In Part 1, we covered how the Dollar originated, and learned that a Dollar was originally a measurement of a specific quantity of gold or silver. Specifically, one dollar meant a coin consisting of 375.64 grains of silver, or 15.238 grains of gold (going forward, we will switch to the more familiar troy oz). As a unit of measure, one could not properly claim to have a dollar in their pocket, but rather a dollar in silver, or a dollar in gold, or a “one dollar note” in their pocket. It is important to realize that a “note” for a dollar was not a dollar. To say I have a dollar in my pocket would be akin to saying I have a quart. A quart of what? This is not just semantics, as you will see.
Under the original system, a dollar bill was similar to a personal check that you might write against the money in your checking account. The check isn’t valuable by itself, but it is valuable because of what it represents. You can exchange it for the amount of cash that is written on the face of it. Similarly, a dollar bill could be brought to a bank, and exchanged for a real dollar of gold or silver. Take a close look at the paper dollar in the photo below. At first glance, it looks familiar, but read what it says right below the picture of Washington.
“One silver dollar, payable to the bearer on demand”. You can see how it is just like a personal check that we use today, except this check is written by the US treasury. Just like our personal check, this piece of paper wasn’t valuable by itself. It was only valuable because you could bring it to a bank, and exchange it for actual money like this.
This is an actual dollar (i.e 0.77345 oz) of silver. This coin is what made the paper dollar note (above) valuable. Of course, if you preferred gold, you could instead choose a dollar (i.e .04837 oz) of gold, and get a coin like the one shown below.
If you are like me, you don’t care much for carrying coins in your pocket, so a paper dollar note was preferable for everyday use. The US treasury created paper dollar notes for our convenience. The important thing to remember though, is that the paper dollar by itself was worthless. It was only accepted as a substitute for a real dollar because everybody knew you could exchange it for real money any time you wanted to.
Now that we’ve shown how a paper dollar is similar to a personal check, let’s expand on this comparison. If we write a check without having the funds to back it, the check is going to bounce, and we are going to have a problem on our hands. Do it often enough, and with large enough sums, and we will land ourselves in jail. But what if we were immune from the law? What if we could write bad checks, but there wasn’t any authority with the power to do anything about it? What if we were the law?
This is the scenario governments find themselves in when they aren’t constrained by a hard money system such as a gold standard. Buying votes is much harder when you first have to collect gold from your electorate. People in government are humans, and when faced with the temptation to cover expenses by slipping a few rubber notes into circulation, there is no higher authority to punish them. Eventually someone would succumb to the temptation. Furthermore, as long as everyone believes they can redeem their paper dollar for a real one, who is going to actually do that? Nobody wants a bunch of heavy coins clanking in their pocket.
You know where we’re going with this. It didn’t take long before a light bulb went off—since very few people actually redeem their notes for real dollars, maybe it wouldn’t hurt to print a few extra notes. Imagine the opportunities that the politicians of the day envisioned when the counterfeit note was accepted just like a real one! Think of how much easier it was to maintain power when they could simply order the printer to make more money, as opposed to first having to take it from their constituents! Now they could promise a tax cut, and increase spending!