Friday, September 19, 2014

U.S. Note Part 1

Part 1: The U.S. Note, 1862 – 1879
Thomas Allen

[Editor’s note: Footnotes in the original are omitted.]

    The U.S. Note, commonly called the greenback, was legal-tender paper money. It was fiat money. Congress and the Secretary of the Treasury, instead of the markets, decided the quantity to issue. Until 1879, it was not redeemable in specie. Even after it became redeemable at par in gold in 1879, it remained fiat money. First, Congress still decided the quantity to issue. Second, unlike gold certificates, which were fully backed and not legal-tender, gold backed only about one-third to one-half of the outstanding U.S notes, which remained legal tender.
    Between 1862 and 1879, the history of the U.S. notes falls into two periods: the inflationary period from 1862 to 1865 and the deflationary period from 1866 to 1879 when it became redeemable in gold.
    On the money issue of this era, people fell into two camps: soft money and hard money. Soft money people preferred legal-tender paper money that was not redeemable in specie. Moreover, if issued, bank notes should be redeemable only in government issued legal tender paper money. Hard money people preferred the gold standard and requiring U.S. notes, if retained, and bank notes and all other forms of credit money to be redeemable in gold on demand.
    The U.S. Note was introduced as a necessity to finance Lincoln’s War against the Southern States. Proponents of the greenback claimed that legal tender paper money was a wartime necessity. Senator Sherman, who favored the legal tender law, argued the “necessity to give currency to treasury notes, necessity to provide money which would in turn purchase bonds.”[1] Senator Sherman expected the legal tender notes that Congress was about to authorize to lose value. That is the primary reason that he insisted that U.S. notes could not be used to pay tariffs on imports.
    Rothbard refutes the necessity claim:
    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. This 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 minuscule 10.7 percent in fiscal 1862 to over 26 percent in 1864 and 1865.[2]
    Some believe that Lincoln could not have fought his war even if the North had adopted an effective system for selling bonds and stringent taxation in 1861. The War could not have been financed with specie because of a lack of confidence in the Lincoln administration; legal tender paper money was necessary. Perhaps this explanation has merit. (This argument is correctly based on the premiss that when people lose confidence in their government, they hoard gold and spend government notes as fast as they can before the notes become worthless.) However, Napoleon fought much of the world for more than a decade and conquered most of Europe with specie; he did not resort to fiat paper money.
    (Issuing irredeemable, noninterest bearing, nonlegal tender Treasury notes was considered. Their issue was rejected because banks might not accept them and customers might refuse to accept them if a bank offered them. Without being legal tender for private debt, people would refuse them unless they wanted the notes to pay taxes.)
    Taxes paid less than 20 percent of the cost of the War.[3] Adopting a highly protective tariff, the Morrill tariff, significantly cut the tax revenue of the U.S. government. If it had the courage to raise taxes much more than it did, the U.S. government could have financed the War with taxation. Any shortfall could have been covered with borrowing. By financing the War with governmental notes, it paid:
    an average premium of 50 per cent on all its purchases from the beginning of 1862 till May 1865. The total expenditure of the four years was $3,352,380,410, of which it is safe to say that $2,500,000,000 consisted of purchases in the open market where the greenback dollar procured only 66 cents’ worth of property. In other words we obligated ourselves for $2,500,000,000 and got $1,630,000,000 in actual value. The difference, $870,000,000, is the unnecessary cost to the taxpayers, caused by the use of a depreciated currency.[4]
    Resorting to legal tender paper money greatly increased the cost of the War. According to Dewey, “The total effect of paper issues in increasing the cost of the war has been estimated at between $528,000,000 and $600,000,000; even this large amount is small when compared with the burdens which inflated prices placed upon the people in the ordinary relations of trade and industry.”[5]
    About resorting to the use of legal tender paper money, Representative Morrill, speaking in opposition said, “It will injure credit; it will increase prices; it will increase many fold the cost of the war.”[6]
    The use of legal tender government notes could have been avoided if:
        1. The Lincoln administration had instilled confidence of the public about the success of Lincoln’s War, which caused depositors to withdraw their money in gold from banks.
        2. The government had used bank checks and clearing houses instead of insisting that banks transfer the principal of government loans immediately in specie instead allowing them to retain the funds temporarily on deposits.
        3. Congress had enacted an extensive system of taxation.[7]

    U.S. notes were like a loan forced on the people. However, unlike real loans, they paid no interest and had no promise of repayment. Actually, the recipient paid the interest, which was the discount to specie. They were imposed on rich and poor, prudent and spendthrift, and speculator and cautious indiscriminately. Nevertheless, the burden fell more heavily on the poor, prudent, and cautious than on the rich, spendthrift, and speculator. As with all fiat monetary systems, a few people win, but most lose. Senator Fessenden, an opponent of legal-tender U.S notes, said that “the loss would fall most heavily on the poor.”[8]
    Besides, if the U.S. government had been willing to pay a higher interest rate, selling its bonds at a discount, it could have obtained sufficient funds. Not wanting to pay higher interest on its bonds had more to do with resorting to the U.S. note than the U.S. note being necessary to finance the War. U.S. notes accounted for less than 17 percent of the cost of the war.[9] The necessity argument was much more palpable and saleable than the stingy, parsimony argument.
    Moreover, once banks stopped redeeming their bank notes, the U.S. government had a choice to make. It could let the banks issue an evermore growing supply of bank notes or the government could issue irredeemable government notes. It could receive the profits from issuing irredeemable currency or let banks reap the profits. Congress chose to take the profits for itself.
    Issuing U.S. notes was a policy decision. Congress had a choice of issuing fiat legal tender paper money, i.e., the U.S. note, or paying a higher interest rate on its bonds. Congress and the Lincoln administration chose the former. Furthermore, Congress preferred receiving the gain from irredeemable paper money instead of letting the banks receive the gain.
    On January 1, 1861, the supply of paper money, bank notes and demand deposits, stood at $459,234,000.[10] (The country had $250 million in gold.[11]) On January 1, 1866, the paper money supply had risen to $1,418,572,000 of which 422,000,000 were U.S. notes.[12] The money supply rose 959,339,000. In 1860, the quantity of paper money per capita was $14.[13] In 1866, it was $41. During the War, “the money supply rose from $45.5 million to $1.733 billion, an increase of 137.9 percent or 27.69 percent per annum.”[14]
    Although many people suffered from the inflation brought on by the U.S. note, other people gained. The people who benefitted most from the greenback during the inflation years were banks, industrialists, railroad owners, borrowers, and speculators.
    Bankers benefitted greatly from the greenback monetary system. State bank notes and deposits rose from $510 million in 1860 to $743 million in 1863, or an increase of 15.2 per cent per year.[15] They could add U.S. notes to the reserves on which they based their loans. Moreover, banks paid out gold deposits made before the legal-tender law in depreciated U.S. notes. When the War began, banks were the largest debtors in the country. Inflation generally benefits debtors. Furthermore, the robust war economy gave banks the opportunity to make many profitable loans.
    Another group that benefitted from the greenback was the industrialists, especially the iron and steel manufacturers. Because foreign exchange markets expected further depreciation of the U.S. note, the U.S. note tended to depreciate faster than prices. A falling greenback dollar and a rising gold premium caused domestic prices to be cheaper and the prices of imports to be higher. Thus, the greenback functioned like a protective tariff. Also, the inflationary policy provided manufacturers with easy credit.
    Railroad owners also benefitted from the depreciating greenback because they were large debtors. They could pay their debts with money worth less than what they had borrowed.
    Furthermore, the legal tender U.S. note was a great benefit to debtors who had borrowed gold. Much of the money lent to them had been gold. Now they could repay these gold loans with depreciated U.S. notes and cheat their creditors.
    Speculators saw a way to profit from the difference in values between gold and U.S. notes. When the U.S. note was first issued, the silver in a dollar of silver coins was worth 97 cents in gold. As the U.S. note depreciated, the value of silver in a dollar of silver coins rose above a dollar in U.S. notes. Massey describes one way that speculators profited from depreciating U.S. notes with silver coins:
    A broker in New York, for example, would buy up quantities of silver coins, offering a premium in paper money to get them. These coins were taken to Canada, where they were accepted as the equivalent of gold. The broker brought back the gold to the United States and sold it at a large profit for more paper money.[16]
    The biggest winner was the U.S. government. It got to spend the U.S. notes first before they depreciated.
    Inflation also brings losers. One big loser during the inflation of 1863 to 1865 was the wager earner. During the War, the cost of living closely followed the gold premium. As with all inflations, wages lagged behind the rise in prices. Thus, workers suffered from the issue of U.S. notes as their standard of living declined. “In 1865, when price index stood at 217 as compared to 100 in 1860, wages had only touched 143.”[17] Salaries and wages of soldiers and governmental employees rose even slower than wages of private employees. Wages of soldiers were $13 per month from the beginning of the War until May 1864 when Congress raised their pay to $16. By the time of their pay raise, prices had about doubled.[18] Unfortunately for them, the U.S. note continued to depreciate.
    Perhaps the people who lost most during the inflation were those who lived on fixed incomes. They ranged from widows, pensioners, college professors, and clergymen to affluent lenders of capital.
    Bondholders, with one exception, lost. The exception was bondholders who had bought U.S. government bonds with U.S. notes and were paid interest and principal in gold and were not taxed on this income.
    Landlords also lost because rents fail to rise as fast as commodity prices.[19] The poor lost as many necessities were priced beyond their reach.
    When the government ceased expanding U.S. notes and other legal-tender currency and began contracting them, deflation followed. During the deflationary period, the winners during inflation typically became losers, and losers during inflation typically became winners.
    One big winner during the deflationary period was the lender. The exception was loans to borrowers who failed to payoff their loans. Therefore, the more conservative investors, such as banks and trustees for widows and orphans, preferred government bonds since the government was less likely to default. Unlike during inflation when lenders were paid with money worth less than what they had lent, during deflation, they were paid with money worth more. Thus, borrowers were big losers during deflation.
    Falling gold prices in terms of U.S. notes hurt domestic manufacturers because it made foreign goods from Great Britain and other countries on the gold standard cheaper in U.S. notes. Foreign goods were bought with gold.
    Importers also suffered; they lost money on their goods if the premium on gold fell between the time that they bought their goods and the time they sold them. They also suffer during the inflationary years when the gold premium fell.
    However, speculators could profit from a fluctuating gold premium if they bought and sold while the premium was rising as occurred during both the inflationary era and deflationary era. Moreover, any good speculator could profit from the fluctuation in the U.S. note price of gold no matter whether the gold premium was rising or falling. All they needed were fluctuating prices.
    Regardless of inflation or deflation, which is caused by inflation, the U.S. note transferred wealth from most people to a few wealthy people.

1. Davis Rich Dewey, Financial History of the United States, 8th edition. (1922, Rpt. Adamant Media Corp., 2005), p. 287.

2.  Murray N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, Alabama: Ludwig von Mises Institute, 2005), pp. 131-132.

3. Irwin Unger, The Greenback Era: A Social and Political History of American Finance 1865-1879 (Princeton, New Jersey: Princeton University Press, 1964), p. 16.

4. Horace White, Money and Banking (Boston, Massachusetts: Ginn & Company, 1896), p. 162.

 5. Dewey, p. 293.

6. Dewey, p. 286.

7. Dewey, pp. 282-283.

8. White, p. 163.

9. Robert P. Sharkey, Money, Class, and Party: An Economic Study of Civil War and Reconstruction (Baltimore, Maryland: The John Hopkins Press, 1959), p. 16.

10. Henry V. Poor, Resumption and the Silver Question: A Handbook for the Times (1878 Rpt. New York, New York: Greenwood Press, Publishers, 1969), p. 197.

11. Joseph French Johnson, Money and Currency in Relation to Industry, Pieces, and the Rate of Interest, Revised Edition (Boston, Massachusetts: Ginn and Company, 1905), p. 278.

12. Poor, pp. 197-198.

13. Poor, p. 199.

14. Rothbard, p. 130.

15. Rothbard, p, 129.

16. J. Earl Massey, America’s Money: The Story of Our Coins and Currency (New York, New York: Thomas Y. Crowell Company, 1968), p. 159-160.

17. White, p. 163.

18. Dewey, p. 294.

19. Unger, p. 23.

Copyright © 2013 by Thomas Coley Allen. 

Part 2

More articles on money.