The money supply is an important determinant of aggregate demand and business conditions in general. Until 1935, a significant proportion of U.S. paper money was issued by commercial banks. The opportunity to issue banknotes was an important source of lending power for banks.
Before the United States gained its independence, paper money was issued by the various British colonial governments. Massachusetts made the first issue in 1690 to finance military expenditures: The bills could simply be paid out to soldiers and suppliers. Most colonies issued currency in the wartime period of 1713-1718, causing significant price inflation. Issuing paper money was a means of financing government deficits before the development of well-ordered interest-bearing government bonds. The notes were not formally convertible into gold and silver (specie) but could be used to pay taxes. Several colonial governments established loan offices, mostly for mortgage loans secured by land. The borrowers received paper money. The new issues of paper were withdrawn as the loans were repaid. Some colonies managed their money creation with restraint, and the money supply grew enough to facilitate the spread of a market economy, specialization, and exchange. Real inflationary abuses occurred in Rhode Island, the Carolinas, and Massachusetts. The British government tried to stamp out the practice and issued a general prohibition in 1764. This enraged many colonists and was one of the many grievances precipitating the move for independence. During the 1770’s, the total money supply was about $12 million, of which half was British and foreign coins and half was paper money.
In 1780, Congress shifted to borrowing by issuing interest-bearing securities and stopped issuing paper money. The last phase of the war was concentrated in the South, and Virginia issued more than $150 million of currency in 1780-1781. With the end of the war in 1781, most of the currency was withdrawn through taxation and through the issue of bonds. The Federal Funding Act of 1790 provided for acceptance of continental currency toward purchase of federal bonds, at a rate of one cent on the dollar.
Congress decreed that the dollar should be the national monetary unit. In 1780, it chartered the first modern commercial bank, the Bank of North America, in Philadelphia. Two more
A serious economic depression swept the country during the mid-1780’s. Seven states resumed issuing paper money, partly to make loans to distressed citizens and partly to cover government deficits created when tax revenues declined. Nearly $3 million of government paper was issued in 1785-1786, creating alarm that the wartime financial disorder would be repeated. In response, the U.S. Constitution of 1787 gave Congress the power to coin money and regulate its value and forbade state governments from coining money, issuing bills of credit, or making anything except gold or silver legal tender.
The number of banks and the volume of banknote currency grew steadily. By 1811, there were eighty-eight state-chartered banks. By then, circulating currency comprised about $15 million in gold and silver coins and $28 million in banknotes. The War of 1812 generated inflationary pressure from large federal military spending financed by borrowing heavily from the banks. More than one hundred new banks were created. In 1814, most of the banks ceased redeeming their notes in specie, which freed them to expand their loans and note issues still more.
To restore order to the monetary situation, Congress chartered the Second
The number of state-chartered or unchartered banks increased greatly during the 1830’s, and the quality of banknote currency deteriorated. “Wildcat” banks were established in remote areas, making note redemption difficult. Many banks failed during a severe business contraction beginning in 1837. Bank expansion resumed during the 1840’s, to be interrupted by another bank panic in 1857. By 1860, there were more than 1,500 banks, almost all issuing their own notes. Coinage legislation during the 1850’s created the hierarchy of copper-nickel penny and silver dime, quarter, and half-dollar. (The nickel was added in 1866.) Circulation of foreign coins was prohibited in 1857.
No formal government paper money was issued after 1787, although the Treasury notes issued during some business recessions temporarily performed that function. The outbreak of the
Monetary expansion generated inflation, and by 1864 consumer prices in the North were 75 percent higher than they had been in 1860. The Confederacy relied even more heavily on paper money issues, which totaled more than a billion dollars and generated far worse inflation–prices in early 1865 were nearly a hundred times those of 1861.
The war provided a basis for government efforts to reform banknote currency. In 1863, Congress authorized the creation of the National Banking system. A bank could obtain a federal charter that permitted it to issue national bank notes that were standardized in design (except for the name of the issuing bank) and secured by U.S. government bonds. In 1865, a punitive tax was imposed on note issues by nonnational banks, and notes from these banks soon disappeared. Between federal paper money and national banknotes, the nation’s paper currency achieved very high quality–especially since the Secret Service effectively combated counterfeiting.
Women examining currency at the Bureau of Engraving and Printing in 1929.
At the end of the war, neither greenbacks nor national banknotes were convertible into specie at par. Political pressure to restore par convertibility was strong, but even greater was the pressure to avoid a deflationary monetary contraction. Market forces gradually brought down the price of gold, and par convertibility was achieved in 1879. Congress authorized new forms of paper money: silver certificates (1878–redeemable in silver coin) and gold certificates (1863, but important only after 1882–redeemable in gold coin).
The economy continued to experience strong business cycles and periodic depressions, and there was pressure for monetary expansion to relieve depressions. During the 1890’s this pressure underlay the
The United States continued to be plagued by bank panics. The panic of 1907 led to renewed effort for currency and banking reform, culminating in the
The new system seemed to work well. When the economy entered a brief but severe depression in 1920 following the end of the inflationary pressures arising from World War I, there was no banking panic. By 1920, Federal Reserve notes constituted about three-fifths of outstanding coin and currency.
As the United States slid into
Franklin D. Roosevelt was inaugurated president in March, 1933, in the midst of the bank collapses. One of his first actions was to take the country off the gold standard.
After the Depression, U.S. currency became more routine and less interesting. The public can “buy” as much currency as it wants, supplied by the Federal Reserve through the banks. Links to precious metals were disconnected, except for gold and silver coins produced for collectors or investors and not intended to circulate as money. Beginning in 1965, silver was removed from U.S. coins, and silver certificates were discontinued. In 1971, the Treasury ceased to maintain a fixed price for gold or to sell it on demand to international buyers. After United States notes were discontinued in 1969, all paper currency consisted of Federal Reserve notes.
Friedman, Milton, and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton, N.J.: Princeton University Press, 1963. The definitive monetary history, with lots of attention to the economic causes and effects of policy decisions. Goodwin, Jason. Greenback: The Almighty Dollar and the Invention of America. New York: Henry Holt, 2003. Colorful, anecdotal history of American money; mostly pre-1900. Hessler, Gene. The Comprehensive Catalog of U.S. Paper Money. 6th ed. Port Chester, Ohio: BNR Press, 1997. This catalog has many color illustrations of the various historical paper money issues. Nussbaum, Arthur. A History of the Dollar. New York: Columbia University Press, 1957. A nice mix of scholarship and readability, this contains lots of detail on all the complexities of U.S. currency history. Trescott, Paul B. Money, Banking and Economic Welfare. New York: McGraw-Hill, 1960. Chapters 14-17 of this college textbook put currency evolution in a full context of economic and political history.
First Bank of the United States
Second Bank of the United States
Federal monetary policy
Panic of 1907
U.S. Department of the Treasury