money in relation to specie.
Indeed, within a year after the initial issue, the new paper pound had depreciated on the market by 40% against specie.
By 1692, the government moved against this market evaluation by use of force, making the paper money compulsory legal tender for all debts at par with specie
and by granting a premium of 5% on all payment of debts to the government made in paper notes.
This legal tender law had the unwanted effect of Gresham's Law, the disappearance of
species circulation in the colony.
In addition, the expanding paper issues drove up prices and hampered exports from the colony.
In this way, the species shortage became a creature rather than the cause of fiat paper
issues.
Thus, in 1690, before the orgy of paper issues began, 200,000 pounds of silver money was
available in New England.
By 1711, however, with Connecticut and Rhode Island having followed suit in paper money
issue, 240,000 pounds of paper money had been issued in New England, but the silver had
almost disappeared from circulation.
Ironically then, Massachusetts and her sister colonies' issue of paper money created rather
have then solved any scarcity of money.
The new paper drove out the old specie.
The consequent driving up of prices and depreciation of paper scarcely relieved any alleged money
scarcity among the public.
But since the paper was issued to finance government expenditures and pay public debts,
the government, not the public, benefited from the fiat issue.
After Massachusetts had admitted another huge issue of 500,000 pounds in 1711 to pay for
For another failed expedition against Quebec, not only was the remainder of the silver driven
from circulation, but despite the legal tender law, the paper pound depreciated 30% against
silver.
Massachusetts Pounds, officially 7 shillings to the silver ounce, had now fallen on the
market to 9 shillings per ounce.
Depreciation proceeded in this and other colonies despite fierce governmental attempts to outlaw
it, backed by fines, imprisonment, and total confiscation of property for the high crime
of Not Accepting the Paper at Par
Faced with a further shortage of money due to the money issues, Massachusetts decided
to press on.
In 1716, it formed a government land bank and issued £100,000 in notes to be loaned
on real estate in the various counties of the province.
Prices rose so dramatically that the tide of opinion in Massachusetts began to turn
against paper as writers pointed out that the result of issues was a doubling of prices
in the past 20 years, the depreciation of paper and the disappearance of Spanish silver
through the operation of Gresham's Law.
From then on, Massachusetts, pressured by the British Crown, tried intermittently to
reduce the bills in circulation and return to a specie currency, but was hampered by
its assumed obligations to honor the paper notes at par of its sister New England colonies.
In 1744, another losing expedition against the French led Massachusetts to issue an enormous
From 1744 to 1748, paper money in circulation expanded from 300,000 pounds to 2.5 million pounds, and the depreciation in Massachusetts was such that silver had risen on the market to 60 shillings an ounce, ten times the price at the beginning of an era of paper money in 1690.
By 1740, every colony but Virginia had followed suit in fiat paper money issues, and Virginia
succumbed in the late 1750s in trying to finance part of the French and Indian War against the
French. Similar consequences, dramatic inflation, shortage of specie, massive depreciation despite
compulsory PAR laws ensued in each colony. Thus, along with Massachusetts' depreciation
of 11 to 1 of its notes against specie compared to the original PAR, Connecticut's notes
had sunk to 9 to 1 and the Carolinas at 10 to 1 in 1740, and the paper of virulently
inflationist Rhode Island to 23 to 1 against specie. Even the least inflated paper, that
of Pennsylvania, had suffered an appreciation of specie to 80% over par.
A detailed study of the effects of paper money in New Jersey shows how it created a boom-bust
economy over the colonial period. When new paper money was injected into the economy,
An inflationary boom would result to be followed by a deflationary depression when the paper
money supply contracted.
At the end of King George's War with France in 1748, Parliament began to pressure the
colonies to retire the mass of paper money and return to a specie currency.
In 1751, Great Britain prohibited all further issues of legal tender paper in New England
in order to move toward redemption of existing issues in specie.
Finally, in 1764, Parliament extended the prohibition of new issues to the remainder
of the colonies and required the gradual retirement of outstanding notes.
Following the lead of Parliament, the New England colonies, apart from Rhode Island,
decided to resume specie payment and retire their paper notes rapidly at the current depreciated
market rate.
The panicky opponents of specie resumption and monetary contraction made the usual predictions
in such a situation, that the result would be a virtual absence of money in New England
and the consequent ruination of all trade. Instead, however, after a brief adjustment,
the resumption and retirement led to a far more prosperous trade in production, the harder
money and lower prices attracting an inflow of specieology. In fact, with Massachusetts
on specieology and Rhode Island still on depreciated paper, the result was that Newport, which
had been a flourishing center for West Indian imports for Western Massachusetts, lost its
In fact, as one student of Colonial Massachusetts has pointed out, the return to specie occasioned remarkably little dislocation, recession, or price deflation.
Indeed, wheat prices fell by less in Boston than in Philadelphia, which saw no such return to specie in the early 1750s.
Foreign exchange rates, after the resumption of specie, were highly stable, and the restored specie system operated after 1750 with remarkable stability during the Seven Years' War and during the dislocation of international payments in the last years before the revolution.
Not being outlawed by governmental decree, specie remained in circulation throughout the colonial period, even during the operation of paper money.
Despite the inflation, booms and busts, and shortages of specie caused by paper issues, the specie system worked well overall.
Here was the silver standard, in the absence of institutions of the central government intervening in the silver market,
and in the absence of either a public or private central bank adjusting domestic credit or managing a reserve of specie or foreign exchange with which to stabilize exchange rates.
The market kept exchange rates remarkably close to the legislated par.
What is most remarkable in this context is the continuity of the species system through
the 17th and 18th centuries.