Hard Money and Paper Money

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Money is a medium of exchange that is generally accepted for the purchase of goods and services and for the payment of debts. Money also serves as a “standard of value,” meaning that the worth of an item can be described in terms of dollars or francs or lira. Precious metals, because of their durability and scarcity, have been used from earliest times as a means of facilitating exchanges. Paper money was introduced in China as early as the seventh century, but did not become common in Western Europe until after 1700. This currency was usually “representative” or “convertible,” meaning that it was possible to exchange it for the precious metal or commodity that backed it. At a later time “inconvertible” or “fiat” paper was introduced; this currency could not be redeemed for any metal or other commodity. The most prized form of money in early America was coined gold, particularly from England or Spain; the Spanish daler (later called the dollar) was more widely circulated than coins from England. Some of the colonies printed their own notes, as in the instance of Virginia and the Carolinas, which issued tobacco notes, paper money backed by the value of tobacco crops. Monetary issues became acute during the War for Independence. The Congress had authorized the printing of large amounts of inconvertible or fiat paper currency. A form of payment was badly needed to pay the soldiers and purchase supplies. Without backing in gold or silver, the “Continentals” (as the notes were called) quickly declined in value. By 1780, it took more than 100 Continentals to equal one gold dollar. Similar problems existed on the state level where local authorities printed fiat paper money. Rhode Island, for example, issued currency that quickly dropped to nearly zero in value.

The legislature responded by proclaiming that this paper was legal tender and had to be accepted as payment for debts. An interesting situation followed in which creditors actually hid from debtors in order to avoid taking the worthless paper. The presence of fiat paper money in circulation was generally inflationary; prices and wages tended to rise, and the value of specie (“hard money,” usually gold or silver) declined. Debtors customarily favored inflationary or “soft money” schemes. Farmers, in particular, were attracted to paper money; they traditionally borrowed funds in the spring for seed, livestock and implements, then hoped to be able to repay with inflated currency after the harvest.

The removal of fiat paper money from circulation is generally deflationary; prices and wages are forced down, and the value of specie rises. Banks, creditors and other wealthy elements usually favored “hard money” over “soft money” policies. Treasury Secretary Alexander Hamilton, clearly a champion of the wealthy, sought to establish a solid basis for the nation’s economy. At his urging Congress created the First Bank of the United States (1791), a decimal-based currency (1792) and a national mint (1794).

Years later, in 1833, Congress failed to renew the Second Bank of the United States, allowing the country to enter an extended period of banking irregularities and scandals. Conditions were even more chaotic on the state level where paper currency continued to be issued. Legislative battles pitted the hard money forces against the soft money supporters.