In the November 10, 2011 issue of the New York Review of Books, Gordon Wood, professor emeritus of history at Brown University, reviews a new book by Ben Tarnoff Moneymakers: The Wicked Lives and Surprising Adventures of Three Notorious Counterfeiters. I found the second paragraph of Wood’s essay, especially arresting.
Almost from the beginning of American history Americans have relied on paper money. Indeed, the Massachusetts Bay Colony in 1690 was the first government in the Western world to print paper currency in order to pay its debts. Although this paper money was not redeemable in specie, the Massachusetts government did accept it in payment for taxes. Because Americans were always severely short of gold and silver, the commercial benefits of such paper soon became obvious. Not only the thirteen British colonies, but following the Revolution the new states and the Continental Congress all came to rely on the printing of paper money to pay most of their bills. By the early nineteenth century hundreds of banks throughout the country were issuing notes that passed as money. No place in the world had more paper money flying about than did America. By the time the federal government began regulating the money supply during the Civil War, there were more than ten thousand different kinds of notes circulating in the United States.
Note the explicit reference to the role of making paper money acceptable in payment for taxes as condition for the success of the paper money printed by the Massachusetts government even though the money was not redeemable in specie.
Wood goes on to recount the important role that counterfeiters played in American history focusing on the stories of the three “heroes” of Tarnoff’s book to illustrate the ways in which counterfeiters actually served the public interest by providing access to paper money that banks were not willing or able to provide, an observation that will resonate deeply with our own esteemed Benjamin Cole, who has loudly proclaimed the benefits of monetary expansion, even if accomplished by counterfeiting.
Another important point that I found extremely interesting comes toward the end of Wood’s piece.
The golden age of American counterfeiting came to an end during the Civil War. In 1862 the United States made paper money printed by the national government legal tender. This “bold expansion of federal sovereignty,” says Tarnoff, “represented nothing less than a revolution in American finance.” The National Currency Act of 1863 followed, and a tax on the notes of state banks put them out of business. The United States had become a new nation. “The war produced something unimaginable: a federal monopoly on paper currency. . . .Never before in American history,” says Tarnoff, “had the power to make paper money been held by a single authority.”
Counterfeiter felt the effects immediately. With a single national currency people no longer had to sift through thousands of different bills trying to distinguish the genuine from the fake. But an agency to detect and arrest counterfeiters was still needed, and in 1865 the Treasury Department created the US Secret Service, which soon severely cut down the number of counterfeiters and counterfeit notes. At the time of the Civil War one third or more of the paper money in circulation had been fraudulent; by the time the Federal Reserve System was established in 1913, counterfeit bills made up less than on thousandth of one percent of the paper money supply.
Obviously, centralizing the issue of bank notes greatly increases the incentive of the monopoly issuer to enforce its property rights and eliminate counterfeiting. With a decentralized supply of bank notes, individual banks have relatively little incentive to seek or undertake enforcement action against counterfeiters who are more likely to counterfeit someone else’s notes than their own. In his first great book on monetary theory, Good and Bad Trade, Ralph Hawtrey cited the reduced costs of identifying counterfeit notes as the principal advantage in suppressing free competition in the issue of banknotes.
Wood closes by noting that most of the $900 billion of Federal Reserve Notes in circulation in 2010 (now well over $1 trillion) are thought to be held outside the US. The amount of gold held in bullion or coins by private citizens is estimated to be 16% of the total of gold in existence in2008. The current stock of gold in all forms is about 170,000 metric tons. So about 25,000 metric tons of gold may now be privately held. At $1700 an ounce, private gold holdings are thus worth about $1.3 trillion. I don’t know how much of this is held outside the US, but I suspect it is much more than a half. Let’s assume it’s a round number like $1 trillion. Then the amount of privately held gold outside the US is about twice the amount of privately held Federal Reserve notes. However, holding Federal Reserve Notes is not the only way that people can hold dollars abroad. They can also hold euro dollar accounts, which are time deposits denominated in dollars held in offshore (outside the US) banks. No one knows what the volume of such accounts is, because it is basically an unregulated market outside the reach of US regulatory authority and pretty much left unregulated by foreign governments. But estimates of the size of euro dollar accounts (which may be denominated in other currencies, but are overwhelmingly denominate in dollars) are probably far more than $1 trillion. So based on the revealed preferences of legally unconstrained choices, the dollar seems to be way, way more popular than gold.