A History of Money and Banking in the United States: The Colonial Era to World War II (18 page)

The volume of redemptions was much larger under Suffolk than under the national banking system. During Suffolk’s existence (1825–57) they averaged $229 million per year. The average of the national system from its start in 1863 to about 1898 is put by Mr. Knox at only $54 million. Further, at its peak in 1858, $400 million was redeemed. But the New England money supply was only $40 million. This meant that, astoundingly, the average note was redeemed ten times per year, or once every five weeks.

102John Jay Knox,
A History of Banking in the United States
(New York: Augustus M. Kelley, [1900] 1969), pp. 368–69.

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Bank capital, note circulation, and deposits, considered together as “banking power,” grew in New England on a per capita basis much faster than in any other region of the country from 1803 to 1850. And there is some evidence that New England banks were not as susceptible to disaster during the several banking panics during that time. In the panic of 1837, not one Connecticut bank failed, nor did any suspend specie payments. All remained in the Suffolk system. And when in 1857 specie payment was suspended in Maine, all but three banks remained in business. As the Bank Commission of Maine stated,

The Suffolk system, though not recognized in banking law, has proved to be a great safeguard to the public; whatever objections may exist to the system in theory, its practical operation is to keep the circulation of our banks within the bounds of safety.

THE SUFFOLK’S DEMISE

The extraordinary profits—and power—that the Suffolk had by 1858 attained spawned competitors. The only one to become established was the Bank for Mutual Redemption in 1858. This bank was partially a response to the somewhat arrogant behavior of the Suffolk by this time, after 35 years of unprecedented success. But further, and more important, the balance of power in the state legislature had shifted outside of Boston, to the country bank areas. The politicians were more amenable to the desires of the overexpanding country banks. Still, it must be said that Suffolk acted toward the Bank of Mutual Redemption with spite where conciliation would have helped. Trying to force Mutual Redemption out of business, Suffolk, starting October 8, 1858, refused to honor notes of banks having deposits in the newcomer. Further, Suffolk in effect threatened any bank withdrawing deposits from it. But country banks rallied to the newcomer, and on October 16, Suffolk announced that it would stop clearing any country bank notes, thus becoming just another bank.

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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 inex-pensive 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
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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 103To be able to keep paying interest in specie, Congress provided that customs duties, at least, had to be paid in gold or silver. For a comprehensive account and analysis of the issue of greenbacks in the Civil War, see Wesley Clair Mitchell,
A History of the Greenbacks
(Chicago: University of Chicago Press, 1903). For a summary, see Paul Studenski and Herman E. Kross,
Financial History of the United States
(New York: McGraw-Hill, 1952), pp. 141–49.

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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 customs-duties scheme.

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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
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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 104Chase and the administration should have heeded the advice of Republican Senator Jacob Collamer of Vermont: “Gold does not fluctuate in price . . . because they gamble in it; but they gamble in it because it fluctuates. . . . But the fluctuation is not in the gold; the fluctuation is in the currency, and it is a fluctuation utterly beyond the control of individuals.” Mitchell,
History of Greenbacks
, pp. 229–30.

105On the war against the gold speculators, see ibid., pp. 223–35. The greenbacks fell further to 35¢ in mid-July on news of military defeats for the North. Military victories, and consequently rising prospects of possible future gold redemption of the greenbacks, caused a rise in greenbacks in terms of gold, particularly after the beginning of 1865. At war’s end, the greenback dollar was worth 69¢ in gold. Ibid., pp. 232–38, 423–28.

106Some of the greenbacks had been decorated with portraits of President Lincoln ($5) and Secretary Chase ($1). However, when Spencer Clark, chief clerk of the Treasury’s National Currency Division, put his own portrait on 5¢ fractional notes, the indignant Republican Representative Martin R. Thayer of Pennsylvania put through a law, still in force, making it illegal to put the picture of any living American on any coin or paper money. See Gary North, “Greenback Dollars and Federal Sovereignty, 1861–1865,” in
Gold Is Money,
Hans Sennholz, ed. (Westport, Conn.: Greenwood Press, 1975), pp. 124, 150.

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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 as 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.