Letters to the Editor

Inflation in the

United States - Part 2

John Steele Gordon

War is, by far, the most expensive of all government operations. And both the Confederate and United States governments faced unprecedented financial stresses in funding the Civil War. How each of them met the challenge helped determine, in no small degree, the outcome of the war.

Governments have only three ways to fund operations. They can tax, they can borrow, and they can print. Both governments did all three, but the particular mix was very different. The northern states had a much more advanced economy and a well-established financial system in place. As a result, the U.S. was able to throw much of the cost of the war onto the future. In 1860, the national debt had stood at $64 million. By 1866, it was at $2.7 billion, and about five percent of the North’s population had invested in federal bonds. So the North was able to raise two-thirds of its revenues by borrowing.

The Confederacy, with far less liquid capital, a much smaller middle class, and few large banks, could raise only about 40 percent of its revenues through bond sales.

It was the same with taxes. The federal government sharply raised tariffs – its main source of income before the war – and excise taxes. It also taxed gross receipts and imposed a stamp tax on legal documents. The country’s first income tax was passed in 1862. Altogether the North raised 21 percent of its revenues through taxation. The Confederacy, with a less developed and cash-poor economy, was able to raise only about six percent of its revenues through taxation.

Thus the federal government needed to use the third means of raising revenue – printing fiat money – for only about twelve percent of its revenue needs. In the course of the war, the Treasury printed $450 million in “greenbacks” (so-called because they were printed in green on the reverse). This caused inflation, as fiat money always does, and prices rose over the course of the war in the North by a manageable 75 percent.

The South had to meet fully 50 percent of its revenue needs by printing money. State and city governments also printed money. And because the South lacked good paper mills and state-of-the-art printing facilities, counterfeiting flourished. Altogether, the South printed about $1.5 billion in fiat money, three times as much as the North, despite having only twelve percent of the circulation currency before the war and 21 percent of banking assets.

The result was catastrophic inflation. Prices rose 700 percent in the South in just the first two years of the war. As the war continued, the inflationary spiral deepened and the southern economy began to spin out of control. Living standards fell sharply while hoarding, shortages, and black markets spread, eroding popular support for the war.

With the end of the war, Confederate bonds and paper money became worthless – indeed, redemption of the bonds was explicitly forbidden by the 14th Amendment, ratified in 1868. The South, deeply impoverished by the war and dependent on agriculture and extractive industries, would be essentially a third-world country inside a first-world country well into the twentieth century.

By 1879, greenbacks had been made redeemable in gold and the country had returned to the gold standard. The gold standard, where the government stands ready to buy or sell gold in unlimited quantities at a fixed price for its currency, makes inflation impossible. If the market begins to have doubts about the value of the currency, it will increasingly trade it for gold, as would foreign central banks. Consequently, the government must rein in the money supply to avoid being forced off the gold standard.

The gold standard was very popular with bankers and industrialists, as it protected the value of their assets. But it was equally unpopular with chronic debtors, such as farmers, who wanted to be able to pay back their loans with cheaper money.

Pulled in two directions, Congress – as legislatures in democratic countries often do – tried to have it both ways. It put the country fully back on the gold standard on January 1, 1879, soon after passing the Bland-Allison Act in 1878 – an act requiring the Treasury to by on the open market between $2 million and $4 million worth of silver every month and coin it at the ratio of 16–to–1 with gold.

That was roughly the free market price of silver at the time. But as silver production soared in the 1880s, thanks to such strikes as the Comstock Lode, the price of silver began to drop, reaching about 20-to-1 by 1890. That year, Congress passed the Sherman Silver Act, mandating that the Treasury buy and coin 4.5 million ounces of silver every month – just about all the silver the country was producing – still at the ratio of 16-to-1.

With the gold standard keeping the value of the dollar steady and the silver policy greatly increasing the money supply, the government managed both to forbid inflation and to guarantee it at the same time.

Inevitable, Gresham’s Law kicked in. With silver worth one-twentieth the price of gold in the marketplace, but one-sixteenth the price when coined as money, people increasingly kept the gold and spent the silver. Gold began to trickle out of the Treasury.

The very large budget surpluses of the 1880s masked the government’s schizophrenic monetary policy. But when the crash of 1893 marked the onset of a new depression and government revenues plunged, the trickle of gold out of the Treasury turned into a flood. Only some very fancy footwork by the country’s leading banker, J.P. Morgan, kept the U.S. from being forced off the gold standard in 1895.

Part 3 in next week’s edition.

The following is adapted from a lecture delivered on January 6, 2022, at Hillsdale College’s Allan P. Kirby, Jr. Center for Constitutional Studies and Citizenship in Washington, D.C., as part of the AWC Family Foundation Lecture Series.