A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  Only the Bank for Mutual Redemption was left, and though it soon had half the New England banks as members, it was much more lax toward overissuance by country banks. Perhaps the Suffolk would have returned amid dissatisfaction with its successor, but in 1861, just over two years after Suffolk stopped clearing, the Civil War began and all specie payments were stopped. As a final nail in the coffin, the national banking system Act of 1863 forbade the issuance of any state bank notes, giving a monopoly to the government that has continued ever since.

  While it lasted, though, the Suffolk banking system showed that it is possible in a free-market system to have private banks competing to establish themselves as efficient, safe, and inexpensive clearinghouses limiting overissue of paper money.

  THE CIVIL WAR

  The Civil War exerted an even more fateful impact on the American monetary and banking system than had the War of 1812. It set the United States, for the first time except for 1814–1817, on an irredeemable fiat currency that lasted for two decades and led to reckless inflation of prices. This “greenback” currency set a momentous precedent for the post-1933 United States, and even more particularly for the post-1971 experiment in fiat money.

  Perhaps an even more important consequence of the Civil War was the permanent change wrought in the American banking system. The federal government in effect outlawed the issue of state bank notes, and created a new, quasi-centralized, fractional reserve national banking system which paved the way for the return of outright central banking in the Federal Reserve System. The Civil War, in short, ended the separation of the federal government from banking, and brought the two institutions together in an increasingly close and permanent symbiosis. In that way, the Republican Party, which inherited the Whig admiration for paper money and governmental control and sponsorship of inflationary banking, was able to implant the soft-money tradition permanently in the American system.

  GREENBACKS

  The Civil War led to an enormous ballooning of federal expenditures, which skyrocketed from $66 million in 1861 to $1.30 billion four years later. To pay for these swollen expenditures, the Treasury initially attempted, in the fall of 1861, to float a massive $150 million bond issue, to be purchased by the nation’s leading banks. However, Secretary of the Treasury Salmon P. Chase, a former Jacksonian, tried to require the banks to pay for the loan in specie that they did not have. This massive pressure on their specie, as well as an increased public demand for specie due to a well-deserved lack of confidence in the banks, brought about a general suspension of specie payments a few months later, at the end of December 1861. This suspension was followed swiftly by the Treasury itself, which suspended specie payments on its Treasury notes.

  The U.S. government quickly took advantage of being on an inconvertible fiat standard. In the Legal Tender Act of February 1862, Congress authorized the printing of $150 million in new “United States notes” (soon to be known as “greenbacks”) to pay for the growing war deficits. The greenbacks were made legal tender for all debts, public and private, except that the Treasury continued its legal obligation of paying the interest on its outstanding public debt in specie.103 The greenbacks were also made convertible at par into U.S. bonds, which remained a generally unused option for the public, and was repealed a year later.

  In creating greenbacks in February, Congress resolved that this would be the first and last emergency issue. But printing money is a heady wine, and a second $150 million issue was authorized in July, and still a third $150 million in early 1863. Greenbacks outstanding reached a peak in 1864 of $415.1 million.

  Greenbacks began to depreciate in terms of specie almost as soon as they were issued. In an attempt to drive up the price of government bonds, Secretary Chase eliminated the convertibility of greenbacks in July 1863, an act that simply drove their value down further. Chase and the Treasury officials, instead of acknowledging their own premier responsibility for the continued depreciation of the greenbacks, conveniently placed the blame on anonymous “gold speculators.” In March 1863, Chase began a determined campaign, which would last until he was driven from office, to stop the depreciation by controlling, assaulting, and eventually eliminating the gold market. In early March, he had Congress to levy a stamp tax on gold sales and to forbid loans on a collateral of coin above its par value. This restriction on the gold market had little effect, and when depreciation resumed its march at the end of the year, Chase decided to de facto repeal the requirement that customs duties be paid in gold. In late March 1864, Chase declared that importers would be allowed to deposit greenbacks at the Treasury and receive gold in return at a premium below the market. Importers could then use the gold to pay the customs duties. This was supposed to reduce greatly the necessity for importers to buy gold coin on the market and therefore to reduce the depreciation. The outcome, however, was that the greenback, at 59¢ in gold when Chase began the experiment, had fallen to 57¢ by mid-April. Chase was then forced to repeal his customsduties scheme.

  With the failure of this attempt to regulate the gold market, Chase promptly escalated his intervention. In mid-April, he sold the massive amount of $11 million in gold in order to drive down the gold premium of greenbacks. But the impact was trifling, and the Treasury could not continue this policy indefinitely, because it had to keep enough gold in its vaults to pay interest on its bonds. At the end of the month, the greenback was lower than ever, having sunk to below 56¢ in gold.

  Indefatigably, Chase tried yet again. In mid-May 1864, he sold foreign exchange in London at below-market rates in order to drive down pounds in relation to dollars, and, more specifically, to replace some of the U.S. export demand for gold in England. But this, too, was a failure, and Chase ended this experiment before the end of the month.

  Finally, Secretary Chase decided to take off the gloves. He had failed to regulate the gold market; he would therefore end the depreciation of greenbacks by destroying the gold market completely. By mid-June, he had driven through Congress a truly despotic measure to prohibit under pain of severe penalties all futures contracts in gold, as well as all sales of gold by a broker outside his own office.

  The result was disaster. The gold market was in chaos, with wide ranges of prices due to the absence of an organized market. Businessmen clamored for repeal of the “gold bill,” and, worst of all, the object of the law—to lower the depreciation of the paper dollar—had scarcely been achieved. Instead, public confidence in the greenback plummeted, and its depreciation in terms of gold got far worse. At the beginning of June, the greenback dollar was worth over 52¢ in gold. Apprehensions about the emerging gold bill drove the greenback down slightly to 51¢ in mid-June. Then, after the passage of the bill, the greenback plummeted, hitting 40¢ at the end of the month.

  The disastrous gold bill was hastily repealed at the end of June, and perhaps not coincidentally, Secretary Chase was ousted from office at the same time. The war against the speculators was over.104, 105

  As soon as greenbacks depreciated to less than 97¢ in gold, fractional silver coins became undervalued and so were exported to be exchanged for gold. By July 1862, in consequence, no coin higher than the copper-nickel penny remained in circulation. The U.S. government then leaped in to fill the gap with small tickets, first issuing postage stamps for the purpose, then bits of unglued paper, and finally, after the spring of 1863, fractional paper notes.106 A total of $28 million in postage currency and fractional notes had been issued by the middle of 1864. Even the nickel-copper pennies began to disappear from circulation, as greenbacks depreciated, and the nickel-copper coins began to move toward being undervalued. The expectation and finally the reality of undervaluation drove the coins into hoards and then into exports. Postage and fractional notes did not help matters, because their lowest denominations were 5¢ and 3¢, respectively. The penny shortage was finally alleviated when a debased and lighter-weight penny was issued in the spring of 1864, consisting of bronze instead of nickel and copper.107

  As soon a
s the nation’s banks and the Treasury itself suspended specie payments at the end of 1861, Gresham’s Law went into operation and gold coin virtually disappeared from circulation, except for the government’s interest payments and importers’ customs duties. The swift issuance of legal tender greenbacks, which the government forced creditors to accept at par, ensured the continued disappearance of gold from then on.

  The fascinating exception was California. There were very few banks during this period west of Nebraska, and in California the absence of banks was ensured by the fact that note-issuing banks, at least, were prohibited by the California constitution of 1849.108 The California gold discoveries of the late 1840s ensured a plentiful supply for coinage.

  Used to a currency of gold coin only, with no intrusion of bank notes, California businessmen took steps to maintain gold circulation and avoid coerced payment in greenbacks. At first, the merchants of San Francisco, in November 1862 jointly agreed to refrain from accepting or paying out greenbacks at any but the (depreciated) market value, and to keep gold as the monetary standard. Any firms that refused to abide by the agreement would be blacklisted and required to pay gold in cash for any goods which they might purchase in the future.

  Voluntary efforts did not suffice to overthrow the federal power standing behind legal tender, however, and so California merchants obtained the passage in the California legislature of a “specific contracts act” at the end of April 1863. The specific contracts act provided that contracts for the payment of specific kinds of money would be enforceable in the courts. After passage of that law, California businessmen were able to protect themselves against tenders of greenbacks by inserting gold coin payment clauses in all their contracts. Would that the other states, and even the federal government, had done the same!109 Furthermore, the private banks of deposit in California refused to accept greenbacks on deposit, newspapers used their influence to warn citizens about the dangers of greenbacks, and the state government refused to accept greenbacks in payment of taxes. In that way, all the major institutions in California joined in refusing to accept or give their imprimatur to federal inconvertible paper.

  Judicial institutions also helped maintain the gold standard and repel the depreciated U.S. paper. Not only did the California courts uphold the constitutionality of the specific contracts act, but the California Supreme Court ruled in 1862 that greenbacks could not be accepted in state or county taxes, since the state constitution prohibited any acceptance of paper money for taxes.

  The state of Oregon was quick to follow California’s lead. Oregon’s constitution had also outlawed banks of issue, and gold had for years been the exclusive currency. Two weeks after the agreement of the San Francisco merchants, the merchants of Salem, Oregon, unanimously backed gold as the monetary standard and refused to accept greenbacks at par. Two months later, the leading merchants of Portland agreed to accept greenbacks only at rates current in San Francisco; the merchants in the rest of the state were quick to follow suit. The Portland merchants issued a circular warning of a blacklist of all customers who insisted on settling their debts in greenbacks, and they would be quickly boycotted, and dealings with them would only be in cash.

  Oregon deposit banks also refused to accept greenbacks, and the Oregon legislature followed California a year and a half later in passing a specific performance law. Oregon, too, refused to accept greenbacks in taxes and strengthened the law in 1864 by requiring that “all taxes levied by state, counties, or municipal corporations therein, shall be collected and paid in gold and silver coin of the United States and not otherwise.”110

  In the same year, the Oregon Supreme Court followed California in ruling that greenbacks could not constitutionally be received in payment of taxes.

  The banking story during the Civil War is greatly complicated by the advent of the national banking system in the latter part of the war. But it is clear that the state banks, being able to suspend specie and to pyramid money and credit on top of the federal greenbacks, profited greatly by being able to expand during this period. Thus, total state bank notes and deposits were $510 million in 1860, and by 1863 rose to $743 million, an increase in state bank demand liabilities in those three years of 15.2 percent per year.111

  It is no wonder, then, that contrary to older historical opinion, many state banks were enthusiastic about the greenbacks, which provided them with legal tender that could function as a reserve base upon which they could expand. As Hammond puts it, “Instead of being curbed (as some people supposed later), the powers of the banks were augmented by the legal tender issues. As the issues increased, the deposits of the banks would increase.”112 Indeed, Senator Sherman (R-Ohio) noted that the state banks favored greenbacks. And the principal author of the greenback legislation, Representative Elbridge G. Spaulding (R-N.Y.), the chairman of the House Ways and Means subcommittee that introduced the bill, was himself a Buffalo banker.

  The total money supply of the country (including gold coin, state bank notes, subsidiary silver, and U.S. currency including fractional and greenbacks) amounted to $745.4 million in 1860. By 1863, the money supply had skyrocketed to $1.435 billion, an increase of 92.5 percent in three years, or 30.8 percent per annum. By the end of the war, the money supply, which now included national bank notes and deposits, totaled $1.773 billion, an increase in two years of 23.6 percent or 11.8 percent per year. Over the entire war, the money supply rose from $45.4 million to $1.773 billion, an increase of 137.9 percent, or 27.69 percent per annum.113

  The response to this severe monetary inflation was a massive inflation of prices. It is no wonder that the greenbacks, depreciating rapidly in terms of gold, depreciated in terms of goods as well. Wholesale prices rose from 100 in 1860 to 210.9 at the end of the war, a rise of 110.9 percent, or 22.2 percent per year.114

  The Republican administration argued that its issue of greenbacks was required by stern wartime “necessity.” The spuriousness of this argument is seen by the fact that greenbacks were virtually not issued after the middle of 1863. There were three alternatives to the issuance of legal tender fiat money. (1) The government could have issued paper money but not made it legal tender; it would have depreciated even more rapidly. At any rate, they would have had quasi–legal tender status by being receivable in federal dues and taxes. (2) It could have increased taxes to pay for the war expenditures. (3) It could have issued bonds and other securities and sold the debt to banks and non-bank institutions. In fact, the government employed both the latter alternatives, and after 1863 stopped issuing greenbacks and relied on them exclusively, especially a rise in the public debt. The accumulated deficit piled up during the war was $2.614 billion, of which the printing of greenbacks only financed $431.7 million. Of the federal deficits during the war, greenbacks financed 22.8 percent in fiscal 1862, 48.5 percent in 1863, 6.3 percent in 1864, and none in 1865.115 This is particularly striking if we consider that the peak deficit came in 1865, totaling $963.8 million. All the rest was financed by increased debt. Taxes also increased greatly, revenues rising from $52 million in 1862 to $333.7 million in 1865. Tax revenues as a percentage of the budget rose from a miniscule 10.7 percent in fiscal 1862 to over 26 percent in 1864 and 1865.

  It is clear, then, that the argument of “necessity” in the printing of greenbacks was specious, and indeed the greenback advocates conceded that it was perfectly possible to issue public debt, provided that the administration was willing to see the prices of its bonds rise and its interest payments rise considerably. At least for most of the war, they were not willing to take their chances in the competitive bond market.116

  THE PUBLIC DEBT AND THE NATIONAL BANKING SYSTEM

  The public debt of the Civil War brought into American financial history the important advent of one Jay Cooke. The Ohio-born Cooke had joined the moderately successful Philadelphia investment banking firm of Clark and Dodge as a clerk at the age of 18. In a few years, Cooke worked himself up to the status of junior partner, and, in 1857, he left the firm to
branch out on his own in canal and railroad promotion and other business ventures. There he doubtless would have remained, except for the lucky fact that he and his brother Henry, editor of the leading Republican newspaper in Ohio, the Ohio State Journal, were close friends of U.S. Senator Salmon P. Chase. Chase, a veteran leader of the antislavery movement, fought for and lost the Republican presidential nomination in 1860 to Abraham Lincoln. At that point, the Cookes determined to feather their nest by lobbying to make Salmon Chase secretary of the Treasury. After heavy lobbying by the Cookes, the Chase appointment was secured, so Jay Cooke quickly set up his own investment banking house of Jay Cooke and Company.

  Everything was in place; it now remained to seize the opportunity. As the Cookes’ father wrote of Henry:

  I took up my pen principally to say that H.S.’s [Henry’s] plan in getting Chase into the Cabinet and [John] Sherman into the Senate is accomplished, and that now is the time for making money, by honest contracts out of the government.117

  Now indeed was their time for making money, and Cooke lost no time in doing so. It did not take much persuasion, including wining and dining, for Cooke to induce his friend Chase to take an unprecedented step in the fall of 1862: granting the House of Cooke a monopoly on the underwriting of the public debt. With enormous energy, Cooke hurled himself into the task of persuading the mass of public to buy U.S. government bonds. In doing so, Cooke perhaps invented the art of public relations and of mass propaganda; certainly, he did so in the realm of selling bonds. As Kirkland writes: