country's demand for money by the simple process of exchanging the notes (and the deposit credits) of banks for the promissory notes of business firms—that is, by exchanging one kind of debt for another. The bank's instruments of indebtedness simply had more general acceptability, at least as a medium of exchange, than the debt instruments of commercial or industrial firms. The pre-1860 money supply was created by monetizing private debt. There is a good case to be made for the proposition that this monetization occurred at an optimum rate in the absence of interference by the federal government.

Restriction of the antebellum money supply to gold and silver coin would have been disastrous. By a substantial majority the electorate supported Jackson's stand against a central bank, which could have provided a homogeneous currency while placing various financial restraints on the economy. So for three decades after 1832 the money supply depended upon: (1) net additions to the quantity of specie resulting from importation of precious metals and from domestic mining, and (2) the paper money and bank deposits created by commercial banks operating under various state laws. In the next chapter we shall see how this arrangement was modified by the federal government.

Establishing

A National Banking System

By 1860 the United States was a major economic power. The preceding

decade had been one of remarkable growth; at its close the United States was second only to Great Britain in manufacturing, and American agricultural products were steadily invading world markets. By modern standards the individual firm was still small, and the banks that served them were even smaller. But the use of the corporate form of business organization was spreading rapidly; and though few firms except railroad companies required an actual investment of as much as a million dollars, signs were clear that the concentration of industry would soon bring much larger business units.

A part of the reason for the country's growth lay in the fact that it constituted a great common market, which assured maximum participation in the benefits of specialization. By the early 1840s three great economic regions had emerged. Beginning after the War of 1812 the South provided through the cotton trade a major impellent to economic growth.1 Cotton linked the United States to the Atlantic economy and the South to the Northeast, for it was the Northeast that provided the services necessary for transporting, financing, insuring, and marketing cotton. But the Northeast did more, for this section manufactured and exported goods to the West and to the South. The West in turn furnished the South a large portion of its food, at the same time exchanging its agricultural products for the manufactured goods of the Northeast. This tripartite regional specialization was at once the basis of strong economic bonds and weakening political divisions. For in the years before the Civil War a pronounced sectionalism directed political energies toward county seats and state capitals, and even by the standards of the time federal receipts and expenditures were incredibly small.

The wonder was not that ties of Union were severed in 1861 but that the Union had endured for nearly three-quarters of a century. The

1 See Douglass C. North, The Economic Growth of the United States, 1790-1860, Englewood Cliffs, N. J.: Prentice-Hall, 1961, pp. 66-100.

conflict between North and South began before the American Revolution. The constitutional crisis that led to Civil War emerged in the divisions that separated American leaders during the Confederation and was forebodingly apparent in the Constitutional Convention of 1787. Southern and Western insistence on states rights and an ineffectual federal government did little to remove these divisions, and those who wished to preserve the Union were seriously hampered by a feeble and inadequately supported government in Washington. The sorry state of national affairs is suggested by two facts: when Salmon Portland Chase became Secretary of the Treasury in the dismal spring of 1861, there was less than $2 million in the Treasury, and the government had recently been required to pay as much as 12 percent for short-term funds.

Secretary Chase was a man of considerable gifts. An ex-Governor and exSenator from the state of Ohio, he had fought his way very nearly to the top of the Republican Party, standing in 1861 so close to the peak of power that he could command the second post in the Cabinet. A humorless man, authoritarian and domineering, he was nevertheless a person of integrity and steadfastness of purpose. Unfortunately for his country, Secretary Chase knew little about public finance, his experience having been limited to that of director and counsel for a commercial bank. But in those days political preferment rather than technical competence made a Secretary of the Treasury. Chase's ideas on public finance were simply the conventional wisdom of hard-money advocates, and he refused to consider imaginative plans suggested by some of his contemporaries for financing the War.

We need sketch only the barest outline of Secretary Chase's approach to the country's financial problems. In the first place, he was persuaded against vigorous and prompt taxation, taking ex-Secretary Gallatin's view that the government need only raise taxes sufficient to cover peacetime expenditures plus interest on the growing public debt. As a consequence, of the more than $3 billion spent by the Lincoln administration during four years of war, less than one-fifth was paid for by taxes. The remaining four-fifths was defrayed by issuing unredeemable paper currency and by borrowing.

As early as the summer of 1861, Secretary Chase began to use noninterest-bearing demand notes, authorized by Congress in small amounts, to pay government salaries. With the passage of the Legal Tender Act

2 These notes were not specifically made payable in coin. However, before the suspension of specie payments, the Secretary of the Treasury proclaimed them redeemable in coin in certain cities, and they were universally regarded as coin notes. For detailed discussion of the controversies and unending perplexities of Civil War financing, see Gerald T. Dunne, "President Grant and Chief Justice Chase: A Footnote to the Legal Tender Cases," Saint Louis University Law Journal, 5, Fall 1959, pp. 539-553, and Bray Hammond, "The North's Empty Purse, 1861-1862," The American Historical Review, LXVII, October 1961, pp. 1-18.

A demand note of 1861, the first noninterest-bearing note issued by Secretary Chase, shows Alexander Hamilton, and the statue of Columbia on top of the U. S. Capitol.

of February 25, 1862, the United States could issue $150 million of noninterest-bearing notes not redeemable in specie. Strictly speaking, this issue made legal tender for all private and public debts except payment of customs duties and interest on United States obligations, was the first paper money issued by the United States government. Printed by the newly established Bureau of Engraving and Printing, these United States notes, nicknamed greenbacks because of the vivid color on their reverse sides, became a permanent part of the American money supply. By the end of the War some $450 million of this paper had been authorized, an enormous amount for the time constituting almost half of the total amount of currency in circulation. As opponents of fiat-money financing had predicted, greenbacks almost immediately fell to a discount compared with gold and silver, so that two sets of prices were soon being quoted for goods and services and foreign exchange. In the darkest days of the War, greenbacks sold at a gold price as low as 35 cents on the dollar, though Northern victories brought them by the end of the War to slightly over

80 cents. During the War state-bank notes, redeemable only in greenbacks, depreciated similarly.

Depreciation of the paper currency was synonymous with rising prices. Only a little while after the issue of the first legal tender notes, it became clear that inflation would place a ceiling on the amount of paper money that could be issued. Since Secretary Chase remained adamant in his refusal to increase taxes, declining to use such authorization to tax as Congress granted him, the only recourse was to borrowing. Yet it was clear from the Treasury's successive efforts to finance its deficit that the market for government bonds would be continuously unfavorable. Chase and his advisers became obsessed with the notion that a plan of national-bank organization requiring banks to have bond-secured note issues would be of great help to wartime financing. At the same time Chase would be able to achieve a reform that he had publicly supported for years-the creation of a uniform paper currency. “I have never entertained a doubt," he wrote to Joseph Medill, "that it is the duty of the General Government to furnish a general currency. Its . . . duty must now be performed, not merely as a duty but as a matter of policy."

The Currency Act of 1863

3

The United States had experimented twice with a central bank, and for a time in the 1840s Congress had attempted to establish a third such institution. The ideal solution to many of the Treasury's problems would have been a central bank. Yet a serious proposal for another Bank of the United States would have raised an intolerable political storm. What other kind of scheme, in the Federalist-Whig tradition, might be devised?

For many years proposals were heard for a uniform currency that would have the advantage of federal coordination without the disadvantage of federal monopoly. As early as 1815, Analectic Magazine had run a sprightly review in which the author suggested a national, uniform currency that would be redeemable in either specie or government stock. As might be expected, advice was also forthcoming from the academic community. In 1827 Professor John McVickar published “Hints on Banking," in which he was the first to suggest unifying the currency through a system of free banks, each bank to invest nine-tenths of its capital in government stocks pledged for the redemption of its notes. Twenty years later Millard Fillmore of New York urged the extension of free banking and suggested

3 Salmon P. Chase to Joseph Medill, October 16, 1861, Chase Mss., Pennsylvania Historical Society.

4 Until the Civil War and even a little later government debt instruments were commonly referred to as "stock."