Resumption of Specie Payments

Wednesday, December 21, 2011

The United States government suspended specie payments in December 1861 in order to protect its reserves of gold and silver after New York banks took a similar action to suspend specie payments. In 1862 the United States issued legal-tender notes that were known as greenbacks; and in 1863 it authorized federally-chartered banks to issue national bank notes. The government suspended specie payments because the army in the field was expecting to be paid and no other expedient solution, except borrowing at very high interest rates, was available. However, the greenback’s legal status was limited by Congress: custom duties and interest on government loans were to be paid in gold in order to maintain the credit of the government, particularly with foreign borrowers. Nevertheless, by the end of the Civil War, a total of $431 million in greenbacks had been issued with an authorization for another $50 million in small denominations known as fractional currency or “shinplasters.”

Given the flood of greenbacks and “shinplasters” issued by the United States government, prices in the North rose dramatically. More importantly, prices rose faster than wages which substantially reduced the real wages of working men and women. For example, a private’s pay rose $11 per month at the start of the war to $16 at the war’s end, a 37 percent increase, but in the meantime prices were rising 69 percent. The result was a substantial loss of purchasing power. In the South, which relied on paper money to finance their war effort more than the North did, inflation was much worse, with the South’s productive capacity severely damaged by the war. By January 1864, the Confederates had $827 million in outstanding notes.

The end of the war did not result in a quick return to resumption. Prices were still far above their 1862 level, which made resumption untenable, for U.S. exports would become expensive and imports cheap, thereby producing an unsustainable loss of gold. Devaluation was not considered a serious possibility by postwar administrations because it would weaken the credit of both the U.S. government and private borrowers with foreign creditors. To accomplish resumption without devaluation, price levels in the United States had to be reduced relative to foreign levels.

Hugh McCulloch, the Secretary of Treasury under Presidents Lincoln and Johnson (and later President Chester A. Arthur) was a strong advocate of hard money. Shortly after taking office he declared: “My chief aim will of course be to provide the means to discharge the claims upon the treasury at the earliest day practicable, and to institute measures to bring the business of the country gradually back to the specie standard, a departure from which, although for the time being a necessity, is no less damaging and demoralizing to the people than expensive to the government." McCulloch confronted inflation by asking Congress for the authority to retire greenbacks out of surplus revenues made available by cutbacks in military expenditures. McCulloch’s ultimate objective was to return the United States to the gold standard. In a speech at Fort Wayne, Indiana in October 1865, McCulloch outlined his financial vision for the United States:

I accepted the office of Secretary of the Treasury with great distrust of my ability to meet the public expectation, but with a sincere desire to do so, and to conduct the affairs of this great department so as to aid in restoring the credit of the government, which has been damaged by the greatness of the public debt, and the uncertainty in regard to the duration, if not to the result of the war, and in bringing up the obligations of the government to the specie standard, I am not one of those who seem to repudiate coin as a measure of value, and to make a secured paper currency the standard. On the contrary, I belong to that class of persons who, regarding an exclusively metallic currency as an impracticable thing among enterprising and commercial people, nevertheless look upon an irredeemable currency as an evil which circumstances may for a time render a necessity, but which is never to be sustained as a policy.

By the common consent of the nations, gold and silver are the only true measures of value. They are the necessary regulators of trade. I have myself no more doubt that these metals were prepared by the Almighty for this very purpose than I have that iron and coal were prepared for the purposes in which they are being used. I favor a well-secured convertible paper currency. No other can to any extent be a proper substitute for coin. Of course, it is not expected that there shall be a dollar in coin in reserve for every dollar of paper in circulation. This is not necessary. For all ordinary home transactions, a paper currency is sufficient, but there are constantly occurring periods when the balance between countries, and in the United States between its different sections, must be settled in coin. These balances are insignificant in amount in comparison with the transactions out of which they arise; and when a vicious system of credit does not too long postpone settlements, they are arranged without disturbing the movements of coin. Whenever specie is needed for this purpose or for any other purpose, the paper currency of the country should be convertible into it; and a circulation not so convertible will not be, and ought not to be long tolerated by the people.

The present inconvertible currency of the United States was a necessity of war, but now that the war has ceased, and the government ought not to be a borrower, this currency should be brought up to a specie standard; and I see no way of doing it but by withdrawing a portion of it from circulation. I have no faith in a prosperity which was the effect of a depreciated currency, nor can I see any safe path to tread but that which leads to specie payment. The extreme high prices which now prevail in the United States are an unerring indication that this business of the country is in an unhealthy condition. We are measuring values by a false standard. We have a circulating medium altogether larger than is needed for legitimate business. The excess is used in speculations. The United States today is the best market in the world for foreigners to sell in, and among the poorest to buy in. The consequence is, Europe is selling us more than she buys of us, including our securities, which ought not to go abroad; and there is a debt rolling up against us that must be settled in part, at least, with coin. The longer the inflation continues, the more difficult will it be for us to get back to the solid ground of specie payment, to which we must return sooner or later.

If Congress shall, early in the approaching session, authorize the funding of the legal tenders, and the work of a reduction is commenced and carried on resolutely, but carefully and prudently, we shall reach it probably without serious embarrassment to legitimate business. If not, we shall have a brief period of hollow and seductive prosperity, resulting in widespread bankruptcy and disaster. There are other objections to the present inflation. It is, I fear, corrupting the public morals, it is converting the business of the country into gambling, and seriously diminishing the labor of the country. This is always the effect of excessive circulation. The kind of gambling which it produces is not continued to the stock and produce boards, where the very terms which are used by the operators indicate the nature of the transactions, but at is spreading through our towns and into the rural districts.

In accordance with McCulloch’s suggestion, Congress passed the Funding Act on April 12, 1866 which allowed the retirement of not more than $10 million in six months and not more than $4 million per month thereafter. However, this action was met with strong opposition by 1868 – the postwar economic boom was over, the crop harvest was poor, and a panic in Great Britain triggered a recession that led to a sharp drop in prices in the United States. The contraction of the money supply was blamed for the deflationary effects and led debtors, particularly farmers and workers, to support a halt to the notes’ retirement. On February 4, 1868, after only $48 million had been retired with $356 million still outstanding, the Funding Act was repealed.

Perhaps as important as the repeal of the Funding Act were the Legal Tender Cases (1870-71), where the Supreme Court upheld the constitutionality of paper money. This allowed Treasury Secretaries George S. Boutwell and William Adams Richardson to expand the money supply in the hope that it would trigger an economic recovery. Both Boutwell and Richardson contended that, though Congress had mandated $356 million as the minimum greenback circulation, the old Civil War statutes still authorized a maximum of $400 million, thereby giving them a reserve of $44 million. While the Senate Finance Committee under John Sherman disagreed, no legislation was passed to assert the Committee’s opinion. Starting in 1872, Boutwell and Richardson used the “reserve” to expand the greenback to $382 million in response to the Panic of 1873. Financial historian Davis Rich Dewey wrote: “The political consequences of the panic were seen in the autumn of 1874, when the congressional elections, for the first time since 1860, went against the Republican party. Under the pressure of political necessity… a bill was enacted for the resumption of specie payments by the expiring Congress, January 14, 1875, while the Republicans still held power to rally to its support sufficient votes for its passage.” The Resumption Act of January 14, 1875 which returned the government to specie payments and reduced greenback circulation to $300 million. The Secretary of the Treasury was directed to “redeem in coin” legal tender notes presented for redemption on or after January 1, 1879. As a result, the currency began to strengthen to the point that by April 1876 the notes were on par with silver coins and began to re-emerge into circulation. On May 31, 1878, the contraction in circulation was halted at $346, 681,016 – a level which would be maintained for almost one hundred years afterwards – although it was by then a small fraction of total currency in circulation in the United States.

Under the presidency of Rutherford B. Hayes, specie payments resumed. This was possible because of the sale of U.S. bonds in exchange for gold under Secretary of Treasury John Sherman. By 1879 the U.S. government had accumulated enough gold reserves to carry out the intent of the Resumption Act. This knowledge that the government could redeem each greenback or bank note at par in gold made the public favorably inclined to use more convenient paper currency.

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