Colonial America was fertile ground for monetary experimentation. Circulating as money would have been precious metal coins, and not only English coins but also others, paper money issuances from the various colonial governments, often circulating in their neighboring colonies as well, and even commodities widely accepted as money. Many colonies over-issued their paper money, including Massachusetts. The result was depreciation of the money and inflation in prices. Because of this, the government of Massachusetts was ultimately pressured to issue an inflation-linked bond, one that would protect its holder from inflation.
Money in Massachusetts
Precious metal coins were not the dominant form of money in the American colonies for much of the 17th and 18th centuries. Paper money, and even commodities like tobacco and beads, circulated more widely than metal coins. To fund an unsuccessful 1690 invasion of Quebec during the War of the Grand Alliance, the colony of Massachusetts issued paper money. It promised to redeem these notes at a later date but they began to circulate as money in the colony in the meantime; they could also be used in payment of debts to the state, such as tax obligations.
More notes were issued to fund the colony’s expenses during the War of the Spanish Succession between 1702 and 1713. Thereafter, the government continued to issue paper money in peacetime. These included notes issued by the colonial government and notes issued by the colony’s land bank in the funding of loans; in either case they were called ‘bills of credit’.
Massachusetts notes were issued in volumes that exceeded the colonial government’s ability to redeem them. This was especially true after 1740, when the stock of notes in circulation per capita would grow by 5.6 times over the next decade. However, in a positive development, money was delivered from Britain to compensate the colony for its expenses borne during the War of the Austrian Succession, which ended in 1748. The money was used to redeem notes issued to finance that war. So, just after the midpoint of the century, there was a tight money supply and monetary stability.
According to the future Secretary of the Treasury, Alexander Hamilton, the money supply of the American colonies was approximately three-parts paper money to one-part precious metal specie just before the War of Independence. However, far more paper money was issued during that war. In Massachusetts, this began with a rather modest issuance of 26,000 Massachusetts pounds in May 1775; hundreds of thousands pounds more would soon follow.
By 1780, there had clearly been years of overprinting. This was not due to Massachusetts’s actions alone. Especially in the earlier decades of the 18th century, the note issuance of neighboring colonies was even more excessive; but since these circulated in Massachusetts as well, they were important parts of the local money supply.
Inflation
In the decades after the War of the Spanish Succession, paper money began to depreciate meaningfully relative to proper pounds sterling. By 1749, the value of the local Massachusetts pound had fallen by four-fifths since 1720. In the 1740s, the Governor of Massachusetts, William B. Shirley, noted that the depreciation represented a loss to creditors. Some reforms were initiated to adjust to the new reality. For example, with respect to judgements, courts were instructed to consider the effect of depreciation in calculating amounts due.
Of course, depreciation goes hand-in-hand with inflation in the prices for goods and services. Thus, the price of molasses in Boston doubled between 1725 and 1735 and doubled again between 1735 and 1745. Between 1744 and 1748, the price had risen by an average of 25% per year. In these same four years, the price of wheat had risen each year by amounts ranging between 19.5% and 66%. During this period, the local money lost 60% of its value against sterling. In all, this was rather significant inflation, even if not hyperinflation. Between 1720 and 1750, average prices in terms of the Massachusetts pound had risen by 618%. For comparison, this was twice the rate of inflation that the United States experienced between 1950 and 1980, also a thirty-year period with high inflation.
The redemption of circulating notes after the end of the War of the Austrian Succession did bring largely stable prices for a period of twenty-five years after midcentury. Indeed, during the 1750s, the exchange rate between the Massachusetts pound and sterling, though approximately 133.33-to-1, was very stable.
Nevertheless, during the War of Independence, the problem of overprinting and inflation returned and had gotten so bad that soldiers’ pay was depreciating meaningfully in the time between when they would be promised pay and when that pay was actually received. Those in higher positions in society had better arrangements; for example, during the war, the salary of the President of Harvard College was regularly adjusted for inflation. Still, that such an adjustment was sought and received illustrates that few anticipated that the inflation would end anytime soon.
Fixing Prices
Governments did resort to trying to legislate prices. A conference of colonies in New England was held in Providence, Rhode Island to address the fixing of prices by the region’s governments. The delegates of the conference agreed to a schedule of prices for various commodities in which most were fixed at the same rate for the entire region and a few left for individual colonies to decide. Following the conference, legislation was passed in January 1777 to fix prices in Massachusetts.
“An Act to Prevent Monopoly and Oppression” fixed the prices for fifty commodities in terms of the depreciating Massachusetts notes. The specific prices set were to apply to Boston only but local officials elsewhere were charged with setting their own prices in relation to their ordinary discount or premium to Boston prices. Whatever limited accommodation to local market reality the law allowed, it was insufficient. So, the law failed to have the desired effect. Rather than ensure a ready supply of basic goods at a ‘fair’ price, the law simply caused the legal market for these commodities to disappear. The 1777 law was watered down in May of the same year and repealed altogether in October.
Inflation-Linked Notes
Soldiers complained regularly about the lack of pay and, when they were paid, the depreciation of the money they were paid in. In January 1779, four battalions from Massachusetts petitioned for relief claiming that by the effect of depreciation they were losing seven-eighths of their pay. The next month, the government agreed to right this wrong, but only after the war ended. Being an unsatisfactory response, worries existed that if the issue were not addressed, soldiers would decline to renew their enlistments. Some were already taking second jobs in between the fighting.
Soldiers’ mutinies occurred in the colonies during the late years of the War of Independence. Thus, an accelerated resolution was called for. Massachusetts established a committee in November 1779 to address the issue of soldier pay. The solution devised was a new instrument that would be linked to the price of various goods and legislation was passed in January 1780 to issue these new notes. Massachusetts issued a rather new kind of obligation, an inflation-linked note, that year. They were used to pay the soldiers and were known as ‘depreciation notes’ or ‘soldiers depreciation notes’. They accrued interest at 6% per year and were more akin to a bond than a banknote; as such, they did not circulate as money.
This was arguably the first inflation-linked bond, at least insofar as it was linked to a well-defined price index, rather than a single commodity. Each note was indexed to the price of five bushels of corn, sixty-eight and four-sevenths pounds of beef, ten pounds of wool, and sixteen pounds of leather. The seemingly strange proportion of these commodities was set so that each was equally weighted according to their value in the index. From then on, a committee comprised of men from a few different counties of Massachusetts would track prices and report these to the state.
Taken together, this basket of commodities was worth about one hundred and thirty Massachusetts pounds as of January 1, 1780, or just over thirty-two times more than they would have cost under the price-fixing law from three years earlier. The price of each of the four components of the index was about one Massachusetts pound back in 1777 revealing just how much the local pound had lost value. The inflation-linked notes were issued with maturity dates ranging from 1781 to 1788; those soldiers who committed to serve through the end of the war received the notes maturing sooner, between 1781 and 1784. Those who declined received the later-dated notes.
Complementing the new issuance, taxes expected to raise eight million Massachusetts pounds over eight years were arranged to eventually fund the redemption of the notes. However, the notes were not paid at maturity. Still, the balance was chipped away at as the notes were accepted as payment for the purchase of confiscated estates, for payment of some taxes, and by conversion into other securities. In the end, remaining notes were consolidated into a restructured state debt in 1786, before the maturity of the last of the notes.
Lesson
Perhaps the most interesting part of the history of the experience with inflation in 18th century Massachusetts is the fact that the government was pressured into offering inflation-protected notes. Governments should be disincentivized from issuing such notes when inflation is high, rising, or expected to rise. It’s a straightforward matter when governments issue such notes in other circumstances. However, when Massachusetts issued the depreciation notes at a time of high inflation, the influence of the state’s creditors in determining the terms of its payment obligations is clear, at least when the state needs something in return, whether more money, or in the peculiar case here, further military service from disgruntled soldiers.
More from the Tontine Coffee-House
Read about the role of land banks in the circulation of paper money in colonial North America and the use of objects such as playing cards, beads, and tobacco as money. Consider subscribing to this blog’s newsletter or checking out book recommendations, which include many of the sources often referenced in my posts.
Further Reading
1. Fisher, Willard C. “The Tabular Standard in Massachusetts History.” The Quarterly Journal of Economics, vol. 27, no. 3, May 1913, pp. 417–54.
2. Smith, Bruce D. “Money and Inflation in Colonial Massachusetts.” Federal Reserve Bank of Minneapolis Quarterly Review, vol. 26, no. 4, fall 2002, pp. 3–16.
3. Shiller, Robert J. The Invention of Inflation-Indexed Bonds in Early America. National Bureau of Economic Research, Working Paper 10183, Dec. 2003.
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Dror Goldberg