This month marks the 40th anniversary of President Nixon’s closing of the gold window, when the dollar became a purely fiat currency, unbacked by any sort of finite, tangible asset. On this anniversary, I think it is important to look back at all of the different notes and coins that have been called “dollars” by Americans over the past three hundred years or so. But it is more important to remember how the history of the American dollar is a history of the constant battle between those who have wanted fiat money and those who have sought hard money (usually gold) backing for their currency. While August 15, 1971 was the final victory for those who felt the dollar should not be backed by any precious metal, the reality is that at many points in US history people or banks or governments rejected convertibility of dollars into gold. You might even say that certain Americans had always fantasized about breaking the restraints of gold, and that 1971 was simply the final implementation of a very old desire to live beyond the uncomfortable confines of reality.
The New World and Paper Money
The period of the late 1600s and early 1700s was an important period in Western Europe in terms of the rise of central banking and paper money. Both represented a desire for creative financing to colonize the world, as well as to open up new markets to trade. For their part, the American colonists were particularly eager to establish banks, or to emit paper money since the colonists had little gold or silver. If Americans possessed specie (gold and silver), they consisted of overseas coins. In fact, the word “thaler or “dollar” comes from the words for several different types of foreign silver coins in circulation in the 17th and 18th centuries, like the Joachimsthalers (one example is the Maria Theresa thaler of the late 1700s), or the Spanish “pieces of eight” which received the name dollar after 1690.
But from the very beginning, people found the discipline of scarce gold and silver inconvenient. Colonial governments- like the one in Massachusetts in 1642- decreed that the silver coins in its colony possess a lower monetary value than their metallic content, basically a form of debasement. This practice was outlawed by the British crown in 1707, but it did not stop the colonies from finding other ways to create inflation with paper money. Beginning in the 1690s, and again starting in Massachusetts, several colonies began to print paper notes, initially with the intention of making them convertible into gold or silver as a way of generating confidence in the notes among the public. But in nearly every case, convertibility stopped quickly, as it was revealed that the colonies had neither the tax revenue nor the specie to back the notes they created. By 1740 most colonies had watched their paper notes (usually referred to as “dollars”) devalue against gold by anywhere from 80 to 99%! Yes, an early and bitter lesson in unconvertible currency- but one to be repeated many times in the years ahead.
The temptation to take on more debt, or to create more loans than available specie (gold or silver) never went away for long. Over the course of the eighteenth century, there would be experiments with so-called “land banks” that also issued bank notes completely unbacked by specie—most failed in a matter of years, if not months. But many Americans- be they poor farmers, or larger land speculators- were addicted to debt, and constantly hoped that they could somehow avoid the discipline imposed by a gold or silver standard.
“Not Worth a Continental”: Revolutionary-Era Funny Money
During the American Revolution, the Continental Congress again found itself needing to finance war efforts without having either sufficient tax receipts or specie to do so. The result was the Continental “Dollar,” a currency experiment which lasted from 1775 to 1781. During this time, the dollar lost nearly 100% of its purchasing power relative to gold. This catastrophe did inspire the authors of the Constitution to mandate that no state should be able to emit paper money, or make anything but gold and silver coin legal tender for payment of debts. Congress alone would have the power “to coin money, [and to] regulate the value thereof, and of foreign coin,” in Article I, section 8 of the Constitution. Acting on this authority, Congress passed the Coinage Act in 1792 which defined the dollar as a weight of 371.25 grains of pure silver and/or a weight of 24.75 grains of pure gold- a bimetallic standard. One year earlier, Congress had also authorized the creation of the Bank of United States, which would issue dollar- denominated bank notes that were fully redeemable by their holders in gold or silver on demand.
But the desire to print more paper than could be realistically backed by gold or silver came back again and again after the founding of the United States. Even though the notes created by the Bank of the United States were convertible into specie, the Bank of the U.S. encouraged the growth of commercial banks- therefore dramatically increasing the money supply. This was in keeping with the intentions of the creator of the B.U.S, Alexander Hamilton, who bemoaned the “scarcity of specie currency” (gold and silver) in the 1790s. It wouldn’t be long before some sort of crisis over convertibility would rear its ugly head. With the country facing a war and the country in need of supplies, the Federal Government allowed a doubling of bank corporations from 117 to 212 in the four years between 1811 and 1815. This was in addition to some 35 private unincorporated banks. Historians often refer to this as the beginning of “wildcat” banking, where numerous state or local banks would produce all sorts of competing dollar banknotes.
The First Betrayal of the Convertible Dollar: August 1814
In early nineteenth century America, a need arose for “money brokers” who were knowledgeable in the solvency of each of the hundreds of banks putting out paper money. Why was this? Because in 1814, the federal government allowed private banks to stop converting dollars into gold and silver due to a lack of specie. Interestingly, this also occurred in the month of August. And this fateful decision meant that the Federal government would allow banks to renege on their contractual obligation to redeem bank notes in gold and silver. With this precedent set, wildcat banking exploded in the period from 1815 up until the Civil War. And there were several episodes where banks stopped redeeming dollar notes in gold and silver: during the panics of 1819, 1837, and 1857, most banknotes in the U.S. could not be exchanged into precious metal.
Greenback Dollars and Civil War Devaluation
Then came the Civil War. As most readers understand by now, governments can’t finance wars without massive amounts of debt. This fact certainly applied to both the Union and to the Confederacy when war broke out in 1861. In the case of the Confederacy, their “dollars” became literally worthless by 1864 (many are worth far more now as collectors’ items than in 1865). For the victorious Union, things didn’t get that bad- but the dollar was again trashed in the 1860s. Beginning in 1862, Congress established the “Greenback” dollar in order to help fund war debts, and this dollar could not be converted into gold or silver. The United States would not return to convertibility until 1879. Meanwhile, when bankers or other merchants began to aggressively bid up the price of gold, the Union tried various schemes (including a stamp tax) to retard gold “speculation.” None of it worked, of course, and at its lowest point, the Greenback lost nearly 70% of its value against gold.
After the war, one “Mrs. Hepburn” challenged the constitutionality of a lower court ruling which had denied that her debt (to a certain Henry Griswold) could be paid with Greenbacks. The Hepburn v. Griswold case reached the Supreme Court in 1867, where in fact the judges denounced the actions of the Lincoln government and denied that Greenbacks dollars were legal tender because of their lack of convertibility. The federal government was not pleased, and neither were many railroads which had racked up large debts that could be paid more easily in the depreciated paper. However, by 1871, the composition of the court had changed and so did the law: in Knox v Lee, the court reversed itself and held that fiat paper money was consistent (somehow) with the Constitution. In addition to receiving the Supreme Court’s approval to issue fiat money, the 1860s saw Congress inch one step closer to a new, stronger central bank.
In 1864, the National Banking System came into existence, which would add a new layer to banking above the state banks. Over time, this new system worked to guarantee that national banks would buy ever larger amounts of government debt. It would not be long before an even stronger central bank, the Federal Reserve, would be created in 1913- a bank that, among other things, would have the monopoly power to force Americans to use Federal Reserve Notes as dollars.
Federal Reserve Notes, Confiscation, and Bretton Woods
For twenty years, Federal Reserve notes were convertible into gold by American citizens. But the Federal Reserve had played a hand in suppressing interest rates and in creating the illusion of a gold standard by allowing Britain to rack up huge debts during the 1920s. A spectacular boom and then bust occurred in 1929, even as the Federal Reserve supposedly existed to stop such excesses. One suggested solution to the Depression brought on by debt with the aid of the Federal Reserve was essentially more debt and dollar devaluation. In 1933, in the midst of the Depression, President Roosevelt ended the convertibility of Federal Reserve Notes into gold for U.S. citizens. In fact, he made private ownership of gold bullion illegal, even as many Americans refused to comply with the law. All European nations also went off a gold standard in 1936 as the western world slipped into renewed warfare. By 1944, with the U.S. being the last western power standing as World War II wound down, the Bretton Woods system effectively made the U.S. dollar “good as gold.” Bretton Woods meant that foreigners could exchange their dollars for gold, and no major world currency was allowed to rise or fall by more than one percent. This arrangement worked for nearly twenty years- until the 1960s, when the United States had racked up enough debt as to cause concern among foreigners regarding the overinflated value of the U.S. dollar.
End of Silver Dollar Certificates and Collapse of Foreign Gold Convertibility
Another event during this time was the rising market price of silver. Since the 1870s, the market price of silver had crashed far below its monetary amount in terms of dollars per ounce. But that was changing in the 1960s. By 1964, it was no longer economical for the U.S to coin silver, and by 1968 the last of the (reduced) silver coins were produced. 1964 also saw the end of silver certificates- where Americans could exchange one or five dollar bills for silver coins. Meanwhile, inflation and indebtedness also meant a rising gold price. By 1963, the market price of gold began to inch above the fixed value of 35 dollars, and eventually, by the summer of 1971, foreigners began to drain the U.S. of gold. Finally, on August 15, 1971, President Nixon ended the last vestiges of gold backing for dollars, by closing the gold window to foreign banks. The United States- and soon much of the rest of the world- would be on a purely fiat currency standard. Money really could be created out of thin air. Money also would be whatever the state (or the central banks) said it would be. Gold and silver seemed to be irrelevant. Currency speculation and other futures markets exploded. The national debt similarly began to explode, and the US soon ran huge trade deficits with the rest of the world. In exchange, Americans received a wonderful credit card in the form of a fiat world reserve currency.
The Fiat Dollar: Dream or Nightmare?
The dream of those Americans who had issued unconvertible paper dollars as early as the 1690s had now become reality. Finally, American governments and banks need not be checked by any sort of attachment to a finite resource when making loans or when taking on debt. And if the banking system got into trouble, infinite amounts of fiat money could be created to keep the confidence game going- or so it was claimed. Some would say that life has improved since 1971: middle classes around the world have grown, Communism has been defeated, and newer technologies have the capacity to make human existence on the planet much easier. But many like myself wonder about this apparent paradise. The world is a finite place- at some point just creating more money or debts or whatever you choose to call them either runs into the nasty reality of resource scarcity or a crisis of confidence. This last point, perhaps, has the most relevance for this August of 2011, a month when the US has finally lost its AAA credit rating. You cannot legislate confidence. You cannot force people to go further and further into debt to finance some sort of consumption. You cannot force people to keep believing that their counterparty is in fact solvent in a trade. I would also add that you cannot force people to believe in the fairy tale that we can, in fact, have it all. (I realize this last idea is practically heresy to many Americans.)
Many will insist that we will never reach a point where confidence in our monetary and financial system could only be restored by a return to some sort of tangible backing for our money. Many seem to believe that the confidence game of endless consumption will somehow restart, and that the world will somehow be able to return to the debt binges of the years before 2007. They will say that we live in a new economy, a new world, and that gold and silver are relics from a bygone era. Some might even say that our leaders in government and finance know better than to repeat the mistakes of the past. As a response, I will trot out the often stated (but not often followed) advice of George Bernard Shaw:
“You have a choice between the natural stability of gold and the honesty and intelligence of the members of government. And with all due respect for those gentlemen, I advise you, as long as the capitalist system lasts, vote for gold.”
