It may seem like the dollar – the U.S. currency – has been around forever.  But in our country’s infancy we had a different currency called the Continental currency, or Continentals.  And even before Continentals, the colonies issued their own currency to finance things like military campaigns, buildings, and pay government officials and the like.  Also, bills of credit were issued by the government and by the states.  Those were, in essence, promises to pay a debt.  There was not much coinage (actual coins made of metal) minted by the U.S. in those early years. 

The Continental

Continentals were issued by Congress in large part to fund the Revolutionary War against the British.  When Congress deemed it needed more money for the war, it printed and circulated more Continentals.  Thus, by the time the war was winding down there was too much paper currency and bills of credit in circulation.  There was also a problem of counterfeit currency on the market.  And by that time, Continentals were worth almost nothing. 

Many attempts were made to shore up the currency to no effect.  When the Continental Congress then ratified the Constitution, it included language prohibiting the states from issuing their own currency, limiting the number and type of currency in circulation.  An attempt also was made to take old currency out of circulation in order to make what was left more valuable.  However, none of these efforts worked effectively.

After the Revolutionary War wrapped up Congress appointed a Superintendent of Finance to monitor monetary policy and a few years later the U.S. authorized a new currency, the U.S. Dollar.

Pieces of Eight

Why “dollar” and not “pound”?  We were a British colony after all.  Well before and during the war, much of the coinage in circulation were Spanish pesos and eight of them were called a dollar (pieces of eight refers the fact that Spanish currency is divisible by eight).  In fact, most of the coinage circulating of the time was from somewhere else, not minted here.  Thus, when it came time to create a national currency, Congress chose a moniker that was already in circulation.  Fun fact: the Spanish dollar was still legal tender in the U.S. up until 1857.

Back when the Continental Congress ratified the Constitution it also included language that connected the dollar to the value of gold and silver.  And our dollar was backed by gold and/or silver for a long period of our history until 1971 when our currency fully became fiat currency rather than currency backed by commodity.

What is the difference you may ask.  Commodity currency is backed by a thing of value, like gold or silver.  But, if your currency is backed by a thing – even if that thing is shiny and pretty and worth a lot – there are only so many of those things.  And if you come to the end of your things to back your currency then you must limit growth.  Or worse, devalue your currency. 

Gold Standard

The U.S. dollar being backed gold and silver is not as straight a line as some may believe.  At times of war and heavy financial pressure the government could and did issue treasury bonds backed only by the government.  Fun Fact: for a long time one could take one’s dollar bills into the Federal Reserve bank or one of the Regional Reserve banks and request they be exchanged for gold or silver.  In 1900 silver was detached from it and only gold was used to back the dollar.  There were several variances in the valuation of a dollar linked to gold until finally in 1971 the dollar was allowed to become fiat currency. 

A fiat currency, which most of the world’s currencies now are (remember our discussion of Bitcoin?), is backed by an entity.  In our case, the dollar is backed, as it states on bills by “the full faith and credit” of the U.S.  So, now instead of things of value determining how much our currency is worth, the stability of the entity determines (among many other factors) the value of the dollar.  This is where the Federal Reserve comes in.  As the central bank of the U.S. it alone determines monetary policy and thus how much cash and debt is in the market at any given time.