The United States Constitution does not mention paper money by that name. Nor does it refer to paper currency or fiat money in those words.1 There is only one direct reference to the origins of what we, and they, usually call paper money. It is in the limitations on the power of the states in Article 1, Section 10. It reads, "No State shall ... emit Bills of Credit. . . ." Paper that was intended to circulate as money but was not redeemable in gold and silver was technically described as bills of credit at that time. The description was (and is) apt. Such paper is a device for expanding the credit of the issuer. There is also an indirect reference to the practice in the same section of the Constitution. It reads, "No State shall ... make any Thing but gold and silver Coin a Tender in Payment of Debts.. . ."Legal tender laws, in practice, are an essential expedient for making unredeemable paper circulate as money. Except for the one direct and one indirect reference to the origin and means for circulating paper money, the Constitution is silent on the question.
With such scant references, then, it might be supposed that the makers of the Constitution were only incidentally concerned with the dangers of paper money. That was hardly the case. It loomed large in the thinking of at least some of the men who were gathered at Philadelphia in 1787 at the Constitutional Convention. There were two great objects in the making of a new constitution: one was to provide for a more energetic general government; the other was to restrain the state governments. Moreover, the two objects had a common motive at many points, i.e., to provide a stronger general government which could restrain the states.
Measures to Prevent a Flood of Un-backed Paper Money
One of the prime reasons for restraining the state governments was to prevent their flooding the country with un-backed paper money. James Madison, one of the leaders at the convention, declared, in an introduction to his notes on the deliberations there, that one of the defects they were assembled to remedy was that "In the internal administration of the States, a violation of contracts had become familiar, in the form of depreciated paper made a legal tender."2 Edmund Randolph, in the introductory remarks preceding the presentation of the Virginia Plan to the convention, declared that when the Articles of Confederation had been drawn "the havoc of paper-money had not been foreseen." 3
Indeed, as the convention held its sessions, or in the months preceding it, state legislatures were under pressure to issue paper money. Several had already yielded, or taken the initiative, in issuing the un-backed paper. The situation was out of control in Rhode Island, and had been for some time. Rhode Island refused to send delegates to the convention, and the state's reputation was so bad that the delegates there were apparently satisfied to be spared the counsels of her citizens. Well after the convention had got underway, a motion was made to send a letter to New Hampshire, whose delegates were late, urging their attendance. John Rutledge of South Carolina rose to oppose the motion, arguing that he "could see neither the necessity nor propriety of such a measure. They are not un-apprized of the meeting, and can attend if they choose." And, to clinch his argument, he proposed that "Rhode Island might as well be urged to appoint & send deputies." 4No one rose in defense of an undertaking of that character.
The ill repute of Rhode Island derived mainly from that state's unrestrained experiments with paper money. Rhode Island not only issued paper money freely but also used harsh methods to try to make it circulate. The "legislature passed an act declaring that anyone refusing to take the money at face value would be fined E100 for a first offense and would have to pay a similar fine and lose his rights as a citizen for a second." 5 When the act was challenged, a court declared that it was unconstitutional. Whereupon, the legislature called the judges before it, interrogated them, and dismissed several from office. The legislature was determined to have its paper circulate.
The combination of abundant paper money and Draconian measures to enforce its acceptance brought trade virtually to a halt in Rhode Island. A major American constitutional historian described the situation this way:
The condition of the state during these days was deplorable indeed. The merchants shut their shops and joined the crowd in the bar-rooms; men lounged in the streets or wandered aimlessly about. ... A French traveller who passed through Newport about this time gives a dismal picture of the place: idle men standing with folded arms at the corners of the streets; houses falling to ruins; miserable shops offering for sale nothing but a few coarse stuffs ... ; grass growing in the streets; windows stuffed with rags; everything announcing misery, the triumph of paper money, and the influence of bad government. The merchants had closed their stores rather than take payment in paper; farmers from neighboring states did not care to bring their produce. . . . Some ... sought to starve the tradesmen into a proper appreciation of the simple laws of finance by refusing to bring their produce to market.6
But there was more behind the Founders' fears of paper money than contemporary doings in Rhode Island or general pressures for monetary inflation. The country as a whole had only recently suffered the searing aftermath of such an inflation. Much of the War for Independence had been financed with paper money or, more precisely, bills of credit.
A Surge of Continentals
Even before independence had been declared the Continental Congress began to emit bills of credit. These bills carried nothing more than a vague promise that they would at some unspecified time in the future be redeemed, possibly by the states. In effect, they were fiat money, and were never redeemed. As more and more of this Continental currency was issued, 1776--1779, it depreciated in value. This paper was joined by that of the states which were, if anything, freer with their issues than the Congress. In 1777, Congress requested that the states cease to print paper money, but the advice was ignored. They did as Congress did, not what it said.
At first, this surge of paper money brought on what appeared to be a glow of prosperity. As one historian described it, "the country was prosperous. . . . Paper money seemed to be the 'poor man's friend'; to it were ascribed the full employment and the high price of farm products that prevailed during the first years of the war. By 1778, for example, the farmers of New Jersey were generally well off and rapidly getting out of debt, and farms were selling for twice the price they had brought during the period 1765--1775. Trade and commerce were likewise stimulated; despite the curtailment of foreign trade, businessmen had never been so prosperous.7
The pleasant glow did not last long, however. It was tarnished first, of course, by the fact that the price of goods people bought began to rise. (People generally enjoy the experience of prices for their goods rising, but they take a contrary view of paying more for what they buy.) Then, as now, some blamed the rise in prices on merchant profiteering.
As the money in circulation increased and expectations of its being redeemed faded, a given amount of money bought less and less. This set the stage for speculative buying, holding on to the goods for a while, and making a large paper profit on them. There were sporadic efforts to control prices as well as widespread efforts to enforce acceptance of the paper money in payment for debts. These efforts, so far as they succeeded, succeeded in causing shortages of goods, creditors to run from debtors trying to pay them in the depreciated currency, and in the onset of suffering.
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