The government isn’t the only entity allowed to issue money. Private citizens and businesses can too, and throughout U.S. history, they often have. But private money—as such money is called—isn’t issued much these days. What lessons have our experiences with private money taught us, and what do they imply for our money today and in the future?
Who is allowed to issue money in the United States? The founding fathers made it clear that the power to create money would not be taken lightly. Their experiences with money and inflation during the Revolutionary War made them wary of paper money and conscious of the power wielded by those authorized to create it. They gave Congress the right to issue money and forbade the states from doing so. But the federal government isn’t the only entity that has, in practice, issued money. Private citizens and private companies have, too.
In the 1800s, for example, much of the country’s paper currency consisted of notes issued by private banks. Nowadays, commercial banks don’t print their own notes, but they create money just the same—in the form of checking accounts. People and companies other than banks have also occasionally seen the need to create their own forms of money.
Private money—money issued by individuals or companies—can be seen as an innovation that arises to fill a void left by the federally provided money of the day. Studying various examples of private money that have arisen throughout U.S. history has taught economists much about the qualities money must have to be useful. In this Commentary, we describe some of the needs private money has arisen to fill and some of the problems people have encountered when making or using private money. We consider the lessons our experiences with private money imply for our money today and in the future.
Who Needs Private Money?
The list of those who have issued private money in the United States is long. Besides state and national banks (that is, banks established by state or federal charter), transportation suppliers such as canal, turnpike, and railroad companies have issued money. Coal mining and lumber companies have issued money, often called scrip, to pay workers. Merchants, farmers, and community groups have created their own money, too. Each of these examples of private money arose to serve purposes that were not well served by government-provided money. These purposes include having a currency suited for making small purchases, having a medium of exchange in remote locations, and having a means of exchange during financial panics.
Problems with Small Denominations
In the 1800s the Treasury issued coins and occasionally a limited number of notes, but paper currency was also issued by state and national banks. Banks were prohibited from making small denominations by their regulating authority (the state legislature or the U.S. Congress), which made their notes hard to use for many purchases.
State banks originally could only issue notes in denominations of $1 or more. New York and Pennsylvania were the first of many states to increase the restriction to $5 or more. National bank notes could be issued only in denominations of $1 or more from 1863 to 1879, and after 1879, only in denominations $5 or more. By 1882, all smaller-denomination national bank notes had been taken out of circulation.
At the time, a denomination as little as $1 represented a large amount of money. In the 1830s, a newspaper cost a penny. In the 1880s, a laborer typically earned $5 per week. In 1890, a family paid about six cents for a pound of bacon. Trying to buy everyday items was awkward with state and national bank notes.
The case for banning small-denomination bank notes goes all the way back to Adam Smith’s The Wealth of Nations, published in 1776. He argued such a ban could prevent inflation. Bank notes of his era were usually redeemable by the issuer into gold or silver coin. Smith believed that if banks were allowed to issue only large-denomination notes, the public would have a greater incentive to redeem them. Frequent redemption was expected to keep banks from overissuing notes. Because small-denomination notes, by contrast, might pass hand to hand for a long time before anyone saw the need to redeem them, it was thought that banks would print more notes than they could redeem with the gold and silver they kept on hand. Without a check on the amount they could issue, a bank might make too many notes, resu
