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We
are ten years into the age of bitcoin. But people are still using national currencies
like yen, dollars, and pounds to buy things. What does history have to say
about switches from one type of monetary system to another? In this post I’ll
dig for lessons from California’s successful resistance to a fiat standard
that was imposed on it in the 1860s by the rest of the U.S.
Not
long after the war American Civil War broke out in 1861, a run on New York
banks forced most of the country’s banks to stop redeeming their banknotes
with gold. A few months later Abraham Lincoln’s Union government began to
issue inconvertible paper money in order to finance the war. These notes were
popularly known as Greenbacks.
 
$1 legal tender note, or greenback
Thus
the 19 states in the Union shifted from a commodity monetary standard onto a
fiat monetary standard. But Californians, who had been using gold as a
payments medium for the previous decade-and-a-half, chose not to cooperate
and continued to keep accounts in terms of gold. As a result, California
stayed on a gold standard while the rest of the Union grappled with fiat
money.
This
had very different repercussions for prices in each region. As the Union
issued ever more greenbacks to finance the war, the perceived quality of
these IOUs deteriorated. Through much of 1863 and 1864, their price fell
relative to gold. Because prices in the Union were set in terms of
greenbacks, consumer and wholesale prices rose rapidly.
U.S. Index of Wholesale Prices (NBER)
In
California, on the other hand, prices continued to be set in gold. Thus Californians
did not experience significant inflation during the Civil War.
The waging of California’s monetary
civil war
Why
did the east so easily switch onto a fiat dollar standard whereas California continued
to define the dollar in terms of gold? By the 1860s, most Americans who lived
east of the Rockies dealt primarily in banknotes. These notes, which were
issued by private banks and convertible into gold on demand, circulated
widely. Gold coins, which were heavy and prone to wear, were largely confined
to bank vaults.
Economists
Greenfield & Rockoff (2006) write that if “most people use a particular
money, then everyone else has good reason to use it.” But if most people
refuse to use a money, then any given individual has no reason to adopt it.
In the chart below, the more firms that choose to post prices in greenbacks,
the greater the benefits to any individual firm of posting prices in
greenbacks. And vice versa with gold. According to Greenfield & Rockoff,
a nation will naturally “tip toward” either general refusal or general
acceptance of a given monetary instrument .
From Greenfield and Rockoff,
“Yellowbacks out West and Greenbacks Back East: Social-Choice Dimensions of
Monetary Reform”
When
private banknotes became inconvertible in 1861 and the prices of gold and
banknotes began to diverge, shopkeepers all across the U.S. had to decide
which of these two instruments would serve as their accounting unit. For
instance, if a horse merchant chose to sell horses at $4, did that mean that
a customer owed $4 worth of greenbacks, or $4 worth of gold coins? The decision
was an important one, since by 1864 one greenback would be worth just 40
cents in gold. Given that banknotes were already the dominant form of doing
business in the east, shopkeepers in most Union states converged on
banknote-based pricing.
But
Californians had never been fond of banknotes. The 1849 First State
Constitutional Convention had prohibited the chartering of banks and issuing
of bank notes:
but
no such association shall make, issue, or put in circulation
any bill, check, ticket, certificate, promissory note, or other
paper, or the paper of any bank, to circulate as money
[California, 1853 #64, Article IV, Section 34]
Suspicion
of banknotes ran so strong in California that when businessman Samuel Brannan
tried to establish a note-issuing bank in 1857, the following was printed in
the Evening Bulletin:
Mr.
Brannan, attempts to violate the Constitution of the State, and to fasten
upon the community that most pernicious of all evils, a shin-plaster
currency….The evils of shin-plaster currency are so great, and the wishes of
nine-tenths of our people are so bitterly opposed to its introduction, that
we call upon every individual who has any regard for the interest of our
State financially or otherwise, to repudiate Mr. Brannan and his shin
plasters. (Cross, 1944)
According
to Cross (1944), people referred to banknotes as shin-plasters because they
were about the size of the plasters put on the injured shins of farmers and
other outdoor workers.
Needless
to say, Brannan’s notes never took hold. In place of banknotes, Californians
had always preferred to pay each other with physical gold. With the discovery
of the yellow metal in 1848 in California, the state had plenty of the stuff.
Gold dust, despite its inconvenience (see below) was a popular early medium
of exchange. Later on, private and government-issued gold coins also became
important. Non-chartered private banks existed, but they issued only
deposits, not notes.
And thus California, unlike the rest of the Union, refused to adopt the
greenback as a medium of account. Since banknotes were rare and merchants
expected other merchants to continue dealing in gold coins, the “$” continued
to be represented by the yellow metal.
It
wasn’t impossible to pay with greenbacks in California, however. But if a
customer needed to pay with paper money, the market value of the notes would
be used and not their face value. So if a horse’s sticker price was $4, and
greenbacks were trading for just $0.50 to the gold dollar, then it would cost
$8 to buy the horse with greenbacks. Also, since the Federal government
continued to accept greenbacks for tax payments, there was constant demand
for greenbacks in order to discharge tax liabilities.
California Gold: 1 dollar gold coin,
1854
San
Francisco’s merchants and the Greenback embargo
Perhaps
Lincoln could have counteracted Californian’s natural predilection to
continue using gold by threat of force. But the Union’s attention was
otherwise occupied with the Confederacy. Furthermore, Californians
simultaneously deployed their own set of defences to ensure that gold
remained the dominant medium.
In
1862, San Francisco’s merchants set up a greenback embargo. The merchants
agreed that they were “not to receive or pay out legal-tender notes at any
but the market value, gold being adhered to as the standard.” Any merchant
who was caught asking for payment in greenbacks was to be reported to the
merchants association, their names recorded in a black book. Once their name
was black listed, rule-breakers could not buy merchandise on credit from
other merchants. Instead, they would have to pay up-front in gold (Shearer,
2000).
Santa Cruz Weekly Sentinel, November
1862
Shearer
points out that the boycott did not work perfectly. For instance, the
following ad appeared in the San Francisco Bulletin in late 1864:
Greenbacks.
Caution is herewith given to all persons doing business with a man named
Charles Strassman of the East India Tea Store on Washington Street opposite
Maguires Opera House, that he has been purchasing goods to a considerable
amount very lately from the subscribers and paying for them in the above
currency, having bought [i.e. contracted for the goods] for gold coin. Castle
Brothers,Jones & Co.
Even
though merchants could be blacklisted if they dealt in greenbacks, they could
still legally compel their creditors to accept them in settlement of any
dollar debt. In 1863, the state legislature closed this avenue by passing the
Special Contract Act. By including a gold clause in a debt contract, a
merchant now had the legal right to force a debtor to pay with gold, not
greenbacks. Usage of these clauses became standard practice in California,
and this would have further marginalized the greenback (Mitchell, 1903).
In Summary…
Californians
rejected the greenback because they had long adhered to gold as a form of
payments. Any given merchant expected the rest of the mercantile community to
continue paying with gold coin, which made it costly to adopt greenbacks. The
reverse happened in the east, the monetary system tipping towards the more
familiar banknote. Even as the greenback inflated, easterners still preferred
to set prices in terms of paper. It was too costly for an individual merchant
to shift onto gold given that every one else already accepted paper.
This
same stickiness explains why new technologies like bitcoin haven’t got much
usage as a way to pay. It also accounts for why Venezuelans have been slow to
shift away from a bolivar monetary system to a dollar-based one despite the
collapse of the bolivar. When groups of people collectively adopt a habit,
this habit is very difficult to change.
References:
1.
Cross, I. Californians
and Hard Money. California Folklore Quarterly, 1945
2.
Greenfield, R and H Rockoff. Yellowbacks
out West and Greenbacks Back East: Social-Choice Dimensions of Monetary
Reform, 1996.
3.
Mitchell, W C . A
history of the greenbacks, with special reference to the economic
consequences of their issue: 1862-65. 1903. Link: https://archive.org/details/historyofgreenba00mitcrich
4.
Moses, M. Legal Tender
Notes in California. The Quarterly Journal of Economics, 1892.
5.
Shearer, R. California
and the Gold Standard During the American Civil War. 2000. Link: https://open.library.ubc.ca/cIRcle/collection...items/1.0340777
6.
Watner, C. Hard Money
in the Voluntaryist Tradition. 1987. Link: target="_blank" http://voluntaryist.com/articles/issue-23/...n/#.XD4Xh2navIW
This
blog post is a guest post on&n target="_blank"bsp;BullionStar’s
Blog
by the renowned blogger&n target="_blank"bsp;JP Koning who
will be writing about monetary economics, central banking and gold.
BullionStar does not endorse or oppose the opinions presented but encourages
a healthy debate.
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