Preamble: this is certainly not the first time the United States has gone berserk printing money in order to address its present woes. This habit dates back to the nation’s founding. Here is an excerpt from my Panic, Prosperity, and Progress book on one such instance. You can find the first part here.
As prosperous as the colonies were, the government itself had very little in the way of assets. The public was not inclined to a strong government, particularly given the behavior of the British crown, and it was agreed by the colonial leaders that the issuance of paper money would be more palatable than the creation of a tax to fund the war. The colonists were, after all, already weary of taxes.
The new currency, a Continental dollar, was carefully designed to be difficult to counterfeit, and initially a prudent issuance of $19 million was distributed, with one Continental dollar being on par with one gold dollar. General Washington intended to fight a war of attrition, counting on the British to eventually grow weary of the war, but it would be years before peace would finally be at hand. Thus, there were many years of substantial expenditures forthcoming, and the temptation to simply print up more Continentals to pay the soldiers and suppliers was hard to resist.
As inflation started to slowly increase, colonial leaders became concerned that the diminishing value of the Continental would be an impediment to their chances of victory. Laws were passed declaring that anyone who refused to take Continental money, or refused to accept them at face value, was an enemy of the country. Early in the war, it was generally accepted that the unquestioning acceptance of the Continental was an act of patriotism, and anything else would be in aid of the enemy.
The same sentiment that promulgated a distrust of a strong central government likewise had a hearty respect for the independence of the individual states, so the states themselves elected to print their own currencies to address their own financial obligations. With the increasing reams of paper flowing through the economy, the value of the currency inevitably declined. The amount of new Continental dollars issued was, over the course of five years:
1775 – $6 million
1776 – $19 million
1777 – $13 million
1778 – $63 million
1779 – $140 million
And this was on top of $209 million of notes issued by the individual states. Thus, while it originally took $1 in Continental paper to buy $1 in gold, by April of 1781 it took $167.50. “Not worth a Continental” became a common phrase of denunciation for many decades after the currency’s cessation.
As the paper money spiraled down in value, Congress resorted to “impressments”, which was simply a polite term for theft. Soldiers were authorized to take whatever they needed, and they would leave what was basically an I.O.U. Had Britain won the war, these notes would of course have been worthless.
All of the colonists, of course, were taking a significant risk by confronting the British empire. Britain had a large, world-class military, superbly-trained and seasoned by years of fighting in Europe, and well-funded with Britain’s deep pockets and ability to borrow whatever funds were required. The wealthiest colonists were taking an even more substantial risk, since they had the most to lose.
Those taking a particularly substantial risk were the 56 delegates who signed the Declaration of Independence. Most of these men were well-to-do, with a handful of famous exceptions, such as Samuel Adams. Nine of the men were large landowners, eleven were wealthy businessmen, and twenty-four were successful lawyers who, in the case of a British victory, would surely lose their license to practice their livelihood. Their willingness to sign their names to the document literally put their lives on the line.
(Figure Knight 4-5: John Trumbull’s painting, Declaration of Independence, created in 1816, shows the five-man drafting committee of the Declaration of Independence presenting their work to the Congress.)
By 1780, with about half a billion dollars of federal and state currency floating around the colonies, Congress addressed the issue through the clever means of assessing a substantial tax, payable with fiat dollars (or, if one were so inclined, silver coins). This succeeded in mopping up a substantial portion of the supply of paper money, putting the young nation on a path to retiring the now-failed currency.
With all the advantages Britain had in its war against the colonies – skilled manpower, outstanding leadership, ample guns and ammunition, access to capital – they had one problem that could not be altered: the American colonies were very large. There was no practical way the British army could control such a vast population over such a large area, so they focused on securing the major naval ports.
After a couple of years of fighting, the British were not making substantial progress, so they decided to seal off New England with the hope of trapping the Continental Army, thus securing it in a confined enough space to open up the prospect of defeat. At the Battle of Saratoga, however, General Burgoyne was defeated and surrendered to the colonial forces.
The British then adopted a form of financial warfare, counterfeiting Continental dollars and distributing them throughout the colonies with the goal of accelerating the plunge in the dollar’s purchasing power.
The defeat at Saratoga greatly improved the public perception as to the colony’s chance of actually defeating the British, and France decided to align itself with the colonial cause, signing a treaty with the Continental Congress. Britain took the news of the French alliance badly, still paying off the debts from its lengthy Anglo-French wars of the past.
In spite of some British victories in 1780, the war finally turned in 1781 as French and American forces defeated Cornwallis in Yorktown, Virginia. Britain at last abandoned its offensive posture in the war, and the Americans could, after six years of fighting, could claim their victory.
By the end of the revolutionary war, the nations who had engaged in the conflict found themselves deeply in debt. The United States spent over $400 million (which was, not coincidentally, very close to the amount of paper money printed during the time); France spent 1.3 billion livres, and Britain had sunk 250 million pounds into debt. Having lost the war, the colonies, and the healthy trade relationship as well, the Britons saw their own taxes increase as they spent years paying off the indebtedness.
In spite of being the venue for years of warfare, the United States was by far the greatest victor, having won not only her independence but also a staggeringly large landscape, now that the west was in its possession, all the way to the Mississippi River. The painful experience of America’s experiment with paper money, however, played a large part in shaping the Constitution of the United States.
Most notably, the federal government learned that it was a severe mistake to allow individual states to create their own currency, so the Constitution expressly forbid states from creating any kind of legal tender. The job of gold and silver coinage was specifically reserved for the national government, and counterfeiting – which had been used as a weapon against the colonies during the war – was spelled out as a punishable crime by the framers.
The right to tax and tariff its citizens was also provided to the national government, since the colonies’ inability to extract wealth directly from its citizens for the purposes of national interest (such as war) severely weakened early efforts against the British. Crucially, the Constitution also create what was effectively a common market between the individual states, reserving any laws with respect to interstate commerce to the national government. This “borderless” economy within the entire United States would obviously be a core reason behind the nation’s future economic success.
From the point of view of an everyday colonist, he found himself paying and supporting one national government (that of the United States) in exchange for another (Britain); indeed, the fiscal burden on the citizens was much greater, now that the United States was on its own. The difference, of course, was that the individuals in North America were now citizens of their own country, no longer at the mercy of an overseas Parliament.
It was not long after that 24 brokers met in 1792 underneath a buttonwood tree on a well-traveled dirt path in New York City called Wall Street. Even though there were a mere five common stocks to trade (most of the trading revolved around bonds, commodities, and various other tradeable instruments), it was the tiny seed that was planted in the fertile economic soil of the Constitution’s framework that would eventually grow into the most important financial exchange in the world.