That Time the U.S. Ran Out of Money
If you have been out and about recently, you likely have seen signs asking you to pay with exact change, letting you know that there is a coin shortage. The problem with physical money is that there is a precise amount of it at any given time. If you have four quarters, two pennies, and a dime in your pocket, additional ones will not appear just because you need them. When the American Civil War started, the nation was broke, and you cannot just pull gold or silver coins out of thin air to pay troops.
The problem of money shortages is not a new thing in the world.
When Sir Isaac Newton was Master of the Mint in England, he produced so few coins that button makers started minting unofficial money. If you collected enough “tradesmen’s tokens,” they could be redeemed for official cash at the button maker’s offices. The same problem haunted the early United States.
On April 10th, 1806, Congress passed a law that said, “that from and after the passage of this act, foreign gold and silver coins shall pass current as money within the United States, and be legal tender for the payment of all debts and demands….” Foreign coins were still in use until the 1870s as money in some parts of the United States, despite Congress revoking the law in 1857.
Americans were very wary of government printed money, so much so, that a passage authorizing Congress to print money was struck from the Constitution when the various sections were voted on. The Constitution doesn’t prohibit printing money either. At the time of the Civil War, leaders were worried about whether silence is the same thing as permission.
The colonial experience with printed money had been bad. Except in Pennsylvania, where the money was backed by land, the other colonies experienced significant inflation. The problem with paper money is that prices will tend to rise to use up all the available paper money in the system. Likewise, legislatures don’t like telling voters “no,” so they feel pressured to print money to pay for things that voters want.
The combination of the bad experience in the colonial period and American distrust of centralized power led to an unusual national situation regarding money before the Civil War. As with England’s experience under Newton, if the government doesn’t produce enough money, the people will get creative in solving the problem. Indeed, that is why we spend dollars and not pounds.
The colonies all produced their own version of the British Pound, whether it was the Maryland Pound or the Massachussettes Pound. However, because their value kept dropping, people preferred the Spanish Dollar. Some speculate that the origin of the $ symbol was the letter S for Spain. The Spanish dollar was also known as pieces of eight because they were worth 8 reales. These are the same pieces of eight that pirate lore says they chased after.
It was this dollar that the Founders used when discussing money in the Constitution. It became the basis of a standard for money in the United States based on the amount of precious metal in a coin.
The Spanish dollar’s influence was so significant that the New York Stock Exchange didn’t stop trading in eighths until the beginning of the twenty-first century, long after pirates were done saying “argh, matey,” and burying pieces of eight in treasure chests.
In the time leading up to the Civil War, there were three types of money circulating in the United States. The first is called specie, which is gold or silver coins that were authorized for the payment of taxes, fines, or levies to the states and the United States. The second type of money was things such as beaver pelts, stacks of tobacco, and so forth, which were used as money when nothing else was available. The third type of money was paper money printed by banks, some cities, and private companies. A few private currencies still exist in America, such as BerkShares, currently in use in the Berkshire Mountains region of the United States.
At the time of the Civil War, Federal and state law required payments to them to be in gold or silver, but for everyone else, there were very few rules. The lack of regulations and diversity of states led to the rise of the free banking era. Almost anybody with enough money could form a bank and print their own money.
Periodically, people, banks, and governments would redeem those private notes for specie. As long as the banks could pony up the coin, the bank remained in business. If the bank failed to do so and couldn’t raise cash from selling assets, their money became worthless.
At the start of the Civil War, around ten thousand different bank-issued notes were floating around the country, each one promising payment in gold or silver on demand. That led to a lot of confusion. Nobody can remember ten thousand different banknote designs.
How do you know which banknotes are legitimate, which are from failed banks that someone was stuck with and is trying to pass off for merchandise, and which are counterfeit? Because paper money was risky to accept for a bank you did not know, merchants would reduce their value. Someone paying with a twenty-dollar bill might get eighteen or nineteen dollars worth of goods, depending on how far away the bank was, or how reputable it was.
Making matters worse, the federal government in 1857 stopped accepting Portuguese escudos, British pounds, French francs, and Spanish milled dollars in payment of taxes. Private citizens could still use them, but they would have to exchange them with someone for U.S. dollars to get the gold or silver to pay their own taxes.
The Buchanan administration is mostly famous for its failures to prevent the Civil War. Had the Civil War not happened, it would have been notorious for destroying any fiscal discipline the United States had with corruption. The Franklin Pierce administration left it with a small budget surplus of 1.3 million dollars and a low to moderate federal debt.
When Lincoln came to office, on the eve of civil war, he faced an empty treasury. The budget he came to office with had a cash shortfall of twenty-five million dollars over expected taxes, and the debt had tripled to seventy-six million dollars from where it had been when Pierce left office. None of that considered the cash needs of a government facing a massive rebellion.
Even without a war, the American government was facing a cash crisis. The problem with a metal standard is that the amount of gold in the world is roughly fixed. Current estimates place the amount of gold in the world if brought together in one place, to a cube that is sixty-eight feet on a side. There was less gold in circulation at the time of the Civil War because it had not been mined yet.
Had the Union been required to pay for the war in gold, it would have needed roughly a 19-foot cube of gold over the course of the war. In reality, it would have been much less as the same coin can be used to pay taxes year after years once the government has spent the money and put the coin back into circulation.
A gold or silver standard is very restrictive, and the cost of federal borrowing was already over twelve percent per year at that time. Within a month of his inauguration, Lincoln would need to find the funds to pay for an additional seventy-five thousand soldiers. By the end of the war, the military and naval forces would grow to seven hundred thousand men at its peak. Overall, the Union recruited or conscripted over two million men into the armed forces. Funds for every soldier and sailor had to be set aside for training, buying uniforms, and building ships, forts, and transportation.
As if nothing else could make the fiscal situation worse, the existing federal budget assumed that taxes would be collected from the Confederate States’ citizens and businesses. New trade relations would have to be structured because seventy percent of all U.S. exports came from the Confederate States. Trade from the south accounted for a significant source of cash flows into the United States.
It is a testament to the ingenuity of Lincoln and his cabinet that the nation survived. It is also important to remember that the south inherited the same banking system the north had.
At the time of Lincoln’s inauguration, all banks were state chartered and regulated. Indeed, this was a contentious political issue. There were two nationally chartered banks in American history up to this point, the first and second Bank of the United States. Both had their charters expire when Congress refused to renew them. The Second Bank of the United States went on to become a state bank after its federal charter expired until it was finally liquidated. National monetary policy was in the hands of each state’s legislature.
Both the Union and the Confederacy inherited the same monetary system, but only the Union was able to reform it. Both faced intense pressures to raise cash, but the work of a group of Union leaders overcame resistance to change to lay the foundations for modern banking.
The weakness of the southern monetary system was caused by its mandate of state’s rights and state-level control. As with the colonial governments, each southern state was now permitted to print its own money, as did the Confederate government. Virtually any entity that wanted to could print money in whatever amounts it felt it needed. While the right to demand specie still existed, a war was going on. If you went to a factory or bank that issued money and demanded gold or silver and said “no,” what could you do?
That worsened the problem in the south of getting access to specie. The south depended on selling cotton and other agricultural products to Europe for its revenues. Still, many planters hoarded their output until the war ended. If a farmer sold their crops for Confederate dollars and they lost the war, then the crop’s entire value was lost.
The federal blockade of southern ports made the issue even dicier. That made gold and silver even more valuable in the south. It made it harder for the south to raise liquid money for the operation of businesses and to continue the war. It was facing no less pressure than the north.
The difference was that the Union also needed to print money, but it wasn’t sure it was allowed to. Several court decisions seemed to indicate it was legal, but what was the point of fighting to defend the Constitution if you were going to throw it aside. The first attempt to create a national currency was designed to pretend it wasn’t actually intended to be used as money.
The Constitution clearly allows Congress to borrow money. So the first attempt was to create a currency that you could take to a government office and collect interest from it. They were to pay 7.3% interest. Thus, a hundred-dollar bill would be worth an additional two pennies each day.
It didn’t work for two reasons.
First, when you spent your money, you had to determine which day of the year it was. After that, you had to multiply that by the interest rate and the face amount of the money. Even though you had performed your calculations, the merchant may not want to honor it at your value. You had to do two negotiations. The first negotiation was over the good’s cost, the second over the price of the money.
Second, if someone was paid the money that liked the interest rate, they could hoard it instead of using it for cash. A currency facilitates the flow of private commerce. Private commerce is necessary to create taxes and to create war materiel. You don’t want a currency that short-circuits the flow of goods and services because some people wanted to hang onto it.
The next attempt was the Demand Note. It was a Treasury Note that did not pay interest. However, it did have the novel feature that the bearer could demand repayment anytime in specie. It also had the unique feature that it was acceptable in payment for taxes. It had the same weakness as Confederate money, though you could demand the specie, but if the gold didn’t exist, who would you complain to?
The logic was that you could pay a Union soldier a five-dollar demand note; they would then purchase something. Eventually, the chain of events would create a federal tax, and that note would be taken back by the government as the tax. The federal government would get the use of a soldier’s time, mostly for free. At the same time, the merchant could hoard specie and extinguish their debt to the government with that same piece of paper.
It had another advantage, as long as nobody came in to demand gold or silver from the government. It was automatically the least valuable asset you could hold. If you used it to buy land, then you could farm the property to get more money. If you used it to buy a bond, then you would get interest on the money. If you used it to buy food, then you got nutrition and happiness. It was most valuable floating around the economy, in a perpetual game of hot potato.
The problem was that as things turned against the Union or additional cash demands rose, people would get nervous and demand payment in metal from the government.
The purpose of the Demand Note was to get free services and to conserve specie. If people started demanding gold or silver, it would be a drain on resources, which is what happened.
By December of 1861, the rising demands of the war combined with increased redemptions from a nervous public resulted in the Treasury defaulting on the Demand Notes. That lead to Congress creating a new note, the Legal Tender Note.
The note had to be accepted for all debts, public or private, except for two. It could not be used in payment of taxes. It also couldn’t be used by the government to pay interest payments on the federal debt. These notes became known as “greenbacks” because of the color of the ink used on the notes’ backs.
There was no promise ever to repay the notes in gold or silver. You were simply required to accept them if somebody owed you money. If a landlord was given them to pay rent, but they owed federal taxes, they had to find someone to sell them either specie or a Demand Note to pay the tax with. That was an obvious problem.
Congress eventually allowed the notes to be used in the payment of taxes. Still, they were obviously inferior to the notes issued by state banks as banknotes were redeemable in gold or silver. At their lowest point during the war, it took one hundred dollars worth of legal tender notes to purchase two twenty-dollar gold coins.
The Legal Tender Act reduced the immediate costs of financing the government but failed to create additional access to specie. The next two innovations set much of the modern banking system in motion and got the needed gold to Washington.
The first was the National Bank Act. The law created a new legal entity, a national bank. The act’s goal was to fill the Treasury and get rid of the thousands of private currency issuers out there. Lincoln was very aware of the colonial period’s disastrous experience and the issues the Confederacy was facing. He had spent his political life fighting for sound money. He was deeply concerned that the continued issuance of greenbacks would place the citizens of the Union in the same place the colonists were in.
The National Bank Act did not create a third Bank of the United States, but instead a set of privately owned national banks to replace state ones. They, too, could issue currency, but the money would be backed by Treasury notes.
The scheme was simple. A state bank could switch to becoming a national bank. They would send their gold to the federal government and receive bonds in exchange. They could then print paper money redeemable in gold or silver. If the bank was having problems with its supply of gold or silver coins, it could sell the bonds to raise the needed cash. Only banks in trouble were required to sell bonds.
That meant that all the gold could be sent to Washington and that gold would only need to be sent back to those cities having cash emergencies. At the same time, it didn’t drain the local money supply because the gold coins were replaced with paper money. The other advantage was one design. The federal government would print the notes so that they were all identical, regardless of what bank owned them.
The second innovation was to tax the state bank notes. That drove state banks away from issuing currency, and they switched to a national charter. After the war, states developed innovations that made some banks want to remain state banks. For the duration of the war, the plan worked. State banks gradually began switching over to national charters for the period of the war. Ultimately, the state banks started using issuing checking accounts to customers to get around the tax, and many national banks switched back to state charters.
When Lincoln came to office, he inherited a budget of sixty-three million dollars. The national operating budget exceeded three hundred million dollars at the height of the war. When the war ended, the federal debt was $2.7 billion. The Confederate banking system collapsed before the war was over under the pressures facing the south.
The U.S. economy got checking accounts as a result of the reforms. It had a single currency for the first time in its existence. The temporary measures created by using greenbacks were ultimately reversed when Congress passed a law redeeming the greenbacks for gold. That put America back on a gold standard.
A broke nation on the verge of dissolution due to slavery would become the industrial juggernaut of the nineteenth and twentieth centuries. Much of that foundation was laid by Lincoln, his cabinet, and leaders in Congress.
For the rest of America’s history, it would jump back and forth between money based on metals and money based on trust, depending on the politics of the day and the crisis of the moment.
The advantage of a gold standard is that the world has just one currency if every nation is on it. An ounce of gold in America is still an ounce of gold in Brazil. As the Civil War showed, the advantage of fiat currency is that a country can react immediately to a crisis without gathering tons of gold from other nations around the world, but it has to have a lot of legislative discipline to control spending in normal times.
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Rockoff, Hugh, Institutional Requirements for Stable Free Banking, Cato Journal, Vol 6, No 2, Fall 1986
Sparks, Evan, Lincoln and the Banks, The ABA Banking Journal https://bankingjournal.aba.com/2018/02/lincoln-and-the-banks/
Noll, Dr. Franklin, A Brief History of US Government Currency 1861-Present Part 1 https://www.treasury.gov/connect/blog/Pages/US-Currency-Brief-History-Part-1.aspx
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Horsley, Scott, The Latest Pandemic Shortage: Coins Are The New Toilet Paper, https://www.npr.org/2020/06/21/880958665/the-latest-pandemic-shortage-coins-are-the-new-toilet-paper
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