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October 1,1976

Fiscal 1777—and 1977
Today marks the beginning of fiscal
year 1977, which ushers in a change
in the timing of the fiscal year and
also in the way Congress formally
handles the budget. First, Congress
has shifted to an OctoberSeptember fiscal year from the JulyJune dating that had been in use
since 1843. More importantly, Con­
gress has adopted (after a dry run in
1976) a new budget procedure that
treats the Federal budget as an
integrated whole, rather than an
unrelated mixture of tax and ex­
penditure bills. For fiscal 1977, Con­
gress has set a limit of $413 billion
on Federal expenditures, which
with estimated revenues of $365
billion will result in a deficit of
nearly $51 billion.
As we arrive at what may be a
turning point in fiscal history, we
should find it instructive to see how
the Founding Fathers handled their
fiscal and monetary problems. Fis­
cal 1777 was somewhat different
from today, except (alas) for the
sizable deficit occurring in that and
every other year of the Revolution­
ary War period. The Continental
Congress operated with a rather
crude budgetary process, covering
most expenditures simply by ex­
panding the volume of money in
circulation. Thus there arose an
inflationary process that led to the
rejection of paper currency as a
medium of exchange—and to the
coining of the phrase, “ not worth
a continental."
Borrowing instead of taxing. . .

The Founding Fathers financed the
new government in a variety of
ways, although notably not by taxa-

tion. Mindful of the role of English
taxation in causing the Revolution,
the Continental Congress failed to
levy any direct taxes, and largely
failed in its attempts to obtain tax
money from the states—the one
exception being requisitions for
supplies, which accounted for
about 7 percent of total war reve­
nues. Another 12 percent came
from foreign loans and subsidies,
which flooded in after the Conti­
nentals had already won their war
at Yorktown in 1781.
Altogether, Congress obtained
about four-fifths of its funds simply
by issuing domestic debt. Some of
this represented interest-bearing
bonds, including the forced invest­
ment of confiscated loyalists'
estates, and some represented cer­
tificates issued by army quartermas­
ters to pay for supplies. However,
most of the war financing came
from frequent new issues of paper
money.
. . .leads to money overexpansion

At the beginning of the Revolution,
the total amount of money in circu­
lation amounted to $12 million—
one-third in gold and silver, and the
rest in paper notes issued by indi­
vidual states or by the Crown. But
then, after the Continental Con­
gress authorized the issuance of
continentals, the money supply
rapidly expanded. Part of the prob­
lem was the proliferation of individ­
ual state currencies; indeed, there
were in effect fourteen separate
monetary authorities, all of them
empowered to issue paper curren­
cy. With fourteen separate mone­
tary authorities failing to coordinate
(continued on page 2)

Digitized for F R A S E R


Opinions expressed in this newsletter do not
necessarily reflect the views of the management of the
Federal Reserve Bank of San Francisco, nor of the Board
of Governors of the Federal Reserve System.

their activities, and with fourteen
separate fiscal authorities failing to
levy taxes, the inevitable result was
an overissue of currency to finance
the war. In 1777, a year of relatively
moderate monetary expansion, the
combined national-state note issue
increased 43 percent.
Following several years of such be­
havior, the Continental Congress
tightened up in 1780, by calling in
the heavily-depreciated old curren­
cy and making a 20-to-1 exchange
for new notes. The currencystabilization plan stipulated that the
individual states would turn in all
old notes, and would then receive
new notes in return for a $15million payment, apportioned ac­
cording to population. This attempt
to fund the outstanding note issue
succeeded in reducing by half the
volume of continental currency in
circulation.
Unfortunately, the individual states
continued along their former path,
so that new state issues in 1780-81
more than replaced the retirement
of continental currency. The depre­
ciation of the outstanding issues
continued, and paper currency
eventually became no longer ac­
ceptable as a medium of exchange.
This paper had only a speculative
value, deriving from the possibility
of eventual redemption.
. . .and thus to inflation

As might be expected, heavy reli­
ance upon the printing press for
war financing helped to drive up
prices. Indeed, one of the more

Digitized for F R A S E R


striking features of the Revolution­
ary era was the rapid and fairly
uniform response of prices to
money-supply changes, with prices
responding normally with a lag of
one to two years. Between 1775 and
1779, the period of greatest note
issue, wholesale prices rose three­
fold (see table below).
But during the following half­
decade, prices dropped sharply as
paper money ceased to be accept­
ed, and as commerce came to be
conducted with a much smaller
money supply consisting of gold
and silver coin. (Because of its lack
of general acceptability, the volume
of paper currency outstanding dur­
ing this period was not a reliable
guide to the effective money stock.)
Prices dropped by one-fourth be­
tween the 1779 peak and 1783, and
they dropped by almost half in the
1783-85 period, when a sharp dete­
rioration in the trade balance led to
a significant outflow of hard money.
Lessons for today

In most areas, it's hard to find paral­
lels between 1777 and 1977. After
all, the financial system of a highly
industrialized nation of 215 million
is vastly different from that of a
farm-based economy of only 3 mil­
lion people. But the relationships of
deficit war-financing, monetary ex­
pansion and inflation are just as
obvious today as they were two
centuries ago. Within the past dec­
ade alone, we have seen the con­
sequences of building a deficitfinanced war economy atop a fully-

employed civilian economy. We
have also witnessed the lagged re­
sponse of prices to the monetary
overexpansion generated by such
deficit financing.
Perhaps the closest link to two cen­
turies ago is our achievement of an
objective of which the Founding
Fathers dreamed—the treatment of
the Federal budget as an integral
document, which gives equal
weight to both the expenditure and
revenue columns. Up to now, the
appropriations and revenue-raising

functions were handled by entirely
separate groups of committees, so
that the amount of deficit or surplus
depended upon separate tax and
revenue decisions. Henceforth,
federal programs will not be
funded independently, but instead
will be considered within the con­
text of an agreed-upon level of
expenditures, in a process which
permits a certain degree of control
over aggregate Federal spending.
The Founding Fathers would be
pleased.
Herbert Runyon

Note Issue and Prices During
the American Revolution

Year

1775
1776
1777
1778
1779
1780
1781
1782
1783

Total
Note Issue*
($ Millions)

Annual
Change
(percent)

Wholesale
Prices

Annual
Change

(1910 - 1 4 = 100 )

(percent)

22.8
52.4
75.0
147.2
303.8
279.2
367.8
367.6
369.5

90.0
129.8
43.1
96.3
106.4
-8.1
33.2
-0.1
0.5

75
86
123
140
226
225
216
210
170

-1.3
14.7
43.0
13.0
61.4
-0.4
-4.0
-3.0
-19.1

•Continental and state issues combined

3




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BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
Selected Assets and Liabilities
Large Commercial Banks

Amount
Outstanding
9/15/76

+
+
+
+
+
+
+

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)—total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.S. Treasury securities
O ther securities
Deposits (less cash items)—total*
Demand deposits (adjusted)
U.S. Government deposits
Time deposits—total*
States and political subdivisions
Savings deposits
Other time deposits!
Large negotiable C D ’s

90,072
68,403
1,995
21,895
20,636
11,457
9,176
12,493
89,212
25,636
625
61,295
5,328
27,088
26,463
10,746

Weekly Averages
of Daily Figures

W eek ended
9/15/76

Member Bank Reserve Position
Excess Reserves
Borrowings
Net free(+)/Net borrowed (-)
Federal Funds—Seven Large Banks
Interbank Federal fund transactions
Net purchases (+)/Net sales (-)
Transactions of U.S. security dealers
Net loans (+)/Net borrowings (-)

Change
from
9/08/76

-

+
+
+
-

+
-

-

683
657
380
194
29
9
156
130
417
151
237
99
44
4
78
72

Change from
year ago
Dollar
Percent
+ 3,748
+ 3,429
+ 282
— 824
+ 990
+ 1,254
+ 492
173
+ 2,690
+ 1,258
+
9
+ 1,120
496
+ 6,214
3,272
- 5,006

W eek ended
9/08/76

+
+
+
+
+
+
+
+
+
+
+
-

4.34
5.28
16.46
3.63
5.04
12.29
5.67
1.37
3.11
5.16
1.46
1.86
8.52
29.77
11.00
31.78

Comparable
year-ago period

16
4
20

20
119
99

+

26
3
23

+

280

-

730

+ 1,679

+ 1,255

+

337

+

-

965

♦Includes items not shown separately. ^Individuals, partnerships and corporations.
Editorial comments may be addressed to the editor (William Burke) or to the author. . . .
Information on this and other publications can be obtained by calling or writing the Public
information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120.
Phone (415) 544-2184.