The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be exempt from any intellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.
— John Maynard Keynes, The General Theory of Employment, Interest, and Money (1936)
A Long-Term Project.
A decade or so ago I was a member of a curious group called the First Wednesday Circus. Our members were professionals engaged in the investment advisory business, and we gathered for lunch on the first Wednesday of each month at the Circus Club in Atherton, California – hence the whimsical name the group had adopted.
At least a couple of the members of the group were what I would call unreconstructed gold bugs – of the opinion that our world would somehow be better if our economy operated on a gold standard. My immediate reaction on discovering this was negative, but inchoate. My sympathies were, and are, largely with Keynes, but in thinking about money specifically, I’d have to say that Irving Fisher’s The Purchasing Power of Money: Its Determination and Relation to Credit, Interest, and Crises (1911) was a stronger influence. Fisher argued, persuasively in my view at least, that the rigid monetary standard of his era was holding back economic activity, and he posited a cycle of expansion and contraction of credit, which explained the periodic panics that had afflicted the American economy during the 19th Century. The rigid monetary standard that my gold bug friends advocated and the strict adherence to market-determined prices and interest rates, in which they expressed such dogmatic faith, seemed a recipe for instability. They sounded too much like the television pundits who, during the global financial crisis of 2008, appeared to advocate a good, cleansing depression as the economic medicine we needed.
The trouble for me was that the best answer I could formulate to counter the gold bugs’ assertions amounted to saying, “My defunct economist can beat up your defunct economist.” I needed a better one, so I started on a project – by now it probably qualifies as a quest – to inquire deeply into money and banking, the sub-area of economics in which these issues live. I began with Alexander Hamilton and the Compromise of 1790 (the subject on the table “In the Room Where it Happened”). In the course of some early historical research, I discovered the joys of primary source materials and the oddly seductive appeal of special collections reading rooms in great libraries. My quest acquired an overlay of addiction.
Before too long I hit on the idea that if I wanted to think deeply about money and banking through the lens of history, one interesting approach would be to concentrate on banking in a time and place where the underlying circumstances were unusual. My notion was that if features that were common in other times and places appeared in the unusual case, they were likely to be universal. The idiosyncrasies would probably be interesting too. Since I live in the Bay Area, the California Gold Rush suggested itself almost immediately.
With no specific list of materials in mind to examine, I visited the Bancroft Library at UC Berkeley and explained to the research librarian what I was up to. She brought me a couple of likely-looking documents. One of them presented an irresistible mystery: Why would a man with the singular name of James King of William (now my favorite Gold Rush character) have been sending $5000 in cash every week to a William Hammond in Sonora, out near Yosemite in 1852? I have been pulling on that thread, and the web of threads connected to it, ever since.
My project has metastasized into a broader study of the economic history of California and the Pacific Rim. There’s a book in it, I’m confident, and it’s already yielded some decent written material. But I haven’t completely lost sight of the original point of the enterprise, which is to contribute to our understanding of money. This is the first of what may become a series of notes, each meant to spotlight a small part of a big subject.
Money.
Money is one of those things, like its proverbial equivalent, time, that we think we understand until we really contemplate them. Or, rather, our everyday understanding of them is plenty for everyday purposes, but the more deeply we look into them, the stranger they seem.
Many of us, I’m sure, can rehearse the undergraduate functional definition of money, which is not a bad place to start: Medium of exchange (one of the reasons I’ve taken that phrase as the title of my Substack), store of value, and unit of account. That definition says nothing about the form money must take, because money needn’t take any particular form. In my research I have found times when silver coins were abundant, but they were no good as money because there was nothing to buy; and I’ve found times when furs and hides functioned as money because there was no silver, gold, or broadly accepted paper money. And our money today? It’s mostly credit, transferred and accounted for virtually.
The broad conclusion I’ve drawn from my research is that privileging gold as money ends up privileging money over commerce and other economic activity. That reasoning inverts the relationship. Money is the servant of commerce, and it can emerge in whatever form best suits the needs for a medium of exchange, store of value, and unit of account in a particular time and place. The supply of money can stimulate or retard economic activity, so money functions best when it remains in balance with the economic activity it facilitates.
Gold bugs, along with cryptocurrency advocates, tend to derogate state-regulated paper money as “fiat currency,” as though the government calls money into being by proclaiming, Fiat pecunia! But in our economy, it is the banks, not the government, that create and destroy money. The business of balancing (or not) money and commerce has a large political component, but that is always the case.
To see the importance of balance between money and economic activity, let’s start with a case about which I suspect my gold bug friends and I would agree. It is a case of a true fiat currency, with inadequate backing and no hope of balance between money and commerce. Let’s look at the Continental Currency of the American Revolution.
The Continentals.
During the Revolutionary War, one of the most urgent problems the Colonies and the Continental Congress faced was how to meet the large expenses of the conflict. In 1775, Congress authorized the issue of some two million Spanish dollars in “Continental Currency,” paper certificates notionally redeemable for Spanish silver. Of course the Continental Congress did not have anything remotely like enough silver to back the notes. The Continentals were a form of revenue-anticipation notes, issued against future taxes that the Continental Congress intended (or pretended to plan) to collect. When Congress failed to demonstrate either the will or the ability to levy those taxes in the necessary amounts, the Continentals rapidly fell in value — hyperinflation, if you like. Before they passed out of circulation altogether, their value in trade had fallen (sources differ) to 1/100 or even 1/1000 of their face value. Some reports describe the peculiarly inverted circumstance of creditors’ fleeing from their debtors, who sought to pay them off in the nearly worthless notes. And for quite some time after the Revolution, anything of little value might be described as “not worth a Continental.”
Two-dollar Continental, 1776. My personal collection.
The trouble with the Continentals was that because Continental Congress had so little taxing authority, they really weren’t much more than pieces of paper. At the end of the war, veterans returned to their homes holding Continentals and other scrip from the legislatures of the Colonies (now States), representing debts that might never be paid.
In September 1783, after the end of hostilities but before the ratification of the Treaty of Paris, the Rev. Samuel Ely (1740-late 1790s) led a crowd of farmers in a protest aimed at closing the Hampshire County courthouse, in Northampton, Massachusetts. Ely and his followers felt that Massachusetts’s new constitution taxed poor farmers unfairly. Many of them had served in the Continental Army, and the Commonwealth owed them significant amounts of back pay, against which many veterans held promissory notes. But the General Court (the Massachusetts legislature) had repeatedly deferred and extended payment on those notes, and the former soldiers were in no mood to pay heavy taxes, especially if a major purpose of those taxes was to pay off the debt they were holding. Many were also heavily in debt themselves, and closing the courthouse that held the records of their mortgages might have stalled foreclosures on their farms.
Ely’s Rebellion was a precursor (or perhaps part of) Shay’s Rebellion, which we learn in school, more or less accurately, was one of the events that led to the collapse of the Articles of Confederation and the adoption of our current Constitution.
One of the leading citizens of Northampton at the time was Joseph Hawley (1723-1788). He was a lawyer, legislator, and militia officer in Northampton, and a leader of the American revolutionary movement in Massachusetts. Like Ely, he was a Yale graduate. Unlike Ely, who was a controversial organizer, Hawley was a well-to-do, established figure in Northampton, and a first cousin of Jonathan Edwards (Ely was a “New Lighter,” aligned with Edwards’s chief theological critic, George Whitefield, during the Great Awakening). Hawley also served in the Massachusetts House of Representatives.
Hawley was able to call out the militia to suppress Ely’s rebellion, but he also recognized that the reliability of the militia was tenuous. He wrote a friend, “[T]hey are on the Point of turning to the Mobb, and if they are not soon relieved and paid off the value of their Securities either in money or by their being made to answer for Taxes, they will become outrageous and the numbers who will side with them will be irresistable.”[1]
Hawley was no friend of “the Mobb.” When he argued for relief for the “Old Continental Soldiers” holding Government Securities, he mostly expressed concern for the public order and for the Commonwealth’s ability to raise a militia in the future. He had a rather Puritanical view of debt, and his papers include a draft of a creditor-friendly bill, which would facilitate the type of foreclosures the farmers were protesting. Yet he believed that the Government Securities those farmers held should be “made to answer for Taxes.”
The Public Credit.
Making government securities valid for payment of taxes is a well-known stratagem for giving those securities the character of money. After all, if I can discharge my tax liability to the face value of those securities, then there will be some price, even if at a discount to par, at which I will be willing to buy them in exchange for other goods or forms of money. But the question of whether Hawley’s proposal would have succeeded in forming a solid monetary base would have rested on the Commonwealth’s credit. If Massachusetts could maintain a sound public credit, then those debt securities could have functioned as money for some time. If not, then high inflation would likely have resulted. That might have reduced the weight of the Commonwealth’s debt burden and relieved those farmers that had mortgaged their property, but creditors in the state would have suffered substantial losses. Nothing in Hawley’s writings suggested that he would have favored such a large transfer of value from creditors to debtors.
Today, we operate under a version of Alexander Hamilton’s plan, in which, while Government securities do not circulate as money, they provide the underpinning of our monetary system. Banks, and the Federal Reserve, hold Treasury securities on the asset side of their balance sheets. The Fed issues currency and credits banks with reserves on the liability side. Commercial banks leverage their reserves to make loans. In this way, the banking system is the chain connecting the money in our economy to Government debt. So long as the Government’s credit is sound, a permanent, well-supported public debt provides a firm anchor for that chain. But let the credit erode substantially, and the chain becomes unmoored, with unpredictable results. This is the issue that arises when members of Congress grasp for public attention by threatening to block increases in the Treasury’s borrowing authority, and the reason hostage-taking over the debt ceiling is irresponsible.
The Continentals provide us an example from our own national history of a form of money that failed because it was out of balance with its underlying economy, and lacked adequate backing by either assets or credit. It is the first of what we hope will be a number of illuminating examples that help us understand the nature of money.
[1] Joseph Hawley to Ephraim Wright, April 16, 178[2], Joseph Hawley Papers, New York Public Library