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Understanding Money

The First Successful Paper Money

Of all the early American intellectuals, the most revered is Benjamin Franklin (1706-1790). In his lifetime, Franklin was a highly accomplished writer, inventor, statesman, politician and scientist, a man who was widely admired for his wit and for his commonsense philosophy. Among his many other accomplishments, he is also remembered as the father of paper money.

In 1729, Franklin wrote an essay entitled "A Modest Enquiry into the Nature and Necessity of a Paper Currency". At the time, the principal money used in the American colonies was the Spanish silver dollar. After Franklin's essay appeared, several colonies tried to follow his plan by printing their own paper money. The British Parliament, however, considered this to be a usurpation of their powers and, in 1751 and 1764, outlawed the use of paper money in the American colonies.

In 1774, the colonists convened the First Continental Congress (federal legislature) and presented the British King, George III, with a long list of grievances. Fighting broke out, marking the beginning of the American Revolution and, in 1775, the Second Continental Congress established an army and appointed George Washington as its commander. On July 4, 1776, the Congress formally declared its independence from Great Britain by adopting the Declaration of Independence.

To finance the new army, the Congress put Franklin's ideas into practice by issuing paper bills of credit that were (supposedly) backed by gold and silver, and by passing a law that forced people to accept the new currency. As the war progressed, the need for money increased and, in 1777, the Congress issued $13 million of Treasury notes, which became known as "continentals" (because the words "Continental Currency" were printed on the notes).

At first, the value of the continental was set to be the same as the Spanish silver dollar. However, the value of the new money soon fell to two for a dollar. Then, as the Congress issued more and more money to pay for the war, the value of the continental slid further and further. It was not until 1780 that Congress finally stopped the printing press although, by then, the states were issuing their own money. By this time, the Congress had issued $241 million worth of paper money and their value had decreased to 40 continentals per silver dollar. By 1781, the value had fallen even further, to 75 per silver dollar.

This experience, unfortunately, was not unique. Once the idea of paper money caught on around the world, governments would often print money for an important cause: to fight a war, to pay for social programs, and so on. At first, everything would seem to work fine. In fact, by injecting new money into the economy, a government would be able to increase production. Eventually, however, the government would print too much money. The money would then decrease in value, which would create inflation, resulting in a significant loss in purchasing power for the general population.

This is exactly what happened in the United States. After the revolution (which ended in 1783), many people were left with continentals that had become virtually worthless. After an extended debate, the U.S. government decided to redeem all the continentals by trading them for government bonds, but at the rate of only $1 worth of bonds for $100 in continentals.

This experience did not sit well in America. The general population was so displeased with paper money that they returned to using coins almost exclusively, and very little paper money was issued for almost a hundred years. Indeed, the U.S. Constitution (written in 1787) specifically dictates that no state shall "make any Thing but gold and silver Coin a Tender in Payment of Debts." It was not until the 1860s, that the U.S. government once again issued paper money, this time to pay for the Civil War.

In Europe, however, the United States' experiment was looked upon as a great success. It was, after all, the first time a government had been able to finance a war simply by printing money. The door to the mint was now open, and before long, the governments of many other countries started to print their own money.

And thus began our modern monetary system.

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