us dollar currency union

American Economic Association

Creating the U.S. Dollar Currency Union, 1748-1811: A Quest for Monetary Stability or aUsurpation of State Sovereignty for Personal Gain?Author(s): Farley GrubbReviewed work(s):Source: The American Economic Review, Vol. 93, No. 5 (Dec., 2003), pp. 1778-1798Published by: American Economic AssociationStable URL: http://www.jstor.org/stable/3132152 .

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Creating the U.S. Dollar Currency Union, 1748-1811: A Quest for Monetary Stability or a Usurpation of State

Sovereignty for Personal Gain?

By FARLEY GRUBB*

The desirability of politically creating currency unions among otherwise sovereign states is an ongoing debate. A key backdrop in this debate is the supposed empirical success of the U.S. dollar currency union. The fact that otherwise sovereign states within the United States are not constitutionally allowed to issue their own currency, thus creating a single currency for the whole United States-the U.S. dollar- is the archetype that underlies many policy choices and recommendations, such as the creation of the European currency union and the condemnation of the separate currencies issued by individual states within Argentina during their recent crisis.

The benefits of the U.S. currency union and, by analogy, the benefits of other politically manufactured currency unions are assumed to be obvious, namely a reduction in monetary

* Department of Economics, University of Delaware, Newark, DE 19716 (e-mail: [email protected]). Sup- port from the Financial Institutions Research Center at the University of Delaware is gratefully acknowledged. Earlier versions were presented at Rutgers University; UCLA; Uni- versity of Colorado; University of Delaware; University Lumiere Lyon 2; University of Maryland; University of Mississippi; the 2000 meeting of the Southern Economic Association, Alexandria, VA; the 2000 meeting of the So- cial Science History Association, Pittsburgh; the 2001 meeting of the Allied Social Science Association, New Orleans; the 2001 Conference "L'Euro et la Pacification des Rela- tions Monetaires Internationales," Lyon, France; the 2001 Conference "Conflict Potentials in Monetary Unions," Kas- sel, Germany; and the XIII Economic History Congress, Buenos Aires, Argentina, 2002. The author thanks the participants of these seminars and conferences, and Burt Abrams, Stacie Beck, David Cowen, Eleanor Craig, Ken Koford, Ronald Michener, John Murray, Laurence Seid- man, Bruce Smith, Ned Stinson, David Stockman, Richard Sylla, Robert Wright, and the referees of this Journal for helpful comments on earlier versions. The author gives special thanks to James Butkiewicz, Leslie Goldstein, Ed- win Perkins, Rene Sandretto, Lorena Walsh, and Marc Weidenmier for encouragement and assistance regarding sources and methods. Mark Mylin, Anne Pfaelzer de Ortiz, and Lisna Utami provided research and Anne Pfaelzer de Ortiz provided editorial assistance.

instability and exchange rate transaction costs within the union thereby stimulating long-run economic growth. These alleged benefits for the United States, however, are not derived from market evidence, but from simple theoretical assertions and from a literature that takes as fact the rhetoric of the winning side at the U.S. Constitutional Convention. Independent of the- ory and rhetoric, little is known about how and why the U.S. currency union was created, or about whether it improved macro performance.

These deficiencies are addressed here. Prices indices, exchange rates, and market-generated transaction data from 1748 through 1811 are used to determine when the market moved from state currencies to the U.S. dollar and to assess the nonwartime performance of prices, exchange rates, and purchasing power parity before versus after this transition. This evidence suggests that the U.S. currency union had more to do with usurpation of state sovereignty by rent-seeking bankers than with solutions to monetary instability and transactions costs.

I. Colony/State Monetary Regimes Before 1787

Three years after the Treaty of Paris ended the Revolution, the Founding Fathers crafted a new constitution that included the clause "No State shall ... coin money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts ..." (Article 1, Sec- tion 10). This clause supposedly created a currency union within the United States. After 1787, states could no longer issue their own bills of credit (paper money).1 To comprehend

1 The Constitution also forbade the federal government from issuing paper money. At the Convention, the Consti- tution's construction was such that any powers not explicitly granted to the federal government were denied to it, and any powers not explicitly denied the states were granted to them. This construction explains the Constitution's brevity.

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GRUBB: CREATING THE U.S. DOLLAR CURRENCY UNION

why the Founding Fathers did this, we need to understand the prior monetary regime-for this clause not only unified the currency but also fundamentally altered the country's monetary system. The supposed failure of the prior monetary system is the reason most often given for why the Founding Fathers constitutionally banned its continued use.

The British North American colonies were the first modem western economies to experiment with large-scale government issuance of fiat paper money.2 Colonial legislatures directly issued bills of credit to pay for their government's expenses and as mortgage loans to subjects who pledged their lands as collateral. These bills were not government bonds. Typi- cally, they earned no interest, came in small denominations, circulated at market-determined rates of exchange to specie (gold and silver coins) and the paper monies of other colonies, and were accepted by the issuing government in payment of that government's fees and taxes. Colonial governments never redeemed on de- mand their paper money for specie nor entered the market at their discretion to buy and sell their paper money for specie to defend a fixed exchange rate. These bills circulated inside, but not outside, the colony of issue as cash alongside specie monies-which only entered and exited the colony through merchant foreign trade and government transfers. Payments to parties outside the colony were in specie units.

Typically, colonial bills of credit were denominated in pound units, e.g., New York pounds and so forth, and were not legal tender for all debts. However, because they were always, explicitly by law, accepted in payment for the issuing government's taxes at an announced rate relative to pound sterling, they were de facto legal tender for public debts. This, in turn, provided the anchor that allowed the bills to

The proposal to allow the federal government to issue bills of credit by inserting such a clause into the Constitution was debated and explicitly voted down by the delegates (Max Farrand, 1966, Vol. 2, pp. 308-10). Mary M. Schweitzer (1989, p. 311); Arthur J. Rolnick et al. (1993, p. 3); and Ben Baack (2001, p. 653) mistakenly claim the opposite.

2 The first was Massachusetts in 1690, then South Caro- lina in 1703, New York and New Jersey in 1709, Rhode Island in 1710, North Carolina in 1712, Pennsylvania in 1723, Maryland in 1733, and Georgia in 1735. The last was Virginia in 1755. Massachusetts reverted back to a specie- only monetary system after 1748 (Leslie V. Brock, 1975).

circulate as cash within that colony. By the middle of the eighteenth century, these bills comprised a substantial portion of the money supply within their respective colonies. For example, Pennsylvania pounds accounted for roughly 78 percent of currency transactions in Pennsylvania between the Seven Years' War and the Revolution (Grubb, 2002a). They were so extensively used within that colony that the legislature had to pass, and frequently renew, an act authorizing the exchange of "torn or ragged" bills for new bills (Statutes at Large of Penn- sylvania, Vol. 4, pp. 203, 414; Vol. 5, pp. 48, 60, 192; Vol. 7, p. 204, various years). Prices within each colony were typically quoted in their respective paper currencies.

Colonial legislatures backed their paper money by linking it not to specie but to future taxes and mortgage payments designed to withdraw it from circulation in a timely fashion. Upon redemption, it was burned. Each colony maintained the market value of its paper money through its timely injection and then redemption-thereby controlling the quantity of paper money in circulation. The presence of competitive currency substitutes (specie) constrained colonies to fol- low a stable path with regard to the relative value of their paper monies (Grubb, 2002b).

The early experiments with paper money were not all successful. The South Carolina pound in the late 1720's and the Massachusetts pound in the 1740's suffered substantial depre- ciation. The British Crown's response to the Massachusetts crisis was the Currency Act of 1751 which allowed colonies to issue paper money as long as it met two conditions: (1) that it not be legal tender, and (2) that ample provi- sions (taxes) be put in place to redeem each issue "within as short and reasonable a time as may be, not exceeding five years at the farthest" (Danby Pickering, 1765, Vol. 20, pp. 306-09). This Act only applied to New England, but was later extended to all colonies by the Currency Act of 1764. Some colonies, such as Maryland, Pennsylvania, and New York, had instituted such policies on their own accord well before 1760. After 1748, only Massachusetts re- nounced paper money and returned to a specie standard for the rest of the colonial period. By 1748, colonial legislatures had learned, for the most part, how to handle their tax-backed paper money regimes (Kathryn L. Behrens, 1923, pp. 12-58; Richard Lester, 1938, p. 372; 1939, p. 207;

VOL. 93 NO. 5 1779



THE AMERICAN ECONOMIC REVIEW

Brock, 1975, pp. 70, 496-508, 524-27; Bruce Smith, 1985; Grubb, 2002b).

This system continued through the Revolu- tion. The Articles of Confederation allowed both individual states and the Continental Con- gress to issue their own tax-backed paper money. Beginning in 1775 the Continental Con- gress issued bills of credit-Continental dollars- that depreciated to zero by April of 1781 and ceased thereafter to circulate. Without the power to levy its own taxes, Congress under the Arti- cles could not credibly commit to redeeming its bills of credit. Each of the 13 states also issued their own paper currencies that, while also depreciating, held their value to a greater extent than did the Continental dollar (B. U. Ratchford, 1941, pp. 33-37; Pelatiah Webster, 1969, pp. 501-02; Donald R. Adams, Jr., 1986, pp. 626-27). After the Treaty of Paris, 7 of the 13 states-Pennsylvania, North Carolina, and South Carolina in 1785; Rhode Island, New York, New Jersey, and Georgia in 1786- returned to issuing their own paper money us- able, as during the colonial period, to pay taxes levied and land mortgages held by the issuing state. In addition, state legislatures in Virginia, Maryland, and Massachusetts were debating whether to issue new bills of credit, but failed to do so before the new Constitution banned such emissions.

Colonial/state legislatures engaged in active monetary policy. First, they understood that creating an "inside" paper money freed them from having to import specie to be used as a medium of exchange within the colony. This specie could then be used to purchase imported goods, which in turn increased the colonists' real income (Pennsylvania Archives, 8th Series, Vol. 4, 1931, p. 3284). Second, they understood seignorage. And the income earned from paper money issued as land-mortgage loans was by itself an important source of government revenue. Third, they understood that foreign trade flows, and thus the inflow and outflow of specie, experienced unpredictable swings of substantial and unsynchronized magnitudes. For example, Benjamin Franklin stated that, "Pennsylvania, before it made paper money, was totally stript of its gold and silver..." (Arthur Nussbaum, 1957, p. 27). As such, if the colony's money supply were imported specie coins only, then the colony would be exposed to excessive short- run price swings. Fourth, they understood that

desired levels of emergency wartime spending could not be met from current tax receipts or foreign borrowing. It could only be met by issuing bills of credit.

Finally, they used the ability to issue and redeem bills of credit as an active monetary policy for ameliorating the short-run effects of macro-trade shocks (Lester, 1938, 1939; Joseph Albert Ernst, 1973, pp. 197-350; Margaret Ellen Newell, 1998). For example, the Pennsyl- vania legislature reacted to the 1772 British credit crisis by moving from a contractionary to an expansionary paper money policy (Grubb, 2002b), and Franklin observed that the injection of paper money "gave new life to business" and "promoted greatly the settlement of new land" (Nussbaum, 1957, p. 27). Likewise, immedi- ately after the Revolution, states that issued new bills of credit were clearly engaged in active monetary policy intended to affect their state's economy. By replacing old bills issued during the Revolution that were now being rapidly taxed out of circulation with new bills, these states ameliorated the circulating-medium scar- city within their borders (Terry Bouton, 1996; George David Rappaport, 1996).

This colonial/state monetary system was fundamentally different from what developed post- 1787. Colonial legislatures exercised direct control over the nonspecie monetary base in a small open economy with a floating exchange rate between paper (inside) money and specie (outside) money. There was also no intervening money multiplier via a banking system to dilute this control.3

3 This colonial/state monetary system is not purely ar- chaic. It resembles one of the monetary/fiscal systems proposed by Milton Friedman (1948). It also resembles the system adopted by states within Argentina in response to Argentina's recent currency crisis. Individual Argentine states issued their own paper currency backed by their own state's future taxes, such as the Patacon 2 issued by the Provincia De Buenos Aires. The Patacon 2 says, "... [the Patacon 2] will have an expiration of a maximum period of FIVE (5) years counted from the date of emission ..." and that "... tender of the 'Patacon 2' will be applicable, at the nominal value, for payment of obligations to the Province of Buenos Aires..." (Patacon note B44266921 translated by Anne Pfaelzer de Ortiz). Personal conversations with merchants in Argentina indicate that they would generally accept as currency U.S. dollars, Argentine national pesos, and their own state's paper currency (at individually negotiated or market-determined exchange rates), but would not directly accept the paper currency issued by other nearby

1780 DECEMBER 2003




II. Was This Monetary System Such a Disaster That It Had to Be Constitutionally Banned?

Federalist rhetoric is relentless in insinu- ating that colonies/states mismanaged their paper money, that said paper money was inherently unsound and inflationary, and that even if this system somehow worked well before the Revolution, state legislatures, freed from British regulation and increasingly de- mocratized, were prone to mismanage the system after 1783. The following examples are illustrative of this copious body of rhetoric.4 In 1780 Alexander Hamilton claimed, "Paper credit never was long supported in any country ... we have seen the effects of it in America, and every successive experiment proves the futility of the attempt. Our new money is depreciating almost as fast as the old ... ." And in 1790, he argued,

The stamping of paper is an operation so much easier than the laying of taxes, that a government, in the practice of paper emissions, would rarely fail in any such emergency to indulge itself too far, in the employment of that resource, to avoid as much as possible one less auspicious to present popularity. If it should not even be carried so far as to be rendered an absolute bubble, it would at least be likely to be extended to a degree, which would occasion an inflated and artificial state of things ..." (Harold C. Syrett, 1961, Vol. 2, pp. 413-14; 1963, Vol. 7, p. 322).

In 1785, Richard Henry Lee remarked, regarding Virginia's plan to issue new paper money, "... the greatest foes we have in the world could not devise a more effectual plan for ruining Virginia." Also, George Mason remarked, "... the Assembly ... [is] resolved to issue a Pa- per Currency ... perhaps upon the old thread-

Argentine states. This system of separate Argentine state currency is almost identical to that used in the North Amer- ican colonies.

4 For similar comments deriding state paper money by George Washington and General Knox, see John C. Fitz- patrick (1939, Vol. 29, pp. 50-52, 123), and by William Grayson and James Madison, see Robert A. Rutland (1973, Vol. 8, pp. 347, 502; 1975, Vol. 9, p. 154), and footnotes 5 and 16 below. More such comments abound in the literature.

bare Security of pledging solemnly the Public Credit. They may pass a Law to issue it, but twenty Laws will not make People receive it" (W. W. Abbot, 1994, Vol. 3, pp. 144, 347). Webster (1969, p. 295), arguing against Penn- sylvania's new paper money in 1785, concluded that only "the most distressed ... will give good security for bad money." Likewise, Robert Morris asserted that Pennsylvania's new state currency was being "pushed from hand to hand, like the lighted stick in the play of 'Jack's alive, and alive like to be,' each holder fear- ing that it should die in his hands" (Janet Wilson, 1942, p. 20). In 1786, James Madison complained about "... the general rage for paper money. [And that] Pena. and N. Carolina took the lead in this folly" (Rutland, 1975, Vol. 9, p. 94).

At the Constitutional Convention in 1787, George Read stated that allowing governments to issue paper money was "as alarming as the mark of the Beast in Revelations." Oliver Ells- worth "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." John Langdon would "rather reject the whole plan [of government] than allow the government to emit bills of credit" (Farrand, 1966, Vol. 2, pp. 309-10, 439). Fi- nally, in the ratification debates in 1788 Madi- son argued that,

The extension of the prohibition to bills of credit must give pleasure to every citizen in proportion to his love of jus- tice, and his knowledge of the true springs of public prosperity. The loss which America has sustained since the peace, from the pestilent effects of paper money, on the necessary confidence between man and man; on the necessary confidence in the public councils; on the industry and morals of the people, and on the character of Republican Govern- ment, constitutes an enormous debt against the States chargable with this unadvised measure ... (Bernard Bailyn, 1993, Vol. 2, p. 94).

Scholars, to this day, have uncritically accepted this rhetoric as reflecting the factual situation of

VOL. 93 NO. 5 1781




the economy.5 The quantitative evidence, however, tells a different story.

5 Many arguments to explain why state-issued bills of

credit were constitutionally banned have been offered. None are satisfactory. For example, Rolnick et al. (1993) argue that the Constitution banned state-issued paper money to prevent ruinous competition among states in the race to collect seignorage from the citizens of other states. Seignor- age competition, however, was never mentioned before, during, or after the Constitutional Convention (Farrand, 1966; Merrill Jensen, 1976-1978; Bailyn, 1993). There is also no credible quantitative evidence that state currency circulated freely as a medium of exchange within the general population of neighboring colony/states that also issued their own paper money or that colony/states maintained fixed exchange rates for their paper monies (Grubb, 2002a). In addition, the Convention delegates voted not to allow the federal government to issue paper money, which would be inconsistent behavior if seignorage competition across states were the key problem.

Another common argument for creating a currency union- removing exchange rate costs between states-was also not mentioned before or during the Convention, but only during the ratification debates in 1788, and then only once. Madison argued that "Had every State a right [to issue bills of credit] ... there might be as many different currencies as States; and thus the intercourse among them would be impeded..." (Bailyn, 1993, Vol. 2, p. 94). Because every state had the constitutional right to charter banks that issued their own banknote currency that traded at nonuniform discounts off their face value, Madison's transaction cost argument would appear to be disingenuous, though he may not have foreseen the future fully on this issue (Farrand, 1966, Vol. 3, p. 495).

Another argument offered for banning state currency was that it produced "warfare & retaliation among the states" (Rutland, 1975, Vol. 9, p. 95; Schweitzer, 1989, p. 319; footnotes 16 and 17 below). In particular, Rhode Island passed laws that allowed its citizens to pay debts contracted within Rhode Island in Rhode Island state currency. Massachusetts and Connecticut "retaliated" by passing laws that allowed its citizens who owed debts contracted in Rhode Island to also pay in Rhode Island state currency. This episode, however, has been misinterpreted. It was hardly "warfare" between these states. In fact, this behavior was exactly what the Constitu- tion's "Full Faith and Credit" clause would have required the states to do anyway (Article 4, Section 1).

Finally, in the ratification debates in 1788, Madison argued that if states could issue currency then they might also engage in "retrospective alterations in its value ... and thus the citizens of other States be injured ... [and] subjects of foreign powers might suffer from the same ..." (Bailyn, 1993, Vol. 2, p. 94). This concern, however, was already solved by the constitutional clauses that prohibited ex post facto laws and making anything but gold and silver a legal tender (Article 1, Section 10; Farrand, 1966, Vol. 2, p. 435). Lacking compelling reasons to ban state currency, Federal- ists frequently conflated legal tender, ex post facto, and full faith and credit issues with the power to emit bills of credit, even though these issues were discussed and voted on separately at the Convention.

cn 3 2 Q U i 2 x 0.

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Colony/State-- 1 U.S. Dollars Currencies

Continental Dollars

- (Hyper-inflation) Unconvertible After 1781

New York

City Prices 100 = 1824-42 1 / V /

I ii ' '. : ;:. Charleston, SC Price - .T A

' \ 100 = 1818-42

- : ? . '""" Philadelphia, PA Price

Revolutionary 100 1821-5

.War Peace War P eace Wa I lll r[ceI I

1761 1770 1780 1790 1800 1810

YEAR

FIGURE 1. PRICE INDICES FOR PHILADELPHIA, NEW YORK

CrrI, AND CHARLESTON, SC, 1761-1811

Notes: For display purposes all series are presented as centered six-month moving averages. The dashed line spans the American Revolutionary War when observations of prices are scanty. The Philadelphia series is a 20-commodity unweighted geometric wholesale price index. The New York City series is produced by splicing together a 15- commodity arithmetic wholesale price index for 1761-1786, a 71-commodity arithmetic wholesale price index for 1787- 1796, and an all-commodity arithmetic wholesale price index for 1797-1811. The base year for the New York City series is standardized following the procedure in Cole (1938, p. 122). The Charleston series is a weighted all- commodity arithmetic wholesale price index. Sources: Anne Bezanson et al. (1936, p. 388); Arthur Har- rison Cole (1938, pp. 120-22, 135, 155-56).

III. Prices, Exchange Rates, and Purchasing Power Parity: 1748-1795

The only continuous data for evaluating colonial/state monetary performance are price indices. Figures 1 and 2 present the price indices currently known for 1761 through 1811. The six colony/states shown, Massachusetts, New York, Pennsylvania, Maryland, Virginia, and South Carolina, comprised two-thirds of the U.S. population, and the delegates from these states would lead the charge to ban state-issued cur-

rency at the Constitutional Convention. The figures also identify when markets shifted from state currency to U.S. dollars-timing not well established in the literature. The sources used to construct the price indices were consulted to determine the shift points, which also corre-

sponded to unprecedented peacetime breaks

1782 DECEMBER 2003

S

esl




Colony/State- l -Currencies _ _. _ _

Continental -Dollars York River

(Hyper-inflation) Basin, VA Unconvertible Farm

- After 1781 / rices 100 = 1790

-; / Western Shore

Chesapeake, MD , Farm Prices 100= 17901 ,^W

/ .. . ...

Revolutionary

:Warl Peace War Peace

U.S. Dollars

t ii

. L

Massachusetts Rural Farm Prices 100 = 1795-1800

Peace War

1761 1770 1780 1790 1800 1810

YEAR

FIGURE 2. FARM PRICE INDICES FOR YORK RIVER BASIN, VIRGINIA; WESTERN CHESAPEAKE SHORE, MARYLAND;

AND RURAL MASSACHUSETTS, 1761-1811

Notes: The data are annual. The Massachusetts series is a weighted arithmetic index. The Virginia and Maryland series are unweighted geometric indices combining corn, wheat, and tobacco prices. The currency regime breaks are taken from Figure 1. Sources: Winifred B. Rothenberg (1979, pp. 983-84). The author constructed the Maryland and Virginia indices from original raw price data provided by Lorena Walsh (personal communication, 1999).

with unprecedented value shifts in the indices.6 In addition, market data confirm the shift point for Pennsylvania. Before 1795 contemporaneous exchanges were almost exclusively trans- acted in Pennsylvania pounds, and forward exchanges primarily in nondollar foreign specie. Not until 1797 were a majority of market transactions, contemporaneous and forward, in U.S. dollars (Grubb, 2003).

While states could not constitutionally issue new bills of credit after 1787, old state bills continued to circulate and dominate market

6 For example, as late as 1795 the main source behind the Philadelphia price index, the Philadelphia Gazette and Universal Daily Advertiser, quoted prices in Penn- sylvania pounds (Bezanson et al., 1936, p. 2). Newspa- pers did not report a sample of individual prices for a given commodity, but only the market average in a commonly used currency. Bezanson et al. (1936, pp. 2, 336, 340) kept prices in the prevailing currency and then spliced the series together across currency regimes by using the official exchange rates at the point of currency transition. The same rates are revealed in market transactions data (Grubb, 2003).

transactions into the early 1790's. This timing fits the issue-redemption pattern of state currencies. In the early 1780's, states that issued bills of credit typically legislated specific taxes last- ing 10 to 12 years that were calculated to redeem that particular currency issue. These taxes could be paid in that state's currency or in specie. The currency so redeemed was burnt. Acceptance of state-issued currency still out- standing after the tax period earmarked to redeem that currency was contingent on new authorization by the state legislature. Thus, state currencies would dominate the paper medium of exchange into the early 1790's as long as market participants preferred them to dollar- denominated banknotes and specie coins, which apparently they did. By 1796, however, the volume of state currencies left unredeemed was too small, and its future redemption too uncertain, to dominate the paper medium of exchange (Behrens, 1923, pp. 68-87; Richard Sylla, 1986, pp. 843-44; Schweitzer, 1989, p. 321). The volume of U.S. dollar-denominated specie and banknotes in circulation did not take off until the mid-1790's, when it increased sixfold (Neil Carothers, 1930, p. 316; N. S. B. Gras, 1937, pp. 38-39; A. Barton Hepburn, 1967, pp. 52, 87).

Figures 1 and 2 show that prices in colony/ state currencies (1761-1795), both before and after the Revolution, were relatively stable and, while experiencing a positive trend, showed no signs of inflationary crisis compared with prices in the national government's Continental dollar during the Revolution or with prices in U.S. dollars after 1795. In fact, the transition to the U.S. dollar was accompanied by the largest inflationary jump ever experienced in peacetime between 1720 and 1860, dwarfed only by the wartime inflations of the Continental dollar during the Revolution and of the U.S. dollar during the War of 1812 (Bezanson et al., 1936, pp. 388-91; Bezanson, 1951, p. 344). While prices right after the Revolution were higher than in the early 1770's, with the highest being in South Carolina and Virginia where the war had been concentrated at its end, they were rapidly re- turning to early 1770's levels.

7 Schweitzer (1989, p. 322) asserts, erroneously, "Not until the 1810s would banks issue notes in significant amounts." By contrast, see the quantitative data in Gras (1937, pp. 38-39) and Hepburn (1967, p. 87).

2

a.

200

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Il'l lllllll11 -,,I..l. 1iJ .....ilII.. 1.[ ,,11

VOL. 93 NO. 5 1783




TABLE 1-AUGMENTED DICKEY-FULLER TESTS FOR PRICE INDICES, 1748-1795

[ln(y) - ln(y, -)] = aO + a1ln(y,_ ) + a2time + a3D + a4(time X D) + a5(time X D)2 + k lags of [n(y) - ln(y,_ )] + e,

Colony-State/Periods k a1 a2 a3 a4 a5

Massachusetts/ 1751-1775 0 -0.870** 0.008** 1751-1775 and 1785-1792 0 -0.878** 0.008** -0.036

New York/ 1749-1775 0 -0.513 0.005** 1749-1775 and 1786-1791 0 -0.523* 0.005** -0.047

Pennsylvania/ 1748-1775 1 -0.550** 0.004** 1748-1775 and 1785-1794 1 -0.522** 0.004** -0.002 1748-1775 and 1785-1794 0 -0.545** 0.003** 7.740* -0.389* 0.005*

Maryland/ 1757-1775 0 -0.843* 0.001 1757-1775 and 1785-1795 0 -0.691* 0.002 0.099

Virginia/ 1758-1775 0 -0.560** 1758-1775 and 1785-1795 0 -0.493* -0.000 0.123 1758-1775 and 1785-1795 0 -1.007** 0.007* 9.221** -0.548** 0.008**

South Carolina/ 1748-1775 0 -0.665** 0.004 1748-1775 and 1785-1791 0 -0.643** 0.004 0.069

England/ 1748-1775 0 -0.492 0.004** 1748-1775 2 - 1.013** 0.009** 1748-1775a 3 -1.532** 0.013** 1748-1775 and 1785-1794 0 -0.525** 0.005** -0.028 1748-1775 and 1785-1794 2 -1.015** 0.009** -0.042 1748-1775 and 1785-1794a 3 -1.428** 0.012** -0.051

Notes: y is the price index for each colony-state, respectively. * and ** indicate that the coefficient is statistically different from zero above the 0.1 and the 0.05 significance levels, respectively. Dickey-Fuller critical values are used for al. The data are yearly. time runs from 0 through n for each sample, respectively. D is a structural break dummy variable representing the

Revolutionary War. It is coded as one for years greater than 1782 and zero otherwise. Missing coefficients for a4 and for a5 indicate that they were statistically insignificant at the 0.1 level and so that specification is not reported. Lags of the dependent variable were added to the specification until the k + 1 lag was statistically insignificant at the 0.1 level. For the first Virginia regression, while time is statistically insignificant at the 0.1 level, if it is retained in the regression a unit root cannot be

rejected. For the first New York regression the t-statistic on the a, coefficient is 3.11, which just barely fails to be statistically significant at the 0.1 level. In this and all subsequent tables, while Period refers to the years spanned by the y, values, the existence and use of y,_ values are also implied for the initial year listed. While Augmented Dickey-Fuller tests are not

always reliable with short spans of data, they are useful confirmation of the visual impressions given in the figures. Sources: See the notes to Figures 1 and 2; Bezanson et al. (1936, p. 388); Cole (1938, pp. 120-21, 135, 155-56); Elizabeth

Boody Schumpeter (1938, p. 35); Rothenberg (1979, p. 983-84). The Maryland price index for 1756-1775 is constructed as an unweighted nine-commodity geometric index by the author using the raw price data reported in Adams (1986, p. 643). The nine commodities are corn, wheat, oats, rye, salt, beef, pork, sugar, and rum. The author constructed the Virginia index and the Maryland index post-1775 from original raw price data provided by Walsh (personal communication, 1999). The Virginia index and Maryland index post-1775 are unweighted geometric indices combining corn, wheat, and tobacco prices.

aWhile three lags (k = 3) are statistically significant, when used they generate coefficients on the ln(y,_ )s that are

substantially less than -1.0, suggesting the presence of oscillatory overshooting or excess volatility in the mean reversion

process. For comparative purposes, the k = 0 and k = 2 specifications are also reported.

Stability of prices is the hallmark of a well- breaks.8 Unit root tests indicate whether the

managed monetary regime. Table 1 analyzes the stationarity of prices in order to assess colonial/ stationarity of prices in order to assess colonial/ 8 Yearly data are used, and the data are extended back to state monetary performance. Three potential the end of King George's War (1748) for New York, Penn- forms of nonstationarity are examined: stochas- sylvania, and South Carolina, and as far back as these data tic trends, deterministic trends, and structural are available for the other three colonies. The end of King

1784 DECEMBER 2003




monetary regime allows shocks to the economy to have permanent effects on prices. Tests for deterministic trends indicate whether the price level shows a tendency to increase or decrease over time. It is particularly interesting to com- pare any trends in the price levels with those of England and pre-1776 Massachusetts who were on a specie price standard. Finally, if the Rev- olution, by freeing states from British regulation and by altering the electorate, lead to misman- agement of state paper money after 1783, then a structural break in prices pre- versus post- Revolution should occur. The absence of a structural break would imply the absence of any post-Revolution deterioration in how legislatures handled monetary policy.

Table 1 shows the results of tests for unit roots, deterministic trends, and structural breaks in price series. A unit root can be rejected at the 10 percent, and in most cases at the 5 percent, significance level during the colonial period (1748- 1775) for five of the six colonies-just barely missing rejection for New York-and during the combined colonial/state currency period (1748- 1775 and 1784-1795) for all six colony/states. In addition, the coefficients on the ln(y,_ )s for the paper money colony/states are generally greater than for England and pre-1776 Massachusetts, suggesting that having an inside paper money not directly tied to specie may have helped ameliorate the effects that transitory real trade shocks had on prices. Table 1 also shows that while prices do exhibit deterministic trends, the price trends in the colony/states that issued paper money are less than for England and pre-1776 Massachusetts.9 Paper-money regimes experienced no excess inflationary tendencies relative to specie monetary

George's War is the appropriate starting point because data are fewer and less reliable before 1748, and because 1748 is arguably a turning point in colonial monetary behavior. The wartime inflation prior to 1748 caused Massachusetts to go off paper money after 1748 and led the British Parliament to pass the Currency Act of 1751.

9 The regression [ln(yt) = ao + a2time] for prices in the colonial-only period in Table 1 reveals the same relative result. The coefficient on a2 for the specie-money regimes of Massachusetts and England are, respectively, 0.008164 and 0.00825. For the paper-money regimes of New York, Pennsylvania, Maryland, Virginia, and South Carolina, they are, respectively, 0.00806, 0.00589, 0.00117, 0.00678, and 0.00717. All estimates are statistically significant above the 0.1 level with the exception of a2 for Maryland. All regressions were AR1 or AR2 adjusted where necessary.

regimes. Finally, the second regression under each American colony/state in Table 1 shows that in all cases there is no evidence of a structural break in prices denominated in state currencies pre- versus post-Revolution as indicated by the statistical in- significance of the a3 coefficients. The claim that state legislatures engaged in increasingly reckless or atypical monetary behavior post-Revolution cannot be sustained with this evidence.

Given that states issued substantial amounts of state paper money during the Revolution, how are the above results possible? For two states, Penn- sylvania and Virginia, the exact time path of prices after 1783 can be estimated. The third regression under these two states in Table 1 shows that, indeed, excessive issuances of paper money during the Revolution caused prices in 1784 to be above those in 1775, as indicated by the large positive a3 coefficients. In both cases, however, post-1783 prices experienced substantial deflation as states engaged in protracted monetary contrac- tion, as indicated by the large negative a4 coefficients. The net outcome was a nonunit root process and a constant deterministic price trend across the Revolution between 1748 and 1795 as shown in the second regression under each Amer- ican colony/state in Table 1.

While the quality and quantity of data on exchange rates for the six American colony/ states in Table 1 are not as good as on prices, analysis of their exchange rates and purchasing power parity (PPP) supports the conclusions above. Table 2 shows that between 1748 and 1775 a unit root can be rejected at the 10- percent significance level for exchange rates and PPP for five of the six colonies. In addition, exchange rates in all six colonies exhibit no deterministic trend. The aftermath of the Seven Years' War and the passage of the Currency Act of 1764 caused only Virginia to experience a structural break in its exchange rate series- with a unit root rejected for the period after 1765.10 Massachusetts is the only colony where a unit root in the exchange rate series cannot be

o0 Unlike other colonies, Virginia had no experience issuing bills of credit before 1755, and was not in compli- ance with the Currency Acts. Initially, Virginia redeemed old bills with new bills rather than with taxes, and failed to adequately redeem and destroy bills of credit so earmarked. Complaints about Virginia's behavior were, in part, respon- sible for the passage of the 1764 Currency Act (Ernst, 1973, pp. 43-88; Brock, 1975, pp. 465-508).

VOL. 93 NO. 5 1785




TABLE 2-AUGMENTED DICKEY-FULLER TESTS FOR EXCHANGE RATES AND PURCHASING POWER PARITY, 1748-1790

[ln(yt) - ln(yt_ )] = ao + a1ln(y, _) + a3D + k lags of [ln(yt) - ln(y1t_)] + e,

Colony-State/Period/Series k a, a3

Massachusetts/ 1751-1775/Exchange Rate 0 -0.708 1751-1775/PPP 0 -0.755** 1751-1775/PPPa 1 -1.289**

New York/ 1748-1775/Exchange Rate 0 -0.543** 1749-1775/PPP 0 -0.515*

Pennsylvania/ 1748-1775/Exchange Rate 0 -0.465** 1748-1775 and 1784-1790/Exchange Rate 0 -0.441** 0.014 1748-1775/PPP 0 -0.624** 1748-1775 and 1785-1790/PPP 1 -0.814** 0.042

Maryland/ 1757-1775/Exchange Rate 0 -0.618* 1757-1775/PPP 0 -0.549

Virginia/ 1758-1775/Exchange Rate 0 -0.157 1758-1775/Exchange Rate 0 -0.601** -0.127** 1758-1775/PPP 0 -0.340 1758-1775/PPP 0 -0.509** -0.075*

South Carolina/ 1748-1775/Exchange Rate 0 -0.841** 1748-1775/PPP 0 -0.695**

Notes: * and ** indicate that the coefficient is statistically different from zero above the 0.1 and the 0.05 significance levels, respectively. Dickey-Fuller critical values are used for a,. y for the Exchange Rate equals the number of colonial-state pounds per 100 pounds sterling, respectively. Postrevolution state currency exchange rate data are missing except for the Pennsylvania pound during 1784-1790. y for PPP (purchasing power parity) equals [(En- gland's Price Index x Exchange Rate)/Colony-State's Price Index] for each colony-state, respectively. The data are yearly. A coefficient on time was estimated in all cases, but in all cases it was statistically insignificant and so was dropped from the specification. D for Pennsylvania is a structural break dummy variable representing the Revolutionary War. It is coded as one for years greater than 1782 and zero otherwise. D for Virginia is a structural break dummy variable coded as one for the years 1766-1775 and zero otherwise (see text for the explanation). Lags of the dependent variable were added to the specification until the k + 1 lag was statistically insignificant at the 0.1 level. Sources: See the source note to Table 1; Bezanson (1951, p. 346); John J. McCusker (1978, pp. 141-42, 164-65, 185-86, 198-99, 211-12, 223-24).

a While one lag (k = 1) is statistically significant, when used it generates a coefficient on

ln(y,_ ) that is substantially less than -1.0, suggesting the presence of oscillatory overshoot-

ing or excess volatility in the mean reversion process. For comparative purposes, the k = 0

specification is also reported.

rejected. Massachusetts is also the only colony not on a paper-money standard. The one colony with data post-Revolution is Pennsylvania. When including this data, a unit root process in exchange rates and PPP is still rejected, and a structural break in the behavior of exchange rates and PPP pre- versus post-Revolution is also rejected.

The evidence here suggests that colonial/state legislatures managed their paper money re-

markably well. Given that unit roots and excessive deterministic trends in prices, exchange rates, and PPP from 1748 through 1795 can be rejected with statistical confidence, why not just adopt a common currency? The answer lies in individual colony/states retaining the flexibility to engage in unilateral short-run monetary action tailored to their unique needs. During the Seven Years' War and the Revo- lution, for example, colonies charted a more

1786 DECEMBER 2003




independent monetary course than they did during peacetime.

The advocates of banning this monetary system at the Constitutional Convention were aware, in spite of their rhetoric, that the problem facing the country after 1783 was not inflationary issuances of state currency, but deflation (Farrand, 1966, Vol. 3, p. 215; Rutland, 1973, Vol. 8, pp. 502-03; Bailyn, 1993, Vol. 2, pp. 420-23, 830). They had lived through, and commercially prospered under, this colonial/ state monetary system. Why they desired to constitutionally ban it cannot be traced to its poor performance. Some other reason must be sought.

IV. Rent-Seeking Bankers

Prior to 1782 there were no banks in the 13 colonies. After the collapse of the Continental dollar, Congress turned to Morris to restore the national government's finances. Morris opened the Bank of North America (BNA hereafter) in 1782. This bank, headquartered in Philadelphia, was intended to be the national government's bank with branches throughout the states. It accepted deposits of specie, kept accounts in dollars, and issued dollar-denominated banknotes as claims against deposits and as loans both to the national government and to private citizens. Morris and Congress asked the states to accept BNA banknotes in payment for each state's taxes and then to remit them to the U.S. Treasury to cover payments each state owed the national government. The banknotes were intended to be the circulating medium for the nation. In support, Congress declared in July of 1785 the "dollar" in decimal units to be the official monetary unit of the United States. Only Connecticut, however, accepted BNA banknotes for payment of its taxes (Lawrence Lewis, Jr., 1882, pp. 13-85; Clarence L. Ver Steeg, 1976, pp. 66-69, 84-87). Massachusetts and New York also chartered banks in 1784 that issued dollar-denominated banknotes backed by fractional reserves in specie.

Morris' initial efforts were successful. The annualized dividend paid by the BNA soared from 9 percent in 1782 to 19 percent in 1784 (Pennsylvania Gazette, 7/3/1783, 1/5/1785; Lewis, 1882, p. 152). Morris bragged, "few will find Other parts of their Fortunes to Yield them so large or certain an income as the Stock they

have in the Bank" (Bouton, 1996, p. 92). How- ever, in 1785 when the Pennsylvania legislature proposed a new issue of Pennsylvania pounds, BNA's dividend collapsed to 6 percent. 1 Mar- ket participants seemed to prefer state currency to Morris' banknotes (Schweitzer, 1989, p. 321; Grubb, 2003). In a letter to Morris, Hamilton remarked, "Your Notes though in Credit with the Merchants by way of remittance do not enter far into ordinary circulation ..." (Bouton, 1996, p. 107). Morris remarked that his banknotes were "constantly returned upon me for payment [in specie] instead of being absorbed by the taxes" (Ver Steeg, 1976, p. 119). Morris pressed customers to accept banknotes instead of specie, and in 1789 issued notes in denominations of 1/90th of a dollar. This odd denomination makes sense when it is noted that 1/90th of a dollar equals one pence in Pennsylvania pounds-a further indication that the BNA was struggling to get its banknotes to displace Pennsylvania pounds in the marketplace (Lewis, 1882, pp. 41-42; Eric P. Newman, 1956, pp. 1369-70; Ver Steeg, 1976, pp. 116-18; Thomas M. Doer- finger, 1986, pp. 302-04; Rappaport, 1996, p. 146). Morris clearly associated competition from Pennsylvania's state currency with the collapse in BNA's dividend. Other events cannot explain the timing of these changes in BNA's stock value (Grubb, 2003). By comparison, the Bank of Massachusetts experienced no comparable collapse in its dividend in this period, but then it was not yet facing competition from new state-issued currency in Massachusetts (Gras, 1937, pp. 171, 581).

The market's reluctance to use BNA's banknotes may have been due to questions about the bank's long-run viability and transparency of operation. Europeans refused to invest in the bank's stock, and Jeremiah Wadsworth, the single largest BNA stockholder, raised concerns, publicly, that the amount of loans given to bank directors to speculate in western lands threatened the bank's solvency. Over 50 percent of the bank's nongovernment loans went to bank stockholders. James Wilson, a BNA board member, borrowed over $100,000, well in excess of his assets, and the bank repeatedly extended the loan when he could not repay on

" Schweitzer (1989, p. 321) mistakenly claims, "... the bank produced steady annual returns of 12 percent...."

VOL. 93 NO. 5 1787




schedule (M. L. Bradbury, 1972, p. 155; Ver Steeg, 1976, pp. 85, 196; Bouton, 1996, pp. 196, 201, 295-301, 307; Rappaport, 1996, pp. 201, 233-36). In 1784, Thomas Willing, the president of the BNA, wrote to would-be bankers in Massachusetts, "the business was as much a novelty to us ... as it can possibly be to you. It was a pathless wilderness, ground but little known to this side the Atlantick ... All was to us a mystery" (Gras, 1937, pp. 209-10). To the Pennsylvania legislature, Morris admitted that the "circulation and amount of bank paper is little understood" (Hans Louis Eicholz, 1992, p. 266).

For Morris to get his BNA banknotes into general circulation he had to eliminate the competing paper money-the Pennsylvania pound. In the state legislature, Morris and Wilson vehe- mently opposed the proposed issuance of new Pennsylvania pounds. The BNA did "every- thing to depreciate it [the new state issue of Pennsylvania pounds]" (Freeman's Journal, 12/ 13/1786). It also refused to accept deposits of Pennsylvania pounds, but later relented when threatened by revocation of its charter (Wilson, 1942, p. 10).

In retaliation for Morris' political meddling in the state-currency issue, the Pennsylvania legislature revoked the BNA's state charter. In the battle to reinstate the bank's charter, from mid-1785 to March 1787, the level of rhetoric, verbosity, and factional polarization escalated. The bank worked to get supporters (stockholders) elected to the state legislature. The BNA also provided Franklin with a loan for the ex- press purpose of his purchase of BNA stock and made Franklin's son-in-law a bank director. The bank was defended in Franklin's newspaper, the Pennsylvania Gazette, and by Thomas Paine, who had switched sides, some say for pay, from opposing to supporting the bank. Bank supporters also asserted, disingenuously, that banknotes would absolutely always be redeemed at face value in specie. In March 1787, the bank regained, with new restrictions, its state charter (Newman, 1956; Bradbury, 1972; Eicholz, 1992, pp. 98-107; Bouton, 1996, pp. 184-88; Rappaport, 1996, pp. 159-221).

To win broad support, the bank's advocates could not boldly say they opposed state currency because the bank could not compete against it in the marketplace. Instead, they had to argue that as a general proposition all state

currency was inherently unsound and inflationary, a position they had only recently adopted. For example, Morris had spoken approvingly, as late as 1781, and Franklin had been a long- time advocate and defender of colony/state paper money (Richard T. Hoober, 1956; Ver Steeg, 1976, pp. 39, 63, 91). Only with their investment in the BNA, and the failure of BNA banknotes to displace state currency in the marketplace, did they change their tune.

Two months after the BNA had regained its Pennsylvania state charter, the Constitutional Convention convened in Philadelphia. Pennsyl- vania sent the single largest delegation, and it was stacked with supporters of the BNA fresh from their battle with the Pennsylvania state legislature.12 Of Pennsylvania's eight delegates, seven were stockholders in the BNA: George Clymer, Thomas FitzSimons, Franklin, Thomas Mifflin, Gouvereur Morris, Robert Morris, and Wilson. The same seven had been vocal supporters of the bank in the Pennsylvania legislature just months before. Robert Morris, FitzSimons, and Wilson were also board mem- bers of the bank, and Gouvereur Morris was Robert Morris' assistant at the bank. Overall, the Pennsylvania delegation was the most vocal at the Convention, with Gouvereur Morris and Wilson being the two most frequent speakers. The single-minded intention of the Pennsylva- nia delegation is illustrated by Wilson's post- Convention comment that "If only the following lines ... [banning state-issued paper money] ... were ... in this Constitution, I think it would be worth our adoption ..." (Jensen, 1976, Vol. 2, p. 500). Until the Constitutional Con- vention, none of these individuals had partici- pated in the constitution revision process. For example, none attended the 1786 Annapolis Convention.

This group transferred the same rhetoric used just months earlier in the fight to save

12 Similar events occurred in Maryland where in 1782 the state Senate passed a bill to establish a bank, but the House of Delegates rejected the bill. The same effort was tried again in 1784 with the same result. In 1785, the House of Delegates proposed that the state issue a new emission of

paper money. The Senate blocked this proposal. The Senate finally won the bank-versus-state currency struggle by pre- venting the election of pro-state-paper-money delegates to the state's convention for ratifying the Constitution (Alfred Cookman Bryan, 1899, pp. 17-19; Behrens, 1923, pp. 79- 87).

1788 DECEMBER 2003




the BNA's state charter to the Constitutional Convention. The Pennsylvania delegation was joined by several banking supporters from other states, such as Hamilton who served as a director of the Bank of New York, Elbridge Gerry who held stock in the Bank of Massachusetts, and James McHenry who was the advocate for the banking bill that was being blocked by pro- state-currency electors in the Maryland legislature (Bryan, 1899, pp. 17-19; Behrens, 1923, pp. 79-87; Gras, 1937, p. 539; footnote 12 above).

What has escaped attention is that it was not until near the end of the constitution revision process that any proposal to ban state-issued paper money appeared. The Articles of Confed- eration was silent on state-issued paper money. In the numerous amendments to the Articles proposed between 1781 and 1786, state-issued paper money was never mentioned. At the 1785 Mount Vernon Conference and in the report of the 1786 Annapolis Convention, the precursors to the Constitutional Convention, state-issued paper money was never mentioned.13 In the many plans proposed at the Constitutional Con- vention from its beginning in May through early August, e.g., the Virginia Plan, the Pinckney plan, the New Jersey plan, the Hamilton plan, and so on, state-issued paper money was never mentioned. On July 26 the Convention delegates turned all the various plans over to a Committee on Detail, of which Wilson was a member, to craft a draft Constitution. Buried in the back of the Committee's last draft, in Wil- son's handwriting, appears for the first time a clause banning state-issued paper money-the same clause referred to above in Wilson's post- Convention comment.14 This draft was submit-

13 Schweitzer (1989, p. 320) claims that the "Mount Vernon Conference of 1785 had produced a mild agreement that paper currency should trade at par between neighboring states ...." She is mistaken. No such agreement or discus- sion occurred at that conference. On monetary matters, the conference only discussed the issues of having a common relative evaluation of foreign gold and silver coins and a common penalty for the nonpayment of merchant bills of exchange, and reached no agreement on either (Rutland, 1970, Vol. 2, pp. 814-22).

14 Within the decade Wilson would default on hundreds of thousands of dollars of bank loans, would be arrested twice, would flee and, in his own words, would be "hunted like a wild beast." The other chief architects of the currency union, Robert Morris and Hamilton, also came to bad ends. Morris' speculative investment in eight million acres of

ted to the Convention on August 9 and from then until the Convention ended on September 17 the Pennsylvania delegation blocked all efforts to temper or remove this clause (Farrand, 1966, Vols. 1-2; Jensen, 1976, Vol. 1; Vol. 2, p. 500).

No statements about banknotes, seignorage, transactions costs, cross-state exchange rates, etc., were offered at the Convention. Only sim- plistic, emphatic, and absolute statements were made asserting that state currency was inherently inflationary.15 On issues unrelated to paper money, speakers would find offhand ways to insinuate that states mismanaged their paper currencies.16 State-issued paper currency became a rhetorical code phrase for evil.17 Only a

western land went sour and in 1798 he was arrested and put in debtors' prison, and in 1804 a political/banking rival shot Hamilton in a duel (M. E. Bradford, 1994, pp. 47, 93, 98; Bouton, 1996, p. 377).

15 This rhetoric led scholars to hypothesize that Conven- tion delegates who were debtors should have opposed the constitutional ban on state-issued paper money because inflationary issues of state monies could have relieved their financial situation (Forrest McDonald, 1958, pp. 5-11, 349; Charles A. Beard, 1960, pp. 28, 31). In a statistical analysis of delegate votes, however, Robert A. McGuire and Robert L. Ohsfeldt (1986, p. 107) found, to their surprise, that debtors were largely indifferent to such a ban. By contrast, the evidence here suggests that debtor indifference is no surprise. Debtors had little to gain because states appear to have managed their currencies responsibly.

16 For example, Madison noted that in support of the proposition that an executive veto not be too easily over- ridden Gouverneur Morris "... dwelt on the importance of public credit.... He recited the history of paper emissions, and the perseverance of the legislative assemblies in repeat- ing them, with all the distressing effects...." And on the proposition that the federal government not be allowed to interfere with the government of the individual states in any matters of internal police "Mr. Gouverneur Morris opposed it. The internal police, as it would be called & understood by the States ought to be infringed in many cases, as in the case of paper money & other tricks by which the Citizens of others States may be affected" (Farrand, 1966, Vol. 2, pp. 26, 299). For additional examples, see Farrand (1966, Vol. 1, pp. 137, 142, 146-47, 154-55, 165, 289, 291-93, 317- 18; Vol. 2, pp. 52, 76, 252).

17 Throughout the Convention and the ratification debates, and up to the present day, Rhode Island was seen as the archetype irresponsible state government regarding paper money. However, Rhode Island was the only state not represented at the Constitutional Convention, had initially voted not to ratify the new Constitution, and had held out against approving the Continental Impost and so helped to destroy the Articles of Confederation. As such, much of the whipping-boy rhetoric pointed at Rhode Island was political retribution. Rhode Island issued paper money in 1786,

VOL. 93 NO. 5 1789




few delegates challenged the anti-paper-currency faction in terms that saw through their rhetoric. For example, regarding an absolute prohibition on government bills of credits, Madison asked, "Will it not be sufficient to prohibit the 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 was proposing the system that had worked well since the end of King George's War. In reply, Gouverneur Morris boldly stated, "The Monied interest will oppose the plan of Government, if paper emissions be not prohibited" (Farrand, 1966, Vol. 2, pp. 309-10).

The Convention's anti-state-currency rhetoric continued through the debates over ratification (Farrand, 1966, Vol. 3; Jensen, 1976-1978; Bailyn, 1993). Because the new Constitution was presented as a complete package, the clause prohibiting state currency was not, by itself, objectionable enough to stop ratification. The lack of objection to this constitutional prohibition may have been due to the fact that only seven states had issued bills of credit after 1784, with three of them, New York, North Carolina, and Rhode Island, also being the last three of the 13 states to ratify the Constitution (Jensen, 1976, Vol. 2, pp. 19-25).18 Given that only nine states were required to ratify the Constitution

which was made legal tender for both private and public debts. This paper money was to be used to retire the state's wartime debts by requiring holders of the state's Revolution- era securities to swap them at face value for these new bills of credit. By August 1787, Rhode Island's paper money was trading relative to face value at 7 to 1. As such, Rhode Island was accused of defrauding creditors. Hillman Metcalf Bishop (1949), however, shows that the legal tender clause was seldom enforced, and that little fraud actually occurred. The post-1786 harsh Federalist rhetoric against Rhode Is- land came from wealthy merchants who had acquired Rhode Island's wartime securities in the market at 8 to 1, and who had hoped, through their control of Rhode Island's legislature, to get the state to increase taxes substantially thereby enabling the state to redeem the securities at 1 to 1. Electoral defeat in 1786 and the subsequent adoption of the

paper money policy thwarted their plan of speculative en- richment. The forced swap at face value of wartime securities purchased at 8 to 1 for paper money that traded at 7 to 1 represented no accounting loss.

18 The lack of opposition was also due to the irregular procedures pushed on ratifying conventions by the Feder- alists (Bouton, 1996, pp. 321-71, 449), and in some states to merchant-bankers working to prevent pro-state-paper- currency advocates from being elected to their state's ratifying convention (see footnote 12).

for it to be made operational in place of the Articles of Confederation, these last three states were faced with a fait accompli.

Assuming that the six states that had not issued paper money post-Revolution could not muster sufficient objection to the paper-money ban to stop them from voting for the Constitu- tion, only three of the seven states that had issued paper money post-Revolution would have to be won over to get the nine needed for ratification. The BNA's control of Pennsylva- nia's ratification process delivered Pennsylva- nia's vote (Jensen, 1976, Vol. 2, p. 732). Two other paper-money states that were among the first nine to vote for the Constitution were Geor- gia and South Carolina. Acute panic caused by Indian warfare led them to vote for the Consti- tution in hope of gaining aid from the rest of the union. Joseph Clay of Savannah observed, "The new plan of government for the Union I think will be adopted with us readily; the powers are great, but of two evils we must choose the least. Under such a government we should have avoided this great evil, an Indian war" (Jensen, 1978, Vol. 3, pp. 232, 281). The prohibition against state-issued bills of credit was a sovereign power states were willing to relinquish considering that the Constitution gave states sovereign power over most matters internal to each state, most notably slavery-as General Pinckney of South Carolina and Abraham Baldwin of Georgia pointed out during the Con- vention (Farrand, 1966, Vol. 2, pp. 371-72).

The uncompromising and rhetorical position held by the anti-state-money faction only makes sense if their goal were something other than establishing principles of sound monetary man- agement. The suggestion here is that these delegates sought the elimination of state and federal bills of credit in order to increase the ability of the BNA, and subsequently the First Bank of the United States (FBUS hereafter), to provide and control the paper medium of exchange for the nation and so (incidentally) em- power and enrich themselves as managers and stockholders of these banks. If these delegates had simply said their goal was to eliminate state-currency competition with BNA banknotes in order to enhance the power and profit- ability of the BNA, they would not have carried the day. The Freeman's Journal, October 17, 1787, reached the same conclusion (Jensen, 1976, Vol. 2, pp. 182-85).

1790 DECEMBER 2003




V. What They Wrought: An Explosion in Banking and Banknotes

New issues of state currency (and new issues of federal paper currency) were constitutionally prohibited after 1787 and enough old state currency would be taken out of circulation through tax redemption by the early 1790's that the paper-money medium fell to banknotes by default. Unable to compete against state currency in the marketplace, bankers had constitutionally eliminated their chief paper-money competitor for seignorage. As a result, banknote circulation increased sixfold between 1790 and 1795-it nearly doubled again between 1800 and 1811- and yearly dividends doubled to 12 percent for the BNA and tripled to 23 percent for the Bank of Massachusetts (Lewis, 1882, p. 152; Gras, 1937, p. 581; Hepburn, 1967, p. 87). The new Constitution allowed states to charter banks, which became the preferred revenue-generating device in place of issuing bills of credit (Sylla et al., 1987). State-chartered banks numbered 28 by 1800 and 88 by 1811 (Hepburn, 1967, p. 87). On the national level, Congress chartered the FBUS in 1791.19 It was intended to do on a

'9 The triumph of the banking faction regarding the creation of a national bank was surreptitious and cunning. As early as 1780, Hamilton thought a national bank was the answer to the national government's problems (Syrett, 1961, Vol. 2, pp. 400-18). At the Constitutional Conven- tion, however, Hamilton did not mention banking in his plan of government. In fact, banking was so controversial and divisive that delegates felt that any mention of banking in the Constitution might prevent its ratification. For example, the delegates explicitly voted against giving the federal government the power of incorporation-being a power that was explicitly interpreted as the power to charter a national bank (Farrand, 1966, Vol. 2, pp. 615-16; Vol. 3, pp. 375-76). Because the Convention was closed with no public record of discussions or votes, only Convention delegates knew which powers had been explicitly denied to the federal government and so were not included among the written enumerated powers given to the federal government. Hamilton, who was absent for the debate over the power of incorporation, exploited this lack of a written public record of what was explicitly denied the federal government by claiming that federal powers not listed could nevertheless be "implied," and that no one from the Convention clearly remembered what powers not listed were explicitly denied the federal government (Syrett, 1965, Vol. 8, pp. 62-134; Rutland, 1981, Vol. 13, pp. 370-404; and footnote 1 above). In a letter to Madison, dated June 20, 1791, George Nicholas concluded, "The Bank &c. prove that paper bar- riers [the Constitution] are very weak; could it have been foreseen that no greater regard would have been paid them

much larger scale what Robert Morris had tried to do with the BNA. Many opined that the country was becoming flooded with bank paper, gripped by bank speculation, and prey to "un- principled gamblers" in banking (James Sulli- van, 1792, pp. 21-76; William M. Gouge, 1833, pp. 42-54; Writings of Thomas Jefferson, 1903, Vol. 1, pp. 290-91; Syrett, 1966, Vol. 10, pp. 562-63; Rutland, 1983, Vol. 14, pp. 41-47, 69, 73, 237).

All these banks issued dollar-denominated banknotes, backed by fractional reserves in specie, which circulated as a medium of exchange alongside specie coinage. While banknotes could be exchanged at face value for specie at the bank of issue, except during liquidity crises, elsewhere they circulated at market-determined discounts off their face value. As such, the reduction in transaction costs and exchange rate risks associated with moving to a single currency may not have been as great as is commonly assumed. While banknotes could not, constitutionally, be made a legal tender and Congress in 1789 legislated that federal taxes must be paid in specie, Hamilton, as Treasury Secretary, had the federal government accept the banknotes of the Bank of New York, Bank of Massachusetts, Bank of Providence, BNA, and FBUS at face value for payment of federal taxes. Hamilton simply declared that banknotes were specie (Syrett, 1962, Vol. 5, pp. 394, 532- 33; Vol. 6, pp. 386-88; 1965, Vol. 9, p. 489; Stuart Bruchey, 1970, p. 377; David Jack Cowen, 2000, p. 139). The Treasury Depart- ment and the FBUS, however, were not really designed to manage the monetary base under this system (Cowen, 2000). The Constitution led to a common specie unit of account, but not to a common paper medium of exchange.

This new government-chartered but pri- vately run bank-based monetary system may have reduced the government's ability to control the money supply. The United States had limited specie reserves, no ability to sterilize specie inflows, no regulation of banking specie-reserve to banknote-loan ratios, and was a small open economy on a specie exchange rate standard. As such, the transition to the U.S. dollar eliminated government

many federalists would have been the warmest opposers of the government" (Rutland, 1983, Vol. 14, p. 33).

VOL. 93 NO. 5 1791




monetary tools and exposed the United States to unmediated trade shocks. Tying the money supply to specie through an unregulated banking money multiplier may have also amplified the effect of these shocks. When facing a recession, banks reduced new loans and called in old loans to protect their specie reserves. These actions reduced the money supply and exacerbated the recession. By contrast, under the prior system states could engage in active monetary policy-adjusting their paper money supplies by altering the speed of new issues and redemption of old issues-to ameliorate, in the short run, the effects of trade shocks. In addition, given that most taxes earmarked for redeeming state bills of credit were on commodity sales, tax payments would vary positively-the amount of paper money left in circulation would vary inversely-with fluctuations in macro-business conditions, thus pro- viding automatic stabilization. The divergent effect of these two monetary regimes was dis- played before the Constitutional Convention in Pennsylvania by the divergent response of the BNA and the state legislature to the 1784 financial crisis (Rappaport, 1996, pp. 165-73).

VI. Prices, Exchange Rates, and Purchasing Power Parity: 1784-1811

The only continuous data available for evaluating monetary performance across the transition to the U.S. dollar are the price indices shown in Figures 1 and 2 above. Table 3 tests these indices between the Treaty of Paris and the War of 1812 for unit roots, deterministic trends, and structural breaks. The data span for the period of state currency, 1784-1794, including years where data are missing, is too short for testing. Thus, only the post-Revolution sample (1784-1811) and the years covering the U.S. dollar regime (1796-1811) are tested. Whether the transition to the U.S. dollar was a monetary regime shift is determined by testing for a structural break at each state's point of transition.

The transition to the U.S. dollar was a monetary regime shift for the whole country, as measured by the large significant a3 coefficient on the structural break variable in the first regression under each American state in Table 3. This regime shift entailed a substantial price spike. This jump in prices is not a direct outcome of the behavior of English prices. Tests on

English prices in Table 3 reject the presence of a structural break prior to 1799, whereas the transition to the U.S. dollar occurred at least three or more years prior to 1799. Table 3 also shows more divergence in the deterministic price trends among the states and with England after the transition to the U.S. dollar compared with what occurred before 1795 (Table 1). Price trends in Table 3 during 1797-1811 are signif- icantly positive in England, negative in South Carolina, and zero in the other five states. The estimated trends in the ln(yt)s reveal an even greater divergence.20 As such, the new U.S. dollar monetary regime would appear to be less unifying than the prior uncoordinated colonial monetary system.

Finally, Table 3 shows that between 1784 and 1812 prices for all six American states are trend-stationary. Of greater interest is the fact that most of the coefficients on the ln(yt_ I)s in Table 3 are less than those in Table 1. This American price behavior is consistent with the colonial/state monetary system-an inside paper money not directly linked to specie trade flow-dampening impacts of macro-trade shocks to a greater degree than the U.S. dollar monetary regime-an inside banknote money directly linked to specie trade flows-could.

The increased volatility in U.S. prices is illustrated more simply in Table 4. With only three exceptions out of 12 comparisons, the standard deviation of the yearly change in the log of prices (the standard deviation of inflation) in all six American locations is statistically greater for prices in U.S. dollars for the period 1797-1811 than for prices in either of the two periods prior to the transition to the U.S. dollar.21 While the volatility of English prices is

20 Using the data in Table 3, the regression [In(y,) =

ao + a2time] for prices in the U.S. dollar era yields coefficients on a2 for each state and England, in the order they are listed in Table 3, of 0.0067, -0.0015, -0.0080, -0.0039, -0.0118, -0.0274, and 0.0175, respectively. All estimates are statistically significant above the 0.1 level with the exception of a2 for New York, Maryland, and Virginia. All regressions were AR1 or AR2 or AR3 adjusted where necessary.

21 Of the three exceptions, one is for colonial Massachu- setts, which was on a specie rather than a paper money standard, and so this exception lacks relevance to the comparison being made. Another is for Pennsylvania, where the standard deviation during the state currency period, while less, is not statistically different than that during the U.S. dollar period. Thus, colonial South Carolina is the only true reverse exception out of the 12 comparisons.

1792 DECEMBER 2003




TABLE 3-AUGMENTED DICKEY-FULLER TESTS FOR PRICE INDICES, 1785-1811

[ln(y,) - ln(y -1)] = ao + alln(y _l) + a2time + a3D + a4(time X D) + k lags of [ln(y) - ln(y,_ 1)] + et

State/Periods k a1 a2 a3 a4

Massachusetts/ 1785-1811 0 -0.889** 0.005 0.185** 1794-1811 0 -0.886* 0.006

New York/ 1786-1811 0 -0.862** 0.019 0.417** -0.021* 1786-1811a 2 -2.128** -0.001 0.828** 1796-1811 0 -0.983* -0.002 1796-1811a 2 -2.235** -0.003

Pennsylvania/ 1785-1811 1 -0.877** 0.017** 0.557** -0.022** 1796-1811 1 -1.137** -0.007

Maryland/ 1785-1811 0 -0.747** -0.001 0.278** 1785-1811 b 3 -1.590** 0.015** 0.377** 1797-1811 0 -0.756* -0.003 1797-181lb 3 -2.401** 0.011

Virginia/ 1785-1811 0 -0.913** -0.013* 0.438** 1785-1811 b 3 - 1.436** -0.005 0.503** 1797-1811 0 - 1.068* -0.013

South Carolina/ 1785-1811 0 - 1.023** -0.027** 0.554** 1785-1811c 2 - 1.898** -0.056** 1.129** 1797-1811 0 - 1.002* -0.026**

England/ 1785-1811 1 -0.739** 0.019** 1785-1811 1 -0.867** 0.015** 0.127** 1796-1811 1 -0.921** 0.018**

Notes: Data are yearly. Data are missing for South Carolina during 1792-1795 and for New York during 1784 and 1792. y is the price index for each state, respectively. * and ** indicate that the coefficient is statistically different from zero above the 0.1 and the 0.05 significance levels, respectively. Dickey-Fuller critical values are used for a,. A missing coefficient indicates that that variable was statistically insignificant at the 0.1 level, and so was dropped from the specification reported. Lags of the dependent variable were added to the specification until the k + 1 lag was statistically insignificant at the 0.1 level, time runs from 0 through n for each sample, respectively. For U.S. states, D is a structural break dummy variable representing the transition from prices quoted in state currency to prices quoted in the U.S. dollar. It is coded as one for years greater than 1792 for Massachusetts, 1794 for New York and Pennsylvania, and 1795 for Maryland, Virginia, and South Carolina, and zero otherwise, respectively. For England, D is a structural break dummy variable representing when Britain's move off the specie standard affected its prices. It is coded as one for years greater than 1798 and zero otherwise. Structural breaks for England before 1799 were tested and they were statistically insignificant. While Augmented Dickey-Fuller tests are not always reliable with short spans of data, they are useful confirmation of the visual impressions given in the figures. Sources: Bezanson et al. (1936, p. 388); Cole (1938, pp. 121-22, 135, 156); Schumpeter (1938, p. 35); Rothenberg (1979, pp. 983-84); and the source note to Table 1.

a While two lags (k = 2) are statistically significant, when used they generate coefficients on the ln(y,_ )s that are substantially less than -1.0, suggesting the presence of oscillatory overshooting or excess volatility in the mean reversion process. For comparative purposes, the k = 0 specification is also reported. b While one lag (k = 1) is statistically insignificant, three lags (k = 3) when used together are all individually statistically significant. However, when used they generate coefficients on the ln(y,_ i)s that are substantially less than -1.0, suggesting the presence of oscillatory overshooting or excess volatility in the mean reversion process. For comparative purposes, the k = 0 specification is also reported. c While one lag (k = 1) is statistically insignificant, two lags (k = 2) when used together are both individually statistically significant. However, when used they generate a coefficient on ln(y,_ ) that is substantially less than -1.0, suggesting the presence of oscillatory overshooting or excess volatility in the mean reversion process. For comparative purposes, the k = 0 specification is also reported.

VOL. 93 NO. 5 1793




TABLE 4-YEARLY VOLATILITY OF Six U.S. PRICE INDICES, 1750-1811

Colonial Currency State Currency U.S. Dollars 1750-1775 1785-1792 1797-1811

Colony/State STD SE of STD STD SE of STD STD SE of STD

Massachusettsa 0.1584 0.0363 0.0791 0.0147 0.0956 0.0184 New York City, NYb 0.0643 0.0080 0.0511 0.0095 0.0933 0.0145 Philadelphia, PA 0.0417 0.0065 0.0758* 0.0176 0.0801* 0.0099 Western Shore Chesapeake, MDC 0.0841 0.0171 0.0461 0.0088 0.1369 0.0227 York River Basin, VAd 0.0669 0.0117 0.1104 0.0185 0.1893 0.0404 Charleston, SC 0.1420 0.0151 0.0841 0.0166 0.1151 0.0174

Notes: STD = standard deviations of [ln(Price Index) - ln(Price Index_ 1)]. SE = standard errors of the STDs derived by bootstrap resampling techniques. With the one exception noted below, per row any two STDs are statistically different from each other above the 0.1 significance level. Currency divisions are taken from Figures 1 and 2. Because of uncertainty over what currency dominated transaction usage in the market (as opposed to newspaper usage) in each index between 1793 and 1796, and to avoid biasing the estimates by erroneously including in the volatility measure the large price index jump that occurred during the transition to the U.S. dollar, state currency measures were only carried through 1792, and U.S. dollar measures were taken to begin in 1796. Sources: See the notes to Tables 1 and 3.

* Not statistically different from one another above the 0.1 significance level. For the Colonial Currency period, only data for 1751-1775 are available.

bFor the State Currency period, only data for 1786-1791 are available. c For the Colonial Currency period, data for 1757-1775 are available. d For the Colonial Currency period, comparable data are only available for 1758-1775. eFor the State Currency period, only data for 1785-1791 are available.

also relatively higher after 1797, this was coin- cident with Britain going to war with Napoleon, which was not the case for the United States. American prices also do not readily mirror En- glish prices-America's primary trading part- ner. The correlation coefficients between English and American prices for the period from 1797 through 1811 range from a high of 0.59 for English to Massachusetts prices to a low of -0.40 for English to Charleston prices.

While real shocks directly affecting the American economy could have been greater during 1797-1811 than during either 1750-1775 or 1784-1793, this possibility seems unlikely. The list of crises between 1750 and 1775 and between 1784 and 1793, e.g., the aftermath of King George's War, the Seven Years' War, the Stamp Act, the Townsend Duties, the 1768- 1769 import boycotts, the Boston Massacre, the financial panic of 1772, the closing of Boston harbor, the weather impact of the 1783 Laki Fissure volcanic eruption, Shay's Rebellion, the Whiskey Rebellion, and so forth, makes the period 1797-1811, even considering the 1807 embargo, look comparatively quiet.

While the quantity and quality of data on exchange rates are not as good as on prices, analysis of this data reinforces the conclusions derived above. Table 5 analyzes the behavior of

the U.S. exchange rate and, for the six states, PPP for the period 1797-1811. A unit root cannot be rejected for the legal and true-mint- parity U.S. exchange rate. Only when this rate is adjusted for banknote discounts can a unit root be rejected at the 10-percent significance level. When applying the same methods and test criteria to PPP for 1797-1811 as were applied to the pretransition data in Table 2, a unit root cannot be rejected for PPP in all six states for 1797-1811 under all formulations of the U.S. exchange rate. Using similar specifications and test criteria, the fact that PPP performs relatively better before versus after the transition to the U.S. dollar, and the fact that price trends diverge relatively more after the transition, undercuts the argument that the switch to the U.S. dollar was about decreasing transactions costs.

The quantitative evidence above suggests that the Constitution's ban on state currency and the switch to U.S. dollars may have produced a marked deterioration in monetary performance. The market's apparent preference for state- issued paper currencies post-Revolution may have been prudent given the recent experience with the Continental dollar and prescient given the inflationary spike and price volatility ac- companying the forced switch to U.S. dollars.

1794 DECEMBER 2003




TABLE 5-AUGMENTED DICKEY-FULLER TESTS FOR EXCHANGE RATES AND PURCHASING POWER PARITY,

1797-1811

[ln(yt) - ln(y- 1)] = ao + alln(yt-1) + k lags of [ln(y,) - ln(yt1,)] + e,

State/Periods/Series k a,

Massachusetts/ 1797-1811/PPP 0 -0.504 1797-1811/PPP` 3 -1.716**

New York/ 1797-1811/PPP 0 -0.410 1797-1811/PPPa 3 -1.211**

Pennsylvania/ 1797-1811/PPP 0 -0.340 1797-1811/PPPa 3 -0.932**

Maryland/ 1797-1811/PPP 0 -0.428 1797-1811/PPPa 3 - 1.669**

Virginia/ 1797-1811/PPP 0 -0.436 1797-1811/PPPa 3 -1.425**

South Carolina/ 1797-1811/PPP 0 -0.269

United States/ 1797-1811/Dollar Exchange Rate 0 -0.545*

Notes: Data are yearly. * and ** indicate that the coefficient is statistically different from zero above the 0.1 and the 0.05 significance levels, respectively. Dickey-Fuller critical values are used for a,. y for PPP equals [(England's Price Index X Exchange Rate)/State's Price Index] for each state, respectively. U.S. dollar exchange rate data are available only after 1795 and are the number of U.S. dollars needed to purchase 100 pounds sterling, and is derived by applying the Baltimore-White banknote discount adjustments to the true mint parity (Lawrence H. Officer, 1996, pp. 51-57, 80-84). Lags of the dependent variable were added to the specification until the k + 1 lag was statistically insignificant at the 0.1 level. Sources: Bezanson et al. (1936, p. 388); Cole (1938, pp. 121-22, 135, 156); Schumpeter (1938, p. 35); Bezanson (1951, p. 346); Rothenberg (1979, pp. 983-84); and the source note to Table 1.

a A unit root can be rejected if statistically insignificant lags (k = 3) are added to the specification (although given that this reduces the degrees of freedom by half-to just seven-caution should be exercised in interpreting these results). In all cases, just the first lag (k = 1) was statistically insignificant at the 0.1 level. In all cases, when adding up to three lags (k = 3) the last lag remained statistically insignificant, and in most cases so did the prior lags. These specifications also generate coefficients on the ln(y,_ )s that are substantially less than -1.0, suggesting the presence of oscillatory overshooting or excess volatility in the mean reversion process. They are presented here for comparative purposes.

Performance may have deteriorated because the shift to the U.S. dollar was also a shift to a system of banknotes fractionally linked to spe-

cie. Governments at all levels surrendered paper- money-making power to private bankers. Given the unregulated specie-reserve to banknote-loan ratio and the inability to sterilize gold inflows, the U.S. dollar regime may have amplified the effect that specie-flow shocks during the Napo- leonic wars had on U.S. nominal values (Nathan Hale, 1826, p. 13; Bray Hammond, 1957, pp. 131-205; Beatrice G. Reubens, 1960, pp. 43- 48, 61-67). President John Adams noted this in 1799 when he wrote, "... the fluctuations of our circulating medium have committed greater depredations upon the property of honest men than all the French piracies ..." (Hammond, 1957, p. 36).

VII. Conclusion

Scholars who trumpet the constitutionally created U.S. dollar currency union and the financial revolution led by Robert Morris and Hamilton as being key to American economic growth may be too sanguine. They forget to ask, "What was the opportunity cost?" The suggestion here is that the relevant opportunity cost was a world where the words "emit Bills of Credit" are absent from Article 1, Section 10 of the Constitution, but the words "No State shall ... make any Thing but gold and silver Coin a Tender in Payment of Debts" are retained. This next-best alternative may not have yielded an inferior macroeconomic outcome. The debate is not about banking per se, but about whether banks should have sole unfettered paper- money-creation power. Stripped of this power, banks would still have proliferated and prospered as financial intermediaries (Robert E. Wright, 2001, pp. 116-37). State currencies could have functioned as bank reserves, as government bonds did later under the National Banking Act, and as loans to the federal government. The federal government would not have been deprived of its borrowing capabilities or creditworthiness, which rested ultimately on its power to enact and credibly enforce tax payments-powers given to it by the new Con- stitution. Protected by the Constitution's gold and silver legal tender clause, foreign creditors would not have been less inclined to invest in the United States, and the federal government could have required that federal taxes be paid in specie (as Congress did in 1789) instead of in state bills of credit. Finally, state governments

VOL. 93 NO. 5 1795




instead of private bankers would have received the seignorage income from creating an inside paper money.

In 1787 would-be bankers saw paper-money- creation power as a profit bonanza whose potential could be reaped only if they could be rid of competing government paper money. The U.S. dollar currency union appears to have been created by merchant-bankers intent on usurping state and federal sovereign power over monetary matters to enhance their personal power and wealth. As Robert Morris confided in a letter to Silas Deane, "The present oppert'y of improving our Fortunes ought not to be lost, especially as the very means of doing it will contribute to the Service of our Country at the same time" (Ver Steeg, 1976, p. 17). The chance timing of events circa 1787 coupled with the recent wartime inflation gave private bankers the opportunity to get rid of their principal money-creating competitor constitutionally thereby making the return of this competitor extremely difficult.

What does this tale imply about current discussions of politically created, as opposed to market-generated, currency unions? Probably the most important implication is that the true motives for monetary unification may have more to do with politics and rent seeking than with economic efficiency gains, and that to de- flect attention from these profit- and power- maximizing motives efficiency gains may be overemphasized.

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