Benjamin Franklin and the Advantages of a Paper Based Money System
Although monetary systems are thousands of years old, our current monetary system finds much of it roots in the system adopted by the American colonies during the time of Benjamin Franklin. There a system called Colonial Scrip had enormous success in generating wealth for the colony.
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Franklin did not invent Colonial Scrip money but he was also a printer and saw the merits that such a paper-based currency could have. He became one of it’s greatest advocate and Franklin’s strong support of paper money as a tool for prosperity in the colonies was a primary reason for fighting America’s War for Independence from the British.
No doubt, many of the colonies were doing very well, especially Pennsylvania and Massachusetts where the amount of new paper money was controlled. But not all the colonies had the same success. For example, earlier attempts in South Carolina resulted in a currency deprecation. A systematic framework was required…one that applied to all the colonies. This is what gave impetus to Franklin to write his groundbreaking pamphlet – “A Modest Enquiry into the Nature and Necessity of a Paper Currency.”
Franklin’s Enquiry is a very lucid treatment clarifying the main advantages of a paper currency for use in the colonies. Franklin began the Enquiry by noting that a lack of money for trade within the province bears a heavy cost. Without paper money, the alternative is not gold and silver coins, shipped off to England from trading, but instead barter. Barter is far less effective than paper money and subsequently increases the cost of local exchange, lowering employment, wages, and immigration.
Scarcity of gold and silver coins due to exchange with England causes high local interest rates, which has a knock on effect of reducing investment and development. Franklin championed paper money as the logical solution to these monetary supply shortage problems.
Franklin’s definition of value of paper currency
What gives paper money value? Here Franklin’s answer elucidates this point for the modern reader. It is neither legal tender laws or fixed exchange rates between paper money and gold and silver coins but the quantity of paper money compared to the colony’s volume of internal trade that sets its value. Excess paper money relative to the volume of internal trade causes it to lose value
Franklin argues 3 points to support his thesis:
1. Gold and silver have no permanent value. Therefore paper money backed by gold and silver (as with bank paper money in Europe) are also of no permanent value.
In the previous 100 years the labor value of gold and silver had fallen as new discoveries expanded supplies faster than demand. The spot value of gold and silver fluctuated just like any other commodity. Unexpected trade disruptions could cause unpredictable changes. In 1729, Franklin observed that the colonies had already parted with silver and gold in trade with England, and the difference between the value of paper money and that of silver is due to “the scarcity of the latter.”
2. Land is a more certain asset to back paper money. For a given colony:
- a. The supply of land will not fluctuate with trade as much as gold and silver do
- b. Its supply will not be subject to long-run expansion as New World gold and silver had been
- c. Land cannot be exported from the province as gold and silver can.
Based on these points, Franklin asserts that Pennsylvania’s paper money will be backed by land. It is issued by the legislature through a loan office, and subjects will pledge their lands as collateral for loans of paper money.
3. Franklin argues that a properly run “coined land” or land bank will automatically stabilize the quantity of paper money issued.
- If there is too little paper money, the barter cost of trade will be high, and people will borrow more money on their landed security to reap the gains of the lowered costs that result when money is used to make transactions. A properly run land bank will never loan more paper money than the landed security available to back it, and so the value of paper money, through this limit on its quantity, will never fall below that of land.
- If too much paper money were issued relative to what was necessary to carry on internal trade and the paper money began to lose its value, people would snap up this depreciated paper money to pay off their mortgaged lands to clear away the mortgage lender’s legal claims to the land. So people could potentially sell the land to capture its real value. This process of paying paper money back into the government would reduce the quantity of paper money in circulation and so return paper money’s value to its former level.
Franklin asserted that there is a natural feedback loop acting from decentralized market competition that would tend to restore the amount of paper money within the province to a natural equilibrium.’
Prelude to the War of Independence
Before the war, the colonies sent Benjamin Franklin to England to represent their interests.
When Franklin arrived, he was greatly surprised by the amount of poverty and high unemployment he witnessed. He wrote “The streets are covered with beggars and tramps.” It made no sense to Franklin why England, then the richest country in the world had an impoverished working class. Some claim that Franklin asked his friends in England how this could be so to which they replied that England had too many workers. Many at the time believed, along with Mathus, that wars and plague were necessary to rid the country from man-power surpluses.
“We have no poor houses in the Colonies; and if we had some, there would be nobody to put in them, since there is, in the Colonies, not a single unemployed person, neither beggars nor tramps.” – Benjamin Franklin
When asked by British colleagues why the colonies were so prosperous, Franklin replied: “That is simple. In the Colonies, we issue our own paper money. It is called ‘Colonial Scrip.’ We issue it in proper proportion to make the goods and pass easily from the producers to the consumers. In this manner, creating ourselves our own paper money, we control its purchasing power and we have no interest to pay to no one.”
Soon after making these statements, the English bankers demanded that the King and Parliament pass a law that prohibited the colonies from using their scrip money and only gold and silver provided by the English bankers. The first law was passed in 1751, and then a second harsher law was passed in 1763. These laws began the plague of debt based money in the colonies that had impoverished the English working class. Franklin claimed that within one year, the colonies were filled with unemployment and beggars, just like in England, because there was not enough money to pay for the goods and work. The money supply had been cut in half.
This blatant injustice was enough to cause Franklin to become one of the main architects of the Indenpendence movement.
Uniting to fight for freedom
When the colonies united to fight for their freedom, congress issued Continental dollars (redeemable in silver and gold) to pay for the war. Unfortunately, the U.S. had no gold or silver and promised to pay later. The value of the currency deprecated since many knew that it was unlikely that they would ever be able to redeem the obligation. The English printed large amounts of counterfeit Continentals on boats equipped with printing presses anchored offshore of the conlonies. They covertly brought them in to the colonies to devalue the currency.
In 1783, Franklin wrote a letter to Joseph Quincy in which he claims that he predicted this outcome and in 1781 had proposed a better paper money plan in a tract called “Of the Paper Money of America” but that Congress had rejected it. Franklin contended that the depreciation of the Continental dollar was effectively an inflation tax or a tax on money itself and that this tax fell more equally across the citizenry than most other taxes.
Foreboding of the Current Financial Crisis
It seems what was said about banks in Franklin’s time holds true today:
“The Colonies would gladly have borne the little tax on tea and other matters had it not been the poverty caused by the bad influence of the English bankers on the Parliament, which has caused in the Colonies hatred of England and the Revolutionary War.” – Benjamin Franklin
“I believe that banking institutions are more dangerous to our liberties than standing armies. Already they have raised up a monied aristocracy that has set the government at defiance. The issuing power (of money) should be taken away from the banks and restored to the people to whom it properly belongs.” - Thomas Jefferson
All the perplexities confusion and distress in America arise not from defects of the Constitution, not from want of honor or virtue, so much as from downright ignorance of the nature of coin, credit and circulation. -John Adams
“History records that the money changers have used every form of abuse, intrigue, deceit, and violent means possible to maintain their control over governments by controlling the money and its issuance.” – James Madison
“It was the monetary system under which America’s Colonies flourished to such an extent that Edmund Burke was able to write about them: ‘Nothing in the history of the world resembles their progress. It was a sound and beneficial system, and its effects led to the happiness of the people. In a bad hour, the British Parliament took away from America its representative money, forbade any further issue of bills of credit, these bills ceasing to be legal tender, and ordered that all taxes should be paid in coins. Consider now the consequences: this restriction of the medium of exchange paralyzed all the industrial energies of the people. Ruin took place in these once flourishing Colonies; most rigorous distress visited every family and every business, discontent became desperation, and reached a point, to use the words of Dr. Johnson, when human nature rises up and assets its rights.” – Historian John Twells
“Banks have done more injury to the religion, morality, tranquility, prosperity, and even wealth of the nation than they can have done or ever will do good.” – John Adams