First Inflation-Indexed Bonds in America, 1777-1780

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First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Thu Apr 23, 2020 1:33 pm

If looking for a short, interesting read in the midst of self-isolation, Robert Shiller wrote a paper in 2003 that reported the origins of America's first inflation-indexed bonds in the late 1700s. From his abstract:
Robert Shiller wrote:The world’s first known inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780 during the Revolutionary War. These bonds were invented to deal with severe wartime inflation and with angry discontent among soldiers in the U.S. Army with the decline in purchasing power of their pay. Although the bonds were successful, the concept of indexed bonds was abandoned after the immediate extreme inflationary environment passed, and largely forgotten until the twentieth century.
A committee of the Massachusetts legislature came up with the idea of indexing the soldier's pay (which was in bearer bonds at the time) to the average index price of four commodities — beef, corn, wool and leather — whose prices were easy to collect and record. Between January 1777 and January 1780, the average price index rose 33% (in red below). Tying the value of the soldier's bearer bonds to this commodity price index ensured they retained their inflation-adjusted value.
Mr. Shiller was even able to find and purchase from a collector a surviving 1780 inflation-indexed bond:
Though inflation-indexed bonds make wonderful sense to us today, they promptly disappeared until the 20th century. Mr. Shiller surmises there was no economic theory in the 1700s about their importance, and there was no need for the indexed bonds and for commodity price indexes beyond the expediency of the war. Which all seems rather strange, since the late 1700s and the 1800s were a time of enormous instability of prices. An idea before its time apparently.
Last edited by SimpleGift on Thu Apr 23, 2020 3:56 pm, edited 1 time in total.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Thu Apr 23, 2020 3:45 pm

Thinking about this a bit more, prices were SO unstable in the late 1700s and the 1800s that inflation-indexed bonds may not have served much of a long-term purpose — beyond the temporary war periods when one might more predictably expect high inflation. When prices are swinging from -20% one year, to +15% the next, then -10% the next (chart below), it's hard to see how inflation-indexed bonds would have been of much practical use?
With the creation of the Federal Reserve in 1913, and the final abandonment of the gold standard in 1971, the fixed expectation of positive future inflation and a positively-sloped yield curve became more or less permanent. In this environment, it's easier to see why inflation-indexed bonds became a thing.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by oldfort » Thu Apr 23, 2020 3:50 pm

It looks like most of the historical inflation periods corresponded to wars: the American Revolution, the War of 1812, the Civil War, and WWI.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Fri Apr 24, 2020 11:08 am

oldfort wrote:
Thu Apr 23, 2020 3:50 pm
It looks like most of the historical inflation periods corresponded to wars: the American Revolution, the War of 1812, the Civil War, and WWI.
Right. We had an insightful Forum thread last month that discussed historical research into wars and pandemics going back to the 14th century. The conclusion: wars have been consistently inflationary and pandemics have been deeply deflationary.

It's a puzzle then that, since inflation-indexed bonds proved so successful during the U.S. Revolutionary War, they were never considered again during and after subsequent conflicts. They pretty much vanish from financial history for about 200 years.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by Harry Livermore » Fri Apr 24, 2020 1:31 pm

Great read, thank you for sharing!
Cheers

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by obafgkm » Fri Apr 24, 2020 8:38 pm

Yes, thanks for posting this!

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by KEotSK66 » Fri Apr 24, 2020 9:11 pm

the note references pounds, 454 pounds in the big writing

weren't we already on our own currency by 1780, just asking

great info, thanks sg
"i just got fluctuated out of $1,500", jerry

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by KEotSK66 » Fri Apr 24, 2020 9:14 pm

maybe answered my own question, i think states were still conducting transactions in their own currencies
"i just got fluctuated out of $1,500", jerry

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Fri Apr 24, 2020 11:08 pm

KEotSK66 wrote:
Fri Apr 24, 2020 9:11 pm
the note references pounds, 454 pounds in the big writing
...snip...
i think states were still conducting transactions in their own currencies
From what I've read, you're right on both these counts. Colonies were issuing their own currencies, and they were denominated in pounds, shillings and pence.

Wikipedia tells us that the value of these denominations varied from Colony to Colony. For example, a Massachusetts pound was not equivalent to a Pennsylvania pound — and all colonial pounds were of less value than the British pound sterling.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by restingonmylaurels » Sat Apr 25, 2020 6:25 am

SimpleGift wrote:
Thu Apr 23, 2020 1:33 pm
If looking for a short, interesting read in the midst of self-isolation, Robert Shiller wrote a paper in 2003 that reported the origins of America's first inflation-indexed bonds in the late 1700s. From his abstract:
Robert Shiller wrote:The world’s first known inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780 during the Revolutionary War. These bonds were invented to deal with severe wartime inflation and with angry discontent among soldiers in the U.S. Army with the decline in purchasing power of their pay. Although the bonds were successful, the concept of indexed bonds was abandoned after the immediate extreme inflationary environment passed, and largely forgotten until the twentieth century.
A committee of the Massachusetts legislature came up with the idea of indexing the soldier's pay (which was in bearer bonds at the time) to the average index price of four commodities — beef, corn, wool and leather — whose prices were easy to collect and record. Between January 1777 and January 1780, the average price index rose 33% (in red below). Tying the value of the soldier's bearer bonds to this commodity price index ensured they retained their inflation-adjusted value.
Mr. Shiller was even able to find and purchase from a collector a surviving 1780 inflation-indexed bond:
Though inflation-indexed bonds make wonderful sense to us today, they promptly disappeared until the 20th century. Mr. Shiller surmises there was no economic theory in the 1700s about their importance, and there was no need for the indexed bonds and for commodity price indexes beyond the expediency of the war. Which all seems rather strange, since the late 1700s and the 1800s were a time of enormous instability of prices. An idea before its time apparently.
SimpleGift,

Interesting historical story, as always but this does not sound completely accurate from Shiller.

All governments involved in this conflict, the new American states, the Continental Congress, the British, the French, the Spanish, the Dutch, were all issuing a variety of financial instruments, some very creative, to fund their participation in the war.

But without a national financial infrastructure like the Bank of England provided and at least on a national level the inability to directly tax, the Americans had it the worst trying to reign in inflation, as the Continental dollar and state currencies devalued significantly.

In essence, all these governments were dealing with the impacts of inflation. Give me awhile and I will get back with an example.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by Harry Livermore » Sat Apr 25, 2020 7:49 am

My favorite quantity of commodity listed:
"Sixty-eight Pounds and four-seventh Parts of a Pound of BEEF"
Really? Not just 68 pounds? Or for that matter, why not just 70?
Four-sevenths???
:confused
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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by Mr. Rumples » Sat Apr 25, 2020 8:33 am

First, thank you for the information and link. I have a deep interest in the colonial era. Virginia was struggling with inflation well before that, but their course was no longer available: to be paid in British treasury notes; on 4 Dec. 1762, a Virginia regiment refused to be paid in Virginia notes due to inflation (Journals of the House of Burgess,1761-1765 pp 124/133).

Regarding the use of portions of pounds, this is not too unusual for the period. For example, this is from a Virginia Act (law) from 1730 (italicized to show where it is):

I. BE it enacted, by the Lieutenant-Governor, Council and Burgesses, of this present General Assembly, and it is hereby enacted, by the authority of the same, That the sum of ten pounds and an half pound of tobacco, be paid by every tithable person, not exempted therefrom by law, within this his majesty's colony and dominion of Virginia, for the defraying and paiment of the public charge of the country; being the public levy, from the first day of February, one thousand seven hundred and twenty seven, to the one and twentieth day of May, one thousand seven hundred and thirty.

I am sure that there are more examples in Hening's Statutes at Large:

http://vagenweb.org/hening/vol04-15.htm

Part of it might also be, I don't really know, that British pound sterling was not on a decimal system and guineas sometimes were 1/7 of a British pound sterling; lots of coinage was in circulation and of course in VA tobacco was still being used, was not on a decimal system at the time. Note payments shown in currency and tobacco:

http://vagenweb.org/hening/vol04-18.htm

(now if only my Confederate bonds had some value, but I digress...)
Last edited by Mr. Rumples on Sat Apr 25, 2020 9:13 am, edited 5 times in total.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by nisiprius » Sat Apr 25, 2020 8:42 am

Nothing about bonds, but one of my first introductions to the concept of inflation and money illusion--well, I also remember a TV news program in the 1950s with a newscaster standing in front of an easel with pictures of a large and a small dollar bill--came from reading A Connecticut Yankee in King Arthur's Court.
A man who hasn’t had much experience, and doesn’t think, is apt to measure a nation’s prosperity or lack of prosperity by the mere size of the prevailing wages; if the wages be high, the nation is prosperous; if low, it isn’t. Which is an error. It isn’t what sum you get, it’s how much you can buy with it, that’s the important thing; and it’s that that tells whether your wages are high in fact or only high in name. I could remember how it was in the time of our great civil war in the nineteenth century. In the North a carpenter got three dollars a day, gold valuation; in the South he got fifty—payable in Confederate shinplasters worth a dollar a bushel. In the North a suit of overalls cost three dollars—a day’s wages; in the South it cost seventy-five—which was two days’ wages. Other things were in proportion. Consequently, wages were twice as high in the North as they were in the South, because the one wage had that much more purchasing power than the other had.
He actually goes on at rather tedious length about this; there is an extended passage, chapter XXXIII, "Sixth Century Political Economy," in which Hank is trying to win an argument about this and fails.

Anyway, it's interesting as you say that inflation did not create a demand for inflation-indexed bonds.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by KEotSK66 » Sat Apr 25, 2020 8:45 am

SimpleGift wrote:
Fri Apr 24, 2020 11:08 pm
KEotSK66 wrote:
Fri Apr 24, 2020 9:11 pm
the note references pounds, 454 pounds in the big writing
...snip...
i think states were still conducting transactions in their own currencies
From what I've read, you're right on both these counts. Colonies were issuing their own currencies, and they were denominated in pounds, shillings and pence.

Wikipedia tells us that the value of these denominations varied from Colony to Colony. For example, a Massachusetts pound was not equivalent to a Pennsylvania pound — and all colonial pounds were of less value than the British pound sterling.
hi SG,

i agree, these different state denominations also contributed to the adoption of the Constitution years later.

again, great thread !
"i just got fluctuated out of $1,500", jerry

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Sat Apr 25, 2020 8:49 am

What impressed me most in all of Mr. Shiller's research paper was this bit of historical context:
Robert Shiller wrote:By the late 1770s, when these first inflation-indexed bonds were conceived and designed, the U.S. War of Independence was in a difficult stage. In 1779, the British Army had just captured the state of Georgia and had taken Charleston South Carolina. The eastern seaboard of the United States was blocked by the British Navy.

The morale of the United States Army was low: They were poorly fed, poorly clothed, and often sick. The morale was so low that, as we now know, there were actual army mutinies in 1780 and 1781. There was real concern in 1779 that it would be impossible to keep an army if something were not done to address the loss of value of their pay. The invention of indexed bonds came in response to this very real and dangerous crisis.
It might not be too much to say that inflation-indexed bonds saved the Continental Army and the budding nation.

PS. In more history, Shiller indicates these bonds were engraved by Paul Revere, the official engraver of Massachusetts.
Last edited by SimpleGift on Sat Apr 25, 2020 12:31 pm, edited 1 time in total.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by SimpleGift » Sat Apr 25, 2020 12:30 pm

Harry Livermore wrote:
Sat Apr 25, 2020 7:49 am
My favorite quantity of commodity listed:
"Sixty-eight Pounds and four-seventh Parts of a Pound of BEEF"
Really? Not just 68 pounds? Or for that matter, why not just 70?
Four-sevenths???
In creating a price index, the legislature had to define a fixed quantity of each of the four commodities — corn, wool, beef and leather — that all cost 1 pound at the prevailing prices in January 1777. Here's Shiller's explanation:
Robert Shiller wrote:The quantities used to define the index were apparently not arrived at by reference to any representative market basket....The quantities were instead defined so that they represent equal currency values of the commodities in 1777.

According to the 1777 Act, “Good Indian meal or corn” cost 4 shillings a bushel, “good merchantable sheeps wool” 2 shillings a pound, “good well-fatted grass fed beef” three pence a pound, “stall fed beef, well fatted” 4 pence a pound, and “tanned hides” one shilling 3 pence a pound. The quantities specified on the bond all cost £1 at these prices (where the two beef prices are averaged to be 3.5 pence a pound.)
Though crude and clumsy, this was apparently the first attempt to create a consumer price index (CPI) in the U.S.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by Harry Livermore » Sat Apr 25, 2020 3:01 pm

It's just funny how all the other items lines up neatly to whole numbers... ;)
Anyway, thanks again for the read!
Cheers

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by restingonmylaurels » Sun Apr 26, 2020 8:16 am

restingonmylaurels wrote:
Sat Apr 25, 2020 6:25 am
SimpleGift wrote:
Thu Apr 23, 2020 1:33 pm
If looking for a short, interesting read in the midst of self-isolation, Robert Shiller wrote a paper in 2003 that reported the origins of America's first inflation-indexed bonds in the late 1700s. From his abstract:
Robert Shiller wrote:The world’s first known inflation-indexed bonds were issued by the Commonwealth of Massachusetts in 1780 during the Revolutionary War. These bonds were invented to deal with severe wartime inflation and with angry discontent among soldiers in the U.S. Army with the decline in purchasing power of their pay. Although the bonds were successful, the concept of indexed bonds was abandoned after the immediate extreme inflationary environment passed, and largely forgotten until the twentieth century.
A committee of the Massachusetts legislature came up with the idea of indexing the soldier's pay (which was in bearer bonds at the time) to the average index price of four commodities — beef, corn, wool and leather — whose prices were easy to collect and record. Between January 1777 and January 1780, the average price index rose 33% (in red below). Tying the value of the soldier's bearer bonds to this commodity price index ensured they retained their inflation-adjusted value.
Mr. Shiller was even able to find and purchase from a collector a surviving 1780 inflation-indexed bond:
Though inflation-indexed bonds make wonderful sense to us today, they promptly disappeared until the 20th century. Mr. Shiller surmises there was no economic theory in the 1700s about their importance, and there was no need for the indexed bonds and for commodity price indexes beyond the expediency of the war. Which all seems rather strange, since the late 1700s and the 1800s were a time of enormous instability of prices. An idea before its time apparently.
SimpleGift,

Interesting historical story, as always but this does not sound completely accurate from Shiller.

All governments involved in this conflict, the new American states, the Continental Congress, the British, the French, the Spanish, the Dutch, were all issuing a variety of financial instruments, some very creative, to fund their participation in the war.

But without a national financial infrastructure like the Bank of England provided and at least on a national level the inability to directly tax, the Americans had it the worst trying to reign in inflation, as the Continental dollar and state currencies devalued significantly.

In essence, all these governments were dealing with the impacts of inflation. Give me awhile and I will get back with an example.
The Continental dollar itself was in essence inflation-linked. Originally issued at a rate of 1 Continental dollar to 1 Spanish milled dollar, through vast over-issuance to pay for the war, the Continental depreciated (and prices reflectively increased).

Within a few years, the Continental Congress estimated it would take 40 Continentals to equal 1 Spanish milled dollar. In reality, they soon exchanged at rates of 100 to 1.

Congress tried to sink (remove from circulation) the Continentals by having them used to pay state taxes (as states were being levied by Congress for the various war expenses).

It was not uncommon to link the payment of contracts during the period when the Continentals were allowed to be used as legal tender to not only specify payment in Continentals but also to an independent commodity, such as tobacco.

Devaluation created significant problems when debtors insisted on paying in the devalued Continentals while creditors wanted the commodity, when different opinions arose on which depreciation date should be used, and when the legal tender status was removed from the Continentals.

The story of war financing during this period is fascinating, including lotteries, life annuities, loans from kings, confiscations of loyalists' property, counterfeiting (including by the British), and drawing on American diplomats in Europe like Benjamin Franklin to personally pay American government debts!

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by restingonmylaurels » Sun Apr 26, 2020 8:47 am

SimpleGift wrote:
Sat Apr 25, 2020 8:49 am
What impressed me most in all of Mr. Shiller's research paper was this bit of historical context:
Robert Shiller wrote:By the late 1770s, when these first inflation-indexed bonds were conceived and designed, the U.S. War of Independence was in a difficult stage. In 1779, the British Army had just captured the state of Georgia and had taken Charleston South Carolina. The eastern seaboard of the United States was blocked by the British Navy.

The morale of the United States Army was low: They were poorly fed, poorly clothed, and often sick. The morale was so low that, as we now know, there were actual army mutinies in 1780 and 1781. There was real concern in 1779 that it would be impossible to keep an army if something were not done to address the loss of value of their pay. The invention of indexed bonds came in response to this very real and dangerous crisis.
It might not be too much to say that inflation-indexed bonds saved the Continental Army and the budding nation.

PS. In more history, Shiller indicates these bonds were engraved by Paul Revere, the official engraver of Massachusetts.
The mutinies of the Connecticut, Pennsylvania, and New Jersey lines had some foundation in the terrible conditions, pay, clothing, housing, medical care, etc. But the proximate cause was enlistment.

Their enlistment duration had been stated as "three years or the duration of the war." It is easy to guess which interpretation the soldiers took versus the officers.

The first mutiny was settled quickly. The second one involved both Congress and the leadership of Pennsylvania. The devaluation of their pay was not immediately solved but kicked down the road. It was uniforms and shoes and re-enlistment bonuses that immediately saved the day.

By the time of the third mutiny, Gen. Washington's patience was worn out. He ordered an immediate surrender of the mutineers and execution of the ringleaders.

Inflation index bonds did little to save the Continental Army during wartime. It was the leadership of Joseph Reed ("governor" of Pennsylvania), Gen. Robert Howe, and as always, Gen. Washington, that save the army and the budding nation when these mutinies arose.

FYI, another "mutiny" broke out after the fighting had finished over the half-pay for life promised to serving American officers. States viewed this as pay for not working but again the leadership of Washington, Hamilton, and Henry Knox helped to diffuse this early crisis in what was to be a long stream of neglect over properly compensating those who had served in this war.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by protagonist » Sun Apr 26, 2020 9:17 am

oldfort wrote:
Thu Apr 23, 2020 3:50 pm
It looks like most of the historical inflation periods corresponded to wars: the American Revolution, the War of 1812, the Civil War, and WWI.
And the post-war years tended to see the deepest deflation.

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Re: First Inflation-Indexed Bonds in America, 1777-1780

Post by WS1 » Mon Apr 27, 2020 8:58 am

I’m going to hijack this thread

Anyone interested in financial and monetary history of this era should check out two books by William Hogeland

Founding Finance
Whiskey Rebellion

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