During the American Civil War, the Money Supply more than doubled. Irwin Unger informs us in his book, The Greenback Era, that the Federal Government borrowed roughly two-and-a-half billion dollars during the War, with about 20 percent of that being directly monetized as Greenbacks (an unbacked legal tender created and printed by the Lincoln Administration). Another large chunk of the borrowed funds served as security for the $300 million dollars’ worth of the National banknotes issued by the newly created Federally chartered banks (with the exceptions of a few “Banks of the United States”, banks had always been State-created beasts before).
Some of all this money-printing was offset by the reduction in the number of State-chartered banks during the same period, and by the hoarding of approximately $250 million dollars’ worth of gold-coin by those people distrustful of the expanding supply of paper currency. Nevertheless, it comes as no surprise that massive inflation did indeed ensue during the War years, with the cost of living doubling during that period.
When the War finally ended, the sudden drop in war-orders combined with the re-injection of hundreds of thousands of men back into the workforce, translated into low wages and a recession. The downturn was also exacerbated by the winding-down of the railroad boom during the ensuing years. The precipitous drop in demand for goods and services caused the country to lurch from the highest inflation since Revolutionary days to a profound deflation.
Many people thought that the economy could be helped by the retirement of the unbacked Greenback currency and a return “hard” money (most envisioned this as being gold, some imagined a mixture of gold and silver). Others were just as vehemently opposed to a return to hard money, demanding, instead, that even more Greenbacks should be printed.
On the Hard Money side were those who wished the country to resume a monetary system in which printed money was directly redeemable for gold at the paper currency’s face-value. Even stricter Hard Moneyists demanded an economy based, not upon paper money, but upon widely circulating gold coins. Among the Hard Money men was Rutherford Hayes, who felt that “irredeemable paper currency” was “one of the greatest obstacles to a return to prosperous times.”
Hard Money men felt that “Easy Money” (money printed without strict backing by specie [gold or silver]), led to wild speculation and corruption. Carl Schurz warned that, if the government were allowed to increase or decrease the national money supply at its “arbitrary pleasure,” then no business venture would be safe and no contract secure.
Soft Money men offered differing solutions… Besides the call for more Greenbacks, some Soft Moneyists called for “Free Banking“– that is, a system in which banks could print their banknotes without any specie-reserve requirements or other limitations or regulations. Another group of Soft Moneyists was composed of reformers who wanted to use money-supply strategies as a means of increasing social justice and improving the quality of life for the average citizen. This last group believed that an expanded Money Supply (according to a wide-spread economic theory of the time) would lower interest rates [yeah, I know], thus helping the common man to free himself from the payment of (relatively) high and “unfair” interest rates.
The common denominator of the Soft Moneyists was that they all were in favor of policies which would serve to expand– or at least make more “flexible”– the Money Supply. Most of them felt that the demand for money in the postbellum era was running higher than currency supply, and that business growth was thus being hampered. They felt that if only the Money Supply were to be expanded, interest rates would naturally drop [ahem], leading to more borrowing and investment, and a resultant upsurge in production, profits, and wages.
A sort of compromise view between the Hard Money and Soft Money interests was the idea of growing up to specie— that is, relying on the growing population and the impending economic recovery to increase the value of the currently circulating paper currencies such as the Greenbacks until they naturally moved up to parity with gold, at which point they could be cashed-in en masse, and the nation could return to the gold standard– which at that time, much of the rest of the world was already using. This is basically what turned-out to happen, largely because it was the least decisive, least-effort path back to gold.
Those in favor of Soft Money observed that the $300 million dollar limit on the total amount of National banknotes in circulation was so inflexible that it led to unnecessary credit crunches every Fall when farmers withdrew their savings to help finance their crop movements. Then, every summer, banks would find themselves awash in the farmers’ savings, which they would then lend out to investors– leading to a yearly warm-weather boom in speculative ventures. Thus, claimed these Soft Moneyists, the $300 million ceiling led directly to repeated, seasonal business cycles. [NOTE: the $300 million limit refers only to the banknotes issued by the new Federally chartered banks; State banks were still issuing their own banknotes during this period; on the other hand, the Greenbacks in circulation were, on the whole, dwindling during this time.]
Those in favor of Hard Money were often creditors who felt, because an expanded Money Supply led to a devaluation of currency, that this was unfair to lenders, who would therefore receive back loan payments in dollars worth less the ones lent out.
Soft Moneyist Francis A. Walker agreed that it was wrong to use the money issue to reduce the debt burden, but he thought it was even worse to maintain an overly constrictive supply of currency… “Is it any the less reprehensible morally– is it not even more a blunder economically,” he said, “to adopt measures which must seriously aggravate the pressure of all existing obligations, public, corporate, and private?”
Some Hard Moneyists insisted that the country should scrap paper currency altogether and move to a currency consisting solely of coins stamped from precious metals– either gold… or a mixture of coins, some from gold, some from silver. Those involved in foreign trade especially loathed paper money because it was more susceptible to sudden fluctuations in value.
Edward Kellogg had a sort of middle-of-the-road view on the money-as-specie question. He was not a bullionist— that is, someone who advocated a currency of only gold and/or silver coins. However, he did feel that banknotes should be redeemable for gold always at their face value– that is, that banknote-issuing institutions should be “properly regulated” and forced to keep their notes circulating at par (no discounts or premiums from the value stated on their face). Because Kellogg favored a policy of abundant money, he was in favor of some form of paper currency and did not want the nation limited only to coin issued by the government. He was also in favor of a single, uniform currency for the whole country, although different banks would be allowed to issue it.
Alexander Campbell proposed an interesting long-term, supposedly automatic fix for the Money Supply question. Campbell suggested that the Treasury offer a Bond yielding a relatively low interest rate, which could be bought with the paper currency in circulation. If banks began to overprint paper currency, he argued that interest rates would fall (interest rates being the “price” of money, and that price being driven down due to an excess of supply arising from overprinting– a common economic view of the day). In this situation, once the bank-offered interest-rates dipped below the interest-rate offered on Campbell’s proposed Bond, investors would switch to the Campbell Bond in order to obtain its yield– which had now become relatively high. These Bond purchases, taken cumulative, would then suck money from the economy (and into the Treasury’s coffers, where it would, assumedly, be merely held).
If, on the other hand, the supply of paper money were to be too small and constrictive, Campbell argued that the interest rates offered by banks would go up (money would then be a scarcer, and thus a more valuable commodity under his theory), and people would NOT purchase the government’s low-interest bonds, instead putting their money into savings accounts which could then be lent out by banks, in turn increasing the Money Supply.
Because the Campbell Bond would have been purchasable by the government-issued currency of the day, the Greenback, the Bond was known as the Interconvertible Bond— they could be converted into Greenbacks, and vice-versa.
The problem with Campbell’s Interconvertible Bond idea was that economic thinkers of his day did not adequately take into account inflation-expectations when calculating theoretical interest rates. Campbell believed that when the Money Supply became overly expanded, interest rates would go DOWN. But history has shown that it is not unusual for interest rates to actually go UP when an economy is awash in currency due to the onset of price-inflation (too many dollars chasing too few goods), which in turn leads investors to demand a higher interest rate on savings… if they did not demand a higher return, then when they collected their principle-plus-interest at the end of their investment period, the money paid-out could be worth LESS than when it was invested due to a rise in prices in the meantime.
The same thinking applies for times when the Money Supply shrinks and currency grows scarce– Campbell thought that this would make offered interest-rates rise, whereas, they are in actuality likely to go DOWN since prices are likely falling and investors do not demand extra interest to compensate for price changes (since they are tending downward).
Campbell’s general idea of using the sale or purchase of Government Bonds to shrink or increase the Money Supply is one of the main mechanisms used today by the Fed to affect the Money Supply (that, and direct interest rate manipulation via the Discount Rate the Fed charges banks for loans).
There were other Bond schemes being kicked around during the time as well. For example, Wallace Groom proposed that a Bond be issued which offered a return of 1 penny per day (3.65%, non-compounded). One role that such a Bond could fulfill, claimed Groom, would be the provision of a liquid investment for otherwise unemployed, unfruitful cash balances. The modern Money Market largely serves such a purpose today.
But Groom went further… He suggested that banks be allowed to keep such bonds to serve as their reserves instead of gold. The advantage to banks would be that they could be earning INTEREST on bond-reserves, whereas bars of gold locked away in their vaults directly earned them nothing. This is the same advantage today enjoyed by countries which hold liquid, dollar-denominated assets as their reserves instead of gold– they can earn interest on these assets, whereas their gold reserves lay idle.