Relative to the resources at their disposal, the struggle for independence by the American colonists was a massive undertaking. Not only did war mean bloodshed and material hardship, but in 18th century America, it also meant building from scratch the institutions necessary to fight a war. New diplomatic, military, and financial institutions needed to be developed with little time or money to spare. Sustaining the American War of Independence was an expensive proposition, taken on at a time when the economic health of Britain’s American colonies was deteriorating under the strain of rebellion. In regards to financing the war, it was a case of desperate times calling for desperate measures.

Printing Money and Bonds

           At the start of the War of Independence, in 1775-6, the rebelling colonies were in dire fiscal condition. The Continental Congress, the closest thing to a central government the Americans had, was in even worse condition; it was raising an army but had no power to raise the taxes needed to pay for it. In short order, the cities of Boston and New York would fall to British occupation. Though these cities accounted for only a small fraction of the population, they were its biggest ports; the military situation had brought the American economy to its knees. Historians have estimated that the contraction brought on by the war was equivalent to an over 40% drop in GDP.

           Naturally, this economic devastation led to a worsening financial condition as the war dragged on. Simply put, the governments of the colonies were unable to finance their own defense by taxing a disintegrating economy. Its been estimated that well under 10% of the war’s expenditures were paid for by tax revenue generated during the war. Though secret French material and financial assistance began in 1776, the Continental Congress was nonetheless unable to marshal the necessary financial resources, at least using conventional means. Contributions to the Congress were voluntary and the rebellious colonies were holding back on making any payments.

           The printing press provided a potential solution, and as such, the Continental Congress turned to it with maximum effect. At a time when each colony had its own currency, what concern was there for creating a new one. Continental dollars were printed by the Continental Congress from 1775 through to the end of 1779 and were used to compensate owners of requisitioned supplies. The new currency was nominally backed by Spanish milled dollars, better known as ‘pieces of eight’, or their equivalent value in gold or silver. However, by the beginning of 1777, just a few months after the signing of the Declaration of Independence, the pace of new issuance had outstripped the supply of precious metals available to back the notes.

           It was from there that the currency began to fall in value precipitously. The phrase “not worth a Continental” became a common expression and it became clear, even to many at the time, that the public would pay for the war through inflation. This inflation was worsened by substantial counterfeiting, which was even employed as a weapon of war. The British forces occupying New York, intent on weakening the American economy, hired counterfeiters to print fake Continental currency and distribute it in the colonies. Two such counterfeiters hired by the British, and earlier supporters of the rebel cause themselves, David Farnsworth and John Blair, were executed for the offense in 1778.

           Notwithstanding the fake notes, about $200 million in Continental Currency were printed. The resulting seigniorage proceeds, the difference between the face value of the notes and their production costs, are estimated to have paid for 40% of the war’s expenses. Together with the money printed by the colonies individually, it likely accounted for the majority of the war’s cost. Not long before, printing presses were busy producing propagandistic pamphlets supporting the rebel cause. Now the machines were doing their part to pay for it; the printing press had become a weapon of war itself.

           Regardless, old-fashioned debt securities were also issued to pay for supplies, much of it forcibly requisitioned. Even soldiers’ wages were increasing paid out in debt certificates as the war went on. This was especially true in the last two years of the war, when Congress stopped printing new money and turned increasingly to traditional debt financing instead, a rare instance of a ‘revolutionary’ state exercising financial restraint. Of course, these obligations were payable in what was perceived of as fiat money; faith that there was any chance of redemption in specie was low and so the securities dropped in value alongside the currency.

Terms and Conditions

           There were various types of debt obligations used to finance the war’s expenditures, some issued by the colonies and some by the Continental Congress. They carried very different terms. For example, most obligations issued by the Continental Congress were zero-coupon certificates, they paid no interest and were issued at discounts to face value to compensate the buyer. This served to ease the debt burden in the near term, though there were some bonds placed with wealthy individuals that did pay interest. However, these interest paying bonds were not as common.

           In contrast, the debt obligations of the colonies did tend to pay interest. The example below is a debt certificate issued by Massachusetts. It was issued in 1777 and matured three years later, in June 1780; it paid 6% interest annually. Curiously, the bond was redeemable in any of several different currencies listed in an act of the Massachusetts government, including Spanish milled dollars and other coins from Britain, France, Spain and Portugal. Maturities on colonial debt most often ranged from one year to six and denominations were not standardized. Bonds were issued for whatever sum a buyer would be willing to subscribe for, leading to denominations as strange as 104 pounds and 2 shillings.

Performance

           In the end, the Americans won their war for independence, but what became of these Revolutionary War debts? Even though the bonds were officially denominated in Spanish milled dollars, faith that this commitment would survive the war was low. Consequently, the bonds sank in value as the Continental currency’s value evaporated, even when the course of the war turned in the rebels’ favor. The last Continental dollars were printed in November 1779, by which point they had fallen to one-fiftieth of their initial value in specie. Despite a halt in new issuance, inflation was still severe; by the beginning of 1781, on the eve of the war’s end, the currency was worth less than 1% of its initial value.

           There was some attempt at normalizing the rebels’ finances even before independence was truly obtained. Robert Morris, appointed the Continental Congress’s Superintendent of Finance in 1781, tried to consolidate the wartime debt and divert precious metal to the central government from the individual colonial governments. However, there was still no plan to actually pay down the large debt; it was simply an issue that had to be left for better times. The individual colonies’ debts were in hardly better shape. Their obligations, like those of the Continental Congress, often changed hands at as little as 10% of face value.

           However, the prospects for bondholders began to improve in the mid-1780s as had the economic climate overall. The war was over and inflation began to subside. Even better for creditors was the drafting of a new Constitution in the late-1780s, one that would give the new federal government the necessary taxation powers to repay the debt. Soon, the newly appointed Treasury Secretary, Alexander Hamilton, made it policy to redeem the bonds at face value rather than buying them up at depressed market prices in order to enhance the nation’s creditworthiness. The government also sought to avoid making distinctions between creditors, aiming to treat all on an equal footing. Some, including James Madison, a future President, had argued in favor of buying at market prices and only paying back face value to any original buyers who had held their bonds through the way down.

           Finally, in 1790, state debts and those of the Continental Congress were consolidated by issuing new securities to retire the old ones. Over $18 million in state debt was assumed; combined with the central government’s debt of around $50 million, the initial federal debt of the United States stood at $70 million. On news of the impending full redemption at face value, market prices on the old wartime certificates surged in late-1789 and 1790. The abrupt recovery meant the market had clearly not priced in much chance of repayment at face value.

           The notes that financed the redemption of the Continental Congress’s debt certificates included 6% coupon bonds which paid interest quarterly. As standardized securities, they were surprisingly liquid. The actions of the new government had established the country’s creditworthiness and this attracted foreign investors; these early American sovereign bonds even traded in London. They had clearly become the worthy predecessors to today’s Treasury securities. 

Lesson

            With its bonds trading at as low as ten cents on the dollar, the country’s creditors were writing them off as a lost cause. Why wouldn’t they? In the 1780s, the new republic lacked a government in any position to pay them back and the overall economic picture looked bleak. However, coming out of that decade things began to look very different; the improvement in the country’s financial fortunes was rapid. The work of men like Alexander Hamilton in putting the new nation’s finances in order is well known in American history. Just how desperate a situation they inherited is not.

Further Reading

1.     Bolles, Albert Sidney. The Financial History of the United States, from 1774 to 1885. 1886.

2.     Calomiris, Charles W. “Institutional Failure, Monetary Scarcity, and the Depreciation of the Continental.” The Journal of Economic History, vol. 48, no. 01, 1988, pp. 47–68.

3.     Doty, Richard G. “Promises to Pay, Promises Unkept.” The Colonial Williamsburg Official History & Citizenship Site, 2003.

4.     Sambasivam, Richard. “What Do Bond Prices Tell Us about the Early Republic?” Journal of the American Revolution, 25 Aug. 2016.

5.     Smith, John L. “How Was the Revolutionary War Paid for?” Journal of the American Revolution, 23 Feb. 2015.

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