The Civil War and Its Consequences

Before the Civil War Minimal federal debt Minimal federal taxes (tariffs, excises) No central bank Fixed (bimetallic) exchange rate State-chartered banks (damaged by panic of 1857 and outbreak of war) HUGELY COSTLY WAR—forces changes

Federal Budget: postwar surplus Fed Defict $M Pub Debt $ M Total Rev Cust o m s Intern al RevOther Total Exp Intere st Milita ry Pensi o nOther , ,297771,25316

Civil War War of 1812 Mexican War

Civil War

How to finance the war? The North Taxes? –Primary source: customs—reduced by war, shift to internal revenue, more indirect taxes and income tax—first time Bonds? –Huge Effort---Massive Bond Sales Money? –Issue of Greenbacks, declared legal tender—government accepts these in payment of taxes and for government expenditure. These are not convertible into gold and silver….gold and silver are hoarded- --fiat money standard

The South? Hyperinflation and default on debt and destruction of financial system

The Union’s Financing of the Civil War Percent Taxation21 Borrowing56 Money Creation23 Total100

Indices of Prices and Real Wages During the Civil War (1860=100) UnionConfederate YearPricesReal Wages PricesReal Wages , ,

The War and the Monetary System What did a bimetallic (or gold) standard guarantee? Gold and economy grow at “about” the same rate: MV=PQ or in rates of change m + v = p + q U.S. abandons gold standard Fixed exchange rate  Floating exchange rate Value of dollar falls, inflation and depreciation of the $. Why did the U.S. go off the standard in the Civil War?

U.S. Bimetallism Coinage Act of defined basic monetary unit as the dollar Set U.S. $ equal to grains of fine (pure) silver or grains of pure gold. Authorized free coinage of both silver and gold at ratio of 15. Public brings in as much gold or silver as it wants and it is coined. U.S. effectively on silver standard because world price > 15:1 Act of 1834—Jackson’s supporters aim to injure Bank of U.S. whose large denomination notes were widely used---set ratio at 16:1---aim to put more gold in circulation…de facto gold standard…

Civil War

The Problem 1860 Exchange Rate £1 = $4.86 under specie standard Cotton dress in U.S. costs $4.86 and in U.K it costs £1. So it is competitive because $4.86/($/ £)4.86 = £1 But in war, no promise to exchange $ for gold or silver. Prices in U.S. rise by 232%. In U.S. prices of dress now: $4.86x2.32=$11.32 At end of war, U.S. cannot compete, $11.32 dresses cost 11.32/4.86= £2.32, would result in huge outflow of specie to Britain Two choices (1) devaluation of $ so £1=$11.32 or (2) allow gold outflows  deflation reduce prices so that dress is again $4.86 Problem of the Debt: $100 principal with 6% coupon sold with promise that will repay in gold. Annual coupon is $6 but this is now only worth $6/2.32=$2.89, imply that $100 bond is worth less if investors continued demand in 6% in real terms: 2.89/.06=$ Bond holders would feel defrauded. So government picks deflation over devaluation.

Postwar Problems: Price Level and the Debt Policy makers understand the need for commitment to repay real value of the debt---decide to reduce the Greenbacks in circulation. Deflation to lower the price level to prewar level--but huge political pressures. Effects on debtors and creditors??

Nominal Debt Price LevelReal Debt in 1865 $ = 1865$ =(100/210)* $ =(100/135)*

How did they move from Greenbacks to Gold? 1866 House of Representatives votes 144 to 6 to return to gold----but parties soon split: Republicans generally “hard money” and Democrats “soft money” Coinage Act of 1873—lists coins to be minted: gold and subsidiary silver but not silver dollar. Clear decision by Secretary of the Treasury, Comptroller of the Currency and leading Senators---but no popular protest Congress sets maximum for greenback issue Resumption Act of sets resumption of specie standard on gold basis on January 1, (Parallels Britain: off specie 1797, demonetize silver in 1816, resumption in 1819 on gold) Resumption of convertibility of dollar into gold!!!

Making Good on Your Commitment How Is Resumption Achieved? Method? (Friedman and Schwartz, 1963) M* + V* = P* + Q* ?????

Federal Budget: postwar surplus key to commitment Federa l Deficit $M Public Debt $ M Total Rev Custo m Interna l RevOther Total Exp Interes tMilitary Pensio nOther , ,297771, , , , , , , , , ,

Success also measured by fall in yields/interest rates

Civil War to World War I and the Politics of Money Civil War, Greenback Period, The Gold Standard, –Deflation and Silver Politics, –Gold Inflation,

Bordo (1981) Chart 2