The Constitutional Creation of a Common Currency in the U.S. 1748-1811: Monetary Stabilization Versus Merchant Rent Seeking

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During the revolution, the Articles of Confederation–-the first U.S. government-–allowed both individual states and the Continental Congress to issue their own paper money. Beginning in 1775 the Continental Congress issued bills of credit-– Continental dollars-–that depreciated to zero by April of 1781 and ceased thereafter to circulate. Each of the 13 states also issued their own paper currencies that, while also depreciating, held their value to a greater extent than did the Continental dollar.
After hostilities ended, states began to levy substantial taxes to redeem rapidly the bills of credit they had issued during the revolution. The resulting sharp monetary contraction produced substantial price deflation. The scarcity of a circulating medium became so acute that a few states resorted to accepting farm produce and land claims as tender for public debts. After the Treaty of Paris, 7 of the 13 states (Pennsylvania, North Carolina, and South Carolina in 1785; Rhode Island, New York, New Jersey, and Georgia in 1786) returned to issuing their own pound-denominated paper money, usable – as during the colonialperiod – to pay taxes levied and land mortgages held by the issuing state. In addition, states, such as Maryland and Massachusetts, were debating whether to issue new bills of credit, but failed to enact such legislation before the new Constitution banned such emissions. These states were clearly engaged in active monetary policy intended to affect their state’s economy. By replacing old bills issued during the revolution that were now being rapidly taxed out of circulation with new issues, these states ameliorated the circulating-medium scarcity within their borders. States that refrained from such action experienced greater deflation and the political unrest it spawned, such as Shay’s Rebellionin Massachusetts early in 1787.
After the complete collapse of the Continental dollar, the Continental Congress turned to Robert Morris to restore the confederation’s finances. Morris opened the Bank of North America (BNA hereafter) in 1782. The bank, headquarteredin Philadelphia, was intended to be the federal government’s bank with branches throughout the states. It accepted private and federal government deposits of specie, kept accounts in dollar units, and issued dollar-denominated bank notes as claims against deposits and as loans both to the federal government and to private citizens. Morris and Congress asked the states not to permit other banks to be established during the war, and asked the states to accept BNA bank notes in payment for each state’s taxes and then to remit these notes to the U.S. Treasury to cover payments each state owed the federal government.The bank notes were intended to be the circulating medium for the nation. Only Connecticut, however, accepted BNA bank notes for payment of its taxes.
In 1787 a Constitutional Convention was held in Philadelphia. This Convention crafted a new U.S. Constitution to replace the Articles of Confederation. In Article I, Section 10, Clause 1, this new Constitution stated: “No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; coin money; emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts; pass any Bills of Attainder, ex post facto Law, or Law impairing the Obligation of Contract, or grant any Title of Nobility.”
This clause created a currency union within the United States. After 1787 states could not issue new bills of credit. Outstanding state bills could continue to circulate until they were redeemed and destroyed by their respective states.Though not explicitly stating so, the U.S. Constitution also forbade the federal government from issuing bills of credit. At the Convention, the Constitution’s construction was understood to be such that any powers not explicitly granted to the federal government were denied to the federal government, and any powers not explicitly denied the states were granted to the states. The proposal to allow the federal government to emit bills of credit by inserting such a clause into the Constitution was voted down by the Convention delegates. In 1791 Congress chartered the First Bank of the U.S. (FBUS hereafter). This bank issued dollar-denominated bank notes and, under Alexander Hamilton’s guidance, tried to do what Morris had attempted to have his BNA do, but on a much larger scale, namely, make FBUS bank notes the chief circulating medium of the nation. While unconstitutional in terms of how the Constitution was designed by founders such as James Madison, the FBUS was deemed constitutional (but not without considerable and continuing controversy) and saved from President Washington’s veto under the aegis of Hamilton’s reinterpretation of the Constitution as rendering “implied powers” to the federal government. State-chartered banks, numbering 28 by 1800, also issued dollar denominated bank notes, backed by fractional reserves in specie, which circulated as a medium of exchange along side BNA and FBUS bank notes and specie coinage. In 1792 Congress passed the Mint Act, which officially fixed the weight and fineness of the U.S. specie dollar, thus legally distinguishing it from the Spanish dollar. The U.S. Mint did not coin U.S. dollars in any quantity until after mid-1794.
In summary, the U.S. Constitution legally forced a transition in the circulating medium of exchange. It led not only to a common monetary unit of account within the U.S. (the U.S. dollar), but also to a transformation of the monetary system. Prior to its adoption, the monetary system consisted of specie (foreign coins) and individual colony/state-issued pound-denominated bills of credit backed by the issuing state’s future taxes and publicly-held land mortgages. These bills of credit circulated at market-determined rates of exchange with one another and with specie currencies. After the adoption of the U.S.Constitution, the monetary system was transformed into one consisting of U.S. dollar and foreign specie coinage, and a plethora of federal- and state-chartered bank-issued U.S. dollar-denominated bank notes backed by fractional reservesin specie. While bank notes could be exchanged at face value for specie at the bank of issue, except during liquidity crises, elsewhere they circulated at market-determined discounts off their face value. Therefore, the reduction in transactioncosts and exchange-rate risks associated with moving to a single currency were not as great as is commonly assumed. Constitutionally, bank notes could not be declared legal tender for all debts, though governments could make them defacto legal tender for public debts by accepting them in payment for taxes.
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The Constitutional Creation of a Common Currency in the U.S. 1748-1811: Monetary Stabilization Versus Merchant Rent Seeking, by Farley Grubb,

Working Paper Series, Department of Economics, Alfred Lerner College of Business & Economics, University of Delaware, Working Paper No. 2004-07,