Before the Civil War, the amount of money in circulation was determined by flows of specie (money in the form of coin) into and out of the country through foreign trade and by flows from U. S. mines. By 1862, gold was flowing out of the banking system so fast that the government and banks were forced to suspend gold payments. Silver, which had been undervalued at the mint (the price in the market for silver bullion was higher than the price paid by the mint) ever since the Currency Act of 1834, had virtually no circulation.
Because sufficient revenues to wage the war were not obtained from sales of U. S. Treasury bonds (at least at interest rates the government was willing to pay), the Treasury in 1862 issued a new fiat currency, U. S. notes, nicknamed “greenbacks.” In addition, in 1863 the National Bank Act was passed, creating a new set of banking institutions (national banks) and new money (national bank notes). This avalanche of new paper money is shown in Figure 19.1, which shows the increase in U. S. Notes and national bank notes and the decrease in gold coin during the Civil War. The results are reflected in Figure 19.2, which shows that prices surged during the War.
Collectively, greenbacks, national bank notes, and silver and gold specie or their certificates, plus small subsidiary coins, made up the currency; they were the base of the money supply. As shown in Figure 19.3 on page 343, however, most of the increase in the total money supply after the Civil War was created by the growth of bank deposits—savings and checking deposits created in the process of issuing loans. The new currency, however, was critical to the total because it constituted the reserves of the banking system. The growth of these reserves allowed the growth of bank deposits and the total money supply. For this reason some economists refer to the monetary base as high-powered money.
The greenbacks solved two problems: the immediate problem of providing additional revenue for the government during the war and the longer-run problem of providing a currency of uniform value throughout the country. In many parts of the country, especially in the West, where the state banks were having difficulties because they had invested heavily in Southern bonds, “Lincoln Green” was popular. Why then did Congress create the national banking system? Conservative Republicans worried that making the greenbacks permanent would create a temptation for weak administrations to issue too many notes. Hence, they created a new institution whose notes would be backed up by government bonds and would have uniform value throughout the country, thus solving the same problems that the greenback had solved. However, the issue of national bank notes would be in private hands, and would be redeemable in gold and silver, thus eliminating the danger of over issue.
To secure its note issue, each national bank was required to buy U. S. government bonds. Each bank was to deposit its bonds with the U. S. Treasurer and was to receive notes, engraved in a standard design but with the name of the issuing bank on the obverse side, in the amount of 90 percent of the par or market value (whichever was lower) of the bonds deposited. A national bank could have any amount of government bonds in its portfolio, but the amount of its notes outstanding could not exceed its capital in dollar amount.
FIGURE 19.1
Forms and Values of Currency in the United States, 1860-1915
From the late 1870s to the early 1890s, substantial additions were made to the nation's monetary stocks of gold and silver, but it was not enough to prevent deflation. After 1895, however, the increase in the stock of gold became even more rapid, and deflation became inflation.
World History
