Commodity Money in Colonial America
[This article is excerpted from A History of Money and Banking in the United States (2002). An MP3 audio file of this article, read by Matthew Mezinskis, is available for download.]
As an outpost of Great Britain, colonial America of course used British pounds, pence, and shillings as its money. Great Britain was officially on a silver standard, with the shilling defined as equal to 86 pure Troy grains of silver, and with silver as so-defined legal tender for all debts (that is, creditors were compelled to accept silver at that rate). However, Britain also coined gold and maintained a bimetallic standard by fixing the gold guinea, weighing 129.4 grains of gold, as equal in value to a certain weight of silver. In that way, gold became, in effect, legal tender as well. Unfortunately, by establishing bimetallism, Britain became perpetually subject to the evil known as Gresham's law, which states that when government compulsorily overvalues one money and undervalues another, the undervalued money will leave the country or disappear into hoards, while the overvalued money will flood into circulation. Hence, the popular catchphrase of Gresham's Law: "Bad money drives out good." But the important point to note is that the triumph of "bad" money is the result, not of perverse free-market competition, but of government using the compulsory legal tender power to privilege one money above another.
In 17th- and 18th-century Britain, the government maintained a mint ratio between gold and silver that consistently overvalued gold and undervalued silver in relation to world market prices, with the resultant disappearance and outflow of full-bodied silver coins, and an influx of gold, and the maintenance in circulation of only eroded and "lightweight" silver coins. Attempts to rectify the fixed bimetallic ratios were always too little and too late.1
In the sparsely settled American colonies, money, as it always does, arose in the market as a useful and scarce commodity and began to serve as a general medium of exchange. Thus, beaver fur and wampum were used as money in the north for exchanges with the Indians, and fish and corn also served as money. Rice was used as money in South Carolina, and the most widespread use of commodity money was tobacco, which served as money in Virginia. The pound-of-tobacco was the currency unit in Virginia, with warehouse receipts in tobacco circulating as money backed 100 percent by the tobacco in the warehouse.
While commodity money continued to serve satisfactorily in rural areas, as the colonial economy grew, Americans imported gold and silver coins to serve as monetary media in urban centers and in foreign trade. English coins were imported, but so too were gold and silver coins from other European countries. Among the gold coins circulating in America were the French guinea, the Portuguese "joe," the Spanish doubloon, and Brazilian coins, while silver coins included French crowns and livres.
It is important to realize that gold and silver are international commodities, and that therefore, when not prohibited by government decree, foreign coins are perfectly capable of serving as standard moneys. There is no need to have a national government monopolize the coinage, and indeed foreign gold and silver coins constituted much of the coinage in the United States until Congress outlawed the use of foreign coins in 1857. Thus, if a free market is allowed to prevail in a country, foreign coins will circulate naturally. Silver and gold coins will tend to be valued in proportion to their respective weights, and the ratio between silver and gold will be set by the market in accordance with their relative supply and demand.
Shilling and Dollar Manipulations
By far the leading specie coin circulating in America was the Spanish silver dollar, defined as consisting of 387 grains of pure silver. The dollar was divided into "pieces of eight," or "bits," each consisting of one-eighth of a dollar. Spanish dollars came into the North American colonies through lucrative trade with the West Indies. The Spanish silver dollar had been the world's outstanding coin since the early 16th century, and was spread partially by dint of the vast silver output of the Spanish colonies in Latin America. More important, however, was that the Spanish dollar, from the 16th to the 19th century, was relatively the most stable and least debased coin in the Western world.2
Since the Spanish silver dollar consisted of 387 grains, and the English shilling consisted of 86 grains of silver, this meant the natural, free-market ratio between the two coins would be 4 shillings 6 pence per dollar.3
Constant complaints, both by contemporaries and by some later historians, arose about an alleged "scarcity of money," especially of specie, in the colonies, allegedly justifying numerous colonial paper-money schemes to remedy that "shortage." In reality, there was no such shortage. It is true that England, in a mercantilist attempt to hoard specie, kept minting for its own prerogative and outlawed minting in the colonies; it also prohibited the export of English coin to America. But this did not keep specie from America, for, as we have seen, Americans were able to import Spanish and other foreign coin, including English, from other countries. Indeed, as we shall see, it was precisely paper-money issues that led, by Gresham's law, to outflows and disappearance of specie from the colonies.
In their own mercantilism, the colonial governments early tried to hoard their own specie by debasing their shilling standards in terms of Spanish dollars. Whereas their natural weights dictated a ratio of 4 shillings 6 pence to the dollar, Massachusetts, in 1642, began a general colonial process of competitive debasement of shillings. Massachusetts arbitrarily decreed that the Spanish dollar be valued at 5 shillings; the idea was to attract an inflow of Spanish silver dollars into that colony, and to subsidize Massachusetts exports by making their prices cheaper in terms of dollars. Soon, Connecticut and other colonies followed suit, each persistently upping the ante of debasement. The result was to increase the supply of nominal units of account by debasing the shilling, inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end. Finally, the English government brought a halt to this futile and inflationary practice in 1707.
But the colonial governments had already found another, and far more inflationary, arrow for their bow: the invention of government-fiat paper money.
- 1. In the late 17th and early 18th centuries, the British maintained fixed mint ratios of from 15.1-to-1 of silver grains in relation to gold grains, to about 15.5-to-1. Yet the world market ratio of weight, set by forces of supply and demand, was about 14.9-to-1. Thus, silver was consistently undervalued and gold overvalued. In the 18th century, the problem got even worse, for increasing gold production in Brazil and declining silver production in Peru brought the market ratio down to 14.1-to-1 while the mint ratios fixed by the British government continued to be the same.
- 2. The name "dollar" came from "thaler," the name given to the coin of similar weight, the "Joachimsthaler" or "schlicken thaler," issued since the early 16th century by the Count of Schlick in Joachimsthal in Bohemia. The Joachimsthalers weighed 451 Troy grains of silver. So successful were these coins that similar thalers were minted in Burgundy, Holland, and France; most successful of these was the Maria Theresa thaler, which began being minted in 1751 and formed a considerable portion of American currency after that date. The Spanish "pieces of eight" adopted the name "dollar" after 1690.
- 3. Since 20 shillings make £1, this meant that the natural ratio between the two currencies was £l = $4.44.