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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 uoiSujqsBM • qeifl • uoSaJO • EpeAON • oqepi J IB M B H • B |U J O p |B 3 . B U O Z JJ V • E > |S E |V dosoor 1 '1 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.
