The Mystery of Banking

greenbacks
, irredeemable paper notes, to pay for
the war effort. Greenbacks had fallen to half their value by the
end of the war, and it took many struggles and 14 years for the
U.S. to return to the gold standard.
8
During the Revolutionary and Civil War periods, Americans
had an important option: they could still use gold and silver
coins. As a result, there was not only price inflation in irre-
deemable paper money; there was also inflation in the price of
gold and silver in relation to paper. Thus, a paper dollar might
start as equivalent to a gold dollar, but, as mammoth numbers of
The Supply of Money
55
8
During World War I, the U.S. Government, in effect, suspended
redeemability of the dollar in gold.
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paper dollars were printed by the government, they depreciated
in value, so that one gold dollar would soon be worth two paper
dollars, then three, five, and finally 100 or more paper dollars. 
Allowing gold and paper dollars to circulate side-by-side
meant that people could stop using paper and shift into gold.
Also, it became clear to everyone that the cause of inflation was
not
speculators, workers, consumer greed, “structural” features
or other straw men. For how could such forces be at work only
with 
paper
, and not with 
gold
, money? In short, if a sack of flour
was originally worth $3, and is now worth the same $3 in gold,
but $100 in paper, it becomes clear to the least sophisticated that
something about 
paper
is at fault, since workers, speculators, busi-
nessmen, greed, and so on, are always at work whether gold or
paper is being used. 
Printing was first invented in ancient China and so it is not
surprising that government paper money began there as well. It
emerged from the government’s seeking a way to avoid physically
transporting gold collected in taxes from the provinces to the cap-
ital at Peking. As a result, in the mid-eighth century, provincial
governments began to set up offices in the capital selling paper
drafts which could be collected in gold in the provincial capitals.
In 811–812, the central government outlawed the private firms
involved in this business and established its own system of drafts
on provincial governments (called “flying money”).
9
The first government paper money in the Western world was
issued in the British American province of Massachusetts in
1690.
10
Massachusetts was accustomed to engaging in periodic
56
The Mystery of Banking
9
Gordon Tullock, “Paper Money—A Cycle in Cathay,” 
Economic His-
tory Review
9, no. 3 (1957): 396.
10
Strictly speaking, the first paper money was issued five years earlier
in the French province of Quebec, to be known as Card Money. In 1685,
the governing 
intendant
of Quebec, Monsieur Meules, had the idea of divid-
ing some playing cards into quarters, marking them with various monetary
denominations, and then issuing them to pay for wages and materials. He
ordered the public to accept the cards as legal tender and they were later
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The Supply of Money
57
plunder expeditions against prosperous French Quebec. The suc-
cessful plunderers would then return to Boston and sell their loot,
paying off the soldiers with the booty thus amassed. This time,
however, the expedition was beaten back decisively, and the sol-
diers returned to Boston in ill humor, grumbling for their pay. Dis-
contented soldiers are liable to become unruly, and so the Massa-
chusetts government looked around for a way to pay them off. 
It tried to borrow 3 to 4 thousand pounds sterling from
Boston merchants, but the Massachusetts credit rating was evi-
dently not the best. Consequently, Massachusetts decided in
December 1690 to print £7,000 in paper notes, and use them to
pay the soldiers. The government was shrewd enough to realize
that it could not simply print irredeemable paper, for no one
would have accepted the money, and its value would have
dropped in relation to sterling. It therefore made a twofold
pledge when it issued the notes: It would redeem the notes in
gold or silver out of tax revenues in a few years, and that
absolutely no further paper notes would be issued. Characteristi-
cally, however, both parts of the pledge quickly went by the
board: the issue limit disappeared in a few months, and the bills
continued unredeemed for nearly 40 years. As early as February
1691, the Massachusetts government proclaimed that its issue
had fallen “far short,” and so it proceeded to emit £40,000 more
to repay all of its outstanding debt, again pledging falsely that this
would be the absolutely final note issue. 
The typical cycle of broken pledges, inflationary paper issues,
price increases, depreciation, and compulsory par and legal ten-
der laws had begun—in colonial America and in the Western
world.
11
So far, we have seen that M, the supply of money, consists of
two elements: (a) the stock of gold bullion and coin, a supply pro-
duced on the market; and (b) government paper tickets issued in
redeemed in specie sent from France. See Murray N. Rothbard,