The rise of the greenback - US dollar - The Fortunes of Money

UNESCO Courier, Jan, 1990 by Jan Kregel

The US dollar brought order to domestic monetary chaos and went on to become the leading international currency IN the last half of the nineteenth century, the British pound sterling ruled supreme as an international currency. Of all its possible rivals, the United States dollar seemed the least likely to take its place. The United States was an international debtor of an uncertain quality without a central bank and without a single unified currency system. The dollar only rose to dominance in the twentieth century as a result of a tortuous sequence of events which led to the creation of a central banking authority, the Federal Reserve System, and to the adoption of the dollar as a liability of the federal government.

The United States Constitution adopted in 1789 did not grant the federal government the exclusive prerogative to issue coins and currency which was enjoyed by the Crown in European monetary systems. The absence of clear legislation on currency matters created a myriad of diverse means of payment virtually without any central control or support. In these chaotic conditions, foreign coins circulated as legal tender until 1857, and as late as 1901 an Oregon silver mine was still issuing its own silver coins for "commercial use".

In the aftermath of widespread default of currencies issued by individual states of the Union, they were prohibited from issuing paper money. But nothing prevented them from creating banks, which were free to issue bank notes. The state of Kentucky, for example, created a private bank of which it was sole owner and proceeded to make payments with its notes. This individualist tradition in money matters found expression in "wildcat" banking and the prevalence in this period of state "free banking" laws which allowed any individual or association of individuals to open a bank and issue bank notes without licence or control.

The absence of a national bank meant that even the federal government had to undertake its financial transactions either through private banks or in specie coin or bullion). In 1840, President Martin Van Buren instituted the "Independent Treasury System" which handled government transactions through nationwide sub-offices. Since the Treasury was not a bank, and could not issue notes, all government receipts and expenditures had to be made in gold or silver. Expenditures in excess of taxation could not be financed except by issue of government debt subscribed in gold.

The Civil War

and the first greenbacks

Many currency arrangements of the late nineteenth century can be traced back to the need to finance the Civil War of 1861 to 1865. The Treasury first issued "demand notes" which were not legal tender, but were convertible into gold. But the weak gold reserves of the Treasury soon led to the suspension of convertibility of these notes. Thereafter the war effort was financed by an issue of United States Notes", based on nothing more substantial than the faith and credit of the government. They were popularly called greenbacks the name by which the United States dollar is still known throughout the world.

The issue of greenbacks had been limited to $433 million, so in the face of increasing difficulty in borrowing and of rising expenditures Treasury secretary Salmon P. Chase decided to apply "free banking" on a national scale. The National Bank Act of 1863 allowed any group of five persons to form a National Banking Association" and issue National Bank Notes" in an amount equal to their holdings of federal government bonds deposited with the Comptroller of the Currency.1

To prevent competition from state bank notes, a 10 per cent tax was placed on the latter which soon drove them out of circulation. The state banks countered by offering payment services cheque against deposit accounts, which proved to be an attractive substitute for National Bank Notes.

By the end of the Civil War, the multiplicity of means of payment representing the liabilities of thousands of state banks had been largely reduced to greenbacks and National Bank Notes, neither of which were convertible into specie, but the issue of which was strictly limited. The money supply of the United States was thus rigidly fixed, unable to respond to either fluctuations in trade, nor the frequent panics that resulted from the failures of the unregulated state banks (two years after the introduction of free banking in Michigan, for example, all of its forty banks had failed).

The dollar set firmly on the gold standard

As the United States was basically an agricultural country, the demands on currency were linked to the harvest. As crops were sold, farmers' bank deposits built up in the agricultural regions, leading to a shortage of funds in the urban banks of the east. The National Bank system of small individual units had no mechanism to recycle excess funds, such as was possible in a multibranch bank. Furthermore, without a central bank to lend reserves, there was no way of meeting these fluctuations apart from sharp changes in interest rates, or declaring bank failure. Together with the net drain of specie to the Independent Treasury and the absence of strict banking regulations, this led to extreme instability and frequent crises.