Financing The American Civil War: Greenbacks & 5-20 Bonds

greenback cover

In order to conduct their war of subjugation upon their departing sister-States during the 1860s, those States opting to remain within the American Union had to come up with a way to pay for the military costs requisite for a good continental bloodletting.

According to author Irwin Unger in his book The Greenback Era, America’s Federal Government largely attempted to fund the War Between The States through the issuance of bonds. In August 1861, Treasury Secretary Salmon Chase began issuing $50 million dollars worth of War Bonds.  Unger informs us that “the most important, and ultimately the most controversial” type of bonds issued by the Lincoln administration were the 5-20 Bonds— so named for their redeemability: the Federal Government could choose to redeem the 5-20s after five years… or it could delay redemption for as long as twenty years. There were several interesting aspects to the 5-20 bonds…

FIRSTLY… 5-20s could be purchased by the public using “Greenbacks.” Greenbacks were Treasury Notes printed (partially in green-ink) and issued in early 1862 in order to help pay for the war. They were not backed by gold or silver but merely by the Federal Government’s decree that the Notes were “legal tender” for most transactions and debt-settlements… In other words, Greenbacks were America’s first experimentation with fiat money.  Although, perhaps Greenbacks would be better labeled as “quasi-fiat”– since according to financial expert, Gary North, Union citizens believed that, after the war, people would be allowed to exchange their Greenbacks for gold (which they were indeed eventually allowed to do). Greenbacks and Government Bonds were mutually self-supportive since Greenbacks could be used to purchase bonds and bond-sales were facilitated by the quantitative easing provided by Greenbacks.

THE SECOND interesting thing about 5-20 Bonds is that they were tax-exempt. This special status for Federal Bonds would periodically pop-up as a controversial issue in American politics for years to come. (Oddly, few people today question the privileged, tax-exempt status of government credit instruments).

THE THIRD notable, and most controversial, aspect of 5-20s is that– although the interest payable (6.0%) was guaranteed to be paid in gold– nothing was said about how the principle was to be paid back. Could the Federal Government get-away with paying-back the principle in Greenbacks?– or would the people demand “hard” money? After the War, the proper payback procedure would be argued vehemently for years. And this was no small problem… Unger informs us that by the end of the war, $800 million worth of 5-20s had been sold, and by 1869, the total issue stood at around $1.6 billion.

By comparison, the “Greenback” Treasury Note issue was about half that size, with about $450 million worth of Greenbacks having been issued by the end of the war in 1865.

After the war, people began considering the best way for the Federal Government to pay-off its War debt. Horace Greeley wanted the Government to issue a new batch of low-interest bonds, using the proceeds to redeem all the outstanding high-interest bonds issued during the War (such as the controversial 5-20s). Today, this sort of maneuver takes the form of simple re-financing, and is commonplace during periods in which interest rates are falling.

Many of the bonds sold during the War had been sold to foreign people and banks; Greeley argued that one advantage of his re-financing plan was that, by replacing the War bonds with new bonds sold to U.S. citizens, the interest received by bondholders would be injected into the American economy instead of being sent abroad.

The Pendleton Plan was the most well-known attempt to deal with 5-20 Bonds after the War, and was much debated during the 1868 Presidential campaign. Pendleton’s idea was to allow the Federal Government to use Greenbacks (not gold) to redeem the some of the 5-20s– those held by banks as reserves (actually, the Greenbacks would only be used to payoff the principle of the bonds, since the interest earned had to paid in gold). According to Unger, bank reserves accounted for about 20% of the total $1.6 billion worth of outstanding 5-20s. The plan was controversial since many bondholders felt they deserved to be paid fully in gold, not just the interest.

Pendleton’s Plan would have required banks to withdraw from circulation any banknotes which had been based on their reserves of 5-20s. I presume that Pendleton imagined that the banks would be able to lend out the received Greenbacks directly, and not just use them as reserves.

By retiring the 5-20 Bonds held by banks, Pendleton claimed that the Government would save $18 million-a-year in saved interest-payments.

Since the interest portion had to be paid in gold, the early retirement of the bonds would free-up gold– which the Government could then convert into more Greenbacks for injecting into the struggling postbellum economy.

Pendleton proposed that the remaining 5-20s (the over $1 billion dollars’ worth NOT held by domestic banks) be retired within the next 13 years. Furthermore, Pendleton advocated cuts in government spending; this would allow, according to his figures, the Government’s War debts to be paid-off within five years. Lastly, Pendleton was against continuing the tax-exempt status granted to Government bonds since other investments were not granted such status.

The Democratic Party platform for 1868 reflected the popularity of the Pendleton Plan. It adopted his call for the end of tax-exempt status for Government bonds. The platform also embraced Edward Kellogg’s proposal that the entire country should move to one, common currency and stop allowing banks to independently print their own banknote-currencies. However, as is often the case with compromise platforms, the plank on a single nationwide currency was vague… it could be interpreted as government-issued paper-money or as specie-coin. Regardless, the Democrats did not take the White House in 1868; Republican Ulysses S. Grant was elected President.

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