1

The Changing Nature of Government Finances and Monetary System After the Revolutionary War

David Mitchell Economics 425: American Financial History

The Revolutionary War, the Articles of Confederation, and eventually the United States Constitution led to sweeping changes in the financial activities of the national and individual state governments. The Revolutionary War exposed the weaknesses in the finances of these governments, especially the national government. The new American citizens were very skeptical of a strong national government, and its perceived abilities to dictate the lives and financial arrangements of its citizens. This idea gave rise to the formation of the Articles of Confederation, which held the rights of the individual states above the needs of the national government. The Articles left the national government with no ability to tax individual citizens, and essentially no power to borrow funds.1 This weakness greatly hamstrung the national governments given powers of common defense and the general welfare of the citizens. The Articles of Confederation exposed even more weaknesses in the financial abilities of the state, local and national. These exposed problems led to a full-scale change in the form of American government with the advent of the United States Constitution. This document greatly changed the way government finances were managed by the newly termed Federal and state governments, and the economy as a whole.
The Congress could actually coin money and borrow money on the U.S. credit but with needed approval of 9 of the 13 states which led to difficulties passing any of the needed legislation.
1

2 The Revolutionary War saddled the government with very heavy debts. After the war, the finances of the national government were in dire straights because of the apathy of state governments to help pay off the debts. The Articles of the Confederation did not help this at all, as each state saw it as their duty to focus on its own internal issues. The loose confederation of states resulted in a lack of cooperation of the states with each other and especially the national government. The lack of tax revenue forced the national government to begin the sale of public land, and even this did not come close to the funds needed by the national government. As a result of the financial difficulties and states trying to gain the upper hand on one another, the American economy began to deteriorate exceptionally fast. These problems, among others, started to change the philosophy of citizens, rich and poor, to see the merits of a strong national government. In 1789, a new document, the Constitution of the United States, became the supreme law of the land. The finances of the state and national governments were changed permanently and so too were relationships between the states, each other, and the federal government. The Constitution gave the Federal government many new and broad powers that the Articles had excluded. Foremost among these was the power of Congress to tax. Congress had the power to enact taxes, duties, imposts, and excises, but also put a limit on direct taxes, as they had to be uniform and apportioned. The powers of Congress to borrow and spend money were also broad and largely unlimited.2 The Constitution strengthened the revenue gathering laws enacted by the Federal government, by limiting the states ability to enact import or export taxes without Congressional consent.3 The power of coining money, when it came to Congress, was not controlled; however, the states were restricted from emitting bills of credit and making
2 3

United States Constitution, Art. I Sec. 8-9 Ibid, Art. I Sec.10

3 anything but gold or silver legal tender.4 With these new and broad powers over the financial affairs of the Federal government, Congress became the dominant fiscal authority of the United States. Flush with new powers, Congress quickly acted to increase the ability of the Federal government of raising revenue by enacting a tariff in 1789. Also in 1789, Congress created the Department of the Treasury, but largely the powers of financial management still lay with Congress. The first Treasurer of the United States, Alexander Hamilton, proposed that the Federal government honor past obligations in full. 5 Congress adopted his proposal in full and thus assumed the debt obligations of each state. With the national debt being pledged to be honored in full, the focus turned to how this debt was going to be funded. The revenues raised by the tariffs enacted in 1789 would, alone, not be sufficient. Congress enacted three internal taxes in 1791, 1794, and 1797, but these revenues were small as well. Congress turned to other sources of revenue, and a large source surrounded the members of Congress, public lands. They began to sell public land to investors, and in 1796 adopted a permanent land ordinance. To ensure the quality of these receipts to finance the government, Congress enacted the Revenue Act of July, 1789 that stated all payments to the government had to be made in gold, silver, or other foreign specie, but United States Bank notes were deemed acceptable as payment also in 1789. With many of these taxes and duties not raising enough funds to cover government expenditures, rising indebtedness of the federal government was a common theme for many years.

Ibid (Studenski and Krooss. Financial History of the United States. p. 48). They note that the opposition to this wanted full repayment, but insisted the current holder of a bond be paid the market price and the original holder be paid the difference between the market price and par.
5

4 In 1794, Congress began the minting of dollars under bimetallist system at a 15 ounces of silver worth 1 ounce of gold.6 However, the market ratio of silver to gold had already changed to a 15.37 to 1 ratio by the end of 1794.7 This meant a person could exchange 15 ounces of silver into 1 ounce of gold at the American mint, and then turn around and sell that 1 ounce of gold for 15.37 ounces of silver on the open market. Gold, as a consequence was hoarded or was exported to Europe where it could fetch a higher price. Since such a high value was placed on gold, it was not ordinarily used as a medium of exchange. The United States was effectively forced onto a de facto silver standard until 1834 as a consequence of Greshams Law8, which states that the undervalued (gold) money will disappear from circulation, and the overvalued (silver) will flood into circulation.9 The United States government could not form an effective circulating medium because of these effects. With the constitution banning states from adopting anything but gold and silver as specie, there was nothing else to provide a medium of exchange except for bank notes. Banks quickly took advantage of the dearth of state paper currency. The main

form of paper currency available in the United States after the adoption of the Constitution were notes issued by banks that were backed by specie. The quantity of these bank notes exploded by 6 times between 1790-1795. While the states could not issue bills of credit, the Constitution did not forbid them from chartering banks, and this became an important source of revenue for the

The government would buy $1.2929 per troy ounce of silver and $19.3939 per troy ounce of fine gold. In 1795 it was 15.55:1, 1796 it was 15.65:1, and the ratio never did return to 15:1. (Roy Jastram, Silver the Restless Metal, p. 63-64) for years until 1820. 8 Milton Friedman. 1994. Money Mischief: Episodes in Monetary History. p. 55 9 Silver money was actually hard to come by as well. American silver dollars were minted slightly lighter than Spanish dollars, and were accepted at the Spanish equivalent. Thus, American silver dollars were often exported too as Greshams Law dictates. (Studenski and Krooss. Financial History of the United States. p. 63)
7

5 states.10 In 1791, Congress charted the First Bank of the United States after the proposal by Alexander Hamilton. Hamilton intended for this bank to create an effective paper monetary system. Hamilton deemed the notes from the First Bank of the United States legal for payment of government dues. Paper currency flooded the United States as it no form of regulations in place to restrict the amount of loans or banknotes issued. Banks at this time would also change their appetite for risk almost seemingly overnight. For example, when first chartered, the First Bank of the United States rapidly increased the available credit, but later that year it cut back on the credit offered. This was a prime factor in the United States first securities market crash in 1792.11 The monetary system was highly unstable for much of early American history. Market sentiment often changed direction quickly and violently, and financial ruin lurked around every corner. However, without the use of paper bank notes as currency, the United States would have been a barter economy. There was an absence of other forms of currency. These bank notes facilitated trade, state revenue and expenditures, and overall economic growth to the fledging American nation. In conclusion, the Constitution addressed many of the perceived weaknesses of the Articles of Confederation. In doing so, the financial functions of the newly created federal government were greatly expanded. The new rights for Congress fundamentally changed the fiscal and monetary future of the United States.

10 11

Farley Grubb. American Economic Review 93, no. 5, p.1791 David J. Cowen, The Journal of Economic History 60, no. 4 (2000): p.1042.

6 References Cowen, David J. 2000. The First Bank of the United States and the Securities Market Crash of 1792. The Journal of Economic History 60 (4): p.1042. Grubb, Farley. 2003. Creating the U.S. Dollar Currency Union, 1748-1811: A Quest for Monetary Stability or a Usurpation of State Sovereignty for Personal Gain? American Economic Review 93 (5) (February 9): p.1791 Jastram, Roy W. 1981. Silver : The Restless Metal. pdf, New York : Wiley, c1981, p.63,64 Friedman, Milton. 1994. Money mischief: episodes in monetary history. San Diego: Harcourt Brace & Co. p. 55 Studenski, Paul, and Herman Edward Krooss. 1963. Financial History of the United States. 2nd Edition. New York: McGraw-Hill. p. 48, 63 Constitution of the United States. 2013. United States Government Manual (November): Art. I Sec. 8-10. p. 8-9