Inconvertible paper money consists of notes promising to pay money to the bearer, but not actually redeemable in specie. Such paper may be issued by banks as well as by governments. It is known also as fiat money, because its use as money depends upon the fiat or command of the government. The essence of fiat money lies in the lack of expectation or intention of redeeming it in specie and in the artificial regulation of the amount issued. It circulates "either because the people have no better money, and the quantity of it is so limited that its evils do not yet appear, or because the Government is strong enough to compel its citizens to accept the paper."1 Usually governments in issuing this kind of paper seek to strengthen it by making it a legal tender for debts and by making it receivable for taxes and other public dues.
Inconvertible government notes have usually been resorted to only in times of great fiscal need, when the government has found it difficult to raise necessary funds by the usual methods of taxation or loans. Many countries have had disastrous experiences with this form of currency. Most of the American colonies issued "bills of credit" to meet the expenses of the French and Indian Wars. This appeared to be such an easy method of raising money that some of the colonies used it to meet ordinary current needs. As larger and larger issues of these notes were authorized, without any provision being made for their redemption, they declined in value until they became practically worthless. A similar situation arose during the Revolutionary War, when both the separate colonies and the Continental Congress issued great quantities of irredeemable paper. Continental notes so depreciated that they were quoted in 1781 at 225 to 1 in coin. After the adoption of the Constitution they were made redeemable at the rate of one cent to the dollar.
1 Kinley: Money, p. 332.
The experience of France during the French Revolution affords a good illustration of the dangers of fiat money. Having exhausted all the ordinary sources of revenue, the French Government in 1789 authorized the issue of non-interest-bearing notes called assignats, which at first were secured by the pledge of confiscated lands of the Church. Successive issues were authorized without any pretence of redemption and in such unlimited volume that they depreciated rapidly and finally became worthless.1
To meet the extraordinary expenditures of the Civil War both the Federal Government and the Southern Confederacy resorted to the issue of inconvertible notes. The Confederate notes were issued in vast quantities and toward the close of the struggle became worthless. The first issue of United States notes or greenbacks, authorized by Congress in 1862, was limited to $150,000,000. Within a few months a second issue of $150,000,000 was put out, and before the war was over a total of $450,000,000 had been issued. Gold disappeared from circulation and prices were quoted in terms of this paper money. Greenbacks fluctuated in value with the fortunes of the war, depreciating in 1864 to about 35 cents on the dollar. When these notes were authorized it was understood that they would be retired as soon as possible after the war was over. In 1866, therefore, Congress authorized their contraction, but strong opposition arose and for many years the greenback controversy agitated the country. It was contended that the reduction of the circulating medium would depress prices, disturb business, reduce government revenues, and hinder the Government in its plan to refund the public debt. In 1868 the act authorizing retirement was repealed, and in 1874, when the amount of greenbacks outstanding was $382,000,000, Congress passed a bill increasing the total issue to $400,000,000. Fortunately, President Grant had the courage to veto this bill and in the following year provision was made for a partial retirement of the greenbacks and for the resumption of specie payments after January 1, 1879. In 1878, when the total amount of greenbacks outstanding was $346,681,016, Congress passed a law providing that they should be reissued by the Government as redeemed or received into the Treasury. This law stopped further retirement of the notes, the amount of which has ever since remained at the total mentioned. When, in 1879, the Government resumed specie payments, the greenbacks returned to a parity with gold, for they were then redeemable in gold.
1 See Bullock: Selected Readings in Economics, Ch. XV, "Paper Money in France," by Andrew D. White.
The change in the character of greenbacks from inconvertible or fiat money to convertible or credit money with the resumption of specie payments did not end the difficulties attending their use as a part of the circulating medium. The injection into the circulation of over $500,-000,000 of silver, either in the form of coin or of notes, under the terms of the silver purchase acts of 1878 and 1890, caused gold to disappear and seriously embarrassed the Treasury in its efforts to maintain sufficient gold reserve to redeem the greenbacks and the treasury notes of 1890. The gold standard act of 1900 provided for a gold reserve of $150,000,000 to be held for the redemption of the greenbacks and treasury notes. It also provided that when these notes were once redeemed they should not be reissued except in exchange for gold. Under present conditions greenbacks constitute a useful and acceptable part of our circulating medium, though many thoughtful people see great disadvantages, if not danger, in their use and urge their removal from our currency system.