Originally posted on Thursday, May 22nd, 2014

James Narron and David Skeie, two of the most erudite monetary officials of our era, write at the NY Fed’s Liberty Street Economics about the currency crisis of 1779.

Some choice excerpts:

April 11, 2014

Crisis Chronicles: Not Worth a Continental—The Currency Crisis of 1779 and Today’s European Debt Crisis

During the late 1770s, a newly founded United States began to run up significant debts to finance the American Revolution. With limited access to credit and little to no tax base, the Continental Congress issued the Continental to finance the war. But by the end of the decade, inflation was nearly 50 percent, a suit cost a million Continentals, and the phrase “not worth a Continental” had entered the national lexicon. With the help of our fourth U.S. president, James Madison, we review why the Continental experiment ended so badly.

Not Worth a Continental
Initially, Continentals were used effectively to equip the army. However, Congress hadn’t prepared for a protracted war and had originally planned on redeeming Continentals beginning in 1779. By mid-1776, despite efforts by Congress to ensure investors that it would redeem the currency in full in gold or silver, Continental currency holders lost confidence in the colonial army’s ability to end the war quickly or for Congress to eventually back the currency through tax receipts, and Continentals began to lose their value.

Although Congress worked to create a sort of monetary union by seeking control over currency issue, and thus monetary policy, they were unable to do so, as states continued to issue their own currencies. By 1779, the Continental had depreciated to pennies on the dollar and inflation reached nearly 50 percent, giving rise to the expression “not worth a Continental.” Congress considered a number of remedies including devaluation, raising taxes, and tying currency issuance to future tax receipts—like a revenue bond—but ultimately elected to cease issuing currency altogether. By mid-1781, Continentals stopped circulating. The Continental army thus had to seize necessary provisions in order to continue to wage war, providing IOUs in return.

As future president James Madison pointed out in a 1779 essay, the value of money was dependent on the credit of the state issuing it rather than on its quantity. The protracted war had created a massive public debt and little confidence that the nation could pay it off. But as we noted in the South Sea Bubble post, there was soon competition to take on the national debt, this time between the states and Congress, for the right to control the debt meant the right to control the means of paying off the debt—in this case, taxation.

While we’ve noted in previous posts that lessons often last only a lifetime, so deep was the public distrust of government money that it wasn’t until the Civil War that paper money was again issued in any substantial quantity.

As elsewhere noted on this site, yet bears repeating:

During the Revolution, in April 1779, Washington wrote to John Jay, president of the Continental Congress,

“In the last place, though first in importance, I shall ask, is there any thing doing, or that can be done, to restore the credit of our currency? The depreciation of it is got to so alarming a point that a wagon-load of money will scarcely purchase a wagon-load of provisions.”

Some lessons do linger longer than others.

The trauma of the Great Depression was mis-attributed to a gold standard that had been effectively suspended with the commencement of the Great War.  The classical gold standard had been replaced with its “evil twin,” the gold-exchange standard, in Genoa in 1922.The pastiche of a mixed gold-paper standard led to an inexorable misalignment of the definition of the reserve currency with prevailing commodity prices.

As Liaquat Ahamed astutely points out in Lords of Finance, the Great Depression began to lift promptly as President Roosevelt, under the direction of agricultural economist (and commodity price expert) George Warren revalued the dollar at its appropriate post-war rate, $35/oz as opposed to the pre-war $20.67.

During the following three months, wholesale prices jumped by 45 percent and stock prices doubled.  With prices rising, the real cost of borrowing money plummeted. New orders for heavy machinery soared by 100 percent, auto sales doubled, and overall industrial production shot up 50 percent.

Unfortunately, this success was taken to be “going off the gold standard” rather than a restoration of its integrity.

This collapsed distinction has lingered for three-quarters of a century after the lifting of the Great Depression.  The distinction between the classical gold and gold-exchange standards, missed by Prof. Eichengreen, gradually is becoming appreciated by other monetary scholars, savants and officials.

As that distinction becomes appreciated, the unfounded animus begins notably to soften toward the classical gold standard. The classical gold standard once again becomes a respectable subject for discussion as a policy option.