by Dr. Clarence Carson, FEE.org
The United States Constitution does not mention paper money by that name. Nor does it refer to paper currency or fiat money in those words. There is only one direct reference to the origins of what we, and they, usually call paper money. It is in the limitations on the power of the states in Article I, Section 10. It reads, â€œNo State shall . . . emit Bills of Credit . . . .â€ Paper that was intended to circulate as money but was not redeemable in gold and silver was technically described as bills of credit at that time. The description was (and is) apt. Such paper is a device for expanding the credit of the issuer. There is also an indirect reference to the practice in the same section of the Constitution. It reads, â€œNo State shall . . . make any Thing but gold and silver Coin a Tender in Payment of Debts . . . .â€ Legal tender laws, in practice, are an essential expedient for making unredeemable paper circulate as money. Except for the one direct and one indirect reference to the origin and means for circulating paper money, the Constitution is silent on the question.
With such scant references, then, it might be supposed that the makers of the Constitution were only incidentally concerned with the dangers of paper money. That was hardly the case. It loomed large in the thinking of at least some of the men who were gathered at Philadelphia in 1787 at the Constitutional Convention. There were two great objects in the making of a new constitution: one was to provide for a more energetic general government; the other was to restrain the state governments. Moreover, the two objects had a common motive at many points, i.e., to provide a stronger general government which could restrain the states.
Measures to Prevent a Flood of Unbacked Paper Money
One of the prime reasons for restraining the state governments was to prevent their flooding the country with unbacked paper money. James Madison, one of the leaders at the convention, declared, in an introduction to his notes on the deliberations there, that one of the defects they were assembled to remedy was that â€œIn the internal administration of the States, a violation of contracts had become familiar, in the form of depreciated paper made a legal tender . . .â€ Edmund Randolph, in the introductory remarks preceding the presentation of the Virginia Plan to the convention, declared that when the Articles of Confederation had been drawn â€œthe havoc of paper-money had not been foreseen.â€
Indeed, as the convention held its sessions, or in the months preceding it, state legislatures were under pressure to issue paper money. Several had already yielded, or taken the initiative, in issuing the unbacked paper. The situation was out of control in Rhode Island, and had been for some time. Rhode Island refused to send delegates to the convention, and the stateâ€™s reputation was so bad that the delegates there were apparently satisfied to be spared the counsels of her citizens. Well after the convention had got underway, a motion was made to send a letter to New Hampshire, whose delegates were late, urging their attendance. John Rutledge of South Carolina rose to oppose the motion, arguing that he â€œcould see neither the necessity nor propriety of such a measure. They are not unapprized of the meeting, and can attend if they choose.â€ And, to clinch his argument, he proposed that â€œRhode Island might as well be urged to appoint & send deputies.â€ No one rose in defense of an undertaking of that character.
The ill repute of Rhode Island derived mainly from that stateâ€™s unrestrained experiments with paper money. Rhode Island not only issued paper money freely but also used harsh methods to try to make it circulate. The â€œlegislature passed an act declaring that anyone refusing to take the money at face value would be fined Â£100 for a first offense and would have to pay a similar fine and lose his rights as a citizen for a second.â€ When the act was challenged, a court declared that it was unconstitutional. Whereupon, the legislature called the judges before it, interrogated them, and dismissed several from office. The legislature was determined to have its paper circulate.
The combination of abundant paper money and Draconian measures to enforce its acceptance brought trade virtually to a halt in Rhode Island. A major American constitutional historian described the situation this way:
The condition of the state during these days was deplorable indeed. The merchants shut their shops and joined the crowd in the bar-rooms; men lounged in the streets or wandered aimlessly about . . . . A French traveller who passed through Newport about this time gives a dismal picture of the place: idle men standing with folded arms at the corners of the streets; houses falling to ruins; miserable shops offering for sale nothing but a few coarse stuffs . . . ; grass growing in the streets; windows stuffed with rags; everything announcing misery, the triumph of paper money, and the influence of bad government. The merchants had closed their stores rather than take payment in paper; farmers from neighboring states did not care to bring their produce . . . . Some . . . sought to starve the tradesmen into a proper appreciation of the simple laws of finance by refusing to bring their produce to market.
But there was more behind the Foundersâ€™ fears of paper money than contemporary doings in Rhode Island or general pressures for monetary inflation. The country as a whole had only recently suffered the searing aftermath of such an inflation. Much of the War for Independence had been financed with paper money or, more precisely, bills of credit.
A Surge of Continentals
Even before independence had been declared the Continental Congress began to emit bills of credit. These bills carried nothing more than a vague promise that they would at some unspecified time in the future be redeemed, possibly by the states. In effect, they were fiat money, and were never redeemed. As more and more of this Continental currency was issued, 1776-1779, it depreciated in value. This paper was joined by that of the states which were, if anything, freer with their issues than the Congress. In 1777, Congress requested that the states cease to print paper money, but the advice was ignored. They did as Congress did, not what it said.
At first, this surge of paper money brought on what appeared to be a glow of prosperity. As one historian described it, â€œthe country was prosperous . . . . Paper money seemed to be the â€˜poor manâ€™s friendâ€™; to it were ascribed the full employment and the high price of farm products that prevailed during the first years of the war. By 1778, for example, the farmers of New Jersey were generally well off and rapidly getting out of debt, and farms were selling for twice the price they had brought during the period 1765-1775. Trade and commerce were likewise stimulated; despite the curtailment of foreign trade, businessmen had never been so prosperous.â€
The pleasant glow did not last long, however. It was tarnished first, of course, by the fact that the price of goods people bought began to rise. (People generally enjoy the experience of prices for their goods rising, but they take a contrary view of paying more for what they buy.) Then, as now, some blamed the rise in prices on merchant profiteering.
As the money in circulation increased and expectations of its being redeemed faded, a given amount of money bought less and less. This set the stage for speculative buying, holding on to the goods for a while, and making a large paper profit on them. There were sporadic efforts to control prices as well as widespread efforts to enforce acceptance of the paper money in payment for debts. These efforts, so far as they succeeded, succeeded in causing shortages of goods, creditors to run from debtors trying to pay them in the depreciated currency, and in the onset of suffering.
By 1779, the inflation was nearing the runaway stage. â€œIn August 1778, a Continental paper dollar was valued (in terms of gold and silver) at about twenty-five cents; by the end of 1779, it was worth a penny.â€ â€œOur dollars pass for less this afternoon than they did this morning,â€ people began to say. George Washington wrote in 1779 that â€œa wagon load of money will scarcely purchase a wagon load of provisions.â€ It was widely recognized that the cause was the continuing and ever larger emissions of paper money. Congress resolved to issue no more in 1779, but it was all to no avail. Runaway inflation was at hand. In 1781, Congress no longer accepted its own paper money in payment for debts, and the Continentals ceased to have any value at all.
A good portion of the dangers of paper money had been revealed, and reflective people were aware of what had happened. Josiah Quincy wrote George Washington â€œthat there never was a paper pound, a paper dollar, or a paper promise of any kind, that ever yet obtained a general currency but by force or fraud, generally by both.â€ A contemporary historian concluded that the â€œevils which resulted from the legal tender of the depreciated bills of creditâ€ extended much beyond the immediate assault upon property. â€œThe iniquity of the laws,â€ he said, â€œestranged the minds of many of the citizens from the habits and love of justice . . . . Truth, honor, and justice were swept away by the overflowing deluge of legal iniquity . . . â€
But the economic consequences of the inflation did not end with the demise of the Continental currency. Instead, it was followed by a deflation, which was the inevitable result of the decrease in the money supply. The deflation was not immediately so drastic as might be supposed. Gold and silver coins generally replaced paper money in 1781. Many of these had been out of circulation, in hiding, so long as they were threatened by tender law requirements to exchange them on a par with the paper money. Once the threat was removed, they circulated. The supply of those in hiding had been augmented over the years by payments for goods by British troops. Large foreign loans, particularly from the. French, increased the supply of hard money in the United States in 1781 and 1782. A revived trade with the Spanish, French, and Dutch brought in coins from many lands as well. In addition, Robert Morrisâ€™s Bank of North America provided paper money redeemable in precious metals in the early years of the decade.
The Impact of Depression
By the middle of the 1780s, however, the deflation was having its impact as a depression. Trade had reopened with Britain, and Americans still showed a distinct preference for British imports. That, plus the fact that the market for American exports in the British West Indies was still closed, resulted in a large imbalance in trade. Americans made up the difference either by borrowing or shipping hard money to Britain. Prices fell to reflect the declining money supply. Those who had gone into debt to buy land at the inflated wartime prices were especially hard hit by the decline in the prices of their produce. Foreclosures were widespread in 1785-1786. This provided the setting for the demands for paper money and other measures to relieve the pressure of the debts. Some people were clamoring for the hair of the dog that had bit them in the first placeâ€”monetary inflationâ€”and several state legislatures had accommodated them.
Though there is evidence that the worst of the depression was over by 1787, if not in the course of 1786, paper money issues and agitations for more were still ongoing when the Constitutional Convention met in Philadelphia. In any case, those who had absorbed the lessons of recent history were very much concerned to do something to restrain governments from issuing paper money and forcing it into circulation. There were those who met at Philadelphia, too, who took the long view of their task. They hoped to erect a system that would endure, and to do that they wished to guard against the kind of fiscal adventures that produced both unpleasant economic consequences and political turmoil. Paper money was reckoned to be one of these.
The question of granting power to emit bills of credit came up for discussion twice in the convention. The first time was on August 16, 1787. (The convention had begun its deliberations on May 25, 1787, so it was moving fairly rapidly toward the conclusion when the question arose.) The question was whether or not the United States government should have power to emit bills of credit. Congress had such a power under the Articles of Confederation, and most of the powers held by Congress under the Articles were introduced in the convention to be extended to the new government.
Constitutional Convention Debates
Gouverneur Morris of Pennsylvania â€œmoved to strike out â€˜and emit bills on the credit of the United Statesâ€™.â€ That is, he proposed to remove the authority for the United States to issue such paper money. â€œIf the United States had credit,â€ Morris said, â€œsuch bills would be unnecessary: if they had not, unjust & useless.â€ His motion was seconded by Pierce Butler of South Carolina.
James Madison wondered if it would â€œnot be sufficient to prohibit making them a tender? This will remove the temptation to emit them with unjust views. And promissory notes in that shape may in some emergencies be best.â€ (Madisonâ€™s distinction between bills of credit that may be freely circulated and those whose acceptance is forced by tender laws should remind us that paper instruments serving in some fashion as money are not at the heart of the problem. After all, private bills of exchange had for several centuries been used by tradesmen, and these sometimes changed hands much as money does. They are what we call negotiable instruments, and the variety of these is large. What Madison was getting at more directly, however, was that governments, if they are to borrow money from time to time, may issue notes, and these may be negotiable instruments which may take on some of the character of money in exchanges. But Madisonâ€™s objection was overcome, as we shall see.)
Gouverneur Morris then observed that â€œstriking out the words will leave room still for notes of a responsible minister which will do all the good without the mischief. The Monied interest will oppose the plan of Government, if paper emissions be not prohibited.â€
However, Morris had moved beyond his motion, which was for removing the power, not specifying a prohibition, and Nathaniel Gorham of Massachusetts brought him back to the point. Gorham said he â€œwas for striking out, without inserting any prohibition. If the words stand they may suggest and lead to the measure.â€
Not everyone who spoke, however, favored removing the power. George Mason of Virginia â€œhad doubts on the subject. Congress he thought would not have the power unless it were expressed. Though he had a mortal hatred to paper money, yet as he could not foresee all emergences [sic], he was unwilling to tie the hands of the Legislature. He observed that the late war could not have been carried on, had such a prohibition existed.â€
Nathaniel Gorham tried to reassure Mason and others who might have similar doubts by declaring that â€œThe power so far as it will be necessary or safe, is involved in that of borrowing.â€
Both Positions Argued
On the other hand, John Francis Mercer of Maryland announced that he â€œwas a friend to paper money, though in the present state & temper in America, he should neither propose nor approve of such a measure. He was consequently opposed to a prohibition of it altogether. It will stamp suspicion on the Government to deny it a discretion on this point. It was impolitic also to excite the opposition of all those who were friends to paper money. The people of property would be sure to be on the side of the plan [the Constitution], and it was impolitic to purchase their further attachment with the loss of the opposite class of Citizens.â€
Oliver Elsworth of Connecticut pronounced himself of the opposite view. He â€œthought this a favorable moment to shut and bar the door against paper money. The mischiefs of the various experiments which had been made, were now fresh in the public mind and had excited the disgust of all the respectable part of America. By withholding the power from the new Government more friends of influence would be gained to it than by almost any thing else. Paper money can in no case be necessary. Give the Government credit, and other resources will offer. The power [to emit bills of credit] may do harm, never good.â€
Edmund Randolph of Virginia still had doubts, for he said that â€œnotwithstanding his antipathy to paper money, [he] could not agree to strike out the words, as he could not foresee all the occasions which might arise.â€
James Wilson of Pennsylvania favored removing the power: â€œIt will have a most salutary influence on the credit of the United States to remove the possibility of paper money. This expedient can never succeed whilst its mischiefs are remembered, and as long as it can be re sorted to, it will be a bar to other resources.â€
Pierce Butler â€œremarked that paper was a legal tender in no country in Europe. He was urgent for disarming the Government of such a power.â€
George Mason, however, â€œwas still averse to tying the hands of the Legislature altogether. If there was no example in Europe as just remarked, it might be observed on the other side, that there was none in which the Government was restrained on this head.â€ His fellow delegates forebore to remind Mason that except for Britain there was hardly a government in Europe that was restrained on that or any other head by a written constitution.
In any case, the last remarks were made by men vehemently opposed to the power. George Read of Delaware â€œthought the words, if not struck out, would be as alarming as the mark of the Beast in Revelations.â€ John Langdon of New Hampshire â€œhad rather reject the whole plan [the Constitution] than retain the three words,â€ by which he meant â€œand emit bills.â€
Denying the Power to Emit Bills of Credit
The vote was overwhelmingly in favor of removing the authority of the United States to emit bills of credit. The delegates voted by states, and 9 states voted in favor of the motion while only 2 opposed it. (New York delegates were not in attendance, and Rhode Island, of course, sent none.) It is a reasonable inference from the discussion that the delegates believed that by voting to strike out the words they had removed the power from the government to emit bills of credit. George Mason, who opposed the motion, admitted as much. Moreover, James Madison explained in a footnote that he voted for it when he â€œbecame satisfied that striking out the words would not disable the Government from the use of public notes as far as they could be safe & proper; & would only cut off the pretext for a paper currency, and particularly for making the bills a tender for public or private debts.â€
The other discussion of paper money took place in connection with the powers to be denied to the states in the Constitution. The committee report had called for the states to be prohibited to emit bills of credit without the consent of the United States Congress. James Wilson and Roger Sherman, who was from Connecticut, â€œmoved to insert after the words â€˜coin moneyâ€™ the words â€˜nor emit bills of credit, nor make any thing but gold & silver coin a tender in payment of debtsâ€™,â€ thus, as they said, â€œmaking these prohibitions absolute, instead of making the measures allowable (as in the XIII article) with the consent of the Legislature of the U.S.â€
Nathaniel Gorham â€œthought the purpose would be as well secured by the provision of article XIII which makes the consent of the General Legislature necessary, and that in that mode, no opposition would be excited; whereas an absolute prohibition of paper money would rouse the most desperate opposition from its partizans.â€
To the contrary, Roger Sherman â€œthought this a favorable crisis for crushing paper money. If the consent of the Legislature could authorise emissions of it, the friends of paper money, would make every exertion to get into the Legislature in order to licence it.â€
Eight states voted for the absolution prohibition against states issuing bills of credit. One voted against it, and the other state whose delegation was present was divided. The prohibition, as voted, became a part of the Constitution.
Paper Money Rejected
Three other points may be appropriate. The first has to do with any argument that there might be an implied power for the United States government to issue paper money since it is not specifically prohibited in the Constitution. Alexander Hamilton, the man credited with advancing the broad construction doctrine, maintained the opposite view in The Federalist. While he was making a case against the adding of a bill of rights, his argument was meant to have general validity. He declared that such prohibitions â€œare not only unnecessary in the proposed Constitution but would even be dangerous. They would contain various exceptions to powers which are not granted; and, on this very account, would afford a colorable pretext to claim more than were granted. For why declare that things shall not be done which there is no power to do.â€ In short, the government does not have all powers not prohibited but only those granted.
Second, this point was driven home by the 10th Amendment when a Bill of Rights was added to the Constitution. It reads, â€œThe powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.â€ The power to emit bills of credit or issue paper money was not delegated to the United States. More, it was specifically not delegated after deliberating upon whether to or not. The power was prohibited to the states. The logical conclusion is that such power as there may be to emit bills of credit was reserved to the people in their private capacities.
And third, not one word has been added to or subtracted from the Constitution since that time affecting the power of government to emit bills of credit or issue paper money.
Since the United States is once again in the toils of an ongoing monetary inflation, it is my hope thatthis summary review of the experience, words, and deeds of the Founders might shed light on some of the vexing questions surrounding it.