Union Financing of the Civil War

1
Union Financing of the Civil War

• Initial solution put forward by Salmon Chase
• tax to meet normal operating expenses
• remainder to be financed from borrowing
• Why? War was expected to be short.
• Failure to gain a rapid victory resulted in
  expenses growing faster than tax revenues, hence
  Union gold supply began to diminish.
• To mitigate the rapidly diminishing gold supply,
  the issue of printing money to meet expenses was
  raised.

2
Arguments concerning the merits of legal tender

• Constitution did not grant Congress the power to
  print paper currency. Issue was debated in
  Congress but not decided.
• Opponents to legal tender made the following
  arguments
• "'The provisions of this bill contemplate
  impairing the obligations of every contract...It
  proposes to say to a party who has entered into a
  contract...Although you have agreed to pay gold
  and silver, you shall be discharged upon the
  payment of these note although you are entitled
  to demand gold and silver, you shall rest content
  with the reception of this paper'"
  (Representative George Pendelton) (Kroos (1969))
• "'It is not in the power of this Congress...to
  accomplish an impossibility in making something
  out of nothing. The piece of paper you stamp as
  five dollars is not five dollars, and it never
  will be, unless it is convertible into a five
  dollar gold piece and to profess that is, is
  simply a delusion and a fallacy.'"
  (Representative Owen Lovejoy) (Mitchell (1903))

3
Argument for legal tender

• Proponents of legal tender made the following
  argument depreciation is a result of issuing
  currency in excess of the ability of nation to
  support the paper moderation was the lesson of
  history, not banning legal tender.
• Opponent rebuttal moderation is not likely to be
  practiced, hence depreciation would result. If
  the currency depreciated, then coin would
  eventually vanish from circulation prices would
  increase dramatically fixed incomes would fall
  creditors would be unable to reclaim their loans
  the value of bank deposits would be depreciated
  and finally, labor would lose as prices rose
  faster than wages.
• Furthermore an issue of paper is equivalent to
  the federal government admitting it cannot meet
  its obligations from taxes or borrowing, hence
  making the paper suspect from the start.
• Also, the resulting inflation would raise the
  cost of financing the war.

4
Taxes to Finance the War

• Taxes John Quincy Adams, in Public Debts,
  outlined the reasons why taxation was the
  preferred method to finance a war in a democracy.
  (Hepburn(1967))
• "It is a recognized fact that self-governing
  peoples are stronger for tax purposes than the
  subjects of a monarchical state, for their will
  lies more closely to the heart of the state. But
  the administration of a self-governing people
  would never undertake a war in favor of which
  there is no strong sentiment. As things go,
  then, in democratic countries it does not appear
  that loans to the full extent of extraordinary
  demands are necessary, and there is no question
  as to the superiority of taxes over loans when
  use will not curtail industrial energy. The
  measure of this first money tax should be the
  popular enthusiasm for the war" (Hepburn(1967))
• Proponent rebuttal Not enough time to levy and
  collect taxes.

5
Bonds to Finance the War

• Sell bonds at current market price and fund the
  war effort from future revenue.
• Proponent rebuttal Bonds were trading at a 25
  discount, hence the federal government would
  assume a substantial loss from such a policy.
• In the end, the argument for the necessity of
  legal tender won the day.

6
The Legal Tender Acts

• Review the 1st and 2nd Legal Tender Act
• Third Legal Tender Act "SEC. 2. And be it
  further enacted, That the Secretary of the
  Treasury be, and he is hereby, authorized to
  issue, on the credit of the United States, four
  hundred millions of dollars in Treasury notes,
  payable at the pleasure of the United
  States...bearing interest at a rate not exceeding
  six per centum per annum...and the interest on
  the said Treasury notes and on the certificates
  of indebtedness and deposit thereafter issued,
  shall be paid in lawful money. ... And said
  Treasury notes may be made a legal tender to the
  same extent as United States notes, for their
  face value, excluding interest"(Act to Authorize
  Issuance of Interest-Bearing Legal Tender Notes
  and Fractional Currency, March 3, 1863).
  (Kroos(1969))
• How would interest bearing currency impact the
  problems of printing money?

7
Origins of the National Banking Acts

• The National Bank Acts of 1863 and 1864
• Problems with Free Banking
• No unified currency
• Money supply and price level were unstable
• Bank runs on even sound banks led to deposit loss

8
National Banking Acts

• Create a system of national banks
• Federal government chartered the banks with a
  higher capital requirement and reserve ratio than
  the state banks.
• Banks were restricted from making real estate
  loans and could not lend to any one person an
  amount exceeding ten percent of the banks
  capital.
• Create a uniform national currency
• National banks accepted all national bank notes
  at par
• Bank notes were printed by the Comptroller of the
  Currency to introduced uniformity and restrict
  counterfeiting.
• Create an active secondary market for Treasury
  securities to help finance the Civil War
• The volume of notes a national bank could issue
  was based on the market value of the U.S.
  Treasury securities it held. If it wished to
  extend additional loans it needed to increase its
  holding of securities.

9
Origin of Checking Accounts

• By 1865 there were 1500 national banks, of which
  800 had formerly been state banks.
• To further reduce state banks, a tax on state
  bank notes was passed making state banking
  unprofitable. By 1870 there were 1638 national
  banks and only 325 state banks.
• State banks did survive by switching to checking
  accounts.
• The popularity of checking accounts led to a
  return to the dominance of state banking by the
  late 1880s.
• By 1890, only 10 of the money supply was in the
  form of currency.