Money of the American Constitution

The US dollar is not what most people think it is. There are a constitutional dollar (C$) and a Federal Reserve dollar (F$). The former is money; the latter is a money-substitute circulating in place of money. They are fundamentally distinct with different definitions.

Many modern economists struggle to define money. Often beginning with an historical overview of the concept of moneyness, they generally end by describing the functions of money. What money ‘does’ is not a definition of what money ‘is’.

Throughout history, money has always been defined as a specific weight of gold or silver. In colonial America a silver coin called the ‘dollar’ circulated widely, and after the War for Independence, the ‘dollar’ as the then prevailing common currency was used in the Constitution.

The original intent of this venerable document is today generally misunderstood or ignored, which is unfortunate because it has led to the wilful abandonment of constitutional money by politicians and the courts. That result has been accepted by the general population out of ignorance or apathy to their detriment as evidenced by the scourges of inflation, rising taxes, bank failures, burdensome regulations, and the soaring national debt , all of which plague economic activity.

The Constitutional Structure

After each colony declared their independence in 1776 to absolve from all allegiance to the British Crown and dissolve all political connection between them and Great Britain, the sovereignty inhered in English kings passed to the American people. To apply these new powers, colonial charters were modified and constitutions written, the ratification of which transitioned each colony to a State self-governed by free and independent people exercising their sovereignty through elected representatives.

With the hope of a peaceful outcome to their Declaration of Independence diminishing, these new States then formed a Union in preparation for war. With it, they created a federal government to act for them as a unified force to secure their sovereignty from the British Empire. The Articles of Confederation provided the framework by which the former colonies fought for their independence, but as the war began, fundamental weaknesses in the structure of their Union became readily apparent.

Peace came with the 1783 Treaty of Paris. King George III acknowledged each of the former colonies “to be free sovereign and independent states, that he treats with them as such, and for himself, his heirs, and successors, relinquishes all claims to the government, propriety, and territorial rights of the same and every part thereof.”

Nevertheless, British presence in Canada and the Caribbean was perceived by the citizens of the States as an ongoing threat to their safety and security, which highlighted the shared benefit from the common defence offered by their State’s participation in the Union. Further, economy activity was suffering from the consequences of war and the hyperinflationary collapse of the continental, a fiat currency issued by the then federal government. Political leaders across the States were determined to address these problems and the weaknesses of the Articles “in Order to form a more perfect Union” as stated in the Preamble of the Constitution.

While acting for the State they represented, the framers drafting the Constitution in 1787 identified three specific areas where they believed a unified power acting on behalf of all the States best served the interests of each State. Their aim, again from the Preamble, was to “promote the general Welfare” of each State’s citizens. So their federal government – already created for their mutual defence and controlled by them through the Articles of Confederation – was altered by the Constitution, bringing to three the tasks to be undertaken:

(1) organising a confederated defence in case any State was invaded,

(2) promulgating a common market among the States, and

(3) coining money to be used as the common currency of the Union.

To complete these tasks, the States defined and delegated to their federal government seventeen of their sovereign powers, withholding for themselves or the electorate those powers not delegated. But there was a problem.

Defining the Dollar

The word ‘dollar’ was a nickname, not a recognised measure of weight like the peso, mark, or pound. It is derived from the German word “thaler”, meaning from the valley, the location where silver used in the coin was mined. It was then minted by the Spanish into coins named pilar, peso, and real. Coins of eight reales – also known as ‘pieces-of-eight’ – were called dollars. Adding to the confusion, coin weights and purity often varied depending on the mint where it was coined.  A definition of a dollar was needed, and Thomas Jefferson was asked to complete this task.

Defining the dollar was an onerous and challenging undertaking given the crude assaying, refining, and measuring techniques available to Jefferson to quantify the weight of silver in a random selection of existing Spanish coins. As he set out to define the dollar, Jefferson recognised the importance of treating fairly the holders of the coins then in circulation. His detailed work did that, and Congress accepted his recommendation, which was a bi-metallic monetary system using both precious metals as was the accepted global practice at the time. Silver would be minted in dollar coins, but gold coins would be called ‘eagles’, recognising the contrasting essential nature of these two different precious metals.

Jefferson understood that the supply and demand of gold and silver fluctuate in relation to each other. This market knowledge was also understood by the framers of the Constitution and enshrined within Article I, Section 8:

“To coin Money, regulate the Value thereof, and of foreign Coin…”

Though flagrantly misinterpreted or wilfully misrepresented for decades, ‘regulate’ means that Congress would need to adjust the gold-to-silver rate of exchange to keep the metal values aligned with global rates. If not, the metal undervalued in the USA would be exported to where it was more highly valued, which if done in large quantities would deprive the US Mint of the supply of metal needed to meet its obligation to provide sufficient coinage required in the economy.

Lawful Money

As one of the seventeen powers delegated by the several sovereign States to Congress, the coining clause above established lawful money. Congress decides the coin weight and purity as the standard by which to measure value throughout the Union, which with the adoption of the Constitution had become a common market among the States without internal trade barriers.

Taking Jefferson’s recommendations, one of the first acts of Congress signed into law by President George Washington was the 1792 Coinage Act. It made the silver dollar as lawful money and defined C$1.00 as 371.25 grains of pure silver, putting the now “more perfect Union” on a silver standard.

The Silver/Gold Relationship

The Coinage Act also created the bi-metallic system Jefferson recommended. It did not authorise a gold dollar coin but nevertheless met Congress’s constitutional obligation to regulate coins by establishing the silver C$’s exchange rate to gold.

The Act created the eagle valued at C$10, containing 247.5 grains of pure gold. The gold/silver ratio was set at 15-to-1, calculated as follows:

Over time silver began to depreciate in relative value, highlighting the difficulty of managing a bi-metallic system that attempts to fix the value of silver in terms of gold or vice versa. Government price fixing never works, even when applied to money, because value is subjective and ever-changing for countless unpredictable reasons.

As the value of the silver in the C$ declined relative to gold, the coin’s circulation became hindered. In other words, market rates often deemed the gold/silver ratio to be higher than the government’s fixed 15-to-1 rate, causing the payer of dollars to favour silver and the payee to favour gold, which in turn led to disputes and transactions that were not completed. Inefficient currency impedes commerce by thwarting economic activity.

To bring silver’s value in relation to gold closer to market rates by regulating their ratio, Congress in the 1830s acted. President Andrew Jackson signed into law two coinage bills that established a 16-to-1 ratio, which remained until the turmoil from the war between northern and southern States, a.k.a. the Civil War.

The Return to Fiat Currency

When the southern states seceded, President Abraham Lincoln’s sought to preserve the Union, which he believed was perpetual and that secession from it was unconstitutional. To finance the war, the federal government issued bills of credit called ‘greenbacks’ that were forced into circulation by the 1862 Legal Tender Act.

Like the failed continental, they were fiat paper currency, over issued, and not backed by gold or silver. Their debasement and resulting inflation caused them to fall at one stage to 30% and 24% discounts to the gold eagle and silver dollar respectively. Their fall at different rates reflected that silver was depreciating further against gold from the statutory 16-to-1 ratio.

With the end of the war, agitation for a return to redeemable currency gathered pace, aided by a Supreme Court decision in Hepburn v. Griswold (1870) that the ‘greenbacks’ were unconstitutional. The displeasure felt by President Ulysses Grant and banking interests from that decision was short-lived. By packing the Court with two new justices favourable to railroad and banking interests – filling one empty seat and replacing one justice who retired – Hepburn was overturned the following year. Nevertheless, the clamour for a return to redeemable currency did not abate.

The Coinage Act of 1873 was signed into law by President Grant. Controversial at the time, it put the C$ on a de facto gold standard and stopped the minting of silver dollars for domestic use. It was followed by the 1875 Resumption Act establishing a mechanism to reduce the quantity of inflationary ‘greenback’ paper currency and set a plan for their eventual redemption with precious metal coin, a goal achieved in January 1879.

These two Acts marked a pivotal moment in American monetary history, and the way forward was clear. Political leaders understood their legal and moral obligation to return to constitutional money, which forced Congress to act. But a bimetallic monetary system had become impractical to “regulate the Value thereof” because the supply and demand of gold and silver was ever-shifting.

Congress took a step in the right direction toward gold as the sole standard but after bending to powerful lobbying interests only went halfway. It tenaciously clung on to bimetallism, rather than coming to grips with the reality of market forces.

Defining Money with Gold

Great Britain, which by this time had become the wealthiest nation and foremost global power, led the way on monetary matters. It was on a gold standard established circa 1700 by Sir Isaac Newton when he was Master of the Royal Mint, but both gold and silver coin circulated. So British commerce was impacted by changes in their relative value. Parliament addressed this problem at the end of the Napoleonic Wars with the Coinage Act of 1816. Though silver was not formally designated as legal tender, a payee was not obligated to accept payment in silver greater than £2.

The same principle could have been adopted by Congress. Namely, recognising the need for subsidiary coinage, it could have designated two dollars of silver coin as the maximum to be offered in payment, after which the payee could request gold coin. But the formal step to gold was not taken. The bimetallic monetary system remained with a de facto gold standard and a fluctuating ratio between the two precious metals. The gold/silver ratio exceeded 20-to-1 in the 1880s and widened to 30-to-1 as early twentieth century approached.

The statutory link to gold as the sole standard was eventually established with the 1900 Gold Standard Act signed into law by President William McKinley. That law designated silver as subsidiary coinage and defined the C$ as 25.8 grains of gold that was 90% pure.

The gold dollar became lawful money and the sole standard to measure value. Silver remained as subsidiary coinage, but the environment was changing.

The Proliferation of Money-Substitutes

By the late nineteenth century, money-substitutes increasingly began circulating in place of money itself. These were bank ledger currencies like paper banknotes and as technology advanced, bank deposits that circulated by check and wire transfer.

Banks promised redeemability of their currency into lawful money on demand, but the reliance upon these bank ledger currencies came with risks. Banks had transformed their promises – credit – into purchasing power purportedly as good as gold. It was alchemy, and with bank ledger currencies being a derivative of physical metal, unsurprisingly there were problems like the inflation of the greenbacks era and banking failures.

Bank promises perforce like all extensions of credit are of questionable value because inevitably some promises are broken. What is worse, defaulted debts can cause bank runs, which became a recurring nineteenth century feature. When the bank issuing these promises of redeemability into lawful money failed, its paper currency proved worthless and customer bank deposits were lost, highlighting the danger of using a currency based on credit instead of the certainty offered by gold or silver coin.

Nevertheless, the derivative currency provided by banks expanded throughout the nineteenth century, and as it did, America was moving ever further from its constitutional roots. But banks had become a political force and 1913 proved to be a watershed year.

Uprooting Constitutional Money

With the 16th and 17th amendments to the Constitution ratified in 1913, direct taxation was introduced, and senators were no longer appointed by State legislatures. With those changes, the several States began losing control of the federal government they created, resulting in its ever-growing expansion beyond the original intent of the framers.

The groundwork for a coup d’etat was completed with the creation of the Federal Reserve that same fateful year. It was an unconstitutional act. The States delegated in the Constitution seventeen powers to the federal government, one of which is the power to “coin Money”, not print currency. Powers not specifically stated are reserved under the 9th and 10th amendments to the States or the people. Thus, the creation of the Federal Reserve and the imposition of the F$ on economic activity contravenes the plain language in the Constitution as well as its intent.

The Federal Reserve began issuing increasing quantities of F$ paper currency that circulated concurrently with C$ coin, which borders on fraud given that the F$ was being portrayed as the C$, a deception that continues to the present. It also began removing gold coin from circulation, a task aided by Gresham’s Law, which holds that bad currency drives good money out of circulation.

With the Federal Reserve distancing itself and the American economy from gold, links to constitutional money were breaking. Further, the immutable discipline that gold imposes on banks to control their aggregate extension of credit was being removed.

As a result, the economy and the stock market were fed with easy credit, and the quantity of F$ money-substitutes soared creating the Roaring ‘20s, the inevitable stock market crash, and subsequent economic collapse. But instead of correctly identifying reckless credit expansion resulting from banks and government policies as the causes, the political control exercised by banking interests came to the fore, like it did with their opposition to the Hepburn decision. With the media largely moving toward greater government influence and with few defenders, gold instead of the banking system was blamed for the Great Depression, a stigma that exists to this day. But worse was to come.

President Franklin Roosevelt upon his inauguration confiscated gold, prevented gold from circulating as currency, and devalued the F$ to F$35 per ounce. The misleadingly named Gold Reserve Act of 1934 also created the Exchange Stabilization Fund, authorising the US Treasury to intervene in markets to manipulate the value of the F$.

Further, the Supreme Court fell prey to the witch-hunt then underway to banish gold. It let stand in the notorious Gold Clause Cases the gold confiscation’s obvious theft of private property while ignoring constitutional monetary provisions, the above coining clause and Article I, Section 10:

“No State shall…emit Bills of Credit; make any Thing but gold and silver Coin a Tender in Payment of Debts;”

The dollar bills in the pockets of Americans are dollar ‘bills of credit’. In the words of one Supreme Court justice who understood the original intent of America’s founding documents: “The Constitution, as we have known it, is gone.”

The deathblow to the C$ came in 1971 when President Nixon broke the F$’s remaining tenuous link to gold. The F$ became fiat currency that can be expanded without restraint, redeemable into nothing, and backed only by the assets of banks, the quality of which is unknowable.

America has gone full circle: from the continental, the paper currency that collapsed in hyperinflation during the War for Independence, to the silver dollar, then to gold, and back to fiat currency like the continental. It is an alarming thought given that no fiat currency has ever survived; they all eventually collapse from over issuance.

What is Constitutional Money?

President Andrew Jackson answered this question in his Farewell Address in 1837. He was the last president to have a direct, living memory of both the War for Independence and the collapse of the continental, which experiences no doubt had an enduring impact on him and shaped his understanding of money.

“The Constitution of the United States unquestionably intended to secure to the people a circulating medium of gold and silver. But the establishment of a national bank by Congress, with the privilege of issuing paper money receivable in the payment of the public dues, and the unfortunate course of legislation in the several States upon the same subject, drove from general circulation the constitutional currency and substituted one of paper in its place…But experience has now proved the mischiefs and dangers of a paper currency.”

Back then the central bank was subject to periodic re-approval by Congress, which like all legislation needed the president’s assent for it to become law. President Jackson vetoed the bill to extend the central bank’s charter, reflecting his disdain for bank ledger currencies. Through prudent decisions, he also managed with constitutional money to repay the national debt in full, a unique achievement. The American economy prospered with constitutional money and without a central bank until 1913.

The Federal Reserve is not independent. It was created by banks conniving with the federal government to purposely sidestep constitutional requirements while conveying the pretence of lawful money. This sleight-of-hand makes the F$ sound constitutional, but it is not. The money of the American Constitution is an unchanging weight of gold or silver decided by Congress and signed into law by the President, not an abstract bookkeeping notion spawned by banks circulating in place of the C$.

America would do well to heed President Jackson’s advice before today’s circulating currency, the F$, suffers the fate of the continental. Some argue it already has taken that disgraceful path because the purchasing power of the F$ is only 1% of what it was in 1913. The F$ circulates only from the force of legal tender law, a politically dishonest crutch not needed by gold and silver, which are natural money and the only lawful money of the American Constitution.