The financial system of the Colonies and United States

(1490-1860)

1.Economy and finance in America upon the Arrival of Columbus

Whatever their origin, there were at least 1.5 million human beings living in the
Americas when Columbus arrived. They spoke over 200 languages that were “as
complex and rich as any language spoken anywhere in the world.” There were
no written languages, no printing presses, and very little use of “money” or other
medium of exchange. Although some ancient tribes appear to have used crude
forms of currency, little of those economies remained in North America at the
time of Columbus. Trading among the Indian tribes was not well developed, but
did exist.
Barter or simple sharing was the chief method of trade among the Indians.
The economies of the Indian tribes differed by region, but included agriculture,
hunting, and fishing, all with varying degrees of sophistication. Buffalo, deer,
bear, and other game were hunted for their meat, hides, and fat. Communal
hunts were conducted in order to kill large amounts of game. Fertilizer was in
use, tobacco was cultivated, sunflower seeds were sown, acorns gathered, and
salmon were being caught long before Columbus arrived. Corn and squash were
being grown in the Southwest United States by Indian tribes as long as 6,000
years ago. Although tools were limited in America, at least some tribes were
engaged in metal working. Absent was a device that had greatly increased
agricultural production in Europe—the iron plow. There were also no Indians on
horseback, as caricatured by the movies, “because no Indians had horses until
Columbus and his followers introduced them into the Americas after 1492.”
Another form of transportation was missing as well—there were no wheels to
facilitate travel.

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 When the European financiers learned of Columbus’s voyage, the New
World’s fate was sealed. The Europeans’ lust for gold, wealth, and adventure
was an irresistible lure that would focus the energy of Europe. Efforts to exploit
the New World began almost immediately after Columbus’s discovery. Two
hundred tons of gold and 18,000 tons of silver were brought from the Americas
to Spain between 1521 and 1660. After Columbus arrived, it took the Spaniards
only about fifty years to loot Central America of most of its gold. Although the
Spaniards and their conquistadors made explorations into what is now the
United States, they did not remain. By 1562, there was not a single white man in
what is now the United States.

2.The English in North America

England’s interest in America began to awaken with the voyages of Sir

Francis Drake and the slave trader John Hawkins in the latter part of the
sixteenth century. Drake’s seizure of Spanish ships and the wealth being
returned to Europe by the Spanish explorers was of particular interest to Queen
Elizabeth I. She had a financial stake in at least one of Drake’s voyages. Queen
Elizabeth sought to encourage further exploitation of the New World in 1578 by
granting a patent to Sir Humphrey Gilbert for discoveries in America. The
patent allowed Sir Humphrey to settle and explore any part of the New World
not already claimed by a Christian prince. Although he was allowed to claim
such discoveries for himself and his heirs, Sir Humphrey did not live to enjoy
the benefits of owning what is now the richest nation in the world.
The mechanism that would organize the English explorations was the
joint-stock company, which had appeared in England by 1553, a scant sixty
years after Columbus returned from his voyage to America. A joint-stock
company generally allowed each investor one vote in company matters,
regardless of the size of their investment. There was no limited liability for

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shareholders in joint-stock companies. Shares could be transferred, and the
company was managed by elected officers. A joint-stock company, once
formed, usually raised additional capital by making calls on existing
shareholders.
The most significant role was played by the Virginia, Plymouth and The
Dutch West India Companies. Authorized by its charter to settle the south
Atlantic coast of America, the Virginia Company financed the expedition that
created the Jamestown colony. There were about fifty merchant company
investors, and it had an equally large governing council. Shares in the Virginia
Company were sold to “adventurers.” “The adventurers were those who stayed
at home and risked their money in the venture.” The individuals who went to
America for the London Company were called “planters.” To encourage
emigration, every planter was to be given one share of the company, which the
company was to bear expenses and receive any trading income. Planters were
given parcels of land for every tenant they transported to the colonies. Those
tenants were often indentured servants who were promised land and profits in
exchange for their services. Subsidiaries of the Virginia Company were formed
for a number of purposes, including the transporting of young women to
Virginia for marriage partners. Of course, since this was a commercial venture,
the new husbands were required to pay for the passage of their future wives.
The Dutch West India Company was chartered in 1621. Five years later
the company made its most famous deal, often cited as the ‘steal of the
millennium. For a load of cloth, beads, hatchets and seeds then worth only $24
the Manhattan Island was purchased from the Indians. On the island a new town
called New Amsterdam was founded, which in 1674 will be renamed by the
English to its present name New York.
The Dutch settlers also gave America its most prominent financial symbol
—Wall Street. Sometime around 1653, the Dutch Settlers built a twelve-foot-
high wooden stockade fence in lower Manhattan in order to protect themselves

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from attacks by the British, the Indians, and other unwanted guests. In 1685,
Wall Street was laid along the line of the fence of the Dutch stockade.

3.Regulation of Trade

The colonies were viewed by England and its merchants as a source of

wealth to be exploited for their benefit. This meant that commerce in the
colonies had to be regulated strictly to assure that any riches found their way to
England. The Crown, for example, reserved the largest and tallest trees in
America for British ships. Equally important was the need to prevent the
colonies from competing with English merchants. England, therefore, ordained
in 1630 that the American colonies could not make woolen, linen, or cotton
cloth. In addition, only plantations owned by the English merchants were
allowed to export produce. Colonists owning “farms” could produce only for
domestic consumption. The corn laws closed the English ports to cereals and
meats imported from the colonies, and heavy duties were placed on whale oil.
The Wool Act of 1699 prohibited exportation of wool from the American
colonies. A report to the Board of Trade in England around 1715 stated that
goods valued at about 1 million English pounds were being brought to England
from the plantations in America. Goods valued at over £700,000 were being sold
to the colonies annually. About two-thirds of English shipping was engaged in
this trade, and this commerce supported about 200,000 persons in England. In
1726, a Mr. Bladen sent a short essay to Lord Townshend that listed the benefits
of the colonies to England. Among other things, Bladen noted that the colonies
consumed one-sixth of the wool manufactured in England, double that amount
of linen and calico, and great amounts of silk, furniture, and trinkets.

4.Money in America

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 Missing on the arrival of the immigrants to America was any functioning
currency. The early settlers were able to create a crude form of money by using
beads and trinkets in their trade with the Indians, as did Columbus. An
excavation of the original fort at Jamestown in 1996 yielded “dozens of sky-blue
glass beads apparently manufactured by the colony for trade with the Indians.
‘John Smith got himself out of hot spots by trading these beads.’” Such beads
would remain a favorite currency for trading with the Indians for at least two
more centuries. The value of the beads varied with their color. As Meriwether
Lewis noted in preparing for his famous expedition across the country in 1803,
blue beads are “far more valued than the white beads of the same manufacturer
and answer all the purposes of money.” Cash in the form of specie (i.e., gold or
silver bullion and coins) was in short supply in the colonies. Mining rights to
gold and silver were granted to the Virginia and Plymouth settlers under their
royal charters. The Crown was to receive one-fifth of all gold and silver that was
mined. But those rights proved to be of little value because quantities of gold
and silver were not among the riches of the Atlantic coast. The lack of gold and
silver meant that the authority given to the Virginia Company’s resident council
to coin money was worthless. Specie would have to be imported or a substitute
found until the western gold discoveries just before the Civil War. This
sometimes required imagination. In Quebec, the French intendant had to use
playing cards as notes for provisioning troops. The cards were later redeemed
from the annual appropriation that came by ship from France in the form of
specie or bills of exchange. The English colonies were equally imaginative.
Nails were scarce, for example, and sometimes used as a currency. Wampum—
strings of purple and white beads made from shells that were sewn together into
belts—became a currency in the trading areas of the Plymouth Company and
was exchanged for furs with the Indians. In 1643, the Massachusetts court ruled
that wampum was acceptable currency for the payment of debts up to forty

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shillings. White wampum was valued at eight to a penny and black wampum at
four for a penny.

6.Commodity Money

Tobacco was an accepted medium of exchange in the southern colonies.

Quit rents and fines were payable in tobacco. Individuals missing church were
fined a pound of tobacco. In 1618, the governor of Virginia issued an order that
directed that “all goods should be sold at an advance of twenty-five percent, and
tobacco taken in payment at three shillings per pound, and not more or less, on
the penalty of three years servitude to the Colony.” Virginians were even
purchasing wives from England in 1620 with tobacco. A joint stock company
for “transporting 100 maids to be made wives” was formed for this trade. The
maids cost twelve pounds for their passage and were sold “at the rate of 150 lbs.
of tobacco.” Young men in Virginia were said to have showed up with tobacco
under their arms to greet and pay for their new wives. A later writer notes,
however, that it would be difficult for one person to carry all of the tobacco
required for full payment. He suggests that what the would-be husbands were
carrying was only enough tobacco to provide earnest money, “thus in fact
buying his wife on margin.”

7.Coins as Currency

The English government discouraged most efforts to bring specie to

America. The imbalance of payments with the colonies assured there would be
few breaches of those restrictions. As Benjamin Franklin later noted, much of
the specie that did find its way to America was quickly withdrawn as a result of
the unfavorable balance of trade with England.

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 Making change was a problem because of the shortage of coins. “The
difficulty in making change in the Colonies had led to the extensive practice of
dividing gold coins with a chisel.” Virginia prohibited “the cutting of gold coins
into lesser pieces to make change” in 1727.
Virginia established the Spanish dollar, valued at six shillings, as the
currency of that colony in 1645. The Spanish piece of eight would become the
basis for the United States dollar. The current dollar sign is said to reflect the
figure eight, and the two lines in the dollar sign are found on the reverse side of
the old Spanish dollars. The word “dollar” is actually a derivation of the name of
a German coin, the “thaler.” Thalers were produced beginning in 1519 in a small
Czech village that later came under German control. The U.S. dollar is also
sometimes referred to as a “buck.” This too traces its origin to the Spanish
dollar. There was a large trade in deerskins in the colonies. “A ‘buck’ was the
standard of the trade, and by 1750 the term already had become a synonym in
the American colonies for its monetary equivalent, the widely circulating
Spanish dollar.”
Even though they depended on foreign coins for most of their specie
transactions, the American colonies used the silver standard that had been
established in England in setting monetary values. Monetary calculation in the
colonies was further based on the English system of pounds, shillings, and
pence. Under that system, twelve pence equaled a shilling and twenty shillings
equaled a pound.

8. Financing Independence

America had no army, other than mostly untrained militia, and there was
no financial system to finance a war with the most powerful nation in the world.
There was no central government, no national treasury or exchequer, and there
was but little support for taxes to finance the revolt. The American states were in

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want of two of the most essential matters which governments could be destitute
of—money and credit. Since the Revolution was based on resistance to taxation,
and because the revolting states had no foreign credit, the colonies were left
collectively and individually to the printing presses to provide the currency
necessary to conduct war. This was indeed paper money. The first issuance of
Continental money was authorized on May 10, 1775. They authorized the bearer
to receive Spanish milled dollars or the value thereof in gold and silver. This
statement was less than truthful. The Continental Congress did not have the
wherewithal to pay specie to redeem the currency. The Continental bills ranged
in denominations from one to twenty Spanish dollars.
The Continental money maintained its value on a par with gold and silver for a
time, but that happy situation soon changed. The value of the Continental dollar
rose and fell with the fortunes of the American army, and then plummeted as the
colonies exhausted their credit. At one point, seventy dollars in paper was not
equal to one dollar in silver. During a three-week period in May of 1779, prices
increased by 100 percent. The Continental dollar plunged until it was worth less
than a copper penny. By 1781, it cost more to print a Continental dollar than it
was worth as currency. The ultimate depreciation of the Continental bills
resulted in the phrase “not worth a Continental,” a measure of worthlessness that
survives today. Yet, even in the face of the massive depreciation in their value,
historians have asserted that the Revolutionary War would not have been won
by the United States without the issuance of its paper money.

9. Robert Morris

A bright spot in Continental government’s finance was the emergence of

Robert Morris as the man responsible for the country’s finances. The position of
Superintendent of Finance was created in 1781 to oversee the finances of the
fledgling government. Morris, a Philadelphia merchant, was appointed to fill

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that position. He was referred to in that role as the “Financier.” Morris accepted
the position only on the condition that Congress would allow him to continue his
private commercial concerns and connections. Morris risked his personal fortune
to support the Revolution. He was said to have raised $1.5 million for the army
by issuing his own personal notes. By placing his personal credit behind the
government, Morris was able to stabilize a financial situation that had nearly
brought the government and war effort to a standstill. Morris issued notes for the
government that he guaranteed personally, as well as in his capacity as
Superintendent of Finance. These notes became known as “Bobs” because of
Morris’s signature. There were “Long Bobs” and “Short Bobs” that were
identified as such by their maturity date. Morris was able to obtain the services
of a partnership of merchants, Comfort Sands & Co., to supply the Continental
Army on credit. He was able to pay for supplies by borrowing funds from
private merchants, including Haym Salomon, who loaned $211,000 to the
government and purchased bills of credit totaling $353,000 that provided funds
desperately needed to pay the Continental Army.
Morris sought to establish a central bank through the “Bank of North
America,” which he controlled. That bank then became, roughly, the
predecessor to our Federal Reserve System. The Bank of North America began
its functions as the nation’s bank in January of 1782, and received the privilege
from the government of its notes being receivable in all duties and taxes to all
governments, at par with specie. In addition, no other banks were to be
permitted to operate in the country. In return for its monopoly license to issue
paper money, the bank would graciously lend most of its newly created money
to the federal government to purchase public debt and be reimbursed by the
hapless taxpayer. The Bank of North America was made the depository for all
congressional funds. The first central bank in America rapidly loaned $1.2
million to the Congress, headed also by Robert Morris. After a year of operation,
however, Morris, his political power slipping after the end of the war, moved

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quickly to end his bank’s role as a central bank and to shift it to the status of a
private commercial bank chartered by the state of Pennsylvania. By the end of
1783, all of the federal government’s stock in the Bank of North America, which
had the previous year amounted to five-eighths of its capital, had been sold by
Morris into private hands, and all U.S. government debt to the bank had been
repaid. The first experiment with a central bank in the United States had ended.

10. Alexander Hamilton and laying the foundations of the United States
financial system

The Revolution freed the colonies from the economic tyranny of England.
That was cause for celebration. More than a little daunting was the fact that the
new nation lacked any coherent financial system. Economic problems were
immediate. Much of the mountain of debt issued by the former colonies and the
Continental Congress to fund the Revolution was still outstanding and in arrears.
The debt of the Continental Congress alone was well over $200 million, and that
of the former colonies was even greater. In truth, no one knew the exact amount
of the debt because there were so many locally issued bills and certificates.
To solve the serious financial problems was appointed, the first Secretary
of the Treasure, the 32 years old Alexander Hamilton. Hamilton laid the
foundations of the young state’s financial system with his specially designed
financial plan, containing several key elements.

10.1 Foreign Debts

The first element called for paying off in full the loans that foreign
governments had made to the Continental Congress during the Revolution. In
1790 the principal on these loans amounted to roughly $10 million. The United

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States owed two-thirds of these debts to France, one-third to the Netherlands,
and a small amount to Spain. No one in Congress or the administration
challenged Hamilton's arguments that the United States had a legal and moral
obligation to pay off these debts, and that it had to do so in order to establish the
credit of the United States, and its citizens, in European financial markets.

10.2 Domestic Debts

The second element was more controversial. This was Hamilton's

proposal for repaying the debts that the Continental Congress and the
Confederation government had incurred by borrowing domestically—that is,
from individuals and American state governments. These debts, amounting to
about $42.4 million, had resulted from the selling of bonds to supporters of the
Revolution and the issuing of various notes to pay soldiers and farmers and
merchants who had supplied the revolutionary armies. This proposal consisted
of two parts. Hamilton believed that the two parts of the plan would work
together. The plan would create a class of wealthy citizens who, because they
were long-term creditors of the new national government, would be loyal to it
and take an active interest in its affairs. As a consequence, the central
government would be strong and able to finance wars or fund major national
projects. In addition, the permanent debt, because its owners could readily
convert it into money or other assets, would provide capital to meet the needs of
an expanding economy.

Members of Congress generally agreed with Hamilton that the new

federal government had a legal obligation to pay the domestic debts that the
Confederation government had incurred. Article VI of the Constitution provides
that "All Debts contracted… before the Adoption of this Constitution, shall be as

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valid against the United States under this Constitution, as under the
Confederation." But many in Congress, including James Madison, argued that
the federal government ought to negotiate down the domestic debts and take into
account the interests of those who had first owned the securities. Critics pointed
out that the inflation of the war years and the depressed conditions of the 1780s
had forced many of the original owners, including revolutionary war soldiers, to
sell them at substantial losses. The speculators, including wealthy American
merchants, Dutch investors, and even British investors, who had bought these
deeply discounted notes, stood to reap huge windfall gains under Hamilton's
redemption program.

10.3 Debts of the States

The third element of Hamilton's policies was the proposal that the federal
government take over the $25 million in debt that the state governments had
accumulated during the Revolution. With this "assumption" program, Hamilton
sought to strengthen further the nation's financial reputation, to bolster the
nation's stock of capital, and to enhance the financial power of the federal
government. All of the states had debts from the war, but their efforts to pay off
the debts had varied greatly. Massachusetts and South Carolina had been
sluggish in paying off their war debts and had much to gain from assumption.
Four southern states—Georgia, North Carolina, Virginia, and Maryland—had
been aggressive in paying off their debts. For them, assumption threatened to be
costly, requiring them to subsidize the plan through new federal taxes.

10.4 The Bank of the United States

In December 1790, Hamilton also proposed the fifth element in his

financial plan: the federal chartering and funding of a powerful institution—a

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national bank, which would be called the Bank of the United States and modeled
to some extent on the Bank of England. The bank was to be a commercial bank,
which was a rare institution in America. State governments had chartered only
four of them. The Bank of the United States, in Hamilton's view, would be very
different from the other commercial banks. One difference would be its sheer
size. Hamilton proposed capitalization for the bank that would make it five
times the size of all the other commercial banks combined. This meant that the
bank could expand significantly the size of the nation's money supply and thus
enhance economic activity.
In February 1791, Congress passed a bill that adopted most of Hamilton's
specific ideas for the new bank. Congress provided for a twenty-year charter, a
pledge that the government would not charter another bank during that period, a
capitalization of $10 million, 20 percent ownership by the federal government, a
requirement that 75 percent of the stock subscribed by private parties be
purchased with United States securities, and a provision for locating the
headquarters of the bank in Philadelphia.

10.5 The Mint

In January 1791, while the Bank of the United States was still under
debate, Hamilton submitted the "Report on the Establishment of a Mint." The
creation of a mint, the sixth element of his economic program, followed the call
of the Constitution for a national coinage. Hamilton's goal was to create a
system of coinage that would be uniform across the United States and provide
monetary stability. Uniformity and stability would promote commerce, enhance
the credit worthiness of the United States, and protect the value of tax revenues.
Hamilton personally preferred gold coinage but he recognized the political
reality that many members of Congress worried about the shortage of gold and
the potential deflationary impact of a gold standard. Hamilton proposed, instead,

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a bimetallic standard based on the minting of both gold and silver coins. Both
gold and silver coins would be legal tender, and the mint would buy gold or
silver at an official ratio of fifteen ounces of silver to one ounce of gold. The
most common coin in circulation was the Spanish silver dollar, and it had
provided the unit with which the new nation valued its debts. To ease the
transition, Hamilton recommended adopting the dollar as the basic unit for the
coinage of the new republic, and keeping the silver content of the new dollar
close to that of the Spanish one. In addition, to facilitate small transactions, he
recommended an elaborate fractional coinage. Congress adopted almost all of
Hamilton's proposals in the Coinage Act of 1792.
The Coinage Act established a bimetallic dollar standard for the United
States. The dollar was defined as both a weight of 371.25 grains (24 грама) of
pure silver and/or a weight of 24.75 grains (1.6 грама) of pure gold—a fixed
ratio of 15 grains of silver to 1 grain of gold. Anyone could bring gold and silver
bullion to the mint to be coined and silver and gold coins were both to be legal
tender at this fixed ratio of 15-to-1. The basic silver coin was to be the silver
dollar, and the basic gold coin the $10 eagle, containing 247.5 grains (16 грама)
of pure gold. The 15-to-1 fixed bimetallic ratio almost precisely corresponded to
the market gold/silver ratio of the early 1790s, but of course the tragedy of any
bimetallic standard is that the fixed mint ratio must always come a cropper
against inevitably changing market ratios, and that Gresham’s Law will then
come inexorably into effect. Thus, Hamilton’s express desire to keep both
metals in circulation in order to increase the supply of money was doomed to
failure. Unfortunately for the bimetallic goal, the 1780s saw the beginning of a
steady decline in the ratio of the market values of silver to gold, largely due to
the massive increases over the next three decades of silver production from the
mines of Mexico. The result was that the market ratio fell to 15.5-to-1 by the
1790s, and after 1805 fell to approximately 15.75-to-1. The latter figure was

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enough of a gap between the market and mint ratios to set Gresham’s Law1 into
operation so that by 1810 gold coins began to disappear from the United States
and silver coins began to flood in. The fixed government ratio now significantly
overvalued silver and undervalued gold, so it paid people to bring in silver to
exchange for gold, melt the gold coins into bullion and ship it abroad. From
1810 until 1834, only silver coin, domestic and foreign, circulated in the United
States.

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Gresham’s law is observation in economics that “bad money drives out
good money.” More exactly, if coins containing metal of different value have
the same value as legal tender (законно платежно средство), the coins
composed of the cheaper metal will be used for payment, while those made of
more expensive metal will be hoarded or exported and thus tend to disappear
from circulation. Sir Thomas Gresham, financial agent of Queen Elizabeth I,
was not the first to recognize this monetary principle, but his elucidation of it in
1558 prompted the economist H.D. Macleod to suggest the term Gresham’s law
in the 19th century.

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