Download colonial and state issues of paper currency in North America In

• colonial and state issues of paper currency in North America
In: Newman, Peter, Murray Milgate, John Eatwell (ed.). 1992. The New Palgrave Dictionary of Money
and Finance, The MacMillan Press Limited, reprint, 1994, ISBN 0-333-52722-4
colonial and state issues of paper currency in North America
'•• .'.liferent explanation from those above for pledging
. - i^ral in loan contracts relates to bankruptcy costs. If
*~'«.i::ng assets to unsecured creditors in the event of
*-i.-ir„pTcy is costly, then such costs can be reduced by
*-*-_• assets collateralized. Secured lenders hold title to the
.•.i-i'i-Til and consequently face considerably lower costs in
« . . - -:ng the asset than do the unsecured creditors in
r-i.-ir.g the firm's remaining assets. The lower costs
«•• - J He reflected in the secured loan rate, thereby benefitTUi •• •. borrower. This explanation would predict that firms
Ľ-J -.J collateralize all their assets, and evidence in support
-f "> explanation comes from public utilities where casual
r^: ~.^]>m suggests that most assets are pledged to particu*• •.". Jt-Ts. It is not evident why other firms do not employ
te-.-'--d debt as much as do utilities; it may be that the
• .a--, ral assets of utilities require little if any costly monii r : • ; -n lenders in contrast to assets such as accounts
"•?•-: ••• a'-Me of industrial firms.
* •-.*'.]}, collateral may also be a meaningful contracting
>*--..i-.Ľ it credit markets are imperfectly competitive or if
«-:-.-•> are risk-averse. The evidence on competition in
• '".:.- iiarkets, however, and the dubiousness of making a
T^T•-. r-jiice assumption for corporate lenders has motivated
~r* ••_ rature's emphasis on the other explanations described
G l . O R G F . K A N A ' 1 AS
KÍDI I RATIONING; C R E D I T RISK; C R K D I T
•
SCRKĽN-
• \ s l \ ( i ; LOAN C O N T R A C T S ; M O N I T O R I N G O F F1NAN'-•- I I I L l ' I O N S ; S I G N A L L I N G .
«>
- K\PHY
sr-i - \ \ . and Udell, G. 1990. Collateral, loan quality, and bank
" »i t'iurnal of Monetary Economics 25: 21-42.
s* J- ' * I) and Thakor, A. 1987a. Collateral and rationing:
- ~ ".£ equilibria in monopolistic and competitive credit
~ *'M.tv International Economic Review 98: 671-90.
'-•-•..•<. [J. and Thakor, A. 1987b. Competitive equilibrium in the
• .J ' market under asvmmetric information. Journal ofEconomic
"- -. 42: 167-82.
* v - i ( 1985. Screening vs. rationing in credit markets with
- r •_ rt ect information. American Economic Review 73: 297-302.
-*-»•• : > and Kanatas, G. 1985. Asymmetric valuations and the
- - t collateral in loan agreements. Journal of Money, Credit and
'• *'..:•.*•, 17: 84-95.
<<p * . k. and Kanatas, G. 1990. Asymmetric information,
iit-ral, and moral hazard. Journal ofFinancial and Quantitative
'--.', ;, 25:469-90.
v
'~ r •.-. IK. and Weiss, A. 1981. Credit rationing in markets with
- rvrtcct information. American Economic Review 1\: 393-410.
"""-•' K \1. and Johnson, H. 1985. An analysis of secured debt.
•* *":ďí tf Financial Economics 14: 501-21.
••"»i- I and Udell, G. 1988. Information production and the
--.. -red line of credit. Manuscript, New York University.
ooAlateralized mortgage obligation. A collateralized
-z> -.age obligation (CMO) is a trust formed from a pool of
-j -„-age-backed securities, where the cash flows from the
r- • are divided into another set of securities called tran. - . - I hese tranches are distinguished by the timing of the
--'-:-. o t their principal. That is, the claims to the principal
. •- r nent of the cash flows from the pool are hierarchical
in nature and the different tranches occupy different posi­
tions in this hierarchy. Therefore, the behaviour of the
different tranches can be quite diverse and can target
investors with specific diverse risk preferences.
J.B.K., D.C.K., W.M.
colonial and state issues of paper currency in North
America. Fiat paper currency was issued at one point or
another during the colonial period by all thirteen British
North American mainland colonies. The colonies suffered
from a shortage of specie throughout the colonial period,
although problems with the money supply never reached
such severity that interest rates or prices were seriously
affected. Paper money, bills of exchange, book credit and a
variety of commodity moneys all variously substituted for
specie in the colonial money supply. After independence
from Great Britain was declared in 1776, the 13 states
continued to issue their own paper currencies until prohi­
bited by the ratification of the United States Constitution in
1787. '
Massachusetts first happened on fiat currency in an effort
to finance a failed campaign against Quebec in 1690. The
commonwealth continued to issue small bills of credit, as did
the other New England colonies. The paper was backed by
the promise of payment through future taxes. The middle
colonies and the Carolinas followed New England's
example, but the Chesapeake region continued instead to
use tobacco as local currency and legal tender.
In the 1700s the focus shifted from government finance to
the explicit creation of a medium of exchange. Pennsylvania
residents blamed an economic recession in the early 1720s
on the lack of currency for local trade. Merchants and
farmers alike supported legislation to lend government notes
to residents, using their land as collateral. The 'land bank',
as it was called, was explicitly modelled after country banks
in Great Britain. Benjamin Franklin referred to the plan as
'coining land'.
Pennsylvania legislators debated at length exactly how
much currency to print. By issuing the paper currency
through mortages on developed farms, they believed they
had found a way to keep the paper money issues tied to the
actual needs of trade in the countryside. The land bank
scheme also provided for a more controlled release of the
paper into the economy over a period of years rather than all
at once. As an unanticipated benefit, interest rates from the
mortages provided a major source of government funding in
Pennsylvania in the mid-1700s.
A third system for emitting paper currency emerged in
Maryland in 1733. When wheat cultivation began to replace
tobacco in large sections of the colony, demand arose for a
paper money supply in imitation of Pennsylvania. Maryland
did not establish a land bank, however, choosing instead to
create a 'sinking fund' in London out of receipts from the
tobacco export tax. The notes were evenly distributed to all
residents as a replacement for the 'bad' tobacco that had
been circulating locally as money. Virginia finally succumbed
to popular pressure and issued paper currency in 1755.
Economic historians disagree as to the importance of the
paper currencies to the colonial economies. The colonists
383
colonial and state issues of paper currency in North America
themselves, merchants as well as farmers, city dwellers as
well as those in the countryside, were convinced that paper
money issues were critical to being able to conduct domestic
trade. However, the actual quantity7 of money issued before
the 1750s was relatively small. But paper currency was the
only form of money that was not generated by foreign trade.
In the middle colonies, where internal trade was increasing
rapidly, paper money proved a useful innovation replacing
the more cumbersome practice of book credit.
The effects of the different issues of paper currency on
price levels in the colonies were mixed. New England had
problems with inflation from the beginning. Tiny Rhode
Island discovered that the other New England colonies paid
with inflation for Rhode Island's emissions, and began
issuing paper currency in large quantities. Excessive emissions by Rhode Island in the 1730s and 1740s caused rapid
inflation in the other New England colonies. Massachusetts
currency depreciated to a rate of 1\ pounds Massachusetts
to 1 pound British sterling; Rhode Island currency fell to a
rate of 26:1 against sterling.
In contrast, prices remained relatively stable in the middle
colonies. Pennsylvania, in particular, experienced 50 years of
price stability7 never again equalled in the commonwealth's
history. The period coincided with growth rates comparable
to those of the early 19th century; the two were perhaps not
unconnected. Prices remained relatively stable in Maryland
and South Carolina after 1730; North Carolina had continual problems with inflation and formally devalued its
currency in 1748.
Colonial experiments with fiat paper money were aided by
the 'benign neglect' of the colonies by Parliament during the
Walpole administration. Paper currency was looked upon
with great distrust by knowledgeable theorists in Great
Britain, and London merchants worried about being forced
to accept it in trade (a fear that never materialized). By the
1750s, the home government had decided to put an end to
the practice, beginning with the worst cases in New England. The Currency Act of 1751 forbade the issue of bills of
credit as legal tender in New England, but ignored the
practice elsewhere.
The commencement of the Seven Years War (known in
the United States as the French and Indian War) between
Great Britain and France interrupted Parliament's plans to
take greater control over American monetary policy. The
colonies were permitted to issue large sums of paper money
in exchange for providing financial and physical support for
the war effort. Surprisingly, the large issues of paper money
did not result in massive inflation, suggesting that the war
had a positive impact on colonial income.
After the war, however, Parliament issued the Currency
Act of 1764 prohibiting the use of bills of credit as legal
tender in all of the colonies. The immediate concern was the
new paper currency in Virginia. For years Tidewater
planters had refused to acquiesce to demands from the
backcountry for a paper currency to supplement tobacco.
London merchants suspected that the planters' sudden
willingness to issue paper currency was not unconnected to
the rising debts the planters owed to them.
Merchants who traded with the middle colonies, however,
had never had a problem with having to accept depreciated
currency. They joined with the lobbyists from the middle
384
colonies' legislatures to protest the penalizing of the middle
colonies for a perceived threat from Virginia. In particular,
colonists were deeply concerned about the effects of retiring
paper currency while the colonies were suffering from a
postwar recession. The issue was finally resolved by
loophole: the colonies discovered that they could continue to
use paper currency as long as it was not termed 'legal tender'
for the payment of private debts. Local merchants advertised
that they would continue accepting colonial currency at the
old rates, and the colonial governments continued to accept
their owrn currencies in payment of local taxes. The Currency Act of 1764 thus had no real impact on colonial
money. However, the experience left many colonists alarmed
at the prospect of future interference in their monetary
policies and probably contributed to worsening relations
between Parliament and the colonial governments.
The newly declared independent state governments
issued their own currencies in 1776, soon followed by the
Continental Congress. Wartime inflation reached a height of
400 percent by 1781; in Philadelphia the rise in prices was
400-fold. Rapid hyperinflation was followed by equally rapid
hyperdeflation. By the mid-1780s prices had again stabilized, but the period of disruption had left in its wake a
plethora of court cases over the proper valuation of loans and
property' tax assessments.
After the Revolution the state governments continued to
pursue their own separate monetary policies, but now there
was no Board of Trade to supervise their activities. Pennsylvania and the other middle states continued to run land
banks and have few problems with prices. Maryland and
Virginia formed a commission to investigate cooperating on
monetan7 and trade legislation. Almanacs and newspapers
ran current rates of exchange between state currencies.
State-issued paper currency might have continued indefinitely, had not problems in New England with currency
resurfaced. Once again, Rhode Island printed far more
paper currency than any of its neighbours; once again the
result was inflation throughout the region. The Rhode
Island legislature exacerbated the problem with a law requiring creditors to accept the rapidly depreciating currency at
nominal value. Rumours circulated through the colonies
of trade completely shutting down in Rhode Island.
Massachusetts retaliated with a law prohibiting Rhode
Island paper currency in payment for any debts owed to
Massachusetts residents, even if incurred in Rhode Island.
At the same time, the Massachusetts legislature had
passed a law prohibiting the use of paper currency to pay
state land taxes. A string of foreclosures on farms in
specie-poor western Massachusetts led to Shays' Rebellion,
when farmers closed down courts in the winter of 1786-7 to
keep from losing their farms. Events in Rhode Island and
Massachusetts were widely reported throughout the colonies. By May of 1787, when representatives met in Philadelphia to discuss a national government, positions on
state-issued paper money had hardened considerably.
Furthermore, the introduction of private banking (effectively
prohibited during the colonial period by restrictions on joint
stock companies) had weakened merchant support for paper
currency.
The new Constitution forbade states to issue their own
currencies. Although there were no new issues after the
commercial banking
Constitution went into effect in 1789, state currency con­
tinued to circulate until all of the old issues were retired
early in the next century. The episode was not fully closed
until the United States Supreme Court ruled against the
state of Missouri in its attempt to establish a land bank for
developmental purposes in the 1830s.
transferable shares were resisted until the scale of financing
required made them desirable, which happened only for
large firms in mining and metallurgy. Limited liability
companies were permitted, but only with approval of their
charter by the State, much as the Bubble Act of 1720
required in England. Formation of joint-stock companies
with limited liability was liberalized in 1863 and 1867,
MARY M C K I N N E V SCHWEITZER
following the British initiatives in 1856 and 1867. But from
then until World War II, only 10 percent of French firms
See also ASSIGNATS; FIAT MONEY;
HYPERINFLATION;
were limited liability corporations, while 15 percent were
HYPERINFLATION: EXPERIENCE; LAND-BACKED CURRENCY;
sociétés en commandite par actions, 15 percent were sociétés en
SCRIP MONEY.
commandite simple, and fully 60 percent simple partnerships.
BIBLIOGRAPHY
Most German states permitted the commandite form as
Brock, L.V.H. 1941. The currency of the American Colonies,
well after the Napoleonic Wars, but generally restrictive
1700-1764. Unpublished PhD dissertation, University of
governments limited its use until after the revolutions of
Michigan.
1848. Even then, the Prussian state preferred to charter
KrnstJ.A. 19/'3. Money and Politics in America: 1755-1775. Chapel
joint-stock corporations with limited liability, but with close
Hill, University of North Carolina for the Institute of Early
state supervision and restrictions. T h e liberalization of
American History and Culture at Williamsburg, Virginia.
incorporation procedures in 1870 led to emphasis on full
Gould, C.P. \9\5.Money and Transportation in Maryland, 1720limited liability corporations, rather than the more restrictive
1765 Baltimore: JHU Press.
kommandite
form.
McCusker, J.J. 1978. Money and Exchange in Europe and America,
In Britain, the commandite form was finally permitted after
1600-1775. Chapel Hill, University of North Carolina for the
decades of agitation by the Companies Act of 1867. But no
Institute of Early American History and Culture at
Williamsburg, Virginia.
such company was formed, as the liberal allowance the
Nettels, C.P. 1934. The M one}1 Supply ofthe American Colonies Bejore Companies Act of 1856 gave for the formation of corpora­
1720. Madison: University of Wisconsin.
tions with limited liability made the commandite a halfway
Weiss, R.W. 1970. The issue of paper money in the American
house that was bypassed entirely by British business.
colonies, 1720-1774. Journal ofEconomic History 30: 770-84.
LARIO NKAL
See also CAPITAL MARKETS AND CAPITALISM IN BRITAIN
commandite system. The commandite system of part­
nerships divides partners into two categories - managing
partners with unlimited liability for obligations of the firm
and investing partners with liability limited to their share of
the capital of the firm. It appears as a hybrid between a
general partnership, in which all partners have unlimited
liability for obligations of the firm, and a limited liability7
joint-stock corporation, in which each stockholder has his
liability limited to his share of the total equity of the firm.
The commandite firm derives its origins from ancient
trading companies called commenda, in which the partners
actually responsible for collection and disposal of trade
goods shared in the profits of the venture even when they
had not contributed capital for the purchase of the sale
goods. T h e passive partners who did put up the capital
shared in the profits of the venture, but risked only what they
had invested, while the active partner or partners risked all
their assets, including life and limb, in the venture. T h e
commenda was the favourite system of the Italian mercantile
cities and dominated European trade throughout the Middle
Ages. From the 16th century on, it was displaced in trade by
partnerships with unlimited liability, probably as an attempt
to reduce the rate of interest paid by trading firms to
short-term lenders.
In 1807, the French Code de Commerce formalized the
societě en commandite with the important provision that it
could be formed with transferable shares among the general
partners {société en commandite par actions), as well as without
transferable shares (société en commandite simple). This was
used sparingly, however, even in France. Although most of
the large business enterprises were limited partnerships,
AND CONTINENTAL KUROPĽ BEFORE 1914; CREDIT EONCIER;
CREDIT J M O B I L I E R ; INDUSTRIAL BANKING; LIMITED LIABIL­
ITY, DEVELOPMENT OFJ PARTNERSHIPS.
BIBLIOGRAPHY
Mathias, P. and Postan, M.M. (eds) 1978. The Industrial Economies:
Capital, Eabour and Enterprise. The Cambridge Economic History of
Europey\o\. 7. Cambridge: Cambridge University Press.
Cottrell, P.L. 1980. Industrial Finance 1830-1914: The Finance and
Organization ofEnglish Manufacturing Industry. London:
Methuen.
commercial banking. Commercial banks provide a wide
variety of financial services, including payments services
(chequing accounts, electronic funds transfers, debit cards,
international trade-related payments), loans (business,
mortgage, instalment, and credit-card loans, among others),
leasing, safekeeping, trust and other fiduciary services,
currency conversion, advisory and accounting services,
financial guarantees, asset management services, and in
some countries, securities underwriting and insurance ser­
vices. In other words, commercial banks are diversified
financial service firms. All of these various services are, to
some degree, provided by nonbank firms as well.
Commercial banks can also be viewed as a particular type
of financial intermediary. Intermediaries facilitate the trans­
fer of funds from lenders to borrowers by creating distinctive
contracts. T h e contracts which distinguish a commercial
bank from other types of intermediaries are deposits and
commercial loan agreements ('indirect securities'). Direct
finance involves the issue and sale of 'primán securities'.
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