Below is the full text of the paper I presented at the MWASECS conference yesterday in Fargo, N.D. It is an elaboration of the 1760s episode that I relate in Bailouts and discuss in more detail in the forthcoming Fubarnomics as well as a forthcoming book with UVA's Ron Michener.
The Circulation of Money in North America Before the Revolution: (Economic) Boundaries and (State) Borders
By Robert E. Wright, Nef Family Chair of Political Economy, Augustana College SD
The denizens of eighteenth-century North America, be they European or Amerindian, used three different types of money: commodity, fiat, and credit. Rather than being confined largely within political borders, as often assumed, colonial monies circulated within ever fluctuating economic boundaries, some local, some regional, and some international. The complicated but flexible system functioned tolerably well until British imperial policies effectively throttled it shortly after the French and Indian War. The widespread economic disruption that followed led directly to the Imperial Crisis that culminated in the American Revolution.
Anything with intrinsic value that is in general demand and has a relatively stable value can serve as a commodity money, or in other words as a medium of exchange in economic transactions. Animal pelts, copper, corn, ginger, gold, indigo, molasses, silver, tobacco, wampum, and a wide variety of other physical goods served as commodity monies at times in different parts of colonial North America. Colonists increased the liquidity or money-ness of commodities in several ways, including rating, standardization, and authentication. Rating was a law or community norm that specified that so much of commodity X was worth Y, usually stated as an abstract measure of value, or unit of account in the parlance of economists.
The moment a bushel of corn or a beaver pelt is fixed at, say, one shilling in the repayment of debt or the purchase of other commodities the debtor or buyer has an incentive to adulterate his payment, or in other words to tender his most rat-infested corn and his smallest, thinnest pelt. Standardization and authentication sought to mitigate adulteration. Payments made at prevailing ratings had to be of good, merchantable quality. Of course parties to a transaction could disagree over what was good and merchantable and what was trash. In some places, that problem was effectively solved by creating warehouses and appointing inspectors who gave out bearer receipts in exchange for deposits of goods that met minimum quality specifications. People then exchanged the paper receipts rather than the commodity itself, thereby economizing on freight, portage, and storage costs. Such systems worked best for hearty commodities sold in international markets, like tobacco.
Most other commodities were too perishable, too local, or simply too variegated to support a warehousing system so colonists generally preferred the precious metals as the commodity money par excellence. Gold, silver, and copper were extremely durable, came in standardized values known commonly as coins, and despite some counterfeiting, clipping, and other forms of adulteration were relatively easily authenticated with scales. They were heavier than warehouse receipts but had a far higher value to weight and bulk than other commodity monies. Moreover, unlike fiat or credit monies the ultimate value of the precious metals was unquestionable due to steady worldwide demand. By about 1700, gold, silver, and copper were the preferred media of exchange for large, modest, and small transactions, respectively. Other forms of commodity money did not disappear, especially in remote rural areas, where so-called country pay persisted, and in mercantile circles, where molasses and other relatively homogenous commodities remained trade goods throughout the century. Nevertheless, most Europeans and Amerindians tied to trade networks preferred the precious metals to all other types of commodity money.
The rest of the world felt likewise, so the colonists found that they did not so much own full-bodied gold and silver coins, known as specie, as they had the use of them for short periods of time. Coins that the colonists earned in trade with the West Indies, for example, were soon exported to Britain or other distant lands. The soliloquy of a debtor about to part with a gold Johannes, or Joe for short, published in the Connecticut Gazette in 1768 captured the essence of the situation:
QUOTE We are come to the unhappy parting hour. Lately I received you into my house as a Traveller, and almost a Stranger; you was welcome and have been a pleasant guest; I delighted in your countenance, and your very looks seem’d to bespeak me and say; I will do you some good Jobb before I leave. … I must tell you, I am now obliged to sell you to a Merchant, don’t think I do it of choice. … I hoped you might have remained an inhabitant of the country, that I might have receiv’d some visits from you, but now I expect you will have a quick dispatch to Boston, or New York; immediately take ship and I shall see you no more. … Think not hard of me for putting you under this sentence of Banishment, necessity knows no Law. Farewell, my friend Jo. UNQUOTE
The full-bodied coins of the eighteenth century knew no state borders but rather flowed constantly towards their highest valued use. In fact, an insignificant fraction of the coins in circulation in the trans-Atlantic economy were minted in North America. Most came from Europe proper or from European mints in Latin America, though some originated in Arabia and other exotic places. Where coins traveled partly depended on trade and migration patterns. New York had a good supply of Arabian gold in the 1690s, for instance, because some New Yorkers set up posts in Madagascar from which they engaged in piracy in the Red Sea and off the coast of eastern Africa. [What, you thought the Somalis thought that one up?] When the Yorkers returned home, their ill-gotten booty entered circulation but of course was soon sent abroad again to pay for British manufactured goods, slaves, and so forth.
For some decades, colonial legislators believed that they could increase the total purchasing power of coins in domestic circulation by raising their ratings. Like other commodities, coins were rated in terms of the local unit of account, so many pounds, shillings, or pence of the local currency, typically denominated as “Pennsylvania money,” “Virginia currency,” “Massachusetts pounds,” “New York shillings,” or similar iterations. By the early eighteenth century, most of the colonial currencies or units of account were worth somewhat less than sterling, the unit of account of Great Britain – analogous to the Canadian dollar or Australian dollar typically being less valuable than the U.S. dollar – because of repeated competitive currency devaluations.
In other words, the colonies raised the rating of coins in terms of the local unit of account in the hopes of attracting and retaining more of them. Such policies often siphoned off some of the coins of neighboring colonies but were ultimately self-defeating because the nominal prices of other commodities, real estate, and labor usually increased by the same percentage as the rating. In the end, then, devaluation provided the colonies with no real, long-term gains, just higher nominal prices and retaliatory neighbors. And of course devaluation did great injustice to creditors, who might lend 10 coins only to be legally repaid 7 or 8 at the end of the contract. For those reasons, imperial regulators constrained colonial legislatures from rating coins. They succeeded, however, only in driving the rating process underground, into the hands of private associations of merchants and/or attorneys.
One of the best documented cases of a private association changing coin ratings comes from the British Leeward Islands – Antigua, St. Christopher’s, Nevis, and Montserrat -- in the latter half of the 1730s. It enforced -- extra-legally -- a rating law passed by the assembly of Antigua that the King refused to approve. Similar associations appeared in some of the mainland colonies and left evidence of their work in the coin rating tables published in almanacs.
Coin ratings could not make a colony rich or affect real money balances in the long term but relative ratings could and did directly influence the types of coins in local circulation. Merchants naturally remitted coins where they would fetch the most, or in other words where they were most over-valued RELATIVE to other coins. Over time, that changed the composition of the local money supply. The smaller the degree of over-valuation the slower the adjustment process. Due to high transaction costs – like insurance and freightage -- only large discrepancies in relative coin values would induce arbitrage, or the direct exchange of over-valued coins for under-valued ones for the purpose of profit.
Due to differences in relative coin ratings, neighboring or nearby colonies could have vastly different sets of coins in circulation, like mostly gold coins in New York and mostly silver ones in Pennsylvania, or vice versa. Even more interesting still, some commercially divided colonies, like New Jersey and Maryland, had different coin ratings in different parts of the colony and hence different sets of coins in circulation. Colonies with significant numbers of Amerindians, like New York, also had areas with distinct sets of coin in circulation.
The geographical circulation of fiat paper money was almost as complex. Colonial governments issued the stuff, commonly called bills of credit, as tax anticipation scrip to finance wars and as loan proceeds to stimulate economic development. Until the late colonial period, bills of credit were typically full legal tender in the colony of issue, meaning that private as well as public creditors or buyers could be forced to accept them at face value. They were generally not legal tender outside of the colony of issue, however, inducing some scholars to claim that they rarely crossed colonial political borders. While it is true that bills of credit were almost valueless in international trade they could and did circulate in colonies where they were not a legal tender.
Before mid-century, in fact, bills of credit issued by any of the New England colonies tended to circulate in all of them. Throughout much of the colonial period, New Jersey bills circulated in New York and Pennsylvania, serving as a conduit of trade between Philadelphia, which controlled the trade of southern Jersey and New York, which controlled the trade of northern Jersey. Pennsylvania bills also often found extensively circulation in Maryland, the bills of which sometimes assumed a major importance in Pennsylvania and Virginia.
Intrinsically worthless bills of credit could circulate even when unsupported by tender laws for two reasons. First, where the volume of bills in circulation did not exceed the demand for them at prevailing prices they remained informally convertible into gold and silver at par. As the essayist Eugenio later explained:
QUOTE The people voluntarily and without the least compulsion threw all their gold and silver, not locking up a shilling, into circulation concurrently with the bills; whereby the whole coin of the government became forthwith upon an emission of paper, a bank of deposit at every man's door for the instant realization or immediate exchange of his bill into gold or silver. This had a benign and equitable, a persuasive, a satisfactory, and an extensive influence. If any one doubted the validity or price of his bill, his neighbor immediately removed his doubts by exchanging it without loss into gold or silver. If any one for a particular purpose needed the precious metals, his bill procured them at the next door, without a moment's delay or a penny's diminution. UNQUOTE
Second, citizens of the colony of issue demanded the bills to make tax or government loan office mortgage payments thus creating a secondary demand in their retail trading partners regardless of their colony of residence. So, for example, a farmer in southern Jersey might take a Pennsylvania bill of credit in payment of a debt because he knew he could use the bill to buy goods in Philadelphia. Likewise, a Philadelphia merchant would take a Jersey bill in payment for a purchase because he knew he could soon use it to pay a southern Jersey farmer for a cow or a cartload of vegetables. The same merchant would reject a Massachusetts or South Carolina bill, however, as he likely did not have any retail dealings with either place or know anyone who did. For that very reason, the bill would not have been remitted to Philadelphia in the first place.
Philadelphia merchants had many wholesale dealings with Boston, New York, Charleston, and indeed numerous ports through North America, the West Indies, and Europe. Wholesale trade, however, was conducted largely on credit. The retail trade was, too, but cash transactions were relatively more common at the retail level, especially in urban areas. Merchant-to-merchant dealings, however, typically went on for years until relatively large balances due were settled. Even then, payments were often in trade goods like molasses or bills of exchange instead of cash. Unlike bills of credit, which were bearer instruments designed to pass easily from hand to hand as a medium of exchange, bills of exchange were mercantile credit instruments denominated in major foreign currencies like sterling. A merchant with a credit in a British bank or mercantile house would draw up and sell for local currency a bill of exchange to another merchant with a sum due in London or Liverpool. The purchaser could then endorse and remit the bill of exchange to his creditor who could cash it locally much the way we cash checks today. Bills of exchange economized on the shipment of commodities, including specie, and hence were generally less costly than shipping coins or bulky goods. When bills of exchange were scarce, however, their price could rise to the point that merchants found it cheaper to export Joes or other coins instead.
Obviously, trans-Atlantic mercantile credit was international and its boundaries were largely the economic ones of trade rather than the political ones of governments. The same held within the mainland North American colonies, where Boston, New York, and Philadelphia wholesale merchants extended trade credit across colonial boundaries to retailers in Quebec, New Hampshire, Connecticut, New Jersey, and Maryland, and across international boundaries to Amerindian traders.
At the end of the French and Indian War, the money supply of New England consisted of coins, most of foreign origin, and layers of trade credit that extended from consumers to retailers to colonial import merchants to British and other European export merchants. Elsewhere on the mainland, bills of credit also circulated promiscuously across colonial political borders, circulating within the economic boundaries of trade. It was complicated enough to confuse contemporaries sometimes and later historians most of the time but all in all it worked. Then the British meddled with it, touching off a monetary crisis that ultimately resulted in the Revolution.
The famous disputes over taxation and sovereignty were not the first rounds of the Imperial crisis. “I must observe,” a colonist argued in 1768, that QUOTE it is not the Stamp Act or New Duty Act alone that had put the Colonies so much out of humour tho the principal Clamour has been on that Head but their distressed Situation had prepared them so generally to lay hold of these Occasions UNQUOTE. What was the nature of that distressed situation? As I tried to explain, the economic forces of trade, not governments, largely determined colonial money supplies and hence interest rates, real estate prices, and overall macroeconomic conditions. The British government, however, could control colonial trade if it wanted to. For a long time it remained content to fiddle around the edges but after the French and Indian War it intruded in unprecedented and highly disruptive ways. For the first time, British trade regulations had significant and palpably negative effects on colonists’ well-being.
During the war, the colonial economy boomed. To help fight the war, colonial legislatures outside New England emitted large quantities of bills of credit. In support of His Majesty’s troops, huge sums of gold, silver, and sterling bills of exchange flooded in. Simultaneously, colonial privateers plied the seas, making legitimate seizures of numerous French ships and cargoes, virtual manna from heaven. Colonial privateers also pretended to seize friendly merchant ships engaged in illegal commerce with the enemy, a ruse that protected smugglers from unfriendly privateers and the Royal Navy. Merchants also used flags of truce and falsified papers to penetrate lucrative but illegal foreign markets in the West Indies.
Thanks to the wartime economic boom, the prices of non-traded goods like labor and real estate soared by 200 to 300 percent. Returning to Philadelphia in 1763 after a long diplomatic mission in London, Benjamin Franklin reported that QUOTE The Expence of Living is greatly advanc’d in my Absence; it is more than double in most Articles; and in some ’tis treble. UNQUOTE He also noted that the QUOTE Rent of old Houses, and Value of Lands, … are trebled in the last Six Years.UNQUOTE About the same time, William Franklin, Ben’s son, noted that in New Jersey QUOTE all the Necessaries of Life in this Country are encreas’d in Price near Three fold to what they were Seven Years ago. UNQUOTE A 1763 pamphlet also painted New Jersey’s economy in glowing terms. QUOTE Your Lands are surprisingly advanced in Value, the author wrote, and … the Province is in Fact richer in a great Degree than ever it was. UNQUOTE
Like Americans today, colonists regularly bought and sold real estate to make room for children, move closer to friends and family, take a new job, build up a business, or simply show off their prosperity. Also like today’s Americans, colonists were enticed by rising real estate prices but could rarely afford to pay for their acquisitions with cash. In most parts of the continent, three types of mortgages were available, private ones callable by the lender after at most a few years, government ones that amortized over ten or so years, and private perpetual interest only (IO) mortgages called ground rents.
If mortgages are not callable, as with ground rents, colonial government mortgages, and most mortgages today, borrowers cannot be evicted from their properties, no matter how low the market value sinks, so long as they continue to make scheduled payments. Similarly, those with long-term fixed rate mortgages need not worry about facing higher payments if interest rates increase. Colonists who borrowed on callable mortgages, by contrast, faced both risks. If real estate values fell, lenders could call for the principal on the grounds that their mortgages were under-collateralized, that the properties pledged to support the loans were no longer of sufficient value in other words. If interest rates increased, lenders could also call simply to reinvest the principal at higher rates. Usury laws or interest rate caps were in place but they were as about as effective as drug laws are today.
All was well during the wartime boom but colonial prosperity, and with it the real estate boom, faded with the war. The British Army left for new battlegrounds, the heaven-sent privateering harvest faded into memory, and, thanks to unprecedented exertions by the British Navy and customs officials, the lucrative trade with the foreign West Indies declined dramatically. The crackdown was so severe that even legitimate trade suffered. British naval vessels, one contemporary complained, QUOTE cramp Trade by stopping and detaining Merchants ships and pressing their Men. UNQUOTE
Due to that unfortunate confluence of events, the colonies suddenly found themselves running huge trade deficits. At the same time, bills of credit were paid in as taxes and retired at a rapid rate, dropping in the Middle Colonies from about £2.50 sterling per capita in 1760 to £1.05 in 1763, the very year that a New Jersey pamphleteer predicted that the confluence of peace and the inability to print new bills of credit could create circumstances QUOTE when we may be exceedingly distressed for want of a Medium of Trade. UNQUOTE Colonial business conditions were indeed dismal in 1764 and grew yet worse in 1765. As the monetary contraction continued, bills of credit became almost unattainable, even among wealthy merchants. In February 1764, merchant Gerald Beekman reported that QUOTE all the money seems to be vanished out of our City and C[o]untry. UNQUOTE Despite having more than £12,000 due to him on bond, he confessed to being unable to raise even £500 at any rate of interest. Trade suffered as a consequence.
Throughout the colonies, tight money and depressed business conditions brought a wave of commercial bankruptcies. Those failures, the scarcity of money, and high interest rates drove real estate prices steadily lower. In 1765, the editor of The New York Gazette or Weekly Post-Boy claimed that QUOTE there is such a general scarcity of Cash that nothing we have will Command it & Real Estates of Every kind are falling at least one half in Value. UNQUOTE By the end of 1766, the contraction of real estate prices had cost landholders approximately £2,000,000 sterling in New Jersey alone.
As a result of falling land prices a vicious cycle took hold, one in which QUOTE the consumers break the shopkeepers; they break the merchants; and the shock must be felt as far as London. UNQUOTE Pamphleteer Stephen Sayre recounted an instance in New Jersey of QUOTE one merchant sueing seventy shopkeepers for debt; the seventy had lands, and their lands were sold at public auction for no more than the sum owing, by which means seventy families were deprived of their substance. UNQUOTE That story sounds exaggerated if not outright apocryphal but private correspondence was replete with similar tales of woe.
By 1768, the crisis finally began to run out of steam, partly because few debtors were left to sue and partly because the futility of ruining one’s debtors by forcing the sale of assets that no one could buy was apparent to all. Creditors did not recoup their full investments and had to suffer with the knowledge that they threw families out of their homes and husbands and fathers into horrid prisons. For food, water, clothing, bedding, and the other necessaries of life debtors had to rely on family, friends, and charity. Conditions ranged from cramped to fetid. In Charleston, South Carolina Anglican minister Charles Woodmason saw 16 debtors crammed into 12 square feet of jail cell in 1767. QUOTE A person would be in a better Situation in the French Kings Gallies, or the Prisons of Turkey or Barbary, he opined, than in this dismal place. UNQUOTE
Conditions were deliberately harsh in order to induce debtors to pay up. The assumption was that debtors could repay if they wanted to, with assets that they must have squirreled away. In other words, all defaults were due to moral hazard. By the late 1760s, even the dullest creditors came to understand that most borrowers could not repay due to macroeconomic conditions well beyond their control. To imprison them served no purpose. Lawsuits therefore began to taper off and Americans’ fury increasingly turned toward the real cause of their economic problems, Britain’s destructive trade policies, especially the Sugar and Currency Acts and the postwar crack down on smuggling.