No Federal Power to Issue Federal Reserve Notes

Written by Ralph J. Benko

Tuesday, August 07, 2012

"At the constitutional convention the founding fathers explicitly voted not to grant the national government the power to emit bills of credit...."

A recent posting here praised the erudite Prof. Natelson’s 2008 paper Paper Money and the Original Understanding of the Coinage Clause, 31 Harvard J.L. & Pub. Policy 1017 (2008). while disputing its observation that the federal constitution invested the central government with the power to issue paper money.  This assertion has been extensively addressed and found wanting in many earlier postings here, such as this one on Jefferson, and, especially, in Monetary History Highlights here and here.

Because Prof. Natelson's prolific scholarship is so widely and wisely respected, and because this is a reiteration of such a common misconception, it is worthwhile to highlight the observations of monetary historian Farley Grubb, professor of economics of the Alfred Lerner College of Business and Economics at the University of Delaware.  Prof. Grubb is the author of what is arguably the definitive study of the intention of the framers as to the federal government’s monetary powers: The US Constitution and monetary powers: an analysis of the 1787 constitutional convention and the constitutional transformation of the US monetary system, published in 2006 in Financial History Review 13.1, pp. 43-71 and republished as an NBER working paper.  Prof. Grubb writes:

At the constitutional convention the founding fathers explicitly voted not to grant the national government the power to emit bills of credit and (debatably) not to charter banks.4 Article 1, section 10 absolutely prohibits individual states from emitting bills of credit and determining what could be legal tender. States, however, retained the right to charter banks.

These radical decisions did not emerge until rather late in the convention, and were not obviously anticipated by its prior deliberations. Thus, they were not only revolutionary in their impact, but were arguably somewhat unexpected. Why mid-convention did the founding fathers shift gears and reject the colonial experience of stable fiat paper money regimes?5 Moreover, why did they opt for a total constitutional ban on paper money issues at all levels of government after 1787?

Prof Grubb enumerates, at footnote 4, many iterations of the commonplace misunderstanding of the prohibition of the paper money power to the federal government of the United States:

A common error repeated often in the literature is the claim that the convention intentionally crafted a Constitution in which Congress was allowed the power to emit bills of credit. For example, see B. Baack, ‘Forging a nation state: the Continental Congress and the financing of the War of American Independence’, Economic History Review, 54 (2002), p. 653; J. E. Ferguson, ‘The nationalists of 1781– 1783 and the economic interpretation of the Constitution’, Journal of American History, 56 (1969), pp. 254, 258; C. P. Nettels, The Emergence of a National Economy, 1775–1815 (New York, 1962), pp. 98–9; A. J. Rolnick, B. D. Smith and W. E. Weber, ‘In order to form a more perfect monetary union’, Federal Reserve Bank of Minneapolis Quarterly Review, 17 (1993), p. 3; M. M. Schweitzer, ‘State-issued currency and the ratification of the US Constitution’, Journal of Economic History, 49 (1989), p. 311. The analysis here, if nothing else, is a valuable corrective in showing that under almost any logically consistent and coherent interpretation such a claim cannot be easily sustained.

This recurring error almost certainly proceeds from the contemporary mindset that takes an unhistorical view of the powers given to the federal government, implicitly assuming that Congress can undertake whatever it so chooses unless explicitly restrained.  Such was not the case at the founding or for decades thereafter.   The inversion which accommodated this unhistorical view in fact was ratified by the US Supreme Court, in the Reconstruction era, in an infamous legal tender case, Julliard v. Greenman.

Prof. Grubb concludes:

The US today has a national paper money, backed not by specie but only by federal government taxes, or the good faith and credit of the federal government. This paper money is also a legal tender ‘for all debts, public and private’, and it is issued by the Federal Reserve Bank, a quasi-government agency in the strict legal sense but as close to a national bank chartered by the federal government as one can get. This monetary system has evolved in the context of the same written Constitution at least in terms of monetary powers that the founding fathers created in 1787. Unless we simply ignore the debates and votes of the founding fathers at the 1787 convention, it is hard not to conclude that the US has strayed far away from the monetary system that the founders tried to prohibit constitutionally.

The founders of the United States believed that they had shut and barred the door to the use of fiduciary paper money forcibly imposed as a legal tender for debts, public or private.