Inflation in Colonial America

0:00Today's lecture is called Inflation in Colonial America. Now, as you've seen through the lecture process so far, this history class is very topical in that each lecture basically is looking at a specific high point or point of importance in American history and applying economic tools to understanding those things. It's not a history in the sense of a stringing of events, one after the other, into a long detailed tale of America. Now that is unfortunate, but we have a limited amount of time in here.

0:45If you are interested in the real history of colonial America, Murray Rothbard, the author of one of our textbooks, has written a real history of colonial America. It's called Conceived in Liberty and it's an excellent history of the period. And it's also written by someone who's an economist as well as an historian so that a lot of the points that I bring up in class are better illustrated or illustrated in greater detail in that four volume set. So if you really wanted to endeavor to know your American history and you wanted to start with the colonial period, that's the set of books that I would recommend.

1:39And I'll try to do that as we go through American history so that by the end of this course you'll have a reading list for Your Private Consumption. May have to wait until you retire, but you'll have it. Okay, in the last class, before this class about inflation, what we were looking at is how well the colonists adapted to British mercantilist monetary policy. The British imposed this mercantilist monetary policy Colonies which restricted their access to British money but we saw that the colonists adopted or adapted, I should say, adapted to that by using commodity-based monies which the British couldn't control and the use of the Spanish peso which the British really couldn't control.

2:49So these were sort of natural adaptive techniques to the problems imposed by the British. Today we're looking at monetary manipulation by the colonies. Not the colonists, but the colonies, the colonial governments themselves. So this is more of an artificial or political response Okay, one of the first things they did was try to manipulate the Spanish peso. Okay, that's what they had. They couldn't figure out a way to manipulate the commodity monies, which were way too market oriented, too flexible and so what the colonists did was they said well we've got the Spanish peso or dollar in circulation and the Spanish peso was equal to four shillings and six pence so if you looked at the amount of silver in a Spanish peso in order to get that same amount of silver In British money, you'd have to have four shillings and six pence.

4:23So in 1642, Massachusetts came up with the idea of just saying, well, instead of that, The Spanish peso in Massachusetts is going to be equal to five shillings. That wasn't just a simple rounding issue, or it wasn't a little error on their part. It wasn't that they didn't understand the British monetary system, they had all grown What the idea was, was to get people who had Spanish pesos to spend them in Massachusetts.

5:31So, for example, if you were a trader, and you were trading in the West Indies, and you acquired Spanish pesos, everywhere else in the world, including all of the other colonies, those pesos you could spend were equal to four shillings and six pence. But if you went If you went to Massachusetts, the Massachusetts Bay Colony, you could spend those Spanish pesos and get five shillings worth of goods. So the idea here was to encourage all these ships and traders who were passing through the colonies to stop in Massachusetts rather than New York or Rhode Island and spend their spend their money there.

6:38Okay, so the idea is here increase the supply of pesos in Massachusetts and encourage exports. So these traders will be coming through and they would be encouraged to buy up things and Export them. Initially this policy apparently had some beneficial effects, it sort of stimulated and the Artificial Stimulation of the Economy.

7:33But problems were just around the corner because other colonies, specifically colonies like Rhode Island and Connecticut, followed suit saying that pesos were now worth five shillings in their colonies. In fact, they even went beyond five shillings. So they were upping the ante. And so people from around the world could spend their pesos and get more and more goods for the same amount of money in these colonies.

8:24This caused prices to increase, or price inflation, and the practice was ultimately banned in 1707 by Great Britain. So that was the first step, the first episode of monetary manipulation, inflation of manipulating currencies. And this is something that various kings in Europe had tried as well, where they changed the exchange ratios of their currencies, manipulating the accounting values of their currencies to try to get an inflationary advantage.

9:46The second and more notable form of monetary manipulation was fiat paper money. It starts out in 1690 in Massachusetts, where Massachusetts is said to have invented paper money. That's actually not true. have been tried in other places at other times, specifically in China, and it's kind of interesting in something that's either not discussed or not discussed a lot at great length, but Massachusetts and some of the other colonies had this little nasty habit of periodic expeditions to Canada.

10:59They call them expeditions, but they were really plunder invasions where the colony would gather an army together and send it up into Canada to Quebec or some other place up in Canada and steal a bunch of their stuff and come back and the idea was they'd sell all of the plunder that they got their hands on and pay the soldiers with that money and and keep the rest for the colonial government. So it was kind of a mercantilist adventure between soldiers for hire and the colonial government. And this worked pretty well as long as the colonial army won. But in 1690, an expedition went to French Canada and lost and was turned back and didn't actually acquire plunder.

11:59As a matter of fact, they were kind of in a bad way in terms of just provisioning themselves on the return trip. But in any case, the soldiers wanted to get paid when they returned. Even though there was no plunder, the colony of Massachusetts could not borrow money because because their credit rating wasn't high enough amongst the local merchants and so they were in a bit of a pickle and they feared an uprising or mutiny on the part of the soldiers because the soldiers weren't going to wait around they had to go back to their farms and start the next crop And so, the colony of Massachusetts printed up 7,000 pounds, another, of course, monetary designation of Great Britain, 7,000 pounds of paper notes to pay for the expedition.

13:07they were told that these notes would be redeemable in gold and silver in a few years and that the colony would never issue any more notes so that's 1690 1690, 1691, they decided and said that that wasn't enough, and that they had to issue Another 40,000 pounds of notes, and this time they said, we'll never issue any more.

14:01Those notes quickly achieved a depreciation of about 40%, indicating that people were We're already not really believing in the colonial government. The following year, the colonial government passes a legal tender law that requires individuals to accept the colonial paper money at par. Now it's worth knowing what legal tender laws are. The money in your billfold will actually tell you, I think, used to at least, that those Federal Reserve notes are subject to our own legal tender law, which requires every individual in the United States to accept those paper notes for all debts, public and private.

15:11So you can use those notes to pay your taxes or to pay your private debts and the other people, including the government, have to accept them. You have to pay your taxes in these notes and they have to be acceptable on the part of everyone else. This is designed to increase the marketability of these paper notes because you're being forced to do it. You can't decide not to take these notes even if they've depreciated 40% in one year versus gold and silver. So you might have lent some money at the beginning of the year.

16:00You might have lent somebody, say, 100 Spanish pesos, and you're supposed to get paid back at the end of the year 110 Spanish pesos. But if in the meantime your colonial government issues these paper notes and a legal tender law and they fall by 40 percent, then at the end of the year the person you lent that money to can pay you 110 of these depreciated paper notes, which are only worth 60 percent. So instead of getting back 110 ounces of silver, you're really only getting, what?

16:5566, the equivalent of 66 ounces of silver. So you've really lost not only your interest, but you've lost 34% of your principal.

17:15An important effect, of course, immediately goes into effect and that's what Gresham's law tells us. Bad money drives out good. In this case, the good money is gold and silver coins. The bad money is the paper notes. So the bad money is in circulation. everybody's using it quickly to make exchanges because it's falling in value and the gold and silver stay out of circulation so you no longer see gold and silver coins those are things that people hold on to because they're not depreciating, they're really appreciating versus the paper money You're also going to get price inflation as with the monetary manipulation of the peso. Other colonies jump in on this process.

18:31Initially it's Massachusetts neighboring colonies, Rhode Island and Connecticut. Silver is disappearing from circulation, and the paper money that's issued by Massachusetts is not redeemed in a few years, unless you consider 40 years to be a few years. in 40 years is of course longer than the life expectancy of the colonists. So it's more than a lifetime before these notes are redeemed. Again, people now are living in that life expectancy is still only in the 20s. in the 20s. So looking back at this episode, you have to wonder, is it a stupid policy where you issue this money because you think money is scarce and you're issuing more and more, it's depreciating in value and it's actually driving out the gold and silver money and ultimately Obviously it's hurting the economy.

19:55Well, you could say it's not really a stupid policy, in the sense that we can understand why they did it. In the breakdown of this policy, we can see that certain groups are harmed by the policy and other groups are helped by the policy. The primary group that it helps is government.

20:40They print the money up and then they spend it. This is obviously something that would help the government. Every time they issue money, that's money that they're actually spending. And they're not like giving everybody a little bit in piece of it. It's not getting an equitable distribution or any kind of equal distribution. It's being spent directly by the government. And people who are in debt, as I just explained, you lent your friend 100 ounces of silver.

21:27He got a great deal out of it. He got to use the money for a year and only had to pay you back the equivalent of two-thirds of what he borrowed.

21:50You on the other hand as a creditor, as a saver and a lender, are harmed. Economy is also harmed in the process, and I mean that in two different senses. The first sense is just the overall economy. This is going to have kind of an initial stimulative effect on the economy, but ultimately it's going to have a depressing effect on the economy. like if you took a stimulant or some kind of stimulating drug initially you'd be very active but then you would have the after effects of whatever it was you ingested caffeine alcohol whatever and also hurts economy in the more general sense of being economical because once you get into an inflationary process of of course, people don't do things the way they typically do things. And in this instance, when you've got all this money pouring into the economy and depreciating very quickly, it's very much the case that you want to spend your money as quickly as possible. And it doesn't matter what it's on, you just got to

23:11spend it before it goes down in value. And so people might buy things that they don't need, buy luxury goods that they otherwise couldn't afford, and find find themselves stuck after the process runs its course. This continues. This episode continues. In 1711, Massachusetts issues a half a million pounds worth of notes after another failed military expedition to Quebec. Naturally, the depreciation of these notes follows, so 1711, you get a half a million pounds.

23:571716, a land bank is founded that issues a hundred thousand pounds of notes and a land Land Bank is basically where you take land holdings and you use it as collateral for the notes. So you've got this ownership of land and they say, well, we're going to capitalize this value of this land in terms of notes. So we're going to back up the notes with the value of the land and ultimately we'll sell And sell this land in order to redeem those notes.

24:49But, of course, people didn't buy that so the notes depreciated. 1744-48 1744, 300,000 pounds are issued, 300,000 pounds, excuse me, and ultimately by 1748 the issue increases to two and a half million pounds of of Notes. So the peso, which traditionally had been equal to 4 shillings 6 pence, was now worth 60 shillings in some of the counties, in some of the colonies. By 1740, every colony except Virginia had resorted to inflation, and even during the 1750s Virginia succumbed to issue paper to cover the expenses of their involvement in the French and Indian wars.

26:15Now notice that a lot of these issuing of paper money is justified by one of the things is the general supposed scarcity of money in the colonies, and the other is war. These military expeditions are sort of junior wars. They're not really declared wars, but they're certainly military expeditions, and then the French and Indian War finally gets Virginia to Issue Money. In addition to all of the problems caused by this money, it also causes A Boom-Bust Cycle

27:19Economist Donald Kemmerer specifically shows that in the case of New Jersey how this money, this issuing of fiat money caused a boom bust cycle and this is just the old-fashioned way of saying the business cycle

27:42except back then it was a little more obvious that you know one period was a booming part in the economy, the other was a bust in the economy where everything went sour and basically what you have here is a multi-step process where you print money which stimulates the economy artificially and that's followed by a crash. not a stock market crash but just a depression on the economy.

28:32Now as we get further along in the colonial period, Great Britain prohibits the New England colonies who had been the worst offenders from issuing any more paper notes in 1751 and they also encourage those colonies to redeem themselves or redeem their paper notes for gold and silver. In 1764 Great Britain prohibits all of the colonies from issuing any more paper notes and again encourages redemption. I have an interesting word there, redemption. Most of the time we hear that word, it's in some religious context. You get redemption or forgiveness or you do something to redeem In this case it's a banking context. The banks have issued the notes and they have to redeem them and the bad part is really the issuing of the paper and the redeeming or the good part is taking the paper in and giving out gold and silver coins.

29:44With redemption, we see the economy returning to normalcy and prosperity. The inflationists of the time, those people who promoted the idea of inflation and sponsored inflationist programs, predicted that this redemption would lead to gloom and doom in the economy. But what they actually saw, from what we can tell, was that the economy returned to normalcy and prosperity after a period of adjustment. And certainly the adjustment was not painless for the colonists. It would be similar to the drug experience where if you take a lot of drugs and you stimulate your body and then you have this withdrawal period before you actually return to normal and that withdrawal period can be very painful on this return to normal see I I want to quote to you from Rothbard's history on page 55 from one student of colonial Massachusetts who pointed out, the return to specie occasioned remarkably little dislocation, recession or price deflation. Indeed wheat prices fell by less in Boston than in Philadelphia which

31:25which saw no such return to species in the early 1750s. Foreign exchange rates after the resumption of species were highly stable and quote, the restored species system operated after 1750 with remarkable stability during the Seven Years War and during the dislocation of international payments in the last years before the revolution. So there was no, whether the economy was really falling apart or anything like that. The upshot here, and it's important to note that there were all these complaints about the scarcity of money.

32:19And with these inventions, these artificial inventions of manipulating the peso and the fiat monetary system, those types of attempts didn't really help at all. As a matter of fact they ended up hurting the economy and driving out all the species from circulation in the first place. So the real shortage of species money was actually caused by the attempt to introduce paper fiat money, unbacked really, or not really backed by gold and silver. And just in case you hadn't seen this, fiat money means money by law.

33:09Money by Government, and one of the key aspects of trying to back that paper money by law are legal tender laws, which add the element of force behind it.

33:39Okay? And some of these legal tender laws would actually, if you didn't accept the paper money for the debts that were owed to you, you could be fined or imprisoned as a result. So there was some real backing here. Now, in modern context, we've gotten so far away from gold and everybody is more or less used to accepting paper money. We've adapted to many of the worst aspects of paper money that the idea of not accepting Federal Reserve notes or the dollars that we have doesn't really occur to us.

34:30We have a little primer here on colonial banking. Banking. If we drive around Auburn, the city of Auburn, you're going to see a bank almost on any corner, any intersection, I should say, and in every shopping mall, including all the Walmarts and grocery stores. But banking was a relatively new and limited function back Back in Colonial America.

35:28Anybody heard of the Knights Templar? Skip that then. No, I'm just kidding. Skip that. If you read the Da Vinci Code or saw that on television, the Knights Templar play kind of a role in all that. They were a group A group of, in the middle ages, a group of military based and knighthood based denomination of the Catholic Church.

36:21They were the protectors of the Holy Land and for people who were visiting the Holy Land, the area now occupied by Israel. People going from Europe to the Holy Land, they were assigned to protect the Holy Land and all the shrines there as well as people who were visiting the Holy Land in transit. And it was not only one of the most powerful military organizations, but it was also one of the most powerful economic organizations in the world for several hundred years. And one of the aspects that they developed was banking, where they had their own money and they held deposits for other people.

37:13They lent money to the popes and kings and things of that nature. And they actually invented some financial services. It's kind of interesting in that people going from Europe to the Holy Land, they have to carry a lot of money with you because you can't carry all your provisions. And everybody knows that and so all of the routes between Europe and the Holy Land would be infested with thieves and robbers. And so the Knights Templar got sick and tired of ushering all of these essentially religious tourists back and forth from the Holy Land, you know, after a couple hundred years that gets old. So they came up with this financial intervention, financial innovation, similar to a credit card, whereby they would give, they would take the tourist money in Europe and give them this encrypted piece of paper, and the tourists would then take the piece of paper, not really knowing what it said, but it gave the tourists the ability to go to any night along the way and buy all of the provisions that they needed, stay overnight, eat in the restaurant, all this kind of thing, food for your

38:45and then the knight would re-encrypt the piece of paper, give it back to the tourist and they're on their way. The thieves couldn't take the piece of paper because the encryption included the identification of the person. So if a thief took one of these pieces of paper from one of the knight's tourists and they showed up at the knight's inn in order to buy some goods and services with this piece of paper, the knight would cut the guy's head off. So this is like an early American Express card.

39:35The bankers of Venice, the bankers of Italy really, become the first merchant bankers who who lend money for purposes of international trade. They say they're usually lending their own money to facilitate international trade. In England, we see the development of really the first multiple deposit type banking and what happened was that Charles I, the King of England, this is really not too important to the overall story but it tells us where the Genesis comes from, Charles I, King of England, confiscated all the gold that his These subjects had deposited at his mint.

40:36So all the wealthy merchants would go to the king and say, can you hold this for me, king, and I'll be loyal to you. The king would say, sure, we've got plenty of room, and we've got soldiers here to guard it. Well, in 1638, Charles confiscated all of the gold as a loan just before the Civil War. And when I say Civil War, I mean the English Civil War. Now the merchants weren't happy with that, so they began to deposit their gold with the and the gold smith. So individuals begin depositing their gold with a gold smith. And gold was after all not just a money, it was a commodity, it was used for a lot of different things goldsmiths including jewelry and religious ornaments.

41:45It wasn't too long after that that goldsmiths got the idea that, you know, people are not coming in for their gold on a regular basis. and people are actually starting to trade their warehouse receipts amongst each other. So Jimmy comes in with a hundred ounces of gold, leaves it here, I give him a piece of paper saying Jimmy has a hundred ounces of gold with me and then Jimmy trades his warehouse receipt with Fred for two horses and a mule. Well actually not a mule, they wouldn't wouldn't have those. And so the goldsmiths start getting the bright idea that hey people are accepting these pieces of paper I'm going to start I'm going to write up one marks hundred ounce of gold and go buy some beer with it. So Goldsmiths picked up the practice of fractional reserve banking, where the gold in the goldsmith's shop represented only a small fraction of all of the deposit receipts that were out there.

43:06Okay, now as we turn our attention back to New England, we have the Massachusetts Land Bank of 1740. Again, as I mentioned, those notes were irredeemable. They depreciated. People didn't like them. People didn't accept them. And they were ultimately outlawed. And now for the general question. And this is something that you could use for a term paper to look at who promoted this inflation during colonial America and in Rothbard's discussion he gives you a lot of footnotes for some older references and one idea for paper would just be to take that as a launching pad just explain what Rothbard says explain what the you know in detail what all of So who's behind the inflation? Well, we've already looked at who's helped and who's hurt by inflation and that tells you most of the story.

44:38Early historians thought it was poor agrarian farmers, poor people who were debtors. but newer historians have found that it was actually sponsored more by wealthy merchants and land speculators people not on the low end of the totem pole the poor agrarian farmers but on the top end of the totem pole the wealthy merchants and the large land speculators Rothbard intimates that it's really a scheme of both the rich and the poor against the middle class via the use of government power and fiat money.