During the 1860s, the American banking system possessed no Central Bank or Federal Reserve System. In those days individual banks across the country issued their own paper money in a largely unregulated affair. It was up to the banks themselves to decide how much paper money, called “banknotes,” to print.
Theoretically, banks were kept from under-printing banknotes by the lure of interest they could receive by lending-out money. And banks were supposed to be kept from over-printing money because their banknotes were redeemable on-demand for gold. It was partially to meet this potential demand that banks kept gold “reserves” in their vaults (there were also other considerations, such as the ability to return to bank-customers their savings upon demand; also, maintaining some specie on hand was prudent in case financial opportunities or other needs presented themselves). In this way, the amount of gold the bank possessed (or could get its hands on really quickly) determined how many banknotes the banks would issue– banks would give out (mostly as loans or interest-payments) as many notes as they thought they could get away with– without running too high of a risk of becoming depleted of gold when their customers chose to withdraw their savings or to redeem their banknotes for “hard” money.
Of course, frequently, the temptation to squeeze just a little more profit out of the same amount of reserves would prove too much, and the banks would overprint banknotes. This would leave them vulnerable to a “run” on the bank– a situation in which many people in a short period of time demand their savings back or present their banknotes for redemption. When such “runs” occurred, banks could find themselves with an inadequate amount of accessible gold. The result would sometimes result in the financial ruin of the bank. And in the days before Federal Deposit Insurance– if you were last in line for your gold, and the bank closed its doors for good, you could be left without your savings or holding a handful of worthless paper.
Before the Civil War, banks were only chartered by individual States. The requirements for starting a bank were actually pretty easy to meet– basically, if you could put together a few investors who could supply a certain minimum amount of start-up capital, then — boom!, you too could own your own bank and print your own money.
During the Civil War, however, the Federal Government decided it prudent that it, too, should get in on the bank-chartering business. However, banknotes from Federally chartered banks were issued a little differently than from State banks. A group starting-up a Federal bank would deposit Treasury Bonds with the Comptroller Of The Currency and receive in return the new, standardized National Banknotes.
These National Banknotes were not decreed by the Federal government as “legal tender” as the Treasury Notes called Greenbacks had been, but since they were redeemable for Greenbacks, they were, Irwin Unger tells us in The Greenback Era, “virtually their equivalent.” The National Banknotes, printed solely by the new, Federally chartered banks, were receivable for all public debts and government obligations except customs and interest on the national debt. The National Banking Act limited the total issuance of National Banknotes to $300 million.
Unger informs us that, in order to entice State banks to re-charter as Federal banks, the Lincoln administration instituted a 10% tax on banknotes issued by State-chartered banks. Due largely to this imposed financial disadvantage, by the end of the war, there had already sprung into existence 1,600 National banks, most of these having previously been State banks which switched their State charters for Federal ones.
By the end of the War, a real revolution in money had occurred within the United States. The Federal government –previously almost completely absent from business of printing paper currency (unless one counts transferable Treasury bonds or the like)– was quickly on the way to becoming the dominant player in the game, due to several innovations… 1) the issuance of National Banknotes via the new system of Federally chartered banks, and 2) the issuance of the new currency known popularly as “Greenback” Treasury Notes– a fiat or a quasi-fiat currency unbacked by specie and decreed as “legal tender” by the Lincoln administration.