The United States government suspended specie payments in December 1861 in order to protect its reserves of gold and silver after New York banks took a similar action to suspend specie payments. In 1862 the United States issued legal-tender notes that were known as greenbacks; and in 1863 it authorized federally-chartered banks to issue national bank notes. The government suspended specie payments because the army in the field was expecting to be paid and no other expedient solution, except borrowing at very high interest rates, was available. However, the greenback’s legal status was limited by Congress: custom duties and interest on government loans were to be paid in gold in order to maintain the credit of the government, particularly with foreign borrowers. Nevertheless, by the end of the Civil War, a total of $431 million in greenbacks had been issued with an authorization for another $50 million in small denominations known as fractional currency or “shinplasters.”
Given the flood of greenbacks and “shinplasters” issued by the United States government, prices in the North rose dramatically. More importantly, prices rose faster than wages which substantially reduced the real wages of working men and women. For example, a private’s pay rose $11 per month at the start of the war to $16 at the war’s end, a 37 percent increase, but in the meantime prices were rising 69 percent. The result was a substantial loss of purchasing power. In the South, which relied on paper money to finance their war effort more than the North did, inflation was much worse, with the South’s productive capacity severely damaged by the war. By January 1864, the Confederates had $827 million in outstanding notes.
The end of the war did not result in a quick return to resumption. Prices were still far above their 1862 level, which made resumption untenable, for U.S. exports would become expensive and imports cheap, thereby producing an unsustainable loss of gold. Devaluation was not considered a serious possibility by postwar administrations because it would weaken the credit of both the U.S. government and private borrowers with foreign creditors. To accomplish resumption without devaluation, price levels in the United States had to be reduced relative to foreign levels.
Hugh McCulloch, the Secretary of Treasury under Presidents Lincoln and Johnson (and later President Chester A. Arthur) was a strong advocate of hard money. Shortly after taking office he declared: “My chief aim will of course be to provide the means to discharge the claims upon the treasury at the earliest day practicable, and to institute measures to bring the business of the country gradually back to the specie standard, a departure from which, although for the time being a necessity, is no less damaging and demoralizing to the people than expensive to the government." McCulloch confronted inflation by asking Congress for the authority to retire greenbacks out of surplus revenues made available by cutbacks in military expenditures. McCulloch’s ultimate objective was to return the United States to the gold standard. In a speech at Fort Wayne, Indiana in October 1865, McCulloch outlined his financial vision for the United States:
In accordance with McCulloch’s suggestion, Congress passed the Funding Act on April 12, 1866 which allowed the retirement of not more than $10 million in six months and not more than $4 million per month thereafter. However, this action was met with strong opposition by 1868 – the postwar economic boom was over, the crop harvest was poor, and a panic in Great Britain triggered a recession that led to a sharp drop in prices in the United States. The contraction of the money supply was blamed for the deflationary effects and led debtors, particularly farmers and workers, to support a halt to the notes’ retirement. On February 4, 1868, after only $48 million had been retired with $356 million still outstanding, the Funding Act was repealed.
Perhaps as important as the repeal of the Funding Act were the Legal Tender Cases (1870-71), where the Supreme Court upheld the constitutionality of paper money. This allowed Treasury Secretaries George S. Boutwell and William Adams Richardson to expand the money supply in the hope that it would trigger an economic recovery. Both Boutwell and Richardson contended that, though Congress had mandated $356 million as the minimum greenback circulation, the old Civil War statutes still authorized a maximum of $400 million, thereby giving them a reserve of $44 million. While the Senate Finance Committee under John Sherman disagreed, no legislation was passed to assert the Committee’s opinion. Starting in 1872, Boutwell and Richardson used the “reserve” to expand the greenback to $382 million in response to the Panic of 1873. Financial historian Davis Rich Dewey wrote: “The political consequences of the panic were seen in the autumn of 1874, when the congressional elections, for the first time since 1860, went against the Republican party. Under the pressure of political necessity… a bill was enacted for the resumption of specie payments by the expiring Congress, January 14, 1875, while the Republicans still held power to rally to its support sufficient votes for its passage.” The Resumption Act of January 14, 1875 which returned the government to specie payments and reduced greenback circulation to $300 million. The Secretary of the Treasury was directed to “redeem in coin” legal tender notes presented for redemption on or after January 1, 1879. As a result, the currency began to strengthen to the point that by April 1876 the notes were on par with silver coins and began to re-emerge into circulation. On May 31, 1878, the contraction in circulation was halted at $346, 681,016 – a level which would be maintained for almost one hundred years afterwards – although it was by then a small fraction of total currency in circulation in the United States.
Under the presidency of Rutherford B. Hayes, specie payments resumed. This was possible because of the sale of U.S. bonds in exchange for gold under Secretary of Treasury John Sherman. By 1879 the U.S. government had accumulated enough gold reserves to carry out the intent of the Resumption Act. This knowledge that the government could redeem each greenback or bank note at par in gold made the public favorably inclined to use more convenient paper currency.
Monetary History Highlights
The Rueffian Synthesis