Backed money/Mike Sproul

[mike sproul <msproul@xxxxxxxx>]

> An interesting thing about the colonial paper money was the effect it
> had on business activity. Before paper money, the colonies suffered from
> an acute shortage of money.

WM: Must have been a deflation?  Also, they probably didn't 'trust'
private
sector 'notes' as they must not have been creditworthy?

MS: No; there had been inflation for decades. The colonists initially
used
"bookkeeping barter", where they would pay 1 shillings worth of tobacco
to a shopkeeper for 1 shillings worth of corn. The shilling in question
had originally been the English shilling, but over time, the
 Massachussetts (and New York, etc.) shilling (which had no physical
existence) fell by
20-30% relative to the English. The inflation continued when the
"imaginary" shillings of the bookkeeping barter era were replaced by
the tangible paper shillings. I would explain both inflations the
same way: There was a loss of backing--meaning, in this case, that
the colony had spent more shillings than it could collect in taxes.
Note that a money shortage is not deflationary on the backing theory.
If there was less money, and also less backing, the money would keep the
same value, even though there wasn't enough to conduct the normal
business of the community.



>When the paper was issued, business activity

> flourished because they now had the circulating medium they had lacked.
>

WM: Also, they were 'compelled' to transfer real resources to the
issuing
govt to get what they needed to pay taxes.  Much of this and related
activity is reported as 'business activity.'

> As notes were paid off, either thru taxes or by loan repayments, the
> money shortages reappeared and business suffered. Hence the pressure
> not to destroy the notes as they were paid in to the treasury. If notes
> were just re-spent after they were paid in to the treasury, the economy
> would revive, but when the colony failed to back the re-issue with
> future taxes, or when they issued and spent more notes than they could
> possibly retire, they suffered inflation.

Yes.  And the colony also only suffered inflation when they themselves
agreed to pay higher prices.  If they somehow had constrained the prices
they were willing to pay 'across the board' that would have limited
spending
to what the private sector was willing to sell at those prices and
prevented
'inflation.'  And we know the private sector would have been willing
to sell at least enough to get the units of currency necessary to pay
its taxes.  With a tax liability 'out there' and a 'money shortage' the
colony
'held all the cards' and price was a function of what 'collateral' the
colony demanded
in return for its 'needed to pay taxes' currency.

MS: I'm not sure what you mean when you say that a colony "agreed" to
pay higher prices. They didn't have much choice. Say a banker that has
issued paper bills has lost some of his assets. He used to be willing
and able to pay 1 ounce of gold for each bill. Now he is only willing
and able to pay .5 oz. because of the loss of backing, so the money
falls. A colony that has tried to back its money with taxes, and then
spends more than it can cover in taxes, is in the same position. This
doesn't seem consistent with your view.

Best,
Mike Sproul