by James Narron and David Skeie - Liberty Street Economics, Federal Reserve Bank of New York
In the late 1700s, France ran a persistent deficit and by the late 1780s struggled with how to balance the budget and pay down the debt. After heated debate, the National Assembly elected to issue a paper currency bearing an attractive 3 percent interest rate, secured by the finest French real estate to be confiscated from the clergy. Assignats were first issued in December 1789 and initially were a boon to the economy. Yet while the first issues brought prosperity, subsequent issues led to stagnation and misery. In this edition of Crisis Chronicles, we review how fiat money inflation in France caused the collapse of the French assignat(subscription required) and describe some interesting parallels between the politics of French government finance (subscription required) in the late 1700s and more recent fiscal crises.
Remembering John Law and the Mississippi Bubble
It was not without grave reservation that the National Assembly elected to pursue a new issue of paper currency. Some who spoke out against issuing the assignat recalled the wretchedness and ruin to which their families were subjected during John Law’s tenure as head of French finance and the Mississippi Bubble of 1720. But there was also great political willpower against raising taxes of any sort and deficits were already high. So the only option was to turn to the printing press once again.
But this time, the National Assembly was convinced it would be different. The currency would be secured by confiscated church property, issued in large denominations appropriate only for major purchases, and would bear 3 percent interest, incenting the government to redeem the currency early. Modern estimates suggest the value of the confiscated land between 2 billion and 3.5 billion livres, which should have easily funded the accumulated debt plus the next year’s operating deficit.
France needed to sell the land quickly, both to raise money to fund the current year’s operating budget and to put land in the hands of the public. But forced sales would drive down the price and value extracted from the confiscation. France was solvent, but illiquid. So instead of a massive issue, a small issue of 400 million livres was authorized in December 1789. The first issue of assignats brought prosperity as the economy improved. So successful was it that the National Assembly approved a second issue of notes in April 1790, making them legal tender. Then came a third, noninterest-bearing issue in September 1790, and a fourth issue of 600 million in June 1791. By the end of 1791, France had printed about 1.8 billion livres in assignats, still within the estimate of the value of the confiscated land. Yet the notes began to depreciate and were worth only 82 percent of their original value.
Reign of Terror
By 1791, France saw that each new issue brought a round of depreciation. Specie disappeared more and more from circulation as Gresham’s law saw bad money (assignats) driving out good money (specie), so smaller denominations were printed to fill the void of disappearing specie. And with each currency issue, prosperity decreased and business further stagnated until manufacturing essentially stopped, leaving thousands unemployed—except at the print works, which added four hundred workers.
With the sale of the confiscated property, a great debtor class emerged, which was interested in further depreciation to make it cheaper to pay back debts. Faith in the new currency faded by mid-year 1792. Wealth was hidden abroad and specie flowed to surrounding countries with the British Royal Mint heavily purchasing gold, particularly in 1793 and 1794.
But deficits persisted and the French government still needed to raise money, so in 1792, it seized the land of emigrants and those who had fled France, adding another 2 billion livres or more to French assets. War with Belgium that year was largely self-funded as France extracted some rents, but not so for the war with England in 1793. Assignats no longer circulated as a medium of payment, but were an object of speculation. Specie was scarce, but sufficient, and farmers refused to accept assignats, which were practically demonetized. In February 1793, citizens of Paris looted shops for bread they could no longer afford, if they could find it at all.
In order to maintain its circulation, France turned to stiff penalties and the Reign of Terror extended into monetary affairs. During the course of 1793, the Assembly prohibited buying gold or silver at a premium, imposed a forced loan on a portion of the population, made it an offense to sell coin or differentiate the price between assignats and coin, and under the Law of the Maximum fixed prices on some commodities and mandated that produce be sold, with the death penalty imposed for infractions.
From Assignat to Financial Ruin
France realized that to restore order, the volume of paper money in circulation must decrease. In December 1794, it repealed the Law of the Maximum. In January 1795, the government permitted the export of specie in exchange for imports of staple goods. Prices fluctuated wildly and the resulting hyperinflation became a windfall for those who purchased national land with little money down. Inflation peaked in October 1795. In February 1796, in front of a large crowd, the assignat printing plates were destroyed.
By 1796, assignats gave way to specie and by February 1796, the experiment ended. The French tried to replace the assignat with the mandat, which was backed by gold, but so deep was the mistrust of paper money that the mandat began to depreciate before it was even issued and lasted only until February 1797. In all, 2.5 billion mandats and 45 billion assignats had been issued.
As our colleagues point out in a recent San Francisco Fed Economic Letter, recovery from a recession triggered by a financial crisis is greatly influenced by the government’s fiscal position. Because of France’s poor fiscal status, the country was plunged into financial ruin for years. The assignats have taken their place in history as another paper money made worthless by over-issuance, with disastrous results. But others have been able to break the cycle of over-issuance and hyperinflation. And in one incredible example, Brazil did it with a virtual currency.
Unit of Real Value
Brazil had experienced heightened inflation as far back as the 1950s as its government spent massively on infrastructure, including a new capital in Brasilia. That inflation persisted for nearly five decades. Early attempts to break the cycle of inflation followed the same failed tactics seen in the assignat episode, such as price freezes and confiscated assets, with the same failed results. Brazil understood that it needed to stop the printing presses, but the country also recognized that it had to reestablish faith in money. And the government decided to try doing so through a virtual currency—the unit of real value or URV.
The idea, conceived by behavioral economists, was to create a stable URV that would be indexed to the local currency—the cruzeiro—with prices quoted in URVs alongside prices in cruzeiros. Each night, the central bank would publish the exchange rate between the URV and cruzeiro. While the prices of goods might continue to go up in cruzeiros, they would remain relatively constant in URVs. It worked. Brazilians started thinking in URVs and hyperinflation began subsiding. The people went from having absolutely no faith in their currency to having absolute faith in a virtual one. Brazil is now the eighth largest economy in the world.
While the URV didn’t display all of the characteristics of a real-time payment like printed money, it did lay the groundwork for Brazil to issue the physical real equal to the value of the URV successfully a short time later. So, could lessons from the case of the URV be used to solve hyperinflation in other countries? And what might we learn from the URV that would inform our thinking about digital currencies? For example, must a digital currency be government-issued to be successful? Tell us what you think.
The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.
About the Authors
David Skeie is a senior financial economist in the Federal Reserve Bank of New York’s Research and Statistics Group.