The Breakdown Newsletter Segment

This is a segment from The Breakdown newsletter. To read full editions, [subscribe].

> “Since 1971, when the United States indefinitely suspended its promise to convert paper dollars into gold, we all use Massachusetts currency.”
> — Dror Goldberg

The American colonies won their independence from Great Britain with a weapon of their own invention: fiat currency.

In 1690, the Massachusetts Bay Colony made monetary history when it issued 7,000 GBP in “bills of credit” to soldiers returning from a failed raid into Quebec.

The disgruntled soldiers had expected to be “paid” in plunder, but when that failed to materialize, the colony issued them newly printed paper money, which was valuable only because it was needed for paying taxes.

This wasn’t the first paper currency ever; that honor belongs to the Song Dynasty, which issued paper money in China roughly 700 years earlier. However, those ancient notes were initially redeemable for copper coins.

The Massachusetts bills of credit were the first paper money to hold value solely because the issuing government required them for tax payments. It was a clever idea: Print paper money and force people to earn it, as they needed it for their taxes.

This monetary innovation was described by Dror Goldberg in Easy Money: American Puritans and the Invention of Modern Currency. He notes that it represented a significant shift in the legal foundation of money, moving from intrinsic value to the circulation of money into and out of the state’s treasury.

“Who needs gold when you have taxes?” Goldberg summarizes neatly.

However, governments were slow to adopt this idea. The Massachusetts Bay Colony ended its initial experiment in fiat money just two years later by retiring all the bills it had issued after collecting them for taxes.

Other American colonies followed suit, yet their experiments were also short-lived. There was only one such effort outside the colonies: a 1716 issuance of billets de banque that led to the financial crisis known as the Mississippi Bubble.

The recognition of tax-backed paper currency’s power didn’t come until decades later when the colonies utilized it to gain independence from Britain.

In 1775, the financially strapped Continental Congress paid its army with paper currency that was only backed by the promise of acceptance for tax payments from the colonial governments. Unfortunately, this method didn’t work well.

Despite Massachusetts’s proof-of-concept, the idea of tax-backed money was poorly received. As a result, the Continental Congress printed its dollars with a grand but fictional promise that stated each dollar “entitles the Bearer to receive TWENTY Spanish MILLED Dollars or the value thereof in Gold or Silver.” In reality, it was meant to give tax receipts.

Additionally, the Continental Congress printed an excessive amount of them, leading to a sharp decrease in purchasing power by 1781.

Yet, against the odds, it managed to sustain an army, proving that fiat currency, despite its shortcomings, could finance wars and even create a nation. According to Goldberg, “The noise of the rebels’ printing press was the stamp heard round the world.”

Post-war, even the victorious Americans found the idea of tax-backed money troubling. Thomas Jefferson expressed this sentiment a decade later, stating, “Paper is poverty. It is only the ghost of money, and not money itself.” This view was widely shared.

It wasn’t until 1971—281 years after Massachusetts’s innovation—that the United States fully embraced the notion of money backed solely by the government’s capacity to collect taxes.