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Government Paper Money and the Resumption of Specie Payments


§ 547. The experience of the United States of America dur ing the Civil War is full of instruction and warning for the nations of Europe ; it shows that the sudden demands of a great war may not only plunge a state whose credit and finances have pre viously been in the most prosperous condition, deeply in debt, but may bring on the further related calamity, of far-reaching significance for the whole of the nation's industrial life—a regime of paper money. This experience serves to show, espe cially, that apart from any of those abuses of the permanent fiscal machinery (e. g., debts, taxes) that are apt to accompany a war epoch, there is a distinct financial danger involved in the employment of bank notes, paper money, etc. This financial danger threatens any financial system, however stable and orderly, if only the political exigencies are present that are cal culated to give rise to it.

A discussion of paper money, therefore, has more than an historical interest, as dealing with one stage or one form of the development of public credit ; —a stage which has been passed through and left behind, at least by the national economics of more mature growth. Such a discussion may be of practical value in shedding light upon conditions which exist in many states today, and which may recur in other states as well, even in spite of all known precautionary measures.

§ 548. Reference may here be made to the observations con tained in the introductory portion of this work (Vol. I. Sec. 412), where, in speaking of money in general, some attention is given to the subject of substitutes for money and the degenera tion to which such substitutes are liable. Even in the days of ancient Greece both debasement of the coin and the use of sub stitutes for coin were resorted to as fiscal expedients. Even Solon remarked that many of the Hellenic states made use of silver money with an alloy of lead or copper, which was received only at a heavy discount, if at all, in foreign trade. When the Clazomenians were twenty talents in arrears in the pay due their mercenaries and were unable to raise the money, they, in order to save interest on the debt, minted iron coins to the amount of twenty talents, ascribed to them the value of silver coins, and distributed them among the wealthiest men in return for silver, with which they discharged the debt. Within the country the iron coins served the same purpose as silver, and the latter could therefore be turned to use in foreign trade. To this extent, says August 13 ockh,' iron served the purpose for the Clazomenians which paper money serves in our day.

Even at that early day this expedient profited by the con fused notions prevalent with regard to the nature of money. The two opposite views on this subject, and the wrongheadedness of both, were recognized as early as Aristotle's time.' Now we are told, says he, that wealth consists in money. Then, again, that money is nothing but a name ; that of itself it is of no value, and what value it possesses is due to the law alone, without which it would be of no use. Plato is of the latter view, and the money which he wishes to employ in his republic is of a nature to correspond to this principle. The Utopias of later socialistic writers are affected with a bias of the same kind_ J. G. Fichte is of the opinion that a closed commercial state can make anything whatever its money by declaring that it will accept nothing in payment but this money.' Of French writers, Boisguillebert is to be cited before all others as an advocate of the view that "if men would agree among themselves they could easily abolish money altogether.' H. D. Macleod has re-affirmed the same view within the last The apostles of Rousseau who tried to put his ideas in practice in the French Revolution (St. Just) wanted to adopt a coin that could never circulate in foreign countries. Indeed, an eminent German historian has in very recent times expressed the opinion that "the best exponent of value, in itself considered, is a token money with the least possible intrinsic value, which, in its most perfect development, would measure the value of other articles almost as exactly as a clock measures time or a yard-stick meas ures space." § 549. In measuring space with a yard-stick we use a (pre viously determined) extent of space as a measure for another extent of space (to be determined). In measuring economic value we can no more employ as a standard anything that is as nearly devoid of intrinsic value as may be, than we can measure space by means of something that is as nearly devoid of exten sion as may be. As length can be measured only by length, so value can be measured only by value.

The seductive promise contained in this erroneous theory is especially dangerous because it sets up as an ideal what is in point of fact only a derangement of any orderly monetary sys tem, and due entirely to extraordinary financial exigencies.

A well-ordered monetary system admits the use of such sub stitutes for money only as confine themselves to serving in place of specie for purposes of payment and circulation, without departing specie basis. They are substitutes for money for certain purposes, without arrogating to themselves those functions of money which they are not capable of performing. They are substitutes for money as a circulating medium, not as a standard of value. They may serve as a symbol of value, but they cannot serve as a standard of value without assuming a function that is beyond their competency. It follows from their character as substitutes for money that they possess value only in virtue of the belief that they will be redeemed in specie, and only to the amount of the specie obtainable for them. They cease to be evidences of debt when it is attempted to erect them into money independent of a specie basis.

A distinction is accordingly to be made between paper money in the broad sense and pape'r money in the strict sense.

The former category comprises—to follow the usage of everyday life—those substitutes for money that are employed in a well-ordered monetary system. Paper money in the stricter sense comprises only such substitutes for money as attempt to supplant specie currency by force of legal enactment, by suspen sion of specie payments and the assigning of a legal-tender quality to the paper, the paper in this way taking the place of coin as money.

It is this final step that is unsound. The idea is untenable that anything not possessed of intrinsic value can be made into money ; paper can maintain its position in the monetary system only so long as the fact is not lost sight of that it is in origin and essential nature an evidence of debt ; its function as circula ting medium rests on its credit, and this credit is impaired by a suspension of specie payments. True paper money is therefore a degenerate credit money.

§ 55o. That the value of paper money is an open question is shown by the unavoidable fluctuations in its value. These fluctua tions may be masked for the time by certain legislative provi sions, but in point of fact they can no more be avoided in the case of paper money than in that of debasement of the coin or substitution of the minor coins for standard coin. By suspen sion of the convertibility into coin the identity of value between paper and coin is brought to an end. In place of an identity we have a divergence in value between paper and specie, the extent of which is not to be determined beforehand. For, inasmuch as the paper has no intrinsic value, but acquires a value solely on the strength of a hope of its future redemption in specie, the ques tion as to how far the value of the paper will depart from that of specie depends on the degree of confidence which exists as to its convertibility.

If the state's credit is exceptionally good and the period of suspension is a relatively short one, then it may happen, in a favorable case, that the divergence in value between paper and specie is inappreciable ; such was the case in France during and immediately after the last war. But this happens only by rare exception. The most recent experiences with paper currency in Austria, Russia, and the United States have been much less favor able. Forced circulation and inconvertibility of the paper money, together with an enormous issue of the paper, the depre ciation of which only affords occasion for a still greater issue,— all this has resulted in an extreme depreciation, with the second ary consequence of a great fluctuation of values.

The first requirement of any standard of measurement is that it must remain constant, so as to afford a reliable unit for the measure of other things. This requirement is binding on money as a measure of value. The thought given to the question of what is the best specie standard and the debate about the dif ferent possible standards (silver, gold, or double standard) turns, in the last analysis, on the question which of them answers most satisfactorily to this requirement of a fixity of value. It must be conceded at the outset that in the nature of things a paper currency does not meet this requirement. Paper can of course have no stability ; it flutters in the wind of public opinion and expectation regarding its value relatively to specie. Paper also differs from a specie currency in this, that it is deprived of the support and regulation which the latter enjoys in the influx and withdrawal of the specie circulating in foreign countries ; gold and silver have an international value, but that is not the case with a paper currency, which has no intrinsic value, and circulates only in virtue of the enactment and compulsion of the state in question.

§ 551. The historical data bearing on the employment of paper money and its mischievous effects may be found in sufficient abundance in the history of modern countries. It is of course a one-sided economic position to assert that we should "rather let the state perish than resort to -forced circulation."' This view overlooks the fact that economic institutions are only means, and not the end of the national life. But apart from exaggerations of this sort, the testimony of history is well agreed that a paper-money regime is an abnormal condition of the politi cal and industrial life of any nation, and that it is to be justified only as an expedient in the state's direst necessity, and is to be avoided by all means if it possibly can be avoided.

The most known example of a paper-money regime was that of the French Revolution.

As the regular sources of revenue failed and repeated exac tions yielded a progressively slighter result, the successive govern ments of the Revolution found themselves all the more irresist ibly pushed to a paper currency with forced circulation (assig nats) as their last resort. Down to January I, 1793, 360o mil lion francs had been put in circulation. The year 1793 doubled this amount, and the first half of 1794 added a further incre ment of 1oo millions. The assignats, which at the beginning of 1793 had stood at 61, declined from week to week in spite of all the penal enactments of the Terror until they reached 17 per cent., although every payment and every increase of price aggregating more than 500,000 francs was watched by spies and visited with the penalties of imprisonment and death. The Com mittee of Safety itself was obliged to violate its own law, in that it both paid prices for goods corresponding to the rapid depre ciation of the assignats, and also obtained specie on the very most onerous conditions for use in its purchases abroad.' By the end of May, 1795, the amount of paper money issued had risen to nearly ten milliards, and its value had declined to 7 per cent. The depreciation constantly led to further issues. By the end of August, I795, there were 16 milliards in circulation, at a market value of per cent. Consequently anyone who had obtained a loan of 10,000 francs in 1790 would discharge it in the summer of 1795 by paying it in assignats of the same nominal value, but which could be bought for 250 francs in specie. A tenant who paid his rent in assignats would be able to discharge the annual rent of an entire estate with a single sack of corn.

The experience of Austria with its " bank bills" [Banco zetteln] at the beginning of the nineteenth century was not much more gratifying. At every succeeding conclusion of peace there was an increasing amount in circulation : Campo-Formio, 150 mil lion gulden ; Luneville, 340 millions ; Pressburg, 450 millions; Vienna, 86o millions. The value of the bank bills in December 1810, fell below 1200 paper gulden to 100 gulden in silver, and thenceforward fluctuated rapidly and violently by hundreds of points above and below that level.' The continued growth of public credit, and the greater polit ical stability and wealth which have been achieved in the course of the nineteenth century, have acted to diminish these extreme manifestations of the paper-money system. The fluctuations in the value of paper money as compared with specie in Austria, Russia and the United States during the last generation, have moved within a narrower range. During the years 1854-1855 the depreciation of the Austrian paper money amounted to 20-30 per cent., the very highest being 42 per cent.; 3 and at the same time the Russian paper money, originating from the same cause (the Crimean War), showed a considerably less depreciation, about 16 per cent., a phenomenon which has since recurred' with the recurrence of a war situation (1859, 1866, 1870, 1877); in Austria it has recurred twice, in 1859 and 1866.

But even when the depreciation and the fluctuations in the value of paper money are confined, as they latterly have been, within these relatively narrow limits, the results are still so dubious as to call for a closer consideration of the effects of a paper-money regime and the remedies for it.

The fundamental fact in the fluctuation of the value of paper money (depreciation of paper, premium on specie, or discount) is the loss of confidence in the nominal value of the paper which on its face is the equivalent of a specified amount of the specie previously in circulation. This loss of confidence occurs because specie payments are suspended under circum stances which afford ground for reasonable doubt as to the ability of the government issuing the paper money to redeem it in the future. The result is a divergence between the real value and the nominal value, based on the degree of probability of a future redemption, and also affected by the amount of paper money issued.

The legal fiction by which the government is apt to try to conceal this divergence, viz., the recognition of both specie and paper as equally competent means of payment, cannot prevent payments from being, in point of fact, made in the cheaper money. Paper money is offered to everyone who has a payment to receive, while specie is hoarded, is hidden away, or goes abroad, for it is only the international currency, specie, and not the national currency, paper money, that, has any purchasing power in transactions between one country and another. The result is similar (only more strongly marked) to what occurs in the case of a double standard (vol. i. sec. 413) when a prefer ence is shown between two legally equivalent metals, or when the circulation is flooded with light-weight coin (debased, by intention or by inattention) or with the minor coins ; the coin of full value is in such cases crowded out because the law authorizes payment in the cheaper coins.

The difference in degree of severity of these pathological phenomena in the case of an unhomogeneous metallic currency as contrasted with a mixed currency of paper and specie is due to the fact that the cheaper coins have stable intrinsic value, though less than that of the dearer, while the paper has no intrinsic value whatever. The result is that the divergence of the paper from the value of specie is potentially unlimited, its degree depending entirely on the degree of confidence with which it is regarded and the amount in circulation. Debased coin, or the cheaper metal in a double standard, possesses a norm in its own intrinsic value which fixes its purchasing power. Paper money has no such intrinsic stability, and consequently fluctuates in value back and forth.

The evil of which paper money is capable is therefore, as it were, a multiple of that wrought by a coin that is below standard. The latter inflicts damage but once and for a short time on those who have payments to receive, viz., during the interval while the facts about the base coin are penetrating into the popular knowledge and appreciation. With paper money this interval is an indefinite period, lasting as long as specie payments are sus pended. Every shock to the public credit lowers the value of the paper ; every fresh depreciation of the paper is an occasion to the government -for fresh issues ; and every fresh issue acts in the direction of a further decline.

§ 553 An absolutely unvarying standard of value is an unattainable ideal, with the best possible provision for a metallic currency, because all valuable objects, including the precious metals, vary in intrinsic value, as the effect of general causes. But this difficulty is accentuated in an extreme degree in the case of a paper currency, because such a currency has no independent value whatever.

The shortcoming of even the most perfect standard of value lies in this, that it is compelled to assume as a fixed norm what is in the nature of things a variable ; and the result of this imperfection, for the business of the community, is that all pecuniary relations, between private parties among themselves and between private parties and the state, have to proceed on the assumption of invariability in a basis which is essentially variable. All future payments due in virtue of a contract entered into today, for loans, rent, wages, salaries, etc., will con sequently not represent just the same value when it falls due. This uncertainty is increased indefinitely under a regime of paper money. A sudden outbreak of war, even when the state in question is not a participant except as an interested third party, may cause a depreciation of the state's paper money to the extent of 2o-30 per cent. (Russia in 1870); and recent loans megotiated for a short term will be found by the creditors on maturity to have shrunk by 2o-3o per cent. in spite of their nominally unaltered amount.

The consequence is that the entire system of pecuniary rela tions and transactions is permeated with an element of risk. All monetary affairs are suspended in a shimmering atmosphere of advance and decline, so that everyone concerned in business becomes perforce a participant in a game of chance, in which he gains and loses with varying fortune. Even the expedient of making all contracts payable in specie is no protection against the evil. In the great proportion of cases one's interests are better protected against the fluctuations of paper money by mak ing contracts in terms of paper. The reason for this is to be sought in the circumstances which go to neutralize the abrupt ness of the fluctuations of viz., the tardiness with which variations in discount are prppagated from the great centers of business, of the foreign exchanges, the export and import trade, through the lesser ramifications of the business community into the affairs of everyday life. The case affords an illustration of the general principle that prices are not fixed with the precision observable in physical phenomena, their determination being effected through the instrumentality of less calculable human factors—customs, opinions, transactions. For a short term, therefore, the employment of the paper currency would in most cases afford a relatively greater security against fluctuations than the use of specie, as the point of importance to those who receive the payments would, after all, commonly lie in the rela tion of the payment to prices as expressed in terms of paper.

§ 554. An incidental effect of a paper currency is that it brings certain temporary benefits and gains to certain classes of the people, but only at the expense of the rest of the community. The chief case to be cited of this kind is the quasi-protective effect resulting from the fact that the discount on the paper money does not correspond precisely to the rise of domestic prices due to the use of the paper currency. As already pointed out, the discount which manifests itself so obviously in all busi ness on a large scale translates itself but slowly into the prices of domestic products ; all the more slowly the more remote the locality is from the great business centers, and the less highly developed the means of communication are. In such situations the prices fixed under a specie currency may maintain themselves for years under a paper-money regime.' The result is that those branches of business which are occupied with buying products in the remote country districts at the old price and selling them at the centers of trade at the new price, augmented by the discount on paper, enjoy an exceptional advantage. This advantage is obviously greatest in cases where the depreciation of paper is great and rapid, especially if it takes place by a sudden drop, to which the prices prevalent in remote districts are able to adjust themselves but slowly if at all.

The resistance offered to a resumption of specie payments by the interests that have got used to the quasi-protective advan tages secured them by the paper-money regime is to be explained on like grounds. The retention of the, paper currency is demanded as a measure of protection (United States, Austria, etc.), and viewed in this light the demand is quite intelligible. The decline of the premium on specie brings a decline of the prices (in paper) of articles of export, and so makes them com pare unfavorably with the prices of the same articles in the pri mary markets, which have been.gradually advancing under the pressure of the premium. With a return to specie payments, therefore, the supply of products for export can be obtained only at a relative advance.

What has been said of the export trade will be found to hold in much the same manner of the import of goods from abroad. As the premium advances import prices (in paper) advance, and the corresponding advance in retail prices can be effected only gradually. After this adjustment has once been effected, a resumption of specie payments will lower the import price and so give foreign an advantage over domestic goods in the home market. This advantage will be more pronounced the more fully domestic prices have been adjusted to the premium during the regime of paper money.

The premium accordingly acts as an export bounty on the home products and as a protective tax against foreign competi tion. This protective feature of a paper currency has something in common with the measures of industrial policy employed (at times quite legitimately) with the same end in view. But there is in sundry respects a difference unfavorable to the paper cur rency. In the first place, a protective duty or an export bounty is placed where a deliberate canvass of the situation shows that it will be of advantage. A blindly accidental secondary effect, following undesignedly from financial distress, is not to be compared with such an intelligently constructed measure of protection, even if it does produce a result of the same general nature.

But in the second place, this circuitous way of reaching the desired end is altogether too unwieldy and costly ; for it is always to be recognized that a paper-money system is very detri mental to the general economic interests of the community. If special advantages are to be afforded particular branches of industry by state interference, the direct method is cheaper and more effective.

§ 555. The governments of the great states of today when ever they have become involved in a paper-money system, have, without exception, made efforts to clear themselves of it.

An instance of the greatest magnitude is that of the United States after the Civil War. The efforts of the kingdom of Italy have also been successful. Austria has (1889) for a long time been near accomplishing the same end, and has only been pre vented from successfully solving the problem by its being com plicated with the presence of a silver standard. Russia is the farthest in arrears, and the ill success of her monetary policy for a generation past is but a feature of the incongruity that exists between her financial development and her growth in political power ; her position closely resembles that of the other Euro pean states in the seventeenth and eighteenth centuries.

The United States at the close of the Civil War had a debt of 2846 million dollars (August 31, 1865), 684 millions being paper money,' with funds in the treasury amounting to 88 millions. As early as December 3, 1866, Secretary McCulloch declared that specie payments could be resumed by July I, 1868. He was filled with the conviction that a nation which adopts paper money as a standard of value "violates the financial laws of the universe" and will inevitably suffer for the offense. This expectation was not fulfilled. But by a vigorous redemption of the great war debt (some $loo,000,000 annually) a rapid approach to its accom plishment was made. The gold value of the paper money on an average for the year was, in 1865, 63 per cent. ; in 1868, 71.6 per cent.; in 1869, 75.2 per cent.; in 187o, 87 per cent.; in 1871, 89.5 per cent' During the succeeding years the value of the paper closely approached that of gold, and specie pay ment was resumed January I, 1879. During the years 1865 1887 the entire debt was reduced from 2846 millions to 1175 million dollars (July 1, 1887). Against the 63o millions of notes outstanding in 1887 there was specie in the treasury amounting to 482 million dollars.

In Italy' forced circulation was introduced May 1, 1866. The paper money in circulation (notes of the National Bank, etc.) reached 940 million lire by the end of 1875. The premium on specie reached its maximum of 20% per cent. the first year of the depreciation (during the war), and ranged during the years 1867-1879 between to and 15 per cent. Toward the close of 1880 the Italian government came forward with a proposition for the discontinuance of forced circulation, and the premium fell directly to a minimum of 2—I per cent. (January and Febru ary, 1881).

The moderate premium which prevailed seems to have exerted but a slight influence on the course of prices and wages in the country ; that is to say, the depreciation of the paper money was inconsiderable. The premium seems to have been little else than an expression of the depreciation of the paper relatively to gold, and to have had an influence mainly on foreign trade.

On September 3o, 188o, the aggregate of legal-tender notes issued on account of the government and the banks amounted to 1665 million lire, while the gold and silver currency was 444 million lire.

The government's project, which was accepted by Parliament early in 1881, contemplated the negotiation of a loan of 644 -million lire as a means to resumption ; 400 millions of this loan, at least, to be made up of gold coin. By this means 600 million lire of paper was to be retired, while the remaining 340 million lire was to be retained in circulation (being first converted into national paper money, instead of its existing form of legal-tender bank notes) convertible on demand into gold or silver.

§ 556. The examples of America and Italy cited above show what is the accepted method of resumption in modern states.

The path which has been followed in the descent during a season of financial embarrassment is retraced in the reascent. The premium which has arisen under the influence of a forced circu lation, an impaired national credit and an inflated paper cur rency, is gradually reduced as the influence of improved credit, the expectation of a speedy resumption and the reduction of the volume of paper money makes itself felt, until the normal level is reached, when paper and specie coincide.

This temperate procedure, in which the cure reverses the steps by which the disease was contracted and developed, best answers the requirements of equity for the course of prices throughout the great body of business activity. The premium does not penetrate current prices with mechanical precision, but rather breaks against the circumference of the business world and makes its way through the system slowly, partially and fragmentarily. It is therefore also not expedient to seize upon the quotation of the premium at any given point of time as the one by which to effect resumption, and then by a single drastic measure restore specie payments at this level.

This latter method (devaluation) can properly be resorted to only where there is a very serious depreciation of long standing, so that the entire system of pecuniary relations has become adjusted to the depreciated standard. If this rule is applied, it appears that the legitimate use of devaluation is essentially a thing of the past. A notable example is the reduction of bank bills in Austria in 1811 to one-fifth of their nominal value, and of the paper currency in 182o to two-fifths. Likewise the reduc tion of the paper money of Russia in 1839 to two-sevenths of its nominal value, and the probable further reduction of the Russian paper money in the future ; this has of late reached a depreciation of nearly one-half, and has suffered a premium of 35-40 per cent. since 1877.

A measure still more extreme than devaluation is that of simple national insolvency, where all attempt at rehabilitating the paper currency is abandoned (as, e. g., in the case of the assignats issued during the French Revolution). But this is a phenomenon of such an ultra-barbarous nature as places it without the pale of civilized public policy, though it is but the practical outcome of a seemingly inoffensive theory.

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