Paper money has often been controversial and misunderstood. Why it has value, why that value changes over time, how it influences economic activity, who should be allowed to make it, how its use and creation should be controlled, and whether it should exist at all are questions that have perplexed the public, vexed politicians, and puzzled economic experts. Knowing how, when, and why paper money first became commonplace in America and the nature of the institutions issuing it can help us better comprehend paper money’s role in society. Benjamin Franklin dealt often with this topic, and his writings can teach us much about it.

There are two distinct epochs of paper money in America. The first began in 1690 and ended with the adoption of the U.S. Constitution in 1789. In this first epoch the legislatures of the various colonies (later states) directly issued their own paper money — called bills of credit — to pay for their own governments’ expenses and as mortgage loans to their citizens, who pledged their lands as collateral.

This paper money became useful as a circulating medium of exchange* for facilitating private trade within the colony/state issuing it. By legal statute and precedent, people could always use their paper money to pay the taxes and mortgage payments owed to the government that had issued that specific paper money, which, in turn, gave that money a local “currency.” There could be as many different paper monies as there were separate colonies and states.

At the 1787 Constitutional Convention, the Founding Fathers took the power to directly issue paper money away from both state and national legislatures. This set the stage for the second epoch of paper money in America, namely, the ascendance of a government-chartered and -regulated, but privately run, bank-based system of issuing paper money, an epoch we are still in today.

Between the late 18th and early 20th centuries, banks backed their issuances of paper money — bank notes — with reserves of gold and silver coins. Under normal conditions, bank notes were convertible at face value on demand into that money. Today, these gold and silver backing and convertibility conditions have been replaced with other assets and regulations.

Benjamin Franklin’s life spans most of the first epoch of paper money, and he is its most insightful analyst and ardent defender. He did not create the first paper money in America, nor was he yet born when it was first used. However, these early experiments with paper money, beginning in 1690 in New England and in the first two decades of the 18th century in the Carolinas, New York, and New Jersey, were limited emergency wartime exercises, temporary in design. Beginning in the 1720s colonial legislatures began to move toward issuing paper money with a view to making it a permanent fixture within their colonies. Pennsylvania was an important leader and the most successful colony in this movement. It is the birth of this permanent peacetime paper money supply that Franklin will affect.

No other American was involved over as long a period of time with so many different facets of colonial paper money as was Benjamin Franklin — certainly no other American with such a preeminent stature in science, statesmanship, and letters.

Franklin arrived in Philadelphia the year paper money was first issued by Pennsylvania (1723), and he soon became a keen observer of and commentator on colonial money. He wrote pamphlets, treatises, and letters about paper money. He designed and printed paper money for various colonies. He entertained ideas about and proposed alternative monetary systems. As an assemblyman for the colony of Pennsylvania, he was involved in the debates during the 1740s and 1750s over the management of that colony’s paper money. As a lobbyist for various colonies to the British court, he dealt with conflicts over colonial paper money that arose between Britain and her colonies in the 1760s and 1770s.

Finally, at the end of his life as one of the preeminent Founding Fathers at the 1787 Constitutional Convention, he participated in constitutionally ending the first epoch and so helped usher in the second epoch of paper money in America. Franklin is arguably the preeminent authority on paper money in America in this period.

ABOUT THE ESSAY:

This essay is based on a lecture given by Professor Farley Grubb on March 30, 2006, at the Federal Reserve Bank of Philadelphia. The Reserve Bank and The Library Company of Philadelphia co-sponsored this lecture as one of many events held in the city of Philadelphia to mark the 300th birthday of Benjamin Franklin.

ABOUT THE AUTHOR:

Farley Grubb holds a Ph.D. in economics from the University of Chicago. He has received numerous professional honors, including an Outstanding Teaching Award from the College of Business and Economics at the University of Delaware and a Pew Teaching Fellowship.

In addition to his other research interests, Grubb has initiated several studies related to Ben Franklin. Among them are a re-examination of how legal tender laws operated in the colonies and a look at Franklin’s analysis of the colonial paper money system and the origins of his monetary philosophy.

Download Benjamin Franklin And the Birth of a Paper Money Economy

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By Farley Grubb
Professor of Economics, University of Delaware, and National Bureau of Economic Research

Glossary of Terms:

Barter: The direct exchange of goods and services among people. No money is used in the exchange.

Continental dollar: Paper currency issued by the Continental Congress to finance the Revolutionary War. The currency was not redeemable on demand for gold or silver. Congress issued so much of this currency during the war that inflation became rampant and destroyed its value, which led people to use the phrase: “Not worth a Continental.”

Equilibrium: A situation in which the quantities demanded and supplied in a market are equal. Equilibrium exists when forces that cause changes in the market are in balance so that there is no tendency for the market price to change.

• Monetary equilibrium: When the quantity of money supplied is equal to the quantity demanded.

Exchange rate: The value of one currency expressed in terms of another currency.

• Fixed exchange rate: A fixed exchange rate is when the value of a currency is fixed by governmental action at some officially determined level in terms of another currency.

Fiat paper money (or Fiat currency): Paper currency that has value because the government has decreed that it is a “legal tender” for making tax payments and often for discharging other debts and payments as well. Fiat money does not represent a claim on some other form of money or commodity such as gold and silver.

Functions of money:

• Medium of exchange: Acts as a go-between to make it easier to buy and sell goods or services or pay debts. Allows buyers and sellers to avoid the difficulties associated with barter exchanges of goods and services.
• Store of value: Allows people to transfer the purchasing power of their present money income or wealth into the future, ideally without a loss of value. Stores purchasing power between the time money is earned and the time it is spent.
• Unit of account: Serves as a way to measure and compare the value of goods and services in relation to one another. When comparing prices, individuals can determine if one good is a better buy than another. It also allows people to keep accurate financial records.

Inflation tax: The transfer of resources to the government from businesses and consumers that occurs when government spending is financed by printing government-issued money rather than being financed by government taxes or borrowing from the public. When the government obtains goods and services by printing new money and inflation occurs, consumers and businesses holding money pay an inflation tax because inflation erodes the purchasing power of their money holdings.

Labor value of money: A theory that holds that the value of a good is determined by the value of the labor that went into making it.

Legal tender laws: Government laws that decree that creditors are required to accept an asset (such as paper money or coins) in settlement of debts and that the government will accept the asset in payment of taxes. When paper money and coins are a legal tender and people use them to settle a debt, the obligation is considered to be paid in full.

Price level: The average level of the prices of products and services purchased by consumers.

Proprietor (of Pennsylvania): Pennsylvania was chartered as a proprietary colony under a royal grant to William Penn, making him (and his heirs) the proprietor of the province. William Penn’s son, Thomas Penn, was the province’s proprietor in the 1750s but had left Pennsylvania and was living in England.

Spot value (or spot price): The value or price at which current transactions of goods and services take place. The spot market is the market in which goods and services are traded for immediate delivery and payment. Purchased or sold “on the spot” as opposed to some later time.

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