American Civil War, Part 2: From "Our Country, Then and Now"
"Financing the War"
Serialization of selections from my book Our Country, Then and Now continues with the cooperation of my publisher, Clarity Press.
The American Civil War was fought from 1861 to 1865, coming to an end over 165 years ago. Its causes and its results remain controversial today. This is especially so as many people are saying the accelerating conflict between the Republican Trump administration and the Democrats he defeated in 2024 has become so vehement as to constitute the possible start of a second civil war. You can read my take on that topic here.
Behind the battlefield drama, often involving horrendous loss of life, lurked profound social, political, and financial issues. Some historians have delved deeper than others, with some asserting that the breakup of the Union was encouraged by the international banking elite centered in Great Britain. These seemed to view the war as weakening the growing industrial might of the US as it was developing in the free-labor states of the North.
In prosecuting the war, the Union under Lincoln was quickly running out of money. When the government turned to the bankers for loans, the demands for interest payments were shocking—25 percent or more. So the Lincoln administration and Congress decided simply to print the money—the Greenbacks. It’s a fascinating story—at least to a US Treasury veteran such as yours truly. I tell the story of the Greenbacks in the following section on “Financing the War.”
Our Country, Then and Now may be ordered directly from the publisher here.
Financing the War
Two days after the surrender of Fort Sumter in the Charleston, SC, harbor on April 13, 1861, President Abraham Lincoln called for 75,000 volunteers to serve for three months to suppress the rebellion. The states of South Carolina, Mississippi, Alabama, Florida, Georgia, Louisiana, and Texas had already seceded. Following Lincoln’s call, Virginia, Arkansas, North Carolina, and Tennessee joined them.
On May 8, 1861, the city of Richmond, Virginia, was named the Confederate capital. In the eastern theater, from the Battle of First Manassas on July 16, 1861, to the surrender of General Robert E. Lee to Union General Ulysses Grant at Appomattox Courthouse on April 15, 1865, a series of battles took place in the relatively confined locales of central Virginia, western Maryland, and southern Pennsylvania. The carnage was beyond belief. Similar havoc was wreaked in the west and south.
When Lincoln issued his call for troops, no one had any clear idea of how the war would be paid for. The struggle to find resources went on by both sides. When the war ended with Union victory, the nation’s economy had been transformed. The South had been crushed and would not begin to recover for decades. The North had become an industrial colossus.
But the problem in wartime was not just producing guns, munitions, or uniforms, or coming up with volunteers and conscripts to fight. The problem was also getting the money to pay for it all, thereby exposing the fatal flaw in modern “political economy.”
In 1861, the federal government’s reliance on “specie” went out the window. Available gold and silver to pay for the war did not exist. Under the Constitution, the government could tax or borrow. But who could be taxed and who would provide loans? Or could the government simply print money as “bills of credit”? No one knew.
Union expenditures on the war skyrocketed from $23.0 million in 1861 to $389.2 million in 1862, to over a billion dollars in 1865. A billion dollars—no one “had ever seen the like.”
Politicians make decisions that the entire population then has to cough up money to pay for. We remember that the American Revolution was fought over “taxation without representation.” The weakness with US democracy was always that people did not want to pay taxes. The Whiskey Rebellion of the 1790s and its suppression proved the case.
The collection of customs duties on imports, the main source of federal revenue, could be isolated to customs houses in port cities. Excise taxes could be extracted from merchants at the point-of-sale of taxed articles like tobacco or salt. Property taxes were left to the states and localities and required a complex system of assessments and collections but were not available to the federal government. Income taxes had long been considered impossible to collect.
So it was easier for the government to borrow and rely on growth of foreign trade, along with sale of Indian lands, to pay for war, though many new taxes were in fact imposed despite widespread evasion. And foreign trade in wartime was static.
Statistics contained in the following account rely heavily on the book Financial History of the United States by Paul Studenski and Herman Edward Krooss, published in 1952 and reprinted in 2003.
Early in the war, Secretary of the Treasury Salmon P. Chase of Ohio began to use non-interest-bearing demand notes; i.e., paper money redeemable in gold, to pay the salaries of government employees. He then began to ask for loans from banks of three-year bonds at 7.3% for a total of $150,000. The trouble was that the entire US banking system, predominantly in the northern states, had only $63 million in specie in their vaults.
The banks balked at coughing up all their “hard money,” causing Chase to threaten to inflate the currency, thereby allowing the specie to cover the debt. The banks tried but failed to sell the government’s bonds to a skeptical public, so Chase issued another $33 million of demand notes, realizing that the government itself could not cover requirements for redemption in specie. Default on these notes would be catastrophic.
Treasury Secretary Chase was now looking at a fiscal year 1862 federal budget estimate of $532 million; the actual expenditure was $469.6 million. Projected revenues, mainly customs duties, were $55 million, with the actual being $52 million. The overall budget deficit for 1862 was $417.6 million.
The Union was facing economic collapse, bankruptcy, and dissolution because the troops, suppliers, and contractors could not be paid. None of these were in a position to work and produce—or kill and be killed—for free. Not in a democracy.
Chase now recommended a restoration of lapsed excise taxes on retail products, both commodities and manufactured goods, large increases in tariffs and customs duties, even as international trade was slowing, and a new national banking system through which government bonds could be marketed and currency values stabilized.
These proposals can be recognized as consonant with past proposals by Henry Clay and others, including Henry C. Carey, now an advisor to President Lincoln, for implementation of the “American System.” Now the American System would be brought out of mothballs.
But the bankers, all from New York with strong ties to London, didn’t buy in to Chase’s proposals. On December 30, 1861, the nation’s banks suspended all specie payments in redemption of circulating paper currency or other financial instruments such as bonds. A day later, the federal government opened a gold market in New York to help ease the crisis where at least gold itself could be bought and sold.
But the government was at a standstill. Despite the 1861 skirmish in Manassas and some fighting in the border states, the Union had yet to place a major army in the field. The Confederacy was busy organizing a government in Richmond, while working on its own program of taxes, debt, and military conscription. But in Washington, D.C., Treasury funds would be exhausted in 30 days.
The government’s credit was so bad that the New York banks, representing both domestic and foreign investors, including Belmont and the Rothschilds, were telling Chase that new government bonds could only be sold at discount rates of 25-50 percent, possibly a 50 percent rate of interest. The terms were ruinous. The nation’s economy would be mortgaged in perpetuity.
Congressman Elbridge G. Spaulding was a banker from Buffalo, NY, descended from Edward Spaulding, an English Puritan, who settled in Massachusetts soon after the arrival of the Mayflower. This was about the time my own ancestor Thomas Bliss had disembarked. Spaulding now proposed the issuance of $150 million in non-interest-bearing Treasury notes not redeemable in specie but legal tender for everything but customs duties.
Secretary Chase supported the measure, which was passed by Congress on February 25, 1862, as the Legal Tender Act. The money was not issued based on a loan to the government, which bank-issued currency would have been.
What were called “Greenbacks” were a true fiat currency, and the Union was saved.[i] Issuance of the unbacked paper was supported by businesses, workers, and soldiers, and immediately began to circulate. Congress authorized a second issue of $150 million on July 11, 1862, and a third of $150 million in January and March of 1863.
Substantial amounts of the money came back to the government in taxes, and Chase now had his hands on the phenomenal amounts of cash needed to prosecute the war. Lincoln said, “We gave the people of this republic the greatest blessing they ever had, their own paper money to pay their own debts.”[ii]
Of course the main argument against fiat currency is that it may cause inflation, and this did happen to some degree with the Greenbacks. In the New York gold market, a Greenback dollar was worth only about 35 cents in gold. But this was at a time when gold was being hoarded. People held onto their gold whenever there was bad news on the war front and spent it when the news was good.
But the inflation was due not only to the Greenbacks. The same thing happened with the money the government was borrowing from the banks, which it continued to do. Eventually, the banks accepted the Greenbacks and even began to buy them as reserves against which they could lend. The government now issued another $50 million in Greenback notes under $5 in value, with $15 million of these small-denomination bills remaining in circulation until 1950!
The government was criticized for not levying enough taxes. In 1862 the government raised and imposed new taxes, including on luxury items, bank capital, and bank deposits, with a 1-1/2 to 3 percent sales tax on railroad fares, ferry boats, steamship tickets, toll bridges, advertisements, paper checks and sale of stocks and bonds, medicines, cosmetics, and playing cards. An inheritance tax was also instituted.
The government now established its first Office of the Commissioner of Internal Revenue. A tax of twenty-cents per gallon was imposed on liquor, which was almost 100 percent of the cost of manufacture. Federal licensing of liquor sales was also imposed. The income tax was now raised to three percent on $600-$10,000 and five percent on amounts over $10,000. In 1863 the liquor tax was raised to $2 per gallon and the income tax was increased, with deductions allowed for house rents, mortgage interest, home repairs, and losses from the sale of land.
From all this we can see that the Civil War introduced much of the federal government’s taxation system that we have today. It also brought bootlegging of liquor to the point that it largely displaced taxed liquor in the market. But consumers took on the brunt of the system, with consumption of all goods dropping up to fifty percent in 1860-1865 due to inflation and taxation. Sale of Indian lands had dropped to almost zero, and by 1865 the government was still looking at a deficit of almost a billion dollars with the total national debt now at $4.9 billion.
So toward the end of the war, even more money was needed. Once again, the government refused to mortgage the nation to the banking system. This time a small-denomination bond campaign was launched under the direction of a financier named Jay Cooke, a Whig lawyer and former congressman from Ohio, who began sending representatives around the country to sell bonds to individuals for as little as $50.
Cooke and his employees sold nearly a billion dollar in bonds that allowed the continued payment of soldiers and suppliers. It was the start of what later became United States Savings Bonds.
Later, Cooke financed the construction of the Northern Pacific Railroad, which ran through the Flathead Reservation in Montana, though he was forced into bankruptcy in 1873 due to over-lending for the development of Duluth, Minnesota, as a railroad hub. Later he recouped part of his fortune through an investment in the Horn Silver Mine in Utah. But it’s for his work for the government in financing the Civil War that Jay Cooke is remembered.
[i] Various parties, including so-called libertarians, deride fiat currency as being improper or downright evil. They are wrong. It all depends on how it is issued, how its value is guaranteed, and how it is used.
[ii] Money: A Monthly Magazine, cited in Xaviant Haze, The Suppressed History of American Banking, Bear and Company (2016), p.142.