A Financial System in Which Bankers Are Public Servants,
Web of Debt, p.409
Whether loans are extended interest-free or interest is returned to the community, community-oriented models would work best if the banks were publicly-owned institutions that did not need to return a profit. Today government-owned banks are associated with socialism, something that has negative connotations in the United States; but they would not have raised the eyebrows of our forefathers.
The Pennsylvania land bank was a provincially-owned institution that generated sufficient profits to fund the local government without taxes; and in this it was quite different from the modern socialist scheme. Even the most successful modern Western democratic socialist countries, including Sweden and Australia, do not eliminate taxes. Rather than funding their governments with profits from publicly-owned ventures, they rely on heavy taxes imposed on the private sector.
Money as Credit,
Web of Debt, p.36
The distinction of being the first local government to issue its own paper money went to the province of Massachusetts. The year was 1691, three years before the charter of the Bank of England. Jason Goodwin, who tells the story in his 2003 book
Greenback, writes that Massachusetts’ buccaneer governor had led a daring assault on Quebec in an attempt to drive the French out of Canada; but the assault had failed. Militiamen and widows needed to be paid. The local merchants were approached but had declined, saying they had other demands on their money.
The idea of a paper currency had been suggested in 1650, in an anonymous British pamphlet titled “The Key to Wealth, or, a New Way for Improving of Trade: Lawfull, Easie, Safe and Effectual.” The paper currency proposed by the pamphleteer, however, was modeled on the receipts issued by London goldsmiths and silversmiths for the precious metals left in their vaults for safekeeping. The problem for the colonies was that they were short of silver and gold. They had to use foreign coins to conduct trade; and since they imported more than they exported, the coins were continually being drained off to England and other countries, leaving the colonists without enough money for their own internal needs. The Massachusetts Assembly therefore proposed a new kind of paper money, a “bill of credit” representing the government’s “bond” or I.O.U. – its promise to pay tomorrow on a debt incurred today. The paper money of Massachusetts was backed only by the “full faith and credit” of the government.
Other colonies then followed suit with their own issues of paper money. Some were considered government I.O.U.s, redeemable later in “hard” currency (silver or gold). Other issues were “legal tender” in themselves. Legal tender is money that must legally be accepted in the payment of debts. It is “as good as gold” in trade, without bearing debt or an obligation to redeem the notes in some other form of money later. When confidence in the new paper money waned, Cotton Mather, who was then the most famous minister in New England, came to its defense. He argued:
Is a Bond or Bill-of-Exchange for £1000, other than paper? And yet is it not as valuable as so much Silver or Gold, supposing the security of Payment is sufficient? Now what is the security of your Paper-money less than the Credit of the whole Country?
Mather had redefined money. What it represented was not a sum of gold or silver. It was credit: “the credit of the whole country.”
The Father of Paper Money
Benjamin Franklin was such an enthusiast for the new medium of exchange that he has been called “the father of paper money.” Unlike Cotton Mather, who went to Harvard at the age of 12, Franklin was selftaught. He learned his trade on the job, and his trade happened to be printing. In 1729, he wrote and printed a pamphlet called “A Modest Enquiry into the Nature and Necessity of a Paper-Currency.” It was circulated throughout the colonies and became very popular, earning him contracts to print paper money for New Jersey, Pennsylvania, and Delaware.
Franklin wrote his pamphlet after observing the remarkable effects paper currency had had in stimulating the economy in his own province of Pennsylvania. He said, “Experience, more prevalent than all the logic in the World, has fully convinced us all, that [paper money] has been, and is now of the greatest advantages to the country.” Paper currency secured against future tax revenues, he said, turned prosperity tomorrow into ready money today. The government did not need gold to issue this currency, and it did not need to go into debt to the banks. In America, the land of opportunity, this ready money would allow even the poor to get ahead. Franklin wrote, “Many that understand . . . Business very well, but have not a Stock sufficient of their own, will be encouraged to borrow Money; to trade with, when they have it at a moderate interest.”
He also said, “The riches of a country are to be valued by the quantity of labor its inhabitants are able to purchase and not by the quantity of gold and silver they possess.” When gold was the medium of exchange, money determined production rather than production determining the money supply. When gold was plentiful, things got produced. When it was scarce, men were out of work and people knew want. The virtue of government-issued paper scrip was that it could grow along with productivity, allowing potential wealth to become real wealth. The government could pay for services with paper receipts that were basically community credits. In this way,
the community actually created supply and demand at the same time. The farmer would not farm, the teacher would not teach, the miner would not mine, unless the funds were available to compensate them for their labors. Paper “scrip” underwrote the production of goods and services that would not otherwise have been on the market. Anything for which there was a buyer and a producer could be produced and traded. If A had what B wanted, B had what C wanted, and C had what A wanted, they could all get together and trade. They did not need the moneylenders’ gold, which could be hoarded, manipulated, or lent only at usurious interest rates.
Representation Without Taxation
The new paper money did more than make the colonies independent of the British bankers and their gold.
It actually allowed the colonists to finance their local governments without taxing the people. Alvin Rabushka, a senior fellow at the Hoover Institution at Stanford University, traces this development in a 2002 article called “Representation Without Taxation.”
He writes that there were two main ways the colonies issued paper money. Most colonies used both, in varying proportions. One was a direct issue of notes, usually called “bills of credit” or “treasury notes.” These were I.O.U.s of the government backed by specifi c future taxes; but the payback was deferred well into the future, and sometimes the funds never got returned to the treasury at all. Like in a bathtub without a drain, the money supply kept increasing without a means of recycling it back to its source. However, the funds were at least not owed back to private foreign lenders, and no interest was due on them. They were just credits issued and spent into the economy on goods and services.
The recycling problem was solved when a second method of issue was devised. Colonial assemblies discovered that provincial loan offices could generate a steady stream of revenue in the form of interest
by taking on the lending functions of banks. A government loan office called a “land bank” would issue paper money and lend it to residents (usually farmers) at low rates of interest. The loans were secured by mortgages on real property, silver plate, and other hard assets. Franklin wrote, “Bills issued upon Land are in Effect Coined Land.” New money issued and lent to borrowers came back to the loan office on a regular payment schedule, preventing the money supply from over-inflating and keeping the values of paper loan-office bills stable in terms of English sterling.
The interest paid on the loans also went into the public coffers, funding the government. Colonies relying on this method of issuing paper money thus wound up with more stable currencies than those relying heavily
on new issues of bills of credit. The most successful loan offices were in the middle colonies – Pennsylvania, Delaware, New York and New Jersey.
The model that earned the admiration of all was the loan office established in Pennsylvania in 1723. The Pennsylvania plan showed that it was quite possible for the government to issue new money in place of taxes without inflating prices. From 1723 until the French and Indian War in the 1750s, except for import duties on liquor,
the provincial government collected no taxes at all. The loan office was the province’s chief source of revenue.
During this period, Pennsylvania wholesale prices remained stable. The currency depreciated by 21 percent against English sterling, but Rabushka shows that this was due to external trade relations rather than to changes in the quantity of currency in circulation. Before the loan office came to the rescue, Pennsylvania had been losing both business and residents due to a lack of available currency. The loan office injected new money into the economy, and it allowed people who had been forced to borrow from private lenders at 8 percent interest to refinance their debts at the 5 percent rate offered by the provincial government. Franklin said that this money system was the reason that Pennsylvania “has so greatly increased in inhabitants,” having replaced “the inconvenient method of barter” and given “new life to business [and] promoted greatly the settlement of new lands (by lending small sums to beginners on easy interest).” The secret was to not issue too much, and to recycle the money back to the government in the form of principal and interest on government-issued loans. In 1776, Adam Smith wrote of the Pennsylvania currency in
The Wealth of Nations:
The government of Pennsylvania, without amassing any treasure [gold or silver], invented a method of lending, not money indeed, but what is equivalent to money to its subjects. By advancing to private people at interest, and upon land security [as collateral], paper bills of credit . . . made transferable from hand to hand like bank notes, and declared by act of assembly to be legal tender in all payments from one inhabitant to another, it raised a moderate revenue which went a considerable way toward defraying . . . the whole ordinary expence of that frugal and orderly government.
. . . [Pennsylvania’s] paper currency . . . is said never to have sunk below the value of gold and silver which was current in the colony before . . . the issue of paper money.
That was true in Pennsylvania, but the paper currencies of the New England colonies – Massachusetts, Rhode Island, Connecticut and New Hampshire – were less stable. Although they helped to finance development and growth that would not otherwise have occurred, they did not maintain their value because they were issued in excessive quantities, both as bills of credit and as loans. The currencies also suffered from a lack of common regulations and standards for valuation. Some paid interest; others did not. Some could be used only for purchase and not in the repayment of debt. Some could be used for public debts but not for private transactions. The result for trade was chaos and confusion.
King George Steps In
Rapid depreciation of the New England bills eventually threatened the investments of British merchants and financiers who were doing business with the colonies, and they leaned on Parliament to prohibit the practice. In 1751, King George II enacted a ban on the issue of new paper money in the New England colonies. Existing issues, however, could still be renewed. This ban was continued under King George III, who succeeded his father in 1760. In 1764, Benjamin Franklin went to London to petition Parliament to lift the ban. He extolled the benefits of colonial scrip to the citizens of Pennsylvania, and assured his listeners that “New York and New Jersey have also increased greatly during the same period, with the use of paper money; so that it does not appear to be of the ruinous nature ascribed to it.”
Jason Goodwin observes in
Greenback that it was a tricky argument to make. The colonists had been stressing to the mother country how poor they were — so poor, they were forced to print paper money for lack of precious metals. Franklin’s report demonstrated to Parliament and the British bankers that the pretext for allowing paper money had been removed. The point of having colonies was not, after all, to bolster the colonies’ economies. It was to provide raw materials at decent rates to the mother country.
Giving the government the benefit of money creation was a complete reversal of the established British school of economics, in which the government had to borrow from private bankers at interest; and Franklin’s appeal was viciously opposed by banking interests. Instead of lifting the ban, Parliament wound up passing a Currency Act that was stricter than the earlier prohibition. It banned not only the issue of any new bills but the reissue of existing currency. The bill declared that “no act, order, resolution, or vote of assembly, in any of his Majesty’s colonies or plantations in America, shall be made, for creating or issuing any paper bills, or bills of credit of any kind or denomination whatsoever, declaring such paper bills, or bills of credit, to be legal tender . . . .”
The colonists were forced to pay all future taxes to Britain in silver or gold, or in Bank of England banknotes supposedly backed by those precious metals. Since the colonists had no mines of their own, that meant they had to go into debt to the British bankers.
Alexander Hamilton, the first U.S. Treasury Secretary, said that paper money had composed three-fourths of the total money supply before the American Revolution. When the colonists could not issue their own currency, the money supply suddenly shrank, leaving widespread unemployment, hunger and poverty in its wake.
The oppressed colonists finally ignored the ban and went back to issuing their own paper money. In
The Lost Science of Money, Stephen Zarlenga quotes historian Alexander Del Mar, who wrote in 1895:
[T]he creation and circulation of bills of credit by revolutionary assemblies . . . coming as they did upon the heels of the strenuous efforts made by the Crown to suppress paper money in America [were] acts of defiance so contemptuous and insulting to the Crown that forgiveness was thereafter impossible . . . [T]here was but one course for the Crown to pursue and that was to suppress and punish these acts of rebellion . . . . Thus the Bills of Credit of this era, which ignorance and prejudice have attempted to belittle into the mere instruments of a reckless financial policy were really the standards of the Revolution. They were more than this: they were the Revolution itself!
This version of the events leading up to the Revolution was echoed by Peter Cooper, founder of Cooper Union College and a former colleague of Treasury Secretary Albert Gallatin. Cooper wrote in his 1883 book
Ideas for a Science of Good Government:
After Franklin had explained . . . to the British Government as to the real cause of prosperity, they immediately passed laws, forbidding the payment of taxes in that money. This produced such great inconvenience and misery to the people, that it was the principal cause of the Revolution. A far greater reason for a general uprising, than the Tea and Stamp Act, was the taking away of the paper money.
This view was also confirmed by historian Charles Bullock, who was a particularly credible source because he was not actually in favor of paper money. He advocated a return to specie (precious metal coinage). Bullock wrote in 1900:
There can be little doubt that the acts of 1751 and 1764, which suppressed further issues of bills of credit, contributed not a little to the final breach with the Mother country. . . . In 1776 when he was examined before the House of Commons, Franklin gave it as his deliberate opinion that one reason for the impatience and disrespect which the colonies were manifesting toward Parliamentary authority was “the prohibition of making paper money.” Too little attention has been given to this fact by most historians. . . . In colony after colony, party lines came to be drawn upon this sole issue.
The Cornerstone of the Revolution
Like Massachusetts nearly a century earlier, the colonists suddenly found themselves at war and without the means to pay for it. The first act of the new Continental Congress was to issue its own paper scrip, popularly called the Continental. Most of the Continentals were issued as I.O.U.s or debts of the revolutionary government, to be redeemed in coinage later. Eventually, 200 million dollars in Continental scrip were issued. By the end of the war, the scrip had been devalued so much that it was essentially worthless; but it still evoked the wonder and admiration of foreign observers, because it allowed the colonists to do something that had never been done before. They succeeded in financing a war against a major power, with virtually no “hard” currency of their own; and they did it
without taxing the people. Franklin wrote from England during the war that “the whole is a mystery even to the politicians, how we could pay with paper that had no previously fixed fund appropriated specifically to redeem it.
This currency as we manage it is a wonderful machine.” Thomas Paine called it a “corner stone” of the Revolution:
Every stone in the Bridge, that has carried us over, seems to have claim upon our esteem. But this was a corner stone, and its usefulness cannot be forgotten.
The Continental’s usefulness was forgotten, however, with a little help from the Motherland . . . .
Economic Warfare: The Bankers Counterattack
The British engaged in a form of economic warfare that would be used again by the bankers in the nineteenth century against Lincoln’s Greenbacks and in the twentieth century against a variety of other currencies: they attacked their competitor’s currency and drove down its value. In the 1770s, when paper money was easy to duplicate, its value could be diluted by physically fl ooding the market with counterfeit money. In modern times, as we’ll see later, the same effect is achieved by another form of counterfeiting known as the “short sale.”
During the Revolution, Continentals were shipped in by the boatload and could be purchased in any amount, essentially for the cost of the paper on which they were printed. Thomas Jefferson estimated that counterfeiting added $200 million to the money supply, effectively doubling it; and later historians thought this fi gure was quite low. Zarlenga quotes nineteenth century historian J. W. Schuckers, who wrote, “The English Government which seems to have a mania for counterfeiting the paper money of its enemies entered into competition with private criminals.”
The Continental was battered but remained viable. Schuckers quoted a confi dential letter from an English general to his superiors, stating that “the experiments suggested by your Lordships have been tried, no assistance that could be drawn from the power of gold or the arts of counterfeiting have been left untried;
but still the currency . . . has not failed.”
The beating that did take down the Continental was from speculators -- mostly northeastern bankers, stockbrokers and businessmen -- who bought up the scrip at a fraction of its value after convincing people it would be worthless after the war. The Continental had to compete with other currencies, making it vulnerable to speculative attack just as foreign currencies left to “float” in international markets are today. (More on this in Chapters 21 and 22.) The Continental had to compete with the States’ paper notes and the British bankers’ gold and silver coins. Gold and silver were regarded as far more valuable than the paper promises of a revolutionary government that might not prevail, and the States’ paper notes had the taxation power to back them.
The problem might have been avoided by making the Continental the sole official currency, but the Continental Congress did not yet have the power to enforce that sort of order. It had no courts, no police, and no authority to collect taxes to redeem the notes or contract the money supply. The colonies had just rebelled against taxation by the British and were not ready to commit to that burden from the new Congress.13 Speculators took advantage of these weaknesses by buying up Continentals at a deeper and deeper discount until they became virtually worthless, giving rise to the expression “not worth a Continental.”
The "Impossible Contract",
Web of Debt, p.403
Like Andrew Jackson and Abraham Lincoln, Benjamin Franklin was a self-taught genius. He invented bifocals, the Franklin stove, the odometer, and the lightning rod. He was also called “the father of paper money.” He did not actually devise the banking system used in colonial Pennsylvania, but he wrote about it, promoted it, and understood its superiority over the debt-based private British system.
When the directors of the Bank of England asked what was responsible for the booming economy of the young colonies, Franklin is reported to have said:
That is simple. In the colonies we issue our own money. It is called Colonial Scrip. We issue it to pay the government’s approved expenses and charities. We make sure it is issued in proper proportions to make the goods pass easily from the producers to the consumers. . . . In this manner, creating for ourselves our own paper money, we control its purchasing power, and we have no interest to pay to no one. You see, a legitimate government can both spend and lend money into circulation, while banks can only lend significant amounts of their promissory bank notes, for they can neither give away nor spend but a tiny fraction of the money the people need. Thus, when your bankers here in England place money in circulation, there is always a debt principal to be returned and usury to be paid. The result is that you have always too little credit in circulation to give the workers full employment. You do not have too many workers, you have too little money in circulation, and that which circulates, all bears the endless burden of unpayable debt and usury.
That is what Franklin is reported to have said, but as with many famous quotes, it may be apocryphal. Whoever said it, it is a succinct explanation of the advantages of the Pennsylvania banking system over the “British system.” Since the provincial bank was a public institution, the profits returned to the local government rather than being siphoned off by external lenders.
In an article titled “A Monetary System for the New Millennium,” Canadian money reformer Roger Langrick explains the “impossible contract” problem in contemporary terms, using an example in which $100 is lent at 10 percent:
The result of creating 100 and demanding 110 in return, is that the collective borrowers of a nation are forever chasing a phantom which can never be caught; the mythical $10 that were never created. The debt in fact is unrepayable. . . . The only solution at present is increased borrowing to cover the principal plus the interest of what has been borrowed.
A better solution, says Langrick, would be to allow the government to issue enough new debt-free money to cover the interest charges not created by the banks as loans:
Instead of taxes, government would be empowered to create money for its own expenses up to the balance of the debt shortfall. Thus, if the banking industry created $100 in a year, the government would create $10 which it would use for its own expenses. Abraham Lincoln used this successfully when he created $500 million of “greenbacks” to fight the Civil War.
In Langrick’s example, a private banking industry pockets the interest, which must be replaced every year by a 10 percent issue of new Greenbacks; but another alternative would be for the loans to be advanced by the government itself, as they were in colonial Pennsylvania. Principal and interest would then return to the government in a circular flow, making the system self-sustaining.
Are you referring to the antitrust laws, like the Sherman Act?
