The Colonial Legacy, the Crisis of the Colonial Regime

and the Seven Years War

Colonial Economy: Labor, Capital, and Land• Labor: populating the

colonies with free settlers, indentured servants, and slaves– Population 1700---160,000– Population 1750---1,177,000– Population 1770---2,132,000

(largest city Philadelphia with 40,000)

• Rural and thinly populated: 2nd U.S. Census 1800: – U.S.: 5,308,483– New Jersey: 211,149---so

with 8722 sq.m. =24 people per sq mile– Today, NJ: 8,724,560 with

1,134 people per sq. mile (most densely populated state)

The Colonial Economy• Capital: buildings, ships and animals for energy

(horses)• Land: royal policy---initial huge land grants but

growth of smaller holdings, fee simple• Large plantations and small farms, small towns

and cities• Agriculture (70-80% of economy): tobacco, rice

and indigo in the South, the breadbasket of the Middle Colonies; mixed farming in the Northern colonies plus shipping, naval stores, shipping, and sea products

• Artisan and home manufactures—no factories.• No Banks or Financial Institutions permitted

GDP in 1790

• Nominal GDP $180 million• Real GDP (year 2000 $) $3.65 billion• Population 3,929,000• Nominal GDP p.c. $46• Real GDP p.c. $929 or twice medieval levels• In 2004, U.S. GDP p.c. is $36,956

Real GDP per capita 1790-2008, (year 2000 $)

$0.00

$2,000.00

$4,000.00

$6,000.00

$8,000.00

$10,000.00

$12,000.0017

90

1798

1806

1814

1822

1830

1838

1846

1854

1862

1870

1878

1886

1894

1902

1910

1918

1926

1934

1942

1950

1958

1966

1974

1982

1990

1998

2006

The Colonial Regime: Governance

• Colonies established as – proprietorships – royal colonies – some delegation of legislation to colonial

assemblies—propertied males. • Appointed Governor can veto.• Board of Trade (in Britain) determines

constitutionality of American laws.

Economic Policy: Mercantilism• Mercantilism---the dominant theory of economic

policy• Mercantilists argued that a strong state required

heavy intervention in the economy.• Key issue was money---to sustain armies and

navies. • Aim to stimulate overseas trade---get an export

surplus---gold inflow. • A zero-sum, predatory world. Gold in king’s

treasury and merchants was gold denied to others.

• Ban export of specie (gold and silver coin) from Britain

Mercantilism and the Colonies• Colonies should provide supplies to Great

Britain, not be a burden or help enemy• Frustration with American colonies. In 1660,

colonies trading heavily with the enemy—the Netherlands and France.

• Result: Navigation Act of 1660 and 1663 and Admiralty Courts to enforce in 1696: Enumerated export products (tobacco, cotton, indigo, sugar) must be carried on colonial or English ships and must first land in British ports.

• Trade restrictions and discriminatory tariffs exacerbate colonial trade deficit.

Annual Balance of Payments 1768-1772 (£ sterling thousands)

Debits CreditsCommodity Exports 2,800Commodity Imports 3,920Sales of Ships 140Shipping, Insurance 600Indentured Servants 80Slaves 200Taxes to Britain 40Military & civil expenditures 450

Balance Financed by specie flows or debt of 30

Consequences for (1) Monetary System and (2) Financing Enterprise

• For the Monetary System– Estimated annual deficit of £20,000 to

£40,000 (av £30,000 must be paid by specie or borrowed)

– No gold or silver mines---hence monetary scarcity

• For Financing Enterprise– Some short-term debt, merchants credit,

increasing indebtedness, especially tobacco planters.

– No long-term investment, except from savings

(2) Financing ConsequencesThe Modern Flow of Funds

BorrowersSavers

Financial Markets

Financial Institutions

Flows Returns

The Colonial Flow of Funds: Consequences for Growth?

BorrowersSavers

Financial Markets---non-existent

Financial Institutions---almost non-existent (a few land banks)

Flows Returns

(1) No Banks, No Paper Money and a shortage of Gold and Silver….so…..

• Barter---what’s the problem?

• Wampum---legal tender for private debts in Massachusetts until 1661.

• Tobacco—in Maryland and Virginia. Quality? Government warehouses—tobacco notes. Crop dependent.

• Other—furs, hides, nails, musket balls

How well do these types of money work?

• Money has three functions–Unit of account–Means of exchange–Store of Value

Payment of Taxes• In 1682, Governor Cranfield listed the articles

to be taken in payment and their prices for tax payments:– Pine Boards at any convenient landing place,26s– White Oak Pipe Staves, at 50s– Red Oak Pipe Staves, at 35s– Beef,2d. per lb. Pork,3d.    – Indian Corn,3s per bush., Wheat,at 5s    – Pease,5s, Malt,3s  Ffish, at price Curr't.– And whosoever shall pay ye Rates in money

   shall be abated one third part."

Colonial Coinage?• Parliament prohibits private export of English coin• Parliament prohibits establishment of a royal mint in the

colonies.• Colonies try and then are fobidden. (In 1652, the first mint

in English America was established at Boston. Pine Tree Shilling below.)

• Colonies used foreign monies, especially coins minted in Spanish America—notably Mexico, which had silver mines.

• But each colony had its own unit of account---there were New Jersey pounds, shillings and pence and so forth.

Colonial Coinage• Parliament expected colonies

to rely on foreign coins---especially Spanish dollar of 8 reales, subdivided by eighths---”pieces of eight”.

• A Spanish dollar if melted down and delivered to English mint would have yielded in British money 4 shillings, 6 pence. The exchange rate was thus, $1.00 = £0.225 or $4.44 = £1.00

NOTE:

1 pound (£)= 20shillings (s) = 240 pence (d)

and then 1shilling = 12 pence

How to handle balance of payments deficit and money scarcity?

• Colonial governments wanted to entice Spanish coin into their colonies so they overvalued it. Equivalent to a devaluation of Colonial pounds.

• In 1642 Massachusetts set the exchange rate at 5 shillings

• In 1645 Virginia set rate at 6 shillings• In 1672 New York set rate at 6 shillings.• Objective to expand the coinage in circulation

and solve the balance of payments problem—how does it fix this?

What’s the balance of payments issue?• Assume price of tobacco is same throughout

world in Britain, Spain, and Virginia: 4s.6d. British pounds sterling or ($1) one Spanish dollar per pound of tobacco

• Exchange rate: 1lb.tobacco = 4s.6d. Colonial = $1 = 4s.6d.British sterling

• Virginia . Two options if there is a balance of payments deficit.– (1) Coin Outflow. Prices fall. Deflation. So 1lb.

Tobacco = 4s colonial. Now $1 or 4s.6d.British buys more tobacco---increases sales, corrects balance of payments. (fall in price of 22%)

– (2) Virginia proclaims that a Spanish $ is now worth 5s colonial ($worth 11% more). So $ buys more tobacco---increases sales, corrects balance of payments. Devaluation of Colonial pound

• Why does Virginia prefer #2---debtors yell

Consequences• Like a modern currency devaluation

(depreciation)---value of debts in colonial pounds falls in value.

• British merchants who lent to colonists furious

• In 1704 Queen Anne issued a proclamation that limited overvaluation to 133% of value.

• Stops efforts to correct balance of payments!

• Benjamin Franklin, “A Modest Inquiry into the Nature and Necessity of a Paper Currency” (1729—age 23). In favor of mortgage-back currency issue by land banks. Increase medium of exchange, no inflation if credibly backed by land or future taxes.

• Adam Smith, “Wealth of Nations” (1776): “a prince who should enact that a certain proportion of taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money, even though the time of its final discharge and redemption should depend altogether on the will of the prince.”

What to do about the Scarcity of Money?

Social Savings of Money

• By increasing real paper money the government allows individuals to conserve specie.

• If paper money is superior as a medium of exchange then it increases welfare by lowering transaction costs.

• Opportunity for government to increase real balances by issuing paper money—a tax.

• But need to credibly commit to back with specie or taxes or land.

(1) Bills of Credit

• Issued by a colony’s treasury to pay for expenditures----mostly wars with Indians or French. Issue specific amount, pledged to be retired out of future taxes, up to 20 years.

(1) Bills of Credit• “Backed” by future taxes—meaning that they

will be redeemed by specie in the future.• Massachusetts first issues bills of credit to pay

soldiers in 1690. • Maryland collected export tax on tobacco to

redeem outstanding currency. • Value of notes fluctuated with credibility of

legislature. Some colonies terrible offenders: New England before 1750, and South and North Carolina---kept notes in circulation or increased quantity.

New Jersey Bill of Credit

(2) Loan Office Notes• Currency issued by government loan offices.

These “loan offices” or “land banks” did not accept deposits.

• Loans granted to residents of colony with real estate as collateral. Collateral usually 2 times value of the loan. Notes are “backed” by land.

• Aim to help purchase land. Set maximum loan £25 to £100 and up to 12 years to repay and low interest.

• Interest on loans pays expenses of colonial government.

• Repayment with currency is then used to retire notes or make new loans.

• Stability of Value depends on credibility of land bank.

Late Colonial Monetary System

• Money=gold and silver coins & currency (bills of credit and loan office notes)

• Problems?

Smith (1984): Colonial Massachusetts

• Two periods: (1) 1720-1750 (2) 1751-1776• Currency—both bills of credit and loan

office notes.• Other New England colonies currency

legal tender.• Small quantity of specie in circulation.

Conclusion for the first period, 1720-1750?

Debtors and Creditors• Most colonies want to expand money supply.

Planters and farmers borrow (debtors) and sell crops.

• English merchants were creditors---Key question for them: would they have to accept colonial pounds or pounds sterling?

• Colonial pounds and pounds sterling exchange rates varied. Problem of colonial depreciation.

• Board of Trade permitted currency to pay taxes and repayment of loans but NOT to pay private debts—that is to make it legal tender.

The British Response• Currency Act of 1751—Parliament sides with English

merchants. New England colonies prohibited from issuing new bills of credit and land banks prohibited.

• The act forced the New England legislatures to finance deficits with sale of interest bearing treasury notes with 2 year maturities in peace and 5 years in war. Notes convertible into specie on demand.

• Act had a sweetener---the British government agreed to reimburse New England colonies for expenses of war with Canada—King George’s War (against French and Indians 1740-1748). Paid in specie. Massachusetts uses specie to reduce its tax anticipation notes.

Conclusion?

Why?

The Crisis of the Seven Years War

War of the Spanish Succession

War of the Austrian Succession or King George’s War

Seven Years War

Seven Years’ War• British send thousands of troops• British pay salaries and expenses in

specie.• Colonies asked to bear a share. They

raise local militia, led by officers below rank of general. (Washington was a colonel.)

• Parliament promise to reimburse colonies for part of their costs.

Seven Years War 1756-1763• The total war expenditures by colonies

were £2.5 million, of which the British Parliament paid £1 million or 40%. The cost represented about 3% of annual income per year.

• The colonies banned from issuing fiat currency. They financed war largely by issuing bills of credit or debt that was then rapidly retired by high postwar taxes.

• Burden disproportionate

Massachusetts• Massachusetts borrows £700,000 at 6% of its

total expenditure of £818,000.• Currency Act of 1751 stipulates all treasury

notes must include rigid schedule of taxation designed to eliminate debt in 5 years. Huge increase in property and estate taxes, especially in Massachusetts.

• Total tax revenue rises from £10,000 to £60,000 p.a. even with £352,000 reimbursement from Parliament.

• Huge burden on Massachusetts population

Other Colonies• Virginia and Pennsylvania pay with currency but

lower taxes and slower phase out.• New York gets ½ of expenditures covered by

Parliament. Only finishes retiring rest by taxes over rest of 1760s.

• New Jersey spends £200,000 but Parliament only grants ¼ for reimbursement. Does not raise enough taxes. Only in 1765 is a plan put in place that reduces this currency over 15 years.

Post-Seven Years War• London merchants fear that colonial courts will side

with debtors and press the Board of Trade. • Board of Trade persuades Parliament to pass

Currency Restraining Act of 1764 extends 1751 act to all colonies.

• Act of 1764 forbids issue of new new currency that included legal tender provisions.

• Colonial outcry. Colonial legislatures force governors to submit legislation to Board of Trade under threat of no salary.

• Board rejects SC and NY, but in 1770 allows PA and NY with legal tender for public only transactions.

After effects of Seven Years War• Seven Years War---1756-1763• Result higher military expenditures—colonists

must provide support: Sugar Act 1764, Stamp Act 1765, Declaratory Act 1766, Quartering Act 1765, Townshend duties 1767, Tea Act 1773, “Intolerable” Acts of 1774, Quebec Act 1774

• Lawrence Harper (1942): “As a mother country, Britain had much to learn. Any modern parents’ magazine could have told George III’s ministers that the one mistake not to make is to take a stand and then yield to howls of anguish.”

At end of colonial period

• 1773 Parliament votes for act to allow currency issue as legal tender at face value for public but not private payments.

The End of the Colonial Regime• War for Independence 1775-1783 cost 15

to 20% of annual GDP, similar to Civil War and World War I (World War II 40%)

• Heavy reliance on money finance (seigniorage) instead of bond finance---the dominant feature in later wars.