The Constitutional Convention was called in 1787 to increase the powers of the Confederation Congress and to place restraints on the states. Article I, section 10 of the eventually proposed and ratified Constitution listed a number of powers denied to the states. Some prohibited powers were not controversial, such as the prohibition to enter into treaties or alliances, to grant titles of nobility, and to pass bills of attainder or ex post facto laws. Other prohibited powers were quite controversial, such as the prohibition to emit bills of credit or to make anything but gold and silver a tender in payment of debts. Some Federalists, such as Benjamin Rush of Pennsylvania, felt that the new Constitution should be adopted “If it held forth no other advantages than a future exemption from paper money & tender laws, it would be eno’ to recommend it to honest men. To look up to a government that encourages Virtue—establishes justice ensures order, secures property—and protects from every Species of Violence, affords a pleasure that can only be exceeded by looking up in all circumstances to a general providence. Such a pleasure I hope is before us & our posterity under the influence of the new Government” (to Jeremy Belknap, 28 February 1788).
Throughout their existence, the thirteen American colonies often suffered from a scarcity of a circulating medium of exchange. To accommodate this shortage, colonial legislatures sometimes made different agricultural commodities a tender in payment of debt and, occasionally legislatures emitted paper money in two different ways. Whenever a revenue was urgently needed (often to finance a war), the legislature would issue paper money as fiat currency. The government would print the currency and use it to pay soldiers and suppliers of goods and services. Sometimes the money was made legal tender and was always made receivable in payment for taxes. Usually when the currency was received by the government in payment for taxes, it was destroyed. Generally, the greater the amount of currency that was circulated, the more it depreciated causing inflation. Runaway inflation occurred during the Revolutionary War, when the Continental Congress and the state governments authorized huge emissions of currency.
Another kind of paper emission occurred to combat economic depressions. Governments created “loan offices” funded with paper money that was loaned to landowners for a number of years—seven to ten years were common. Farms or real estate in towns worth twice the value of the loan was usually required as collateral. The money was sometimes made legal tender in payment of debts (or perhaps legal tender only in cases of lawsuits) and could always be used to pay taxes. Loans, with a modest rate of interest, were to be repaid in annual installments. Currency received by the government (either in loan repayments or in payment of taxes) was usually withdrawn from circulation and destroyed; but, occasionally, incoming paper currency was re-loaned. Although unaware of the principles of Keynesian economics, early Americans knew that this pump priming (called “currency finance” by modern historians) contributed to the restoration of the economy.
If too much currency was issued, it depreciated. Inflation often benefited debtors by making it easier for them to pay their debts and taxes. Private creditors, however, who were the main source of loans because banks did not exist, usually opposed emissions of paper money fearing that the loans they made with gold and silver would be repaid with depreciated paper money. One notable exception occurred in Maryland where wealthy speculators, who had purchased confiscated loyalists estates, hoped to pay their mortgages with a depreciated paper currency. But the Maryland senate rejected an emission, leaving these wealthy speculators in a precarious financial situation.
The wartime runaway inflation led many Americans to lose confidence in the idea of paper money. Consequently, when the postwar depression occurred in 1784–1786, heated political battles occurred in every state over a variety of relief measures, most prominently the issuance of paper money. In fact, the battle over paper money aroused more debate than any other issue during the 1780s. It was, in the eyes of George Washington, “among the important questions of the present day” (to James Madison, 5 November 1786). When relief wasn’t provided and farmers lost their farms to foreclosures, they resorted to violence in Exeter, N.H., Rutland and Windsor, Vt., Sharon, Conn., Charles County, Md., and Camden, S.C. In two Virginia counties, courthouses were burned to destroy tax records. The largest and most sustained violence occurred in western Massachusetts when debtor farmers attempted to close the civil courts to stop foreclosures. With many militiamen sympathetic to the farmers, Boston merchants provided funds to assist the government in raising an army to quash what has come to be known as Shays’s Rebellion.
During the mid-1780s, seven state legislatures voted to issue paper money to be loaned to landowners (many were former soldiers) to help forestall foreclosures on their property. Governments also used the currency to pay the interest and principal on their wartime debts much of which had been bought up by speculators.
The paper money of New York, Pennsylvania, and South Carolina circulated successfully (with only modest depreciation) in large measure because merchants in those states willingly accepted the currency. New York and Pennsylvania even used their state currency to redeem not only state securities but also federal securities owned by their residents, so much so that these two states became net creditors of the federal government. The currencies of New Jersey and Georgia were marginally successful, while North Carolina and Rhode Island currencies greatly depreciated by design of the agrarian-oriented legislative majorities.
Rhode Island, often referred to at the time as Rogue Island, had the most radical economic policy in postwar America. Running on the platform “To Relieve the Distressed,” the state’s Country Party won complete control of all branches of the state government in April 1786. The following month the legislature approved an emission of £100,000 of paper money—a huge amount for such a small state. Declared legal tender, the currency depreciated immediately, eventually falling to 15 to 1. In June 1786, the state passed a penalty act calling for the prosecution of anyone who refused to accept the paper money at par in payment for a debt. If convicted, the creditor would be fined £100. A second conviction carried the same fine as well as disenfranchisement or the right to hold political office. A second penalty act passed in August 1786 provided that paper-money cases were to be tried in special courts without juries and without the right to appeal. Debtors were further aided by a law that allowed them to lodge paper money with a judge (or later expanded to include justices of the peace) in payment for their debt. The judge would place an ad in a newspaper announcing the lodgement always introduced with the ominous words: “Know Ye.” If the creditor failed to claim the lodgement within three months, the debt was forever cancelled and the lodged money was forfeited to the state minus any fees to the judge and the newspaper. In October, a meeting of Providence County farmers petitioned the governor for a special session of the legislature to consider the state ownership of ships, wharves, and stores while all mercantile activities would be controlled by the legislature. Then, in December 1786, newspapers reported that the legislature considered a bill calling for the cancellation of all debts and the equal distribution of all property among freeholders every thirteen years. These radical proposals, widely printed in newspapers throughout the country, along with the violence of Shays’s Rebellion, aroused widespread fear.
Taking advantage of the depreciated currency, Country Party leaders in 1787 devised a popular plan paying Rhode Island’s wartime debt in quarterly installments. By this time, speculators, usually members of the opposing Mercantile Party, had bought state securities well below par. The Constitution’s prohibition of state paper money threatened this convenient way for Rhode Island to eliminate its state debt to the political benefit of the Country Party. In fact, when the North Carolina and Rhode Island ratifying conventions initially refused to ratify the Constitution, they each proposed an amendment prohibiting the federal government from interfering with any state paper money already in circulation. Succumbing to economic threats by the first federal Congress, however, North Carolina ratified the Constitution in November 1789 and Rhode Island became the last state to ratify in May 1790. Although the Constitution prohibited further emissions of paper money, states eventually found ingenious ways to circumvent the restriction, especially through the chartering of state banks that often issued currency of their own.