Are you aware that a Federal Reserve dollar bill is not a constitutional dollar? Perhaps you are, but if so, do you know what a constitutional dollar literally is? Is it gold? Is it silver? Is it both? What is actually meant by a metal standard? Can the United States or any country be on two standards at the same time? Can two metals circulate as coin if there is but one standard? Or does one metal have to drive the other out of circulation? How and why does Gresham’s law work when a country uses metal coin for money? In what ways are certain statements of Gresham’s law misleading?

Sooner or later, if and when the power of the Federal Reserve over money is revoked in a constitutional manner, and if and when constitutional coin comes back into use, these questions will need to be asked, answered, and understood. That is what this article does in a compact fashion.

In his meticulously researched two-volume work, Pieces of Eight, constitutional lawyer Edwin Vieira Jr. shows beyond any doubt that the constitutional dollar in the United States is an “historically determinate, fixed weight of fine silver.” The Coinage Act of 1792 is but one source among many that makes this evident, reading,

“the money of account of the United States shall be expressed in dollars or units … of the value [mass or weight] of a Spanish milled dollar as the same is now current, and to contain three hundred and seventy-one grains and four sixteenth parts of a grain of pure … silver.

The United States has a legal and constitutional silver standard, although we would not know it today, since the government has illegally and unconstitutionally removed silver as currency and replaced it with the Federal Reserve notes that we know as dollar bills. The term “dollar bills” obscures the actual and tangible meaning of “dollar” as a specific weight of silver.

The United States has historically minted gold coins as well as silver coins, as the constitution instructed. It regulated their “value,” the weight of gold they contained, in order to bring the meaning of a gold dollar into conformity with the silver standard coin, which contains 371.25 grains of pure silver. This too was constitutionally mandated. The government did the same for foreign coins up until 1857.

The United States never was or could be constitutionally on a dual standard or a gold standard. It circulated silver and gold coins as media of exchange by adjusting the content of the gold dollar to a silver-standard dollar. For example, the Coinage Act of 1792 authorizes “Eagles — each to be of the value of ten dollars or units [i.e., of ten silver dollars], and to contain two hundred and forty-seven grains, and four eighths of a grain of pure … gold.” Since the dollar contained 371.25 grains of silver, this brought into legal equivalence 3712.5 grains of silver and 247.5 grains of gold. The ratio was 1:15.

In the Coinage Act of 1834, Congress adjusted the gold eagle: “Each eagle shall contain two-hundred and thirty-two grains of pure gold.” This brought into legal equivalence 3712.5 grains of silver and 232 grains of gold. The ratio was 1:16. The reason for the change was that gold had appreciated in market value relative to silver.

Old coins could be brought in and reminted for free (after waiting 40 days.) If old coins were not reminted, they were to be accepted as payments “at the rate of ninety-four and eight-tenths of a cent per pennyweight.” The weights of the earlier and later eagles were influenced by a change in the standard gold alloy. The rate of 94.8 cents per pennyweight took that change as well as the alteration in the pure gold content into account, so that payments made in either the old or the new coins became very nearly equivalent in terms of the amounts of pure gold being paid.

With this as an introduction, let us go on to an explanation of Gresham’s law and the reason why Congress was constitutionally mandated to make such adjustments in the weight of gold in the gold-dollar coin.

Suppose that the dollar is defined as a unit that contains 371.25 grains of silver, and suppose that the unit is physically identified with a specific silver coin that contains that mass of silver. Since grains are unfamiliar units, let us use ounces. Let us note that There are 480 grains in one troy ounce. Hence, 371.25 grains weighs 0.7734375 oz. That is to say that if a silver-dollar standard is officially and constitutionally instituted, with each dollar having the mass of 371.25 grains of silver, this means that the dollar is defined as containing 0.7734375 troy ounces of silver.

In all nonfraudulent exchanges involving dollars, someone who pays or receives a dollar is supposed to pay or receive that mass (or loosely weight) of silver in coin or its equivalent in bullion (bars or ingots). The dollar sign, “$,” in such a regime means 1 silver dollar of the official weight of 0.7734375 troy ounces of pure silver. The word “dollar” means the silver coin of that specific mass.

A standard is something that is unchanging. A yard always has 36 inches. A pound always has 16 ounces. A standard, constitutional dollar always has the same amount of the metal that is chosen as its definition, until the constitution is amended to alter the standard, or unless the constitution allows the legislature to alter the standard.

Economically, there can only be a single such standard dollar at a time. One cannot simultaneously have the dollar mean a certain amount of silver and another amount of gold. An economy cannot have two concurrent and different standards of the dollar. The reason for this is that, as will now be discussed, the relative prices of any two metals fluctuate over time.

The exchange rates of gold for silver vary over time due to the changing supplies and demands for these metals in markets. At one time, 1 oz of gold may exchange for 16 oz of silver, while at another time it may exchange for 25 oz of silver. These fluctuations go on unceasingly.

If an attempt is made to define a dollar by two standards simultaneously, it will fail. If a dollar is made to be 1 oz of gold and also 16 oz of silver, what is a dollar when those metals no longer exchange at that ratio? What is a dollar when they exchange at 1 oz of gold to 25 oz of silver? There is no answer. There is no answer because the dollar cannot simultaneously be two different weights of two different metals whose rates of exchange vary over time. One or the other of the two metals has to be chosen as a standard.

Fluctuations occur in the market even if the government sets an official rate of exchange between the two metals, which is what was done in the various coinage acts. The government can attempt to force a given exchange rate, but this will not alter the fact that the market exchange rate departs from the forced exchange rate. The result of a discrepancy between legal and market rates of exchange will be that one of the metals will disappear from circulation. That result comes under the heading of Gresham’s law in operation.

There are two ways that the government can, without the direct use of force, keep both silver and gold circulating as money even if only one of them is the standard. One way is to regulate the value of the official gold dollar as time passes, which means to change the official rate of exchange between gold and silver in order to bring it into accord with the market rate of exchange. That is what the coinage acts did.

The other way is to avoid using a gold dollar altogether and produce gold coins that have a known weight but no designation as a dollar. The gold coin can “float” or have a changing price against the silver-standard dollar. This method was not used but it could and should be used in the future if and when the constitutional silver dollar is restored as the unit of account.

Let us examine in more detail how a money standard, such as the silver standard, works; and then let us examine Gresham’s law.

Suppose that there is a single silver standard: that of a dollar containing 0.7734375 oz of silver. Suppose also that at some specific time, the price of a troy ounce of gold in terms of silver is $16 in the market. This means that 1 oz of gold exchanges in the market for 16 silver dollars, each dollar containing 0.7734375 oz of silver. That is, 1 oz of gold exchanges for 12.375 oz of silver.

Now suppose that the government issues a gold coin. If an official gold coin is made that says it is a $16 gold coin, stamped literally 16 dollars, it will contain 1 troy ounce of gold, worth exactly $16, that is, worth 16 silver dollars. Suppose that the government goes one step further: it makes this exchange rate the official rate, such that in debt contracts one is permitted to pay either 16 silver dollars or 1 of these gold coins.

The official exchange rate is 1/16 oz of gold per silver dollar. The silver standard and accompanying law make silver a legal payment or legal tender in debt contracts, unless perhaps the private parties to the contract are allowed to specify otherwise. With gold’s price officially fixed at 1 oz per 16 silver dollars, then gold at that price is also a legal tender in payment of debts. The government in this example is attempting to keep both gold and silver in circulation by making the official rate the same as the market rate.[1]

In the unlikely case that the market price of gold remains at $16 indefinitely, this gold coin provides a substitute or equivalent to the silver standard, even though there is but a single standard. If this market ratio prevails through time, staying at the official rate, there is no real difference between gold and silver for payment purposes. In this situation, one can think in terms of either a silver or a gold standard, even though there is really only a single standard. There is no significant difference.

However, this situation never actually occurs. Market prices do change. A single standard then becomes essential in an economic sense if the dollar is to retain a clear definition as a standard. The silver standard fixes the dollar at 371.25 grains of silver, no matter what happens to the market price of gold in terms of silver. If the relative prices of silver and gold change, that shows up in a change solely in the price of gold. This will make the “16 dollar” designation on the gold coin obsolete from a market point of view, but not from an official point of view.

This disparity will set in motion certain events that we now look into. These events are certain to occur because the discrepancy between the market and official rates will create a profit incentive.

Consider two examples in which the market prices deviate from the official exchange ratio. The first example occurs when gold rises in price relative to silver. Suppose that 1 oz of gold becomes able to buy 20 silver dollars in the market. The market exchange ratio becomes 0.05 oz of gold per silver dollar, while the official rate is still 0.0625 oz of gold per silver dollar. The gold piece becomes more valuable. An ounce of gold now exchanges for 15.46875 oz of silver, which is the amount of silver in 20 silver dollars. At the official rate, it exchanges for only 12.375 oz of silver.

Now we explore the profit opportunity that lies at the heart of Gresham’s law: If someone owes 16 dollars and can pay in either silver or gold coins, which will they chose? Will it be silver or gold? Intuitively, one pays with the less expensive metal, which is silver. One holds gold off the market and instead uses silver for payments. The more expensive metal disappears from circulation as money or coin, although it will continue to be used for jewelry, teeth, and industrial applications.

The official contractual rate in debt contracts calls for either 16 silver dollars or 1 gold coin. But 1 gold coin now exchanges for 20 silver dollars in the market. If a person possesses 1 gold coin, he can buy 20 silver dollars in the market by ignoring the official rate of exchange. He can then pay the debt with 16 of these silver dollars and have 4 silver dollars left over. This is clearly preferable to paying out the entire gold coin to satisfy the debt, since he gets rid of the debt and still has 4 dollars left over. Hence, he will pay at the official rate in silver dollars, not in gold coins.

This situation contains a risk-free arbitrage (or profit) opportunity. Exploiting it drives gold out of circulation as money. For example, suppose a person starts by borrowing 1 gold coin. He then buys 20 silver dollars and keeps 4 of them. He then repays the loan of the gold coins with 16 silver dollars, since they are legal tender. He can repeat this operation again and again to augment his pile of free silver. This is a money machine — a risk-free arbitrage — in which one party gains and the other loses.

The lender of gold coins is obeying the law by honoring the official exchange rate, but he is losing on this deal since the 16 silver dollars that he is repaid cannot buy 1 gold coin in the market. He will stop lending gold coins. He will put an end to the money machine. This is why finance theories typically assume that assets are priced so as to preclude risk-free arbitrage opportunities.

Let us think of this in another way, which is in terms of exchange rates. An exchange rate when silver is the standard is expressed as a number of ounces of gold per silver dollar. When gold appreciates in price relative to silver, the exchange rate falls. That is, less gold is required to exchange for each silver dollar. In the example above, one can satisfy the debt at the official exchange rate of 0.0625 oz of gold per silver dollar, whereas the silver dollar fetches only 0.05 oz of gold in the market. Silver that is used to extinguish debt has a greater value than silver that is used to buy gold in the market as coin. Therefore, silver will be used for payments of debt and all other exchanges, not gold.

The result of gold having appreciated in price relative to silver and thus of the market rate of exchange of gold for silver having fallen below the official rate of exchange (0.05 oz of gold per silver dollar as opposed to 0.0625 oz of gold per silver dollar) is that gold will disappear from circulation as payments. This is an example of Gresham’s law.

When two metals are legal tender at an official rate of exchange and one metal’s market price increases, that metal (here gold) will disappear from circulation as money. Gresham’s law is an application of the idea that money machines do not exist in equilibrium, that there is no free lunch, and that risk-free arbitrage opportunities do not exist in equilibrium.

There is another way of describing what happens when gold appreciates in price relative to silver, but the official rate is lower: One could say that the official exchange rate undervalues gold. The undervalued metal disappears from circulation.

This language is misleading and confusing, however. Is silver overvalued? It seems natural to conclude that silver is overvalued if gold is undervalued. However, silver is not overvalued. Silver cannot possibly be overvalued because it is the standard being used to define the dollar.

Despite the very great drawback introduced by the terms “undervalued” and “overvalued” in this context, they have been common in debates on bimetallism. These terms have contributed to confusion, erroneous analysis, and policy blunders with costly consequences, because they obscure the reality that one metal is always the standard. In the United States, that constitutional metal has always been silver.

One also hears Gresham’s law stated as “bad money drives out good.” This too is misleading, confusing, and erroneous. In the example of gold appreciating and disappearing, silver is by no means “bad money,” nor is gold “good money.” There is no good and bad money at all. Silver is the metal being used as the standard. It has not driven gold or good money out of circulation. The fixed exchange rate of gold set at too high a level compared to the going market rate has driven gold out of exchange.

For completeness, we consider the opposite case in which gold depreciates relative to the silver standard. Suppose that the market exchange rate rises from 0.0625 oz to 0.076923 oz of gold per silver dollar, which means that one ounce of gold now trades for 13 silver dollars. Suppose that a debt of $16 is to be paid. A person can pay in either silver or gold dollars. This again requires 1 gold coin at the official rate. The cost of that coin in the market is 13 silver dollars. If one had 16 silver dollars, one could use 13 of them to buy 1 gold dollar in order to pay off the debt. One would then have 3 silver dollars left over. Therefore, it’s less expensive to pay the debt with gold.

Gresham’s law again goes to work. Silver disappears from circulation. When two metals are legal tender at an official rate of exchange and one metal’s market price depreciates in terms of the metal used as a standard (silver), that depreciated metal (gold) will circulate, and the other metal (silver) will disappear from circulation as a medium of exchange while maintaining its role as a medium of account.

In practice, a rather small depreciation of gold (1–3 percent) is enough to cause silver coins to disappear from circulation. Suppose we start with an official and market ratio of silver to gold at which there is the equivalent of 0.05 oz of gold in one silver dollar. This means that 1 silver dollar buys exactly $1 worth of gold at the official and market rate, and that 20 silver-dollar coins buy 1 gold coin that weighs 1 oz and is worth 20 times as much as the silver in one silver dollar.

Suppose now that the market price for gold declines such that 0.051 oz of gold buys 1 silver dollar. This is a 2-percent increase in the market exchange ratio. At the official exchange rate of 20 silver dollars per gold coin, the 0.051 oz of gold is worth 0.051 × 20 = $1.02 (i.e., 1.02 silver dollars.) If a person had to pay $1, it would be better to pay it in the less-expensive metal (here gold), at the official rate of 0.05 oz of gold per dollar. People will thus tend to use gold for exchanges and hold silver off the market.

If small changes drive one metal or the other out of circulation, the government has to adjust the official exchange rates frequently if both are to be kept in circulation. This is both costly and inconvenient. The solution to this is straightforward. Choose one metal as a standard and allow the price of the other metal to fluctuate freely or float in the market.

If silver is the standard, then gold coins can be minted with no dollar designation at all. They can be minted with the weight of pure gold shown. Then when they are used as payments or used as a basis for issuing e-credits or gold certificates, their weights can be used in conjunction with the changing price of gold to gauge appropriate payments and receipts.

Frequently Asked Questions

Q: What is a constitutional dollar literally (in the United States)?

A: It is a silver coin containing 371.25 grains (0.7734375 troy ounces) of pure silver.

Q: Is a gold standard constitutional?

A: No, not for the United States as the constitution is written. It should be noted, however, that individual states have a constitutional power to make specie (silver, gold, or both) legal tender.

Q: What is meant by a metal standard?

A: It means a monetary unit that contains a specific weight of metal.

Q: Can the United States or any country be on two metal standards at the same time?

A: No, this will be impracticable because of the continual changes in relative prices of any two metals.

Q: Can two metals circulate as coin if there is but one standard?

A: Yes. The metal that is not the standard can circulate as a coin of a given weight of that precious metal whose value at any given time is determined by reference to market prices. Such a coin need not carry any specific dollar designation. This obviates Gresham’s law.

Q: Does one metal have to drive the other out of circulation?

A: No. As long as the metal that is not the standard is not legally made to exchange at a fixed ratio to the standard metal, both metals can circulate just as silver and gold both trade in today’s markets. Gresham’s law will not come into play.

Q: How and why does Gresham’s law work when a country uses metal coin for money?

A: Gresham’s law takes hold when the government fixes an exchange rate between two metals. When the market rate of exchange deviates from the fixed rate, arbitrage opportunities arise that make it profitable to use the less-expensive metal as means of payment at the official rate. Then the more-expensive metal disappears from circulation as a medium of exchange.

Q: What is an accurate rendition of Gresham’s law?

A: When two metals are legal tender at an official rate of exchange and when one metal’s market price appreciates in terms of the metal used as a standard, the appreciated metal will disappear from circulation as money and the metal used as a standard will circulate. Conversely, when two metals are legal tender at an official rate of exchange and one metal’s market price depreciates in terms of the metal used as a standard, the depreciated metal will circulate; the metal used as a standard will disappear from circulation as a medium of exchange, although it is still the medium of account.

Put more simply, when two metals are legal tender at a fixed, official rate of exchange, the metal that is less expensive at the market rate of exchange will tend to circulate for payments while the more expensive metal will tend to disappear as a medium of exchange.

Michael S. Rozeff is the Louis M. Jacobs Professor of Finance at the University at Buffalo.

Copyright, Mises Institute, printed under the Creative Commons License, 3.0

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, “No State shall . . . emit Bills of Credit . . . .” 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, “No State shall . . . make any Thing but gold and silver Coin a Tender in Payment of Debts . . . .” 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 “In the internal administration of the States, a violation of contracts had become familiar, in the form of depreciated paper made a legal tender . . .” 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 “the havoc of paper-money had not been foreseen.”

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 state’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 “could see neither the necessity nor propriety of such a measure. They are not unapprized of the meeting, and can attend if they choose.” And, to clinch his argument, he proposed that “Rhode Island might as well be urged to appoint & send deputies.” No one rose in defense of an undertaking of that character.

The ill repute of Rhode Island derived mainly from that state’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 “legislature passed an act declaring that anyone refusing to take the money at face value would be fined £100 for a first offense and would have to pay a similar fine and lose his rights as a citizen for a second.” 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 Founders’ 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, “the country was prosperous . . . . Paper money seemed to be the ‘poor man’s friend’; 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.”

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.

Runaway Inflation

By 1779, the inflation was nearing the runaway stage. “In 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.” “Our dollars pass for less this afternoon than they did this morning,” people began to say. George Washington wrote in 1779 that “a wagon load of money will scarcely purchase a wagon load of provisions.” 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 “that 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.” A contemporary historian concluded that the “evils which resulted from the legal tender of the depreciated bills of credit” extended much beyond the immediate assault upon property. “The iniquity of the laws,” he said, “estranged 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 . . . ”

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 Morris’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 place—monetary inflation—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 “moved to strike out ‘and emit bills on the credit of the United States’.” That is, he proposed to remove the authority for the United States to issue such paper money. “If the United States had credit,” Morris said, “such bills would be unnecessary: if they had not, unjust & useless.” His motion was seconded by Pierce Butler of South Carolina.

James Madison wondered if it would “not 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.” (Madison’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 Madison’s objection was overcome, as we shall see.)

Gouverneur Morris then observed that “striking 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.”

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 “was for striking out, without inserting any prohibition. If the words stand they may suggest and lead to the measure.”

Not everyone who spoke, however, favored removing the power. George Mason of Virginia “had 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.”

Nathaniel Gorham tried to reassure Mason and others who might have similar doubts by declaring that “The power so far as it will be necessary or safe, is involved in that of borrowing.”

Both Positions Argued

On the other hand, John Francis Mercer of Maryland announced that he “was 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.”

Oliver Elsworth of Connecticut pronounced himself of the opposite view. He “thought 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.”

Edmund Randolph of Virginia still had doubts, for he said that “notwithstanding 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.”

James Wilson of Pennsylvania favored removing the power: “It 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.”

Pierce Butler “remarked that paper was a legal tender in no country in Europe. He was urgent for disarming the Government of such a power.”

George Mason, however, “was 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.” 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 “thought the words, if not struck out, would be as alarming as the mark of the Beast in Revelations.” John Langdon of New Hampshire “had rather reject the whole plan [the Constitution] than retain the three words,” by which he meant “and emit bills.”

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 “became 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.”

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, “moved to insert after the words ‘coin money’ the words ‘nor emit bills of credit, nor make any thing but gold & silver coin a tender in payment of debts’,” thus, as they said, “making these prohibitions absolute, instead of making the measures allowable (as in the XIII article) with the consent of the Legislature of the U.S.”

Nathaniel Gorham “thought 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.”

To the contrary, Roger Sherman “thought 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.”

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 “are 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.” 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, “The 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.” 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.

The financial panic that has engulfed the planet is considered by politicians, bureaucrats, journalists and mainstream economists to be a problem of regulation. I find myself in the uncomfortable position of having to agree with this gang of opinion makers, but it is not a problem of insufficient regulation, inadequate regulation, unenforced regulation, out-dated regulation, or anything of the kind.

The problem is with regulation itself. With regard to financial markets, government regulates everything. There is the Federal Reserve that regulates the money supply, interest rates and everything else. There is the Treasury with its array of regulatory powers.

There is the Comptroller of the Currency, the Securities and Exchange Commission, the Federal Deposit Insurance Corporation, and the Federal Home Loan Bank Board. Government has multiple layers of regulators concerning mortgages, financial institutions, and stock markets.

I have taught money and banking and was formerly the Assistant Superintendent of Banking in the state of Alabama and I can not think of a single thing related to this financial crisis that is not regulated.

Government regulation is the problem. Since going off the gold standard in 1971 we have experienced a series of bubble and bust cycles in the economy and each time the crisis has been dealt with bailouts, more regulations, and loosening of gold standard era constraints. The money supply as measured by M2 had long been just a couple of hundred billion and is now approaching $8 trillion dollars and we supposedly are still suffering from a lack of liquidity!

The American public once again finds itself playing 3 Card Monty with a dealer who insists we play and tells us that we cannot lose. We will put our bailout money down on the table, we will be reassured that we cannot lose (with more government regulation and “oversight”), the Fed will inject more fiat money and when the cups are turned we will all have our wealth ripped off.

What the American public needs to be told is that the crisis is actually the market trying to reestablish some rational order in the economy beset by regulation. It is the market that is tearing down these mega financial firms and disposing of the crazy financial products that they created. It is the market that is punishing those who grew rich on paper money schemes, derivatives, sub prime mortgages, and hedge funds. These are the same people the taxpayer is being asked to bail out–Wall Street fat cats.

What the American public needs to hear is that regulation is the problem and that the “unfettered market” is the only way to break out of the business cycle. All that is required is a gold coin system of money and for the rule of law to be applied to banking whereby demand deposits are held as reserves in the bank. The economics of gold would regulate the money supply and the interest rate would regulate the amount of demand and time deposits as well as borrowing and lending. No government regulation is required. There is no systemic or macroeconomic risk and the market eliminates the business cycle.

The only requirement is the legal recognition of the statement in the US Constitution that gold and silver are money. The market can handle everything else.

Recently Congress sent the latest Farm Bill to the president. The bill features brand new federal programs, expansion of existing subsidies, more food stamps and more foreign food aid. This bill hits the taxpayer hard, while at the same time ensuring food prices will remain elevated. The president vetoed the bill, citing concerns over its costs and subsidies for the wealthy in a time of high food prices and record farm income. Nevertheless, this over-reaching, government-expanding Farm Bill will soon be law.

The truth is most farmers simply want honest pay for honest work. However, if the government is providing competing farms with advantages, and one wants to remain a farmer, one must seek a proportional advantage from government. It is a difficult position for the farmer. Some are better at qualifying for taxpayers’ largesse than others as evidenced by the fact that more than 60% of the subsidies go to just 10% of recipients, edging out the small family farm. This entire system is unfair and demoralizing. It disproportionately benefits big agribusiness at the expense of struggling family farms.

Third world countries also lose with these continued government manipulations. Agricultural subsidies lead to overproduction, which leads to foreign food aid as a form of dumping. By “dumping” government-created agricultural surpluses, agrarian economies are artificially kept in a constant state of economic depression. The would-be third world farmer cannot compete with “free” grain, thus he and his countrymen remain perpetual beggars rather than competitive producers. Also, by keeping food prices high, we keep more of our own citizens dependent on government food stamps, instead of paying fair market prices for food.

Free trade helps farmers and consumers much more than this convoluted system of subsidies, surpluses and central planning. Newly opened markets would create increased demand for what we produce. There is absolutely no reason we trade with China , yet not with Cuba . With energy and transportation prices as high as they are, opening up trade with a country as close as Cuba just makes sense. The recent power shift from Fidel Castro to his brother Raul, and the somewhat positive steps he has taken, provides an opportunity to lift the embargo.

Removing unreasonable, confiscatory tax policies would also make good farm policy. We need to permanently repeal the estate tax, which would again take a devastating 55% cut of family farms upon death of an owner. This tax will force the sale of many family farms, and further huge corporate agriculture.

Those who believe federal farm programs benefit independent farmers, should take note that after 70 years of this type of government intervention, small farms continue to struggle while large corporate farms control an ever-increasing share of the agricultural market. Subsidies for agribusiness should be stopped and the free market should be allowed to work. With commodity and food prices on the rise, Congress had an opportunity to scale down government controls and taxpayer funding of agriculture. Instead, despite the warning sent by an 18% approval rating, Congress stubbornly opted for more of the same.

Ron Paul is a republican member of Congress from Texas.