They say that "money makes the world go round". Consequently, having a basic understanding of how money works, and its history, is crucial. Otherwise, it's very easy to be misled about things like debt, power, inequality, and inflation.

In this two-part series we are going to briefly cover the history of money in the United States, from colonial times to the modern day, in order to better understand the origins of the financial system we operate under today.

Landing At Jamestown (1607)

The Spanish and Portuguese were the first to colonize the Americas in the late 1400s, settling in places like the Caribbean, Mexico and Venezuela. The wealth from gold, silver, and other resources flowing back to Spain created envy across Europe.

After nearly a century of voyages alongside the US coastline by European explorers, the first permanent English settlers setup camp in Jamestown Virginia in 1607, operating under a royal charter granted by the King of England.

Rather than quick riches however, the first 10 years at Jamestown were full of disease, starvation, and conflict with the native population. Nevertheless, the English settlers did manage to cultivate tobacco around 1612, turning Virginia into a prosperous colony.

What kind of money did the colonists use throughout these early years?

The Colonial Period (1607 to 1776)

When the colonies belonged to the English crown, physical gold and silver coins (specie) were used to conduct trade whenever possible, especially the Spanish dollar.

However, chronic shortages of specie (due to a persistent trade deficit with England) led to widespread barter where goods and services were exchanged directly without money. For example:

• A Virginia farmer might exchange barrels of tobacco for a blacksmith's horseshoes.
• A New England fisherman might barter fresh cod for clothing or farm produce.
• A carpenter could trade a handmade chair or table for a farmer's pig or chicken.

In 1690, after a failed military expedition against French Quebec that brought back no plunder, Massachusetts was the first colony to issue paper money (backed by future taxes or land) to pay their soldiers.

In the 1700s, the other colonies also began to issue their own paper money ("bills of credit" or "colonial scrip") amid chronic shortages of gold and silver coins.

These notes began circulating as a medium of exchange, easing trade. However, their over-issuance sometimes lead to inflation. This upset British creditors who complained that depreciated notes allowed debtors to repay loans with less real value.

After The American Revolution (1776 to 1860)

The British parliament passed the Currency Act of 1764, which prohibited all colonies from issuing new paper bills of credit as legal tender for public or private debts.

The colonists believed the Currency Act worsened specie shortages, was an impediment to economic growth, and asserted parliamentary control over local affairs.

Moreover, the British had just finished a 7-year-war against the French, leaving them with substantial debt. In order to manage war debts, new taxes were imposed on the colonists (The Sugar Act, for example), adding to revolutionary sentiment.

Fed up, America unilaterally declared their independence in 1776, but it was not until 1783 that it was recognized by the British as a sovereign nation. In 1788, the American constitution went into effect, giving congress the authority to coin and regulate the value of money.

The Coinage Act of 1792 made the dollar the national currency, defined it on a bimetallic standard (fixed amounts of gold and silver), and authorized the minting of gold, silver, and copper coins denominated in dollars and cents.

American states began chartering their own banks in the 1780s, including the Massachusetts Bank in 1784. These state banks routinely extended credit to customers and issued their own bank notes, backed by (and redeemable in) gold and silver. The value of these state bank notes varied, depending the perceived solvency of the bank.

The Controversial National Banks (1791 - 1836)

Despite fierce debate (especially from Thomas Jefferson) over whether or not congress had the constitutional authority, the First Bank of the United States was chartered in 1791, and lasted until 1811. It was similar in function to the Second Bank, but much smaller, and wielded less control over the state banks.

The Second Bank of the United States was chartered by congress in 1816, primarily to combat inflation and curtail unreliable state-issued paper currency that resulted from the war of 1812. It was a de facto regulator of state-chartered bank note issuance, and performed several functions:

• Provided a uniform national currency (its notes were widely accepted and backed by substantial reserves)
• Served as the federal government's fiscal agent (handling deposits, making payments, transferring funds, collecting taxes, and providing loans to the government)
• Regulated the supply of credit by restraining excessive note issuance from state banks (through demands for specie redemption)

Despite the advantages, critics argued it benefited speculators and foreign investors (including Europeans) at the expense of farmers, small businesses, and western/southern interests. They also believed it restricted competing state banks, and concentrated too much financial control in one institution.

After the Second Bank of the United States lost its charter in 1836 (thanks to a veto by President Andrew Jackson), state-chartered banks began to proliferate across the country. Before the Civil War broke out in 1861, there were upwards of 1,300 state-chartered banks in the country, each issuing their own proprietary bank notes.

From 1837 to 1863, lenders and depositors needed to do their own research into banks to assess their reputation and soundness. Market discipline, rather than the government, played a major role in weeding out weaker or reckless banks. There was no "lender of last resort" that banks could rely on.

This competitive, decentralized, "Free Banking Era" peaked in the early 19th century before federal reforms were enacted.

Post-Civil War (1865 - 1913)

Civil War broke out in America in 1861 as the northern states aimed to prevent the expansion of slavery, while the southern states sought to preserve it. After a brutal 4-year-war, the south surrendered to the north, rejoined the Union, and slavery was abolished.

Primarily to raise funds for the war effort, congress passed the National Currency Act of 1863, nationalizing the issuance of currency.

Any nationally chartered bank was now required to purchase US bonds, and deposit them at the US Treasury. The bonds served as collateral for the national bank notes the bank could issue. In the event of a bank failure, the bonds would be sold to redeem the notes at full face value.

National bank notes were indirectly redeemable in gold. This meant that the holder could exchange notes for "lawful money" (gold/silver certificates, etc) at any bank, and then redeem the certificate for physical gold at a US treasury office.

A 10% tax on state-chartered bank notes was imposed, effectively compelling them to convert into national banks if they wanted to issue paper money. Many state banks eventually transformed into demand deposit banks, a safe storage place for the national bank notes.

Critics argued that these National Banking Acts forced private banks to finance government debt, and favored a national system at the expense of state sovereignty. It's safe to say that neither Andrew Jackson nor Thomas Jefferson would have been pleased with the new regulations.

The transition to the National Banking System represented a major shift from "free banking" toward a centralized, federally controlled financial infrastructure. But this was just the beginning of an increasingly centralized banking system.

Until Next Time

In the next post, we will cover pivotal moments in US banking history including the creation of the Federal Reserve in 1913, the end of the gold standard for US citizens in 1933, and the closing of the gold window for foreign countries and banks back in 1971.

We will also discuss how these actions led to the unsustainable debt burden we find ourselves in today, reduced our economic freedom, and was the impetus for an innovative solution that has spread like wildfire over the Internet since 2009.

If you learned something new from this article, be sure to

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Sources

- Maryland Colonial Money
- Gold Eagle Coin

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