Can Interest-Bearing Money Circulate? A Small-Denomination Arkansan Experiment, 1861-63
Burdekin, Richard C. K., Weidenmier, Marc D., Journal of Money, Credit & Banking
The Treasurer has succeeded in procuring plates for striking off [interest-bearing] treasury warrants of the denominations of one, two, three, five and ten dollars. These will resemble a bank bill.... We apprehend that they will come into general circulation. (Arkansas True Democrat, January 23, 1862)
ONE LONGSTANDING QUESTION in monetary economics is why non-interest-bearing money circulates in place of interest-bearing alternatives. In practice, however, interest-bearing assets have tended to be of too large a denomination to serve as a viable transactions medium. The legal restrictions theory of money suggests that the historical dominance of non-interest-bearing currency has been made possible only through legal impediments that prevent financial institutions from offering interest-bearing alternatives (Wallace 1983). (1) Admittedly, even in a case like pre-1844 Scotland, where banks were not prevented from paying interest on their notes, interest-bearing notes as such were still not offered (White 1987, Cowen and Kroszner 1989). Today's interest-bearing demand deposits could arguably represent an electronic equivalent of such private interest-paying notes (Andolfatto 2006), but, if so, this implies coexistence with conventional non-interest-beating money rather than dominance. While interest-bearing notes were issued by both Northern and Southern governments during the Civil War, neither government granted them legal tender status, and it is unclear how widely they circulated (Gherity 1993, Makinen and Woodward 1999). In the case of the South, their failure to chase non-interest-bearing notes from circulation may actually be explicable in terms of government-imposed restrictions on banks, however (Burdekin and Weidenmier 2002).
A dilemma recognized by proponents and opponents of legal restrictions theory alike is that the interest-bearing medium must be small enough for transactions purposes and yet be large enough to make interest calculations and interest payments feasible and cost effective (White 1987). The South's interest-bearing notes were most commonly of $100 denomination, for example, making them too large to be conveniently used in day-to-day transactions at first--although as the war progressed, this became increasingly less of an issue owing to rapid inflation. Makinen and Woodward (1986) cite post-World War I France as a case where a government issued small-denomination interest-bearing debt. As with the Confederate currency, the interest-bearing securities clearly did not drive non-interest-bearing currency out of circulation. It is doubtful that these French notes of 100 francs or greater denomination could really be considered small enough for everyday use, however. Adolfatto (2006) points out that even the low-end denomination of 100 francs was equivalent to between $100 and $300 today, surely making such notes suitable only for large business transactions.
In the absence of any clear-cut historical examples with small-denomination interest-bearing issues, the scope for their circulating in line with the predictions of legal restrictions theory has been left effectively untested--with interest-bearing currency issues seemingly never having smaller denominations comparable to available non-interest-bearing alternatives. Civil War Arkansas stands out, therefore, as a rare, if not unique, instance where large quantities of small-denomination interest-bearing money were actually issued. In 1861, the Arkansas state legislature approved the issuance of war bonds that could be used to purchase goods and services. The bonds initially did not circulate much. But their role changed dramatically after new small-denomination warrants were authorized on November 18, 1861--and all bonds and warrants became receivable for taxes at par, eliminating the old requirement that one-third of taxes be paid in coin or overdue coupons. (2) By September 1862, nearly $1. …