A Brief Monetary History Of The United States: Part III

Today we bring you Part III of “A Brief Monetary History of the United States” from the Ron Paul Monetary Policy Anthology. The full series can be found at the following links:

  • Part I – Colonial Money and the Coinage Act of 1792
  • Part II – The Banks of the United States, McCulloch v. Maryland, and Private Coinage
  • Part III – Government Begins to Monopolize Currency
  • Part IV – The Legal Tender Cases and the “Crime of ’73”
  • Part V – The Rise of the Fed
  • Part VI – The Great Depression, Gold Confiscation, and the Gold Exchange Standard
  • Part VII – The Dollar Reigns Supreme: From Bretton Woods to Stagflation
  • Part VIII – The 1980s to the Great Recession and on to the Future

    Coinage Act of 1857

    As the 19th century progressed, the federal government sought to enhance its control over the banking industry and the monetary system. In 1857, Congress passed a coinage act which removed the legal tender status that circulating foreign coinage had until then enjoyed. All circulating foreign coins received by the Treasury were to be melted down and recoined. By driving foreign coinage out of circulation, Congress sought to ensure that only U.S. coins circulated, a step towards federal government dominance of the money supply. This was ostensibly to provide a uniform national currency, a stated goal of the federal government since the country’s founding. By “uniform national currency” the federal government did not mean adherence to a dollar defined as a specific weight of metal with coinage circulating by weight and valued in relation to that dollar. Instead, the federal government sought to ensure that only the United States Mint’s coins would circulate in commerce, regardless of what type of coins the market desired.

    A further strike against market choice in currency came in 1864, when Congress passed legislation to prohibit private production of coins. The minting of any coins intended for use as current money was made illegal, even if the coins were of completely original design. This prohibition remains in force today, and was most famously used in recent years to prosecute the creators of the Liberty Dollar.

    Legal Tender and National Currency

    US legal tender note, known as the "Greenback"

    US legal tender note, known as the “Greenback”

    War often leads to the strengthening of central government, and the Civil War was no exception. In an effort to fund its war efforts, the federal government attempted to raise hundreds of millions of dollars. Facing difficulty in selling its notes and bonds to banks, as well as decreased holdings of specie, Congress in 1862 passed the Legal Tender Act, issuing $150 million in non-interest-bearing United States Notes. These notes were not backed by specie but had a vague promise to be redeemed at some point in the future. Specie redemption had by this point been suspended, so Congress felt confident that these notes would be accepted. The reverse of the notes was printed with green ink, so the notes came to be known as “greenbacks.” The notes were to be accepted as legal tender for all debts, public and private, except for duties on imports, which were required to be paid in specie. This was the first instance in which the federal government issued unbacked paper money and declared it to be legal tender.

    The Legal Tender Act of 1862 was followed by two major National Banking Acts, the National Banking Acts of 1863 and 1864. The system of state banks was much-maligned, and not without reason. Note issue by state banks was required to be backed by state bonds. Banks that needed to issue more banknotes had to buy more state debt. State legislators were only too willing to engage in that symbiotic relationship, with state governments spending into debt without discipline and banks willingly purchasing that debt to back new note issues and inflate the money supply.

    For all its drawbacks, however, the state banking system was at least a decentralized banking system that was not controlled by any single entity; as such it was also a system in which banks that made mistakes could fail without taking down the entire system at the same time. The National Banking Acts of 1863 and 1864 attempted to nationalize the banking system and place it completely under federal control, strengthening the federal government’s control over the economy and eroding the power of the states. The Acts created a new system of national banks regulated by the newly-created Comptroller of the Currency. Rather than having to back their notes with state debt as state banks did, these banks had to back the creation of notes with U.S. Treasury securities, providing a ready market for the debt the federal government needed to sell in order to fund the Union war effort. The notes, while issued by national banks, would be printed by the Treasury, and thus would further the aim of a unified national currency.

    State Bank Note. Image: SPMC

    State Bank Note. Image: SPMC

    Unfortunately, this did not fix the major problem with the state banking system: note issue required to be backed by government debt. The National Banking Acts merely replicated an already-flawed system, but this time at the national level where its inflationary nature could cause more harm to the economy. In a further attempt to destroy the state banking system, in 1865 Congress assessed a 10 percent tax on state banknotes aiming to force state banks to convert to national charters or leave the banking business. The result was, as intended, a precipitous decline in the number and influence of state banks.

    The Greenback Dilemma

    In the aftermath of the Civil War, Congress was faced with severe monetary and fiscal problems. The national debt had ballooned in order to fund the war, approaching nearly $3 billion in late 1865. Specie redemption was still suspended, and hundreds of millions of dollars worth of greenbacks were outstanding and awaiting redemption. Almost from their inception, and despite government attempts to force them to circulate at par, the greenbacks had depreciated against specie. At one point, greenbacks were circulating at a value of 40 cents to the dollar.

    While there were a great mass of people wishing to see the wartime expedient greenbacks retired from circulation and specie redemption resumed, there were quite a few others who wished to continue issuing greenbacks. Throughout history there have always been those who believe that the path to prosperity can be achieved merely through the creation of additional monetary units, and the era following the Civil War was no different.

    Proponents of easy money and credit have always heralded the supposed benefits of currency creation, while ignoring the drawbacks. The “Greenbackers” believed that the creation of additional United States Notes would lead to untrammeled economic growth. Among their ranks were found many railroad owners and speculators who knew that the depreciation of the value of the currency, brought about by the creation of additional unbacked fiat paper greenbacks, would steadily depreciate the value of the bonds issued by the railroad companies. Inflation always benefits debtors since they are able to pay their debts with devalued currency. In this way inflation acts as a form of wealth distribution, siphoning wealth from creditors to debtors.