05 May, 2015

You can learn many important lessons about a nation’s history through studying the development of its currency; the story of the American dollar is an excellent example. As with the currency system in many other nations, the USA borrowed many concepts of its economic system rather than inventing them, but what emerged took on a unique American flavor.

The dollar came into being before the United States was even formed and has stayed with us over all these years. It has gone through many different transformations, but it still holds its own in the world marketplace. The dollar went from being a humble, unofficial currency of a would-be nation, to become the most powerful financial currency in the world. Many economists think this dominance is about to fade but this situation takes nothing away from the achievement.

The Beginnings of the American Dollar

The term “dollar” is not originally American. This phrase was borrowed from the Spanish who called their colonial money “dollar”. As a familiar term, America’s early currency borrowed the terminology, and it has stood the test of time.

The dollar, composed of one hundred cents, has been used as a means of purchasing goods and services since before the United States was ever envisaged. The use of the dollar term could be traced back to the 1690s. Massachusetts Bay was the first of the American colonies to use a paper currency with the name of “dollar.” These original dollars were used to help fund military endeavors. So-called colonial script, an early version of paper currency, came into use regionally as a convenient means of purchasing or trading services. The early dollars, often referred to as “notes”, were backed by a variety of physical, tangible goods and even services.

In 1786, the dollar was approved by Congress as the basic unit of American currency, but the official establishment of the dollar as the financial tool of the United States was put into place by Alexander Hamilton in 1792. Hamilton, who was treasury secretary at the time, helped put through the Coinage Act that made the dollar the national, official currency of the United States.

The Gold Standard

In 1853, the gold standard was introduced, albeit informally. It would not be until the turn of the century that the gold standard would be officially implemented, as, in the mid-nineteenth century, the value placed on silver began to decline. The composition of coins containing silver also began to change with the amount of silver put into coinage, as well as the actual size of the coins being reduced. The reason that silver would become devalued so quickly was the result of the discovery of a huge deposit of silver resources in America; this led to a lower market value of silver, and therefore lowered its purchasing power.

It is interesting to note that until 1857 foreign currencies such as the Spanish dollar were legal currencies that could be used, without exchange, to purchase goods and services in the USA. This would change, however, in 1863 when the dollar became the sole legal currency of the United States. This came as a result of the National Banking Act, as well as the onset of the Civil War.

The gold standard was finally signed into law on March 14, 1900. This made gold the only legal basis of the American currency with the dollar’s value set to the equivalent of 1.5 grams of gold. The gold standard was seen as a solid, safe way to ensure confidence in the currency since paper bank notes could now be exchanged for actual gold.

The End of the Gold Standard and the Introduction of the Fiat Dollar

While the gold standard was seen as a stable system of currency, it quickly became clear that this was not the case if debts and war affected the economy. The Federal Reserve Act of 1913 also fundamentally changed the way in which America’s economic system worked. This Act introduced the Federal Reserve, a private bank, as the keeper of the nation’s economic and monetary policy. While the gold standard was still in place at this time, the introduction of the Federal Reserve and its alternative views of currency marked the beginning of the end of the gold standard.

Around this time, due to the talk of war and the massive debts incurred, corporations began to make a run on gold to liquidate their bank notes and repay their debts. This triggered an economic chaos that led to an emergency suspension of the gold standard and the unprecedented closing of the New York Stock Exchange on July 31, 1914. After a few months of economic turmoil that rocked the world at the start of the First World War, the gold standard was reintroduced. The New York Stock Exchange reopened, but the gold standard wouldn’t last for much longer.

Eventually the United States remained the only Western nation that still employed the gold standard. This was made possible in large part because the USA remained neutral for much of the First World War. The costs of war wrought havoc on the economies of Europe, but the USA emerged relatively strong. However, the return of peacetime did not bring a long period of economic recovery. During the Great Depression of the 1930s the dollar began quickly to deflate in value. To stem the bleeding of the American economy and ensure that the American dollar remained competitive, President Roosevelt suspended the gold standard, yet again.

To help stabilize the currency, and attract outside investment into the United States, the Gold Reserve Act was introduced in 1934. This based the value of the dollar on the price of a troy ounce of gold, valuated at $35 at the time. This measure helped to stem the tide of deflation, but the days of the gold standard, in any shape or form, were now numbered.

In recent years there has been some discussion about the merits of returning to a gold standard system. Nobody is seriously going back to a situation with gold coins in regular circulation. Although the US Mint still produces gold dollars, they are now aimed at the investor and collector market. Nobody would be foolish enough to use these gold dollars in place of paper dollars since they are worth hundreds of times more than the equivalent dollar bills.

The arguments over reinstating a gold standard focus on whether linking the currency to the country’s gold stocks will increase stability. The government will be unable to print more notes if the gold backing is not available. This will restrain excess government spending and the growth of national debt. While some believe this will be good for the economy, other economists argue against restricting the government’s ability to intervene in the economy. For example, if unemployment rises the government can reduce interest rates and print more money to stimulate the economy. A person’s attitude to interventionist government policies usually determines on which side of this debate they will find themselves.

Today’s Dollar

The current valuation of the American dollar is not backed by any gold or silver. Whereas one used to be able to exchange bank notes for tangible materials, the US dollar is now managed by what is called a fiat system. Fiat currencies have no physical backing but their value is based on economic health—a country’s productivity combined with world confidence in the marketplace regarding that country’s economy. This effectively means that bank notes, which used to be exchangeable for gold, are now backed by confidence and nothing more. For the US dollar this amount to another step in its evolution from a group of different regional currencies collectively called the dollar into the most powerful currency in the world.

Today economists also have serious doubts over the dollar’s continued dominance. The US bank collapses of 2009-2010 led to a serious decline in world confidence in the dollar. The European Union wants the Euro to become the chief means of exchange. The rapidly growing economies of India and China could promote their currencies to occupy the role up until now fulfilled by the dollar. Nevertheless, America remains a country rich in natural recourses and with a highly skilled workforce. The dollar has shown great resilience and its fall from prominence is far from certain.

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