He wishes to thank Paul David, Paul Evans, John McCusker, Ronald Michener, Joel Mokyr, Elizabeth Nuxoll, Bruce D. Smith, Gavin Wright, and three anonymous referees for helpful criticisms of earlier drafts, and Claudia Goldin and Carol Petraitis for the care with which they edited the manuscript.

The quotation is given in a letter from John Adams to John Taylor. See Charles Francis Adams, ed., The Works of John Adams (Boston, 1850), vol. 10, p. 376.

¹ Colonial notes took two forms: obligations backed by colonial land banks and notes of colonial treasuries without land backing. Both were receivable in payment of tax obligations at colonial treasuries.

² Fite, Gilbert C. and Reese, Jim E., An Economic History of the United States (2nd edn., New York, 1973), p. 95.Google Scholar

³ See Friedman, Milton, The Optimum Quantity of Money and Other Essays (Chicago, 1969).Google Scholar

⁴ See Smith, Bruce D., “Some Colonial Evidence on Two Theories of Money: Maryland and the Carolinas,” Journal of Political Economy, 93 (12 1985), pp. 1178–1211,CrossRefGoogle Scholar“American Colonial Monetary Regimes: The Failure of the Quantity Theory of Money and Some Evidence in Favor of an Alternate View,”, Canadian Journal of Economics, 18 (08 1985), pp. 531–65, “Money and Inflation in the American Colonies: Further Evidence on the Failure of the Quantity Theory” (unpublished manuscript, University of Western Ontario, 1987);Google ScholarWicker, Elmus, “Colonial Monetary Standards Contrasted: Evidence from the Seven Years' War,” this Journal, 45 (12 1985), pp. 869–84;Google ScholarSargent, Thomas and Wallace, Neil, “Some Unpleasant Monetarist Arithmetic,” Federal Reserve Bank of Minneapolis Quarterly Review (Fall 1981), pp. 1–17;Google ScholarWallace, Neil, “A Modigliani-Miller Theorem for Open-Market Operations,” American Economic Review, 71 (06 1981), pp. 267–74;Google ScholarBarro, Robert J., “Are Government Bonds Net Wealth?” Journal of Political Economy, 82 (11 1974), pp. 1095–1117.CrossRefGoogle Scholar

⁵ Consumer surplus refers to the utility gain from consumption over and above the cost of consuming. Consumers pay a price in foregone interest earnings equal to the marginal gain from holding a unit of money, but they receive utility from infra-marginal money holdings in excess of this cost.Google Scholar

⁶ See Sparks, Jared, ed., The Works of Benjamin Franklin (Boston, 1840), vol. 2. Franklin argues that abundant money leads to lower interest rates, greater production, immigration, and specialization by enhancing the rapid settlement of debts and by insuring that traders will always be able to purchase the bundle of goods they desire. Furthermore, in a currency-scarce economy, merchants who deal in foreign goods often are forced to pay wages and debts in kind from inventories, and thereby promote the consumption of foreign goods to the detriment of local commerce. In this context, land-backed paper money has a developmental “bootstrapping” role in moving the economy beyond a critical initial threshold which allows exchange and specialization to thrive, given that settlers are land-rich, lack tradeable wealth, and face limits on borrowing abroad.Google Scholar

⁷ Hanson points out that the costliness of importing small-denomination coins made small-denomination paper currency especially desirable to colonial moneyholders, and that colonial governments elected to print a large proportion of relatively small denomination bills. See Hanson, John R. III, “Money in the Colonial American Economy: An Extension,” Economic Inquiry, 17 (04. 1979), pp. 281–86,Google Scholar and “Small Notes in the American Colonies”, Explorations in Economic History, 17 (10 1980), pp. 411–20.Google Scholar

⁸ See Sparks, , Franklin, vol. 2, pp. 273–74.Google Scholar

⁹ Smith, Adam, The Wealth of Nations, Canaan, Edwin, ed. (New York, 1937), p. 311.Google Scholar

¹⁰ Evidence that other contemporaries interpreted events in these terms abounds. While specific examples are too many to enumerate, a prominent illustrative one is a letter of Gouverneur Moms of March 5, 1782, which summarizes his tax-based interpretation of the depreciation of the continental. See Catanzariti, John and Ferguson, E. James, eds., The Papers of Robert Morris (Pittsburgh, 1984), vol. 4, pp. 353–58. I am indebted to Elizabeth Nuxoll, associate editors of The Papers of Robert Morris, for bringing this example to my attention. Additional evidence of the prevalence of the tax-based view of government money is provided in the appendix to Smith, “Further Evidence”.Google Scholar

¹¹ In “Colonial Monetary Standards,” Wicker points out that currency issues during the Seven Years' War typically had promised terminal dates of redemption.

¹² In “Further Evidence”, Bruce D. Smith claims there was a positive correlation between specie flows and paper money issues, rather than the negative association which specie displacement by paper would imply. He argues this is evidence against competition in demand between specie and paper monies. Smith's argument relies implicitly on the assumption that changes in the supply of bills were uncorrelated with changes in the level of demand for money. If money supply were procydical, however, increases in real paper money would not necessarily be associated with outflows of specie. Lester's discussion of the factors influencing the timing of currency issues in Pennsylvania, New York, New Jersey, and Delaware argues for an important connection between changes in the supply and demand for paper money. He shows that paper currency was issued to stimulate the economy; thus currency issues were procyclical. Lester also argues that noninflationary currency issues led to secie resource savings, increased prosperity, and an environment conducive to financial contracting (for example, p. 133). See Lester, Richard, Monetary Experiments: Early American and Recent Scandinavian (Princeton, 1939).Google Scholar

¹³ Either finite time horizons or imperfect capital markets can account for the non-equivalence of debt and taxes. See Hubbard, R. Glenn and Judd, Kenneth L., “Liquidity Constraints, Fiscal Policy, and Consumption,” Brookings Papers on Economic Activity, 1 (1986), pp. 1–60.CrossRefGoogle Scholar

¹⁴ Smith and Wicker were not the first to notice these differing patterns. Other useful comparative studies of colonial monetary institutions and experience include: Brock, Leslie, The Currency of the American Colonies, 1700–1764: A Study of Colonial Finance and Imperial Relations (New York, 1975);Google ScholarErnst, Joseph, Money and Politics in America, 1755–1775 (Chapel Hill, 1973); Lester, Monetary Experiments;Google ScholarMcCusker, John, Money and Exchange in Europe and America, 1600–1775 (Chapel Hill, 1978);CrossRefGoogle ScholarThayer, Theodore, “The Land Bank System in the American Colonies,” this Journal, 13 (Spring 1953), pp. 145–59;Google ScholarWeiss, Roger, “The Issue of Paper Money in the American Colonies, 1720–1774”, This Journal, 30 (12 1970), pp. 770–84;Google Scholar and West, Robert Craig, “Money in the Colonial American Economy”, Economic Inquiry, 16 (01 1978), pp. 1–15.CrossRefGoogle Scholar

¹⁵ Colonies with reliable tax backing which maintained a relatively stable value of their currencies may have further reduced transacting costs by encouraging the use of credit. In her detailed study of colonial wealth in 1774 Alice Hanson Jones finds that in the Middle Colonies—New York, Pennsylvania, New Jersey, and Delaware—financial assets of each wealth and occupational class are much greater a percentage of total assets or net worth than they are in New England or the South. See Jones, Alice Hanson, Wealth of a Nation to Be: The American Colonies on the Eve of the Revolution (New York, 1980).Google Scholar

¹⁶ Webster rejected Hamilton's estimate of $30 million outstanding, “on a more critical examination of the subject.” Ronald Michener supports this estimate as being, “more consistent with the probate evidence and our knowledge of the amount of colonial currency in circulation at that time.” See Webster, Pelatiah, Political Essays on the Nature and Operation of Money, Public Finances,… and Other Subjects (Philadelphia, 1791), p. 142;Google Scholar and Michener, Ronald, “Fixed Exchange Rates and the Quantity Theory in Colonial America,” Carnegie-Rochester Conference Series on Public Policy, 27 (Autumn 1987), p. 279.CrossRefGoogle Scholar Hamilton's estimate is given in his letter to Morris, Robert dated 04 30, 1781.Google Scholar See Catanzariti, and Ferguson, , eds., The Papers of Robert Morris, vol. 1, p. 35.Google Scholar

¹⁷ Nominal emissions are taken from Robinson, Edward F., “Continental Treasury Administration, 1775–1781: A Study in the Financial History of the American Revolution,” (Ph.D. dissertation, University of Wisconsin, 1969), pp. 327–28.Google Scholar Data are adapted from figures reported in Harlow, Ralph V., “Aspects of Revolutionary Finance, 1775–1783,” American Historical Review, 35 (10, 1929), pp. 46–68. I am indebted to Ronald Michener for bringing these data to my attention.CrossRefGoogle Scholar

¹⁸ Table 2 summarizes data and sources for nominal currency issues and their real value.

¹⁹ For more detailed accounts of the financing of the Revolution than that offered here see Bolles, Albert, Financial History of the United States, 1774–1789 (New York, 1883);Google ScholarBullock, Charles, “The Finances of the United States from 1775 to 1789,” Bulletin of the University of Wisconsin: Economic, Political Science, and History Series, 1 (06 1895);Google ScholarDewey, Davis, Financial History of the United States (New York, 1903);Google ScholarFerguson, E. James, The Power of the Purse: A History of American Public Finance, 1776–1790 (Chapel Hill, 1961);Google Scholar and Sumner, William Graham, The Financier and the Finances of the American Revolution (New York, 1892).Google Scholar

²⁰ From 1777 to 1780 state bills were relatively small, and states maintained parity between federal and state bills. Thus the inclusion of state bills in Figure I would increase real values for 1775/76 significantly, but contribute proportionately less to real supply for 1777/79.

²¹ See Bolles, , Financial History, pp. 147–49.Google Scholar

²² These statistics are derived from Bullock, , “Finances,” pp. 177ff.Google Scholar

²³ Catanzariti, and Ferguson, , eds., The Papers of Robert Morris, vol. 4, p. 354.Google Scholar

²⁴ The aggregate wealth to support the taxation needed to back the bills clearly existed. See the discussion in Bolles, , Financial History, p. 85.Google Scholar

²⁵ Bezanson, Anne, Prices and Inflation during the American Revolution (Philadelphia, 1951), p. 48.Google Scholar

²⁶ Ibid. It is important to keep in mind that specie substitution for paper was precluded by the state of war. Only in 1780 did specie inflows begin to play a role.

²⁷ Winning lottery tickets were repudiated as well.Google Scholar

²⁸ For example, the fiscal crisis which led Louis XVI to convene the estates general was precipitated by credit rationing in foreign markets which had its root cause in the large existing debt relative to available future tax flows. If the present value of the existing tax stream is less than outstanding debt, either monetization of the debt or an increase in net taxes must result.

²⁹ Sumner, , Financier, vol. 1, p. 273.Google Scholar

³⁰ Ibid., vol. 2, p. 76.

³¹ Sparks, , Franklin, vol. 2, p. 424.Google Scholar

³² For a review of government policy during and after the Civil War, see Studenski, Paul and Krooss, Herman, Financial History of the United States (New York, 1963);Google Scholar and Calomiris, Charles, “Price and Exchange Rate Determination during the Greenback Suspension” (unpublished manuscript, Northwestern University, 1987).Google Scholar

³³ See Hurst, J. Willard, A Legal History of Money in the United States (Lincoln, Nebraska, 1973), p. 16, for a discussion of the constitutional debate over federal monetary powers.Google Scholar

³⁴ Ironically, overvalued foreign coins, which were made receivable for payment of U.S. taxes, provided a token, resource-saving alternative to full-specie-value coins. These coins were an intermediate step in terms of savings between specie and paper currency. A thorough discussion of the use of token foreign coins can be found in Martin, David, “The Changing Role of Foreign Money in the United States, 1782–1857,” this JOURNAL, 37 (12 1977), pp. 1009–27.Google Scholar

³⁵ See Calomiris, “Greenback Suspension,” for an analysis of resumption expectations and their effect on the value of greenbacks.

³⁶ The motivation for government intervention in the creation of paper money must rest on a comparative advantage which the government enjoys in supplying liquidity relative to private citizens. Typically, the government's claim on the future through taxation is viewed as the source of that advantage. If one defines liquid assets as those whose backing is a matter of common information, then dependable taxation would provide superior backing for liquid assets than most other forms of backing.

³⁷ For continental notes the upper bound on their value was set by the promise to redeem the currency at par for Spanish milled dollars. Clearly, this represented the maximum future value for the currency.

³⁸ In “Fixed Exchange Rates and the Quantity Theory in Colonial America,” Michener argues that fixed exchange rates rather than tax backing explain colonial price movements in many cases. Michener does not provide a convincing explanation for how fixed parities were maintained, and the evidence he presents against the tax-backing approach seems inadequate. He focuses on evidence of government deficits, tax collection fraud, and failures to retire currency issues by the alleged strong-backing colonies as evidence that their backing was in fact poor. The tax-backing model presented here requires only that individuals expect to be able to redeem currency for future taxes. Continuing reissues of currency or temporary deficits do not in themselves imply poor backing or depreciation, so long as parities in tax collection remain in force and the present value of future taxes is viewed as adequate. Moreover, one can extend this model to the case where potential rather than actual taes back money. If credible taxation parity is maintained beyond the redempton date of bills, individuals may decide not to pay in paper currency for taxes in order to retain paper as a medium of exchange. In this case it may be that the present value of money balances exceeds the present value of future tax receipts (but not the present value of potential taxes which the government would be willing and able to levy if currency-holders came to doubt its commitment). In other words, the government could issue currency with minimal actual tax backing so long as it could levy taxes when needed to support the currency.

³⁹ Note that the optimality of increasing the real supply of paper money by increasing taxes depends critically on the assumptions of non-distortionary (lump-sum) taxation and government transfers. These assumptions allow one to abstract from the potentially negative effects of distortions created by tax incentives and the loss of economic resources due to wasteful government expenditures.