A Blog of the Global Justice Movement

Monday, February 18, 2013

Avoiding Monetary Meltdown, II: Salmon P. Chase and the Greenbacks


Last week we posted the first part of our “open letter” to Bob Marshall of the Virginia House of Delegates.  Since it seemed to be rather well-received (and even generated a couple of e-mails to let Mr. Marshall know people actually care about this sort of thing), we’re starting off the week with the second part, and should finish tomorrow with the third part.

If you think that Bob ought to talk to CESJ president Norman Kurland, you might want to send Bob an e-mail at delegatebobmarshall [at] Hotmail [dot] com to that effect after reading today’s posting — if you haven’t done it already.

Anyway, last week we noted that Andrew Jackson had drained the economy of gold and silver with his Specie Circular of 1836.  A similar situation occurred during the Civil War.  In November 1861, Treasury Secretary Salmon P. Chase (who wanted to be president) decided it was more politically expedient to finance the Union war effort by emitting bills of credit rather than by raising taxes.  He began issuing massive amounts of United States Notes — “Greenbacks.”  Chase had just promised the nation’s bankers in August that he would do no such thing.

The notes being convertible into gold on demand, the public immediately rushed to the banks to exchange the new government paper for gold.  By the middle of December, gold reserves were almost completely depleted.  The banks suspended convertibility on December 31, 1861.  Convertibility was not resumed until January 1, 1879, following the Panic of 1873 and the “Great Depression” of 1873-1878.  As a result of financing the war with debt instead of taxes, the North experienced a 600% inflation rate, while the Confederate currency simply ceased to have any value at all as the tax base disappeared.

The Panic of 1873, while triggered by events in Europe engineered by Prince Otto von Bismarck, Chancellor of the new German Reich, was caused by the fact that (in the U.S. at least), the debt-backed paper currency was being deflated to restore parity with gold.  This “starved” consumers, small businessmen and farmers for credit and depleted savings.

At the same time, the railroads and the large industrial and commercial interests could create all the money they wanted virtually at will — and were receiving government subsidies into the bargain.  They created money by drawing and offering bills of exchange backed by the present value of the new capital the bills were financing: future increases in production instead of past reductions in consumption.

The bills were accepted in trade and commerce, or discounted or rediscounted to back demand deposits at the new National Banks.  The National Banking Act of 1863 created the National Bank system to serve as a quasi-central bank.  This was to stabilize the currency and impose uniformity on the specie and paper currencies once parity with gold was reestablished through deflation.

Consequently, productive capacity soon outstripped effective consumer demand.  Economic growth slowed dramatically.  Abraham Lincoln’s 1862 Homestead Act fueled rapid rates of growth from 1865 to 1873, and from 1879 to 1893.  By limiting the “small man” to past savings for economic development, however, and allowing large interests to self-finance, productive capacity kept exceeding the capacity of ordinary people to consume all that was produced.  The Panic of 1893 ensued.  The country experienced another “money famine,” inhibiting the daily consumer transactions that necessarily drive an economy.

The Panic of 1893 and the ensuing Great Depression of 1893-1898 revealed serious weaknesses in the U.S. financial system.  The most serious weakness was that consumers, small businessmen and farmers were limited to a deflated, debt-backed currency to finance economic development and consumption.  At the same time, the rich could create investment capital in the form of private sector asset-backed bills of exchange virtually at will.

Again, gold and silver coin only supplemented the government debt-backed National Bank Notes, the Treasury Notes of 1890, and the United States Notes, which in turn only supplemented private sector bills of exchange.  The National Bank Notes, the Treasury Notes of 1890, and the United States Notes were convertible into gold on demand.  Had there been universal conversion, however, the amount of gold reserves could not possibly have met the demand, as had been demonstrated in the 1830s and during the Civil War.

There was not, and there has never been enough gold to supply the transactions demand for money.  Having managed after nearly fifteen years to restore the faith and credit of the government following the Civil War by deflating the paper currency and restoring parity with gold, the government was reluctant to inflate the currency.  This was despite the increasing calls for “free silver,” particularly by “the Great Commoner,” William Jennings Bryan, to cheapen the dollar and expand the money supply for ordinary people.

Bumper crops in the U.S. in 1897 and 1898 combined with crop failures in Europe brought the country out of the Great Depression of 1893-1898.  The pressure to inflate the currency lessened.  Nevertheless, the problems of an inelastic, government debt-backed currency for ordinary people combined with an elastic, private sector asset-backed money supply for the rich remained.

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