The American Revolution
The newly established colonies in the Americas were an opportunity to exploit raw materials and garner crops for the British luxury market that could not be grown at home, either owing to unsuitable climate or because the requisite cheap labor was unavailable. Despite the empire’s best efforts, things got out of hand with the uppity colonists.
Britain did not furnish coins to the American colonies and forbade colonials from making them. The British hoped that keeping money scarce would force colonists to trade exclusively with England. Economic development in the American colonies was stymied as the colonies could not issue convertible banknotes.
To circumvent the shortage of precious metals upon which to found a decent currency, some colonies issued paper notes which were treated as legal tender. Some southern states had long used tobacco leaves in lieu of printed paper. The notes were labeled in values of rare coins, notably English pounds, but especially Spanish dollars. These notes were bogus in not being backed by deposits of the currencies they claimed – but it worked, as it was backed by trust in the local colonial government.
This monetary system resembled the Roman Empire, in that monetary creation was entirely in the hands of the government. Scriptural money was not created via synergy between individuals and private banks, as was happening contemporaneously in England.
The indebtedness which Britain had incurred during the 7 Years’ War (1756–1763) caused consternation among the British political elite. This led to novel forms of taxation. Among them was trying to milk the American colonies with a variety of taxes. The response was revolt.
When war broke out in 1775, the confederation of states did not want to resort to taxation, which was the wellspring of the revolution, and therefore hated by most Americans. The Continental Congress had no choice but to finance itself by printing credit notes, called “continentals.”
Acceptance of continentals was voluntary. The artifice that justified their fabrication was the promise of later exchange for gold or silver, with interest.
American continentals constituted history’s first large issue of fiat money: inconvertible paper currency backed only by assurance. By comparison, banknotes were an intermediate commodity, while credit notes approached pure money.
Paper money was immediately controversial. The Quakers of Pennsylvania refused it on religious grounds. For their righteousness (some thought it avarice) they were fined, imprisoned, and their property confiscated. The American way got off to an early start.
Individual states followed the confederation’s lead. The egregious exercise of printing presses for fiat notes took the nascent nation from deflation from want of currency to hyperinflation that was matched only by Germany in the wake of the 1st World War.
In 1781, American soldiers paid in valueless paper money mutinied, leaving the American army on the brink of collapse. France saved the day, sending warships and reinforcements, as well as precious silver coins.
With that, continentals became utterly worthless. Despite victory in the War of Independence, the country was wracked by financial chaos and attendant violence.
Paper money polluted the equity of our laws, turned them into engines of oppression, corrupted the justice of our public administration, destroyed the fortunes of thousands who had confidence in it, and went far to destroy the morality of our people. ~ American merchant and economist Pelatiah Webster
With the war over in 1783, the new American government had the power to keep its promise to repurchase continentals. In 1791, those still holding the paper were “generously” offered exchange at 1/100 their face value in Federal Treasury bonds, not noble metal.
The federal government repurchased and exchanged state notes in the same way. Treasury bonds were denominated in the new currency, which was ostensibly based upon a bimetallic standard (gold and silver).
To grease the acceptance of government bonds via increased liquidity, Alexander Hamilton, the first Treasury Secretary, favored creation of a financial market. His envisioned stock and bond exchange opened in 1792, when 24 merchants met under a buttonwood tree in New York City. This followed the establishment of the Philadelphia stock exchange 2 years earlier.
Initially influenced by the inflation brought about by Continental currency, the new country’s financial policy was conservative. The Constitution forbade the federal government and the states from issuing paper money. Business was to be done with gold and silver, and bank notes redeemable in these precious metals. A central bank, the First Bank of the United States, was created in 1791 to enforce discipline on state-chartered banks, by refusing to accept the notes of those that did not pay out in specie on demand.
The by-now conservative northeastern states approved. The needy south and west most certainly did not: they valued easy credit. So, in 1810, under attack for its financial rigor, the charter of the First Bank was not renewed.
Prices rose in the wake of the War of 1812 (1812–1815), which was financed by public borrowing. State banks, relieved of the burden of forced redemption, were chartered with abandon. These banks issued notes, as did other trustworthy establishments, from barbers to bartenders. Leverage magically levitated throughout the country.
Following the War, property values rose wonderfully, attracting speculation from those who were convinced that greater increases were in the offing. This gave rise to the feeling that a higher regulatory authority was once again needed.
The Second Bank of the United States was chartered in 1816. It initially added to the boom by enthusiastically involving itself in real estate loans.
The boom collapsed in 1819. Prices and property values plummeted. Loans were foreclosed. Bankruptcies soared.
In this first speculative episode in American history, the term panic entered the language as pertaining to money. Later, capitalist apologists sought less alarming references; hence: crisis, depression, recession, and growth adjustment successively denoted the aftermaths of greedy optimism run amok.
Sobering up before the bottom fell out in 1819, the Second Bank had begun calling in some notes for payment. So, in the aftermath, it was pinned with the blame.
Populist President Andrew Jackson derided the Bank, and so rallied opinion against renewing its charter. Nearly a century would pass before a central bank was again tolerated in the United States.
Suspicions are entertained, and charges are made, of gross abuse and violation of its charter. ~ President Andrew Jackson to Congress in 1832 on the Second National Bank
With no central bank, new banks sprang up like weeds, pollinating the economy with a flood of notes. The speculative bubble was once again in real estate, especially in the west, including claims on public lands.
Manufacturing and commodities took advantage of the ample liquidity, which poured in from across the Atlantic, especially Britain. State-backed infrastructure investments, such as canals and turnpikes, were especially considered safe. Meanwhile, small investors across America and Europe were snapping up exotic financial instruments based on slave holdings.
The inevitable disenchantment and collapse came in 1837. A period of marked depression ensued. With it arose the distinctly modern attitude toward outstanding loans: repudiation. Several states dismissed their debts, expressing anger that foreign banks and investors should now, in hard times, demand payment for capital so foolishly given. This sentiment would echo over a century later when Third World debtor nations went insolvent.