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The Civil War and Its Consequences. Before the Civil War. Minimal federal debt Minimal federal taxes (tariffs, excises) No central bank Fixed (bimetallic) exchange rate State-chartered banks (damaged by panic of 1857 and outbreak of war) HUGELY COSTLY WAR—forces changes.
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Before the Civil War • Minimal federal debt • Minimal federal taxes (tariffs, excises) • No central bank • Fixed (bimetallic) exchange rate • State-chartered banks (damaged by panic of 1857 and outbreak of war) • HUGELY COSTLY WAR—forces changes
Civil War War of 1812 Mexican War
How to finance the war? The North • Taxes? • Primary source: customs—reduced by war, shift to internal revenue, more indirect taxes and income tax—first time • Bonds? • Huge Effort---Massive Bond Sales • Money? • Issue of Greenbacks, declared legal tender—government accepts these in payment of taxes and for government expenditure. These are not convertible into gold and silver….gold and silver are hoarded---fiat money standard
The South? Hyperinflation and default on debt and destruction of financial system
The War and the Monetary System • What did a bimetallic (or gold) standard guarantee? • Gold and economy grow at “about” the same rate: MV=PQ or in rates of change m + v = p + q • U.S. abandons gold standard • Fixed exchange rateFloating exchange rate • Value of dollar falls, inflation and depreciation of the $. • Why did the U.S. go off the standard in the Civil War?
U.S. Bimetallism • Coinage Act of 1792---defined basic monetary unit as the dollar • Set U.S. $ equal to 371.25 grains of fine (pure) silver or 24.70 grains of pure gold. • Authorized free coinage of both silver and gold at ratio of 15. Public brings in as much gold or silver as it wants and it is coined. • U.S. effectively on silver standard 1792-1834 because world price > 15:1 • Act of 1834—Jackson’s supporters aim to injure Bank of U.S. whose large denomination notes were widely used---set ratio at 16:1---aim to put more gold in circulation…de facto gold standard…..1834-1860
Civil War 1834-1860
The Problem • 1860 Exchange Rate £1 = $4.86 under specie standard • Cotton dress in U.S. costs $4.86 and in U.K it costs £1. So it is competitive because $4.86/($/ £)4.86 = £1 • But in war, no promise to exchange $ for gold or silver. Prices in U.S. rise by 232%. In U.S. prices of dress now: $4.86x2.32=$11.32 • At end of war, U.S. cannot compete, $11.32 dresses cost 11.32/4.86= £2.32, would result in huge outflow of specie to Britain • Two choices (1) devaluation of $ so £1=$11.32 or (2) allow gold outflows deflation reduce prices so that dress is again $4.86 • Problem of the Debt: $100 principal with 6% coupon sold with promise that will repay in gold. • Annual coupon is $6 but this is now only worth $6/2.32=$2.89, imply that $100 bond is worth less if investors continued demand in 6% in real terms: 2.89/.06=$43.10. Bond holders would feel defrauded. So government picks deflation over devaluation.
Postwar Problems:Price Level and the Debt • Policy makers understand the need for commitment to repay real value of the debt---decide to reduce the Greenbacks in circulation. • Deflation to lower the price level to prewar level--but huge political pressures. • Effects on debtors and creditors??
How did they move from Greenbacks to Gold? • 1866 House of Representatives votes 144 to 6 to return to gold----but parties soon split: Republicans generally “hard money” and Democrats “soft money” • Coinage Act of 1873—lists coins to be minted: gold and subsidiary silver but not silver dollar. Clear decision by Secretary of the Treasury, Comptroller of the Currency and leading Senators---but no popular protest. • 1874 Congress sets maximum for greenback issue • Resumption Act of 1875---sets resumption of specie standard on gold basis on January 1, 1879. (Parallels Britain: off specie 1797, demonetize silver in 1816, resumption in 1819 on gold). • 1879---Resumption of convertibility of dollar into gold!!!
Making Good on Your CommitmentHow Is Resumption Achieved? Method?(Friedman and Schwartz, 1963) M* + V* = P* + Q* ?????
Civil War to World War Iand the Politics of Money • Civil War, 1861-1864 • Greenback Period, 1864-1879 • The Gold Standard, 1879-1914 • Deflation and Silver Politics, 1879-1897 • Gold Inflation, 1897-1914