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When war broke out in
1861, the federal government was without its own money machine, though that
would soon change. As expenses from the war mounted, the U.S. government once
again issued Treasury Notes to help finance it. The Act of July 17, 1861
authorized Secretary of the Treasury Salmon P. Chase to issue notes at 7.30%,
a rate chosen to make interest calculation so easy they would circulate as
money -- a $50 note accrued interest at a penny a day, for example. Though
the seven-thirties, as they were called, didn’t circulate,
the same Act provided for the issuance of Demand Notes that did circulate. As their name implies,
Demand Notes were redeemable in specie, but that
promise was broken by December, 1861 when the government suspended specie payment.
With no money to fund the war, the Union government could
either end it or get creative with money. For the Republicans, it was not
really a choice. [1]
In January, with Demand Notes eroding in value, Lincoln
turned to former political rival Colonel Edmund Dick Taylor, the only man to
ever beat him in an election (1832), who suggested the government issue new Treasury
notes bearing no interest but printed “on the best banking
paper.” Lincoln took his advice, and on February 25, 1862 signed the
First Legal Tender Act authorizing the Treasury to issue a fiat paper
currency that rose to infamy under the name of “greenbacks.” In
appearance, the greenback was almost indistinguishable from the Demand Note. Where the five-dollar
Demand Note bore the inscription, “payable to the bearer five dollars
on demand,” a greenback of the same denomination had the same message,
minus the “on demand” part. This slight omission meant “guns
and badges” would now replace gold.
The greenbacks kept the blood flowing on the battlefields,
but their proliferation also caused wholesale prices to soar. [2] Also, from
the perspective of certain bankers, the greenbacks were fundamentally flawed
because they were government fiat money instead of bank fiat money. Their
objection, in other words, was not over the ruinous (and unconstitutional)
policy of issuing irredeemable paper money, but who would benefit from
it--the government or the bankers.
The idea of issuing more debt instead of printing greenbacks
was gaining favor in high places. Following Lincoln’s call for an
“organization of banking associations” in his State
of the Union address of December, 1862, the government established the
National Banking System on February 25, 1863.
The banker who profited most from the new system was also its
chief architect, Jay Cooke. When Lincoln first took office, Cooke had lobbied
hard to get Chase appointed as Secretary of the Treasury. After forming the
investment banking house of Jay Cooke & Co., Cooke convinced Chase, in
the Fall of 1862, to make the House of Cooke the monopoly underwriter of
public debt, bestowing on Jay Cooke the title of United
States Subscription Agent. Then Cooke and his brother Henry, who was editor
of Ohio’s leading Republican newspaper, along with Treasury Secretary
Chase and Ohio Senator John Sherman, pedaled the proposed banking system to a
reluctant Congress as simply an emergency scheme for funding the war. The
Cooke brothers were paying large fees to newspapers for advertising the bonds
they were selling, which made it relatively easy to promote their national
banking scheme in the editorial pages. [3]
The bank acts of 1863-1865 established the National Banking
System and authorized the Comptroller of the Currency to charter national
banks. By law, any bank meeting the requirements could be chartered, but the
reserve and capital requirements were so high as to rule out small national
banks, and many state banks elected not to join the new system. Under this
new arrangement, the Independent Treasury, which
had funded the Mexican War without inflation, was suspended, with Treasury funds now kept
in a tripartite hierarchy of “pets,” which were the nationally
chartered banks. State banks could still issue notes, but after March 1865,
Congress imposed a 10 percent tax on all state notes, in effect giving the
nationals a legal monopoly to issue bank notes. While the new system was sold
to the public as a war emergency, its political purpose, according to Senator
Sherman, was to “nationalize American politics.” [4]
The truth of Sherman’s statement is reflected in the
relationship between the national banks and the national government. National
banks could expand their note issue only to the extent they monetized the
public debt. The more debt they purchased, the more they could inflate, and
when carried out by the larger Wall Street banks, it allowed other nationals
to create additional inflation through the mechanism of reserve pyramiding.
[5] Thus, the banks could engage in what they perceived as low-risk inflation,
while giving the government an assured market for its debt.
The printing of greenbacks, which was discontinued in
mid-1863, accounted for only $430 million of the $2.61 billion accumulated
war deficit. [6] Along with gold and silver, greenbacks were considered
lawful money and could be part of a bank’s reserves. National bank
notes themselves possessed some of the privileges of legal tender: the
government required all the national banks to accept each other’s notes
at par, and it agreed to accept each national bank’s notes at par in
taxes. And to minimize the threat of redemption, the government maintained
its pre-Civil War policy of keeping branch banking illegal, which forced note
holders to go to a bank’s home office for redemption, while making it
difficult for any one bank to clear the notes of the others. In addition, the
government imposed a $3 million per month maximum limit on net note
contraction, which thereby placed a limit on the amount of notes they were
required to redeem for specie. [7]
The House of Cooke feasted on this new system. Not only did
Cooke "sell the national banks their required bonds,
he also set up new national banks which would have to buy his government
securities. His agents formed national banks in the smaller towns of the
south and west. Furthermore, he set up two large national banks, the First
National Bank of Philadelphia and the First National Bank of Washington,
D.C." [8]
Cooke’s bond sales ranged between $1 to $2 million a
day, and by war’s end, the House of Cooke had underwritten nearly $2
billion in bonds. [9] Though he lost his monopoly for a year in 1864, he
remained in that privileged position until the Panic of 1873 closed his
banking operation. The financier of the Civil War, who had made millions with
his pyramided system of fractional-reserve lending, filed for bankruptcy on September 18, 1873.
Asking who paid for the war is misleading; in a very real
sense we’re still paying for it and will be until we return to sound
money – money, in von Mises’ words,
that obstructs “the government's propensity to meddle with the currency
system.” [10]
But for the powers-that-be, the idea of sound money bordered
on academic. What was clearly not academic was the fatal flaw in the National
Banking System. Granted, the system of national paper money and pyramided
reserve banking had financed a major war and made certain men very rich. But
any scheme that left the country’s biggest financier bankrupt was destined
to be short-lived. Ironically, Progressivism, the turn-of-the-century
movement that sought to bring down the fat cats, provided the political means
to raise them to new heights. [11]
References:
1. G. Edward Griffin, The Creature from Jekyll Island: A
Second Look at the Federal Reserve, Fourth Edition, American Media, Westlake
Village, CA, 2002, p. 383
2. Murray N. Rothbard, The
Mystery of Banking, Mises Institute, Auburn, AL, 2008, pp. 219-220
3. Ibid., pp. 223-224
4. Murray N. Rothbard, A
History of Money and Banking in the United States: The Colonial Era to World
War II, Mises Institute, Auburn, AL, 2002, p. 136
5. Mystery, p. 225; History, pp. 138-141
6. Mystery, p. 220
7. Murray N. Rothbard, The Case Against the Fed, Mises Institute,
Auburn, AL, 1994, pp. 77-78
8. History, p. 146
9. Mystery, p. 221
10. Ludwig von Mises, The Theory of Money and Credit, The Foundation for Economic Education, Inc.,
Irvington-on-Hudson, New York, 1971, p. 414
11. Gabriel Kolko, The Triumph of
Conservatism: A Reinterpretation of American History, 1900-1916, The Free
Press, New York, NY, 1977.
George F. Smith
Read his book : The
Flight of the Barbarous Relic
Visit his website
Read his blog
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