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Early American Experiences With Taxes and Inflation

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There’s no doubt many of those who speak out loudly against “fiat money” imagine they are harkening back to an earlier age of “sound money.” They may be surprised, however, that the history of fiat money in America is very, very long and the acceptance of governments issuing fiat money was almost uniquely American for quite some time.

I’ve been reading the book “American Public Finance and Financial Services, 1700-1815” by Edwin J. Perkins. It makes for some enlightening reading about the early monetary system of the United States.

The first thing to note about the early issuance of fiat currency is that one of the central claims made by Modern Monetary Theorists is true. Spending in the colonial days was not fully constrained by revenue. The colonies did not have to collect money before they spent it. In fact, the entire purpose of issuing fiat money was to allow for spending first.

A colonial government would vote to issue fiat currency that it promised to redeem at a future date. This currency would be spent to pay public debts. It was really a form of indebtedness, often referred to as a “tax anticipation bill.”

And here’s another part where the historical record supports MMT.

Colonial taxes really were levied to retire the fiat currency. They were a means of controlling inflation . In fact, it appears that very often it was necessary to raise taxes to prevent inflation rather than pay for any current expenditures.

Sometimes the colonies failed at this. The people would refuse to raise taxes on themselves, which would end up devaluing their currency.

But note that what devalued their currency was not the idea the government was going to default on its debt—it was simply the refusal to remove currency from the economy through taxation.

Why were people willing to accept this fiat currency? The MMT folks say it is because of the very tax anticipation element. In the future the government would levy taxes that could be paid in this currency.

This meant individuals were more or less required to collect the currency in their own anticipation of having to pay taxes in it.

I’m not sure this is correct. It seems to me the opposite might be true as well: People accepted the currency because they trusted that the government would protect the scarcity—and therefore the value—of the currency through taxation. I don’t see why we need to make the need to pay the sovereign central to this story.

What’s more, the way future taxes were employed to retire fiat currency emissions seems to undercut this view. Sometimes the taxes were levied in fiat currency. But the taxes were often levied not in the fiat currency but in commodity or specie currency. The proceeds were then used to retire—or buy back—the fiat currency. In this case, the “anticipation of taxes” storyline breaks down. The fiat currency appears to be much more a loan to the government, rather than a result of a prior indebtedness to the government.

A far more advantageous reason for accepting fiat currency, it seems to me, was the ability to pay foreign creditors in devalued foreign currency. Because the fiat currency was considered legal tender for the extinguishing of debts in the relative colonies, merchants shipping goods from England to the colonies were often forced to take the currency at face value, despite the fact that its market value was lower.

In short, fiat currency was attractive because of currency arbitrage opportunities.

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