Given the Constitution\'s ban on the states being able to issue paper money, wha

Question

Given the Constitution's ban on the states being able to issue paper money, what type of institution was the source of paper money in the United States, especially after 1800? How did this form of paper money enter into circulation? How could it be removed from circulation? During the antebellum period, paper money that circulated some distance from its source of issue often traded at a discount; that is, it was worth less than its face value. Economists have typically offered two reasons for this discount: (i) given the distance, there was less information about the financial health of the institution that issued the money and (ii) there was a cost involved in transporting the money back to where it had been issued. Briefly describe why each of these factors would lead paper money to trade at a discount. It has also been noted that the discounts on paper money issued by new banks was higher than those on paper money issued by established banks. Provide an economic explanation for why this would be the case.

Explanation / Answer

Source of paper money in US after 1800 was the Bureau of Printing and Engraving. The bureau was laid down after the civil war, until the bureau was formed to the congress authorized the Secretary of the Treasury to issue paper currency in form of demand notes to the government. Demand Notes were issued in the monetary value of 5, 10, and 20 dollars. The notes were originally known as treasury notes, the name demand notes was given to them as the notes were redeemable for gold coins. The merchants and industries then redeem the demand notes at a discount. During the antebellum period, the demand notes issued by the treasurer were traded at a worth less than the face value as Given the distance there was less information about the institution that had issued the currency: Further the trade was financed by the help of the demand notes, there was limited knowledge of the institution that had issued the currency. By the end of Civil War there were several counterfeits that were circulating in the economy and the coins were being hoarded for the precious metal base that they had. Under this situation, it was difficult to judge the strength of the currency issuing authority. Cost involved in taking money where it was issued- The paper currencies can only be redeemed for the true value in the place that the currency was issued. This will require the merchants to take the currency back to source of origination to get payment against the currency. Hence the money need to be returned to the original source to be converted. The new bank or financial institution has a higher discount rate than a reputed financial intermediary as the reputed institution currency can be traded anywhere across the globe hence there will be higher demand of the currency and the supply will be limited increasing the worth of the currency.

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