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A Short History of U.S. Monetary Policy


The monetary system that the Framers established with the Constitution was the most unusual and the most radical in history. That unique monetary system, along with such things as the absence of an income tax, a welfare state, and a warfare state, along with open immigration, contributed to the tremendous economic prosperity that pulled countless people out of poverty in the 19th century here in the United States.

From the inception of the United States until the Franklin Roosevelt administration in the 1930s, the official money of the American people consisted of gold coins and silver coins. Contrary to popular opinion, the “gold standard” did not consist of a system of paper money that was “backed by gold.” There was no paper money because the Constitution did not authorize the federal government to issue paper money. The Constitution gave the federal government the power to “coin” money,” not print it. Coinage involved coins, specifically coins made of the precious metals, as well as copper coins for small transactions.

Everyone understood that federal bills and notes were promises to pay money, not money itself. The money the bills and notes were promising to pay was the gold and silver coins.

Moreover, under the Constitution the states were expressly restricted from making anything but gold and silver coins “legal tender.” They were also expressly prohibited from printing paper money (i.e., “emitting bills of credit).

Examine a one-dollar bill. Notice that at the top, it says, “Federal Reserve Note.” But a note is ordinarily a debt instrument — it promises to pay something. What is a Federal Reserve “Note” promising to pay? Actually, it promises to pay nothing. The Federal Reserve Note is a throwback to America’s founding monetary system, one where everyone understood that the money was gold and silver coins and that federal bills and notes were promising to pay the creditor gold and silver coins.

Historically, Governments had debased their nation’s money by simply printing more of it. This process was especially useful for governments who had incurred mountains of debt. To pay off the debt, they simply would crank up the printing presses and use the newly printed money to pay off creditors.

The payment of debts in this fashion brought big benefits to government officials. For one, it relieved them from raising taxes to pay off the debt, something that isn’t always very popular. Second, when prices for everything would start to rise, in response to the inflated supply of paper money, most people had no idea that the government was behind it. They blamed business establishments for the rising prices. Of course, the government would reinforce the deception by condemning business for being greedy and by imposing price controls on them.

That’s not to say that there wasn’t legalized plunder through inflation before the invention of the printing press. There was. For example, in the olden days when gold coins would come into the realm for payment of taxes, the king would have his people shave off the edges and melt them down into new coins. The old coins would now contain, say, a bit less than an ounce of gold.

Under America’s founding monetary system, the federal government was responsible for minting the gold and silver coins. One of the fascinating aspects to this was that for more than 125 years, there was no intentional debasement of the money. That is, there were no edges shaved off and melted down into new coins for the government to use to pay off its debts or fund its operations. U.S. coins were honest and were what they were represented to be. The only disparity that would periodically take place was when the government’s exchange rate between gold and silver coins would be adjusted in accordance with market conditions.

Thus, sound money was a core feature of America’s economic system throughout the 19th century. Corporations would even issue 100-year bonds, which people would purchase without fear that they would lose their value to government debasement.

That all came to an end in 1934, when the federal government, under President Franklin Roosevelt, made it illegal for Americans to own gold coins. Imagine that: What had been the official money of the American people for more than 125 years was suddenly made illegal to own. U.S. officials mandated the American people, on pain of a felony conviction, to turn in their gold coins to the federal government. Federal bills and notes were made the new official money of the United States, even though they were now irredeemable in gold and silver coins. Ironically, people in other countries were still free to own gold coins without being turned into felons for doing so.

When gold and silver coins were the official money, U.S. officials were effectively precluded from printing an over-supply of bills and notes and using them to fund their activities. If they printed too many, they ran the risk that everyone would demand to be paid their gold and silver coins. That’s why we often hear about how the “gold standard” kept federal spending and borrowing in check.

Once Americans were converted into felons for owning gold coins, however, everything changed for federal officials. Now they could spend and borrow to their heart’s content because they could now print money to their heart’s content. That was what the Federal Reserve, which had been established in 1913, was all about — to expand the money supply to accommodate the ever-increasing expenditures and debts of the welfare state, which Roosevelt brought into existence in the 1930s, and the warfare state, which he brought into existence in the 1940s.

Adding insult to injury was that it was the Federal Reserve, through monetary mismanagement, that had brought on the stock market crash of 1929, which led to the Great Depression, which Roosevelt then used as his excuse for nationalizing gold and go to a fiat money system. Of course, U.S. officials didn’t tell people that. They said that the stock market crash and the Great Depression constituted the failure of America’s “free enterprise system” and that welfare, regulation, and fiat money were necessary to save free enterprise.

Another of the fascinating parts about all this was that it was done without even the semblance of a constitutional amendment. Keep in mind that that’s the process that the Framers established with the Constitution. If anyone wanted to change the U.S. government in a fundamental way, he would have to go the very difficult route of amending the Constitution. It would be difficult to find a better example of a fundamental change in our governmental system than an abandonment of what had been the monetary system under the Constitution for more than 125 years in favor of a totally different monetary system.

In any event, that’s how we ended up with decade after decade of inflationary debasement of the currency, to the point where silver coins were driven out of circulation by cheap, alloyed coins. It’s also how we got out-of-control federal spending and borrowing to fund the ever-increasing expenditures of the welfare-warfare state. It’s how we ended up with a federal government whose profligate ways are threatening to send our nation into bankruptcy.

This post was written by:

Jacob G. Hornberger is founder and president of The Future of Freedom Foundation. He was born and raised in Laredo, Texas, and received his B.A. in economics from Virginia Military Institute and his law degree from the University of Texas. He was a trial attorney for twelve years in Texas. He also was an adjunct professor at the University of Dallas, where he taught law and economics. In 1987, Mr. Hornberger left the practice of law to become director of programs at the Foundation for Economic Education. He has advanced freedom and free markets on talk-radio stations all across the country as well as on Fox News’ Neil Cavuto and Greta van Susteren shows and he appeared as a regular commentator on Judge Andrew Napolitano’s show Freedom Watch. View these interviews at LewRockwell.com and from Full Context. Send him email.