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ECONOMICHISTORY OpportunityMonetary PolicyCost in the Confederacy BY ERIC NIELSEN

ars may be won or lost on repercussions long after the war Unable to finance the battlefield, but gener- ended. The conduct of monetary poli- Walship, bravery, and cy in the Civil War is not simply of the war effort organization are of little use to an interest to historians. The era also pro- army if its government can’t pay its vides important lessons for monetary through taxation, expenses. The ability of a government policymakers and researchers. The to finance a war is often critical to the experience of the Confederacy in par- the South turned to war’s outcome, even if the effects of ticular illustrates the consequences of financing seem far removed from mili- poor financial infrastructure and gov- the printing press, tary action. In turn, a government’s ernance. It also shows the power of a voracious appetite for resources to generally monetarist explanation of and the result was fund its military and the peculiar inflation. strain on production that characterize At the start of the war, the hyperinflation times of war further complicate good Confederacy faced many daunting monetary and fiscal policymaking. barriers to the conduct of sound mon- These tensions clearly played a signifi- etary policy. Perhaps most important cant role in the conduct of the of these was the decentralized power American Civil War. structure of the Confederate govern- The need for wartime funding in the ment. The Southern states had North and South led to policies that seceded under the banner of states’ illustrate basic tenets of monetary rights and were reluctant to obey the economics while precipitating a dra- economic policies of President matic restructuring of the national Jefferson Davis or Secretary of the financial system, changes that had Treasury Christopher Memminger. The South also lacked a well-devel- oped financial infrastructure since in the antebellum period most large banking operations were in the North, where most of the gold was held. Each state could charter banks, and there was considerable heterogeneity in banking and regulatory practices across the Southern states. Since each bank could issue its own currency notes, the government had limited ability to conduct coordinated mone- tary policy. Further, the absence of a central bank to act as a lender of last resort made the banking industry prone to liquidity crises. The only source for centralized economic policy After the fall of Atlanta in July 1864, was the Confederate Treasury under the Confederacy’s Memminger, but this office was sub- prospects looked dim. ject to the vagaries of the executive Southerners started and legislative branches of govern- spending their ment, meaning that policy could be Confederate notes influenced for political, not economic, rapidly, increasing reasons as argued by economist money velocity — and with it, prices. Eugene Lerner. PHOTOGRAPHY: LIBRARY OF CONGRESS, PRINTS & PHOTOGRAPHS DIVISION [LC-B8171-2715] PRINTS & PHOTOGRAPHS OF CONGRESS, LIBRARY PHOTOGRAPHY:

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The structure of the Southern econ- As more and more tax bills were Confederacy. So rapid was the expan- omy also impeded effective monetary passed, the tax code became increas- sion of the Confederate money supply policy. Heavily dependent on agricul- ingly complicated, further hindering that at one point during the war, the ture, the South had little industrial collection efforts. Indeed, the only orders for new currency exceeded the capital and few liquid assets. The lack taxes that could reliably raise revenue printing capacity of the Treasury’s of liquidity made tax collection in the were taxes-in-kind, which meant that presses. To fill the order, the Treasury rural South very hard, while the lack of goods were confiscated directly. But began to accept counterfeit currency economic diversification made the Lerner argues that this practice ulti- as valid to further expand the supply of economy prone to adverse shocks in mately led to a decline in market money. its few export goods such as cotton. activity, as farmers began to produce The enormous increase in the quan- Finally, the South had a relatively only enough to support themselves, tity of currency precipitated an era of uneducated population which led to fearful that their surplus crop would hyperinflation in the Confederacy as constant worker shortages in the be captured by taxation agents. more dollars chased fewer goods. The Treasury’s office in Richmond and in Jefferson Davis and Secretary price level in the South rose by rough- other posts requiring a high degree of Memminger were also stymied in their ly 10 percent per month during the literacy. attempts to raise revenue through bor- conflict and by the end of the war, the The combination of these structural rowing. Though their initial bond price level had increased in the problems coupled with shortsighted offering of 50 million Confederate Confederacy by a factor of 92, though policymaking by the Confederate dollars sold well, subsequent issues did imports tended to inflate more quick- Congress meant that taxation and bor- not sell well except in some foreign ly and exports more slowly. At the rowing ultimately failed to raise markets. One problem with these later same time, the blockade, military sufficient funds to conduct the war. So bond issues was timing — the war destruction, and the loss of workers to the Confederacy had to finance itself started in April just as farmers were the war caused real wages and output through the excessive printing of planting and strapped for cash. Also, to fall dramatically, with per-capita money, which led to hyperinflation. the 6 percent to 8 percent coupons consumption falling by 50 percent in Increased taxation, the most direct paid by most of these bonds were real terms. Indeed, if banks had not and obvious way of raising additional more than eaten up by high inflation. sharply increased their reserve ratios revenue, failed to finance a significant Throughout the entire course of the for fear of bank runs, the inflation cre- portion of the war for the war, the South managed to secure only ated by excess money in the South Confederacy. Only 8 percent to 11 per- one overseas loan, from Erlanger & would likely have been even more cent of all wartime revenue in the Co. in Paris. The loan had a face value severe. South came from taxation, despite the of $15 million and was issued at a time Hyperinflation had a number of introduction of many new taxes on when things looked bright for the negative effects on the Southern income, professional licenses, and South, on the eve of the battles of wartime economy. As currency property. In addition, a new excise tax Vicksburg and Gettysburg. The became useless as a store of value, the on cotton, the most significant export Confederacy’s defeats at these two rate at which people spent their cash crop in the South, also failed due to pivotal battles caused the value of the reserves — the velocity of money — the surprisingly effective naval block- loan to plummet so that after commis- increased, driving prices still higher. ade orchestrated by the Union. sion, Erlanger likely netted the South In many areas of the South, Prior to the Civil War, the Southern only $3 million in real terms, not Confederate dollars became worth- states enjoyed one of the lightest tax enough to make much of a difference less unless accompanied by some burdens in the world; when the war to the war effort. valuable underlying commodity such started there was thus no infrastruc- With no other avenue open, as cotton or leather, impeding the ture in place to efficiently levy and Secretary Memminger reluctantly smooth economic exchanges on collect taxes except for duties on turned to the printing press to meet which healthy economies depend. In imports and exports at major ports. the Confederacy’s financing needs. border areas, the Union greenback Many state governments were very Memminger was aware that such a currency became the preferred medi- hostile to collection efforts by the move would likely cause a rise in the um for exchange due to its superior Confederate government and actively price level and warned the government stability. Faced with the danger of aided their citizens in tax evasion as repeatedly about this danger, to no imminent invasion and the burden of documented by Lerner in his classic avail. The Treasury bills issued during supporting and hosting the military, study of Confederate economic policy. the war had a peculiar feature: They the border areas tended to be partic- For instance, only South Carolina paid were redeemable for gold two years ularly harmed by the war. for the Tax of 1861 by collecting duties after the war ended, which meant that The Confederate government from its citizens; the other states sim- the value of the bills was partially tied passed the Currency Reform Act of ply took out loans to pay their share. to expectations of victory for the 1864 in an effort to stem the rampant

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inflation ravaging the South. The Act tising effort presaged the modern era underlying commodity, was used as effectively removed one-third of all in which bond issues to the general legal tender. A year later the Union currency in the South from circula- public were used to help pay for wars. government passed the National tion by mandating that all large During the war, the Union also man- Banking Act of 1863 which created a denomination bills be converted to aged to expand its tax base and revamp system of nationally chartered and reg- 4 percent Treasury bonds before its collection system. After some ini- ulated banks to ensure a market for April 1, 1864, and imposing a 3-to-2 tial tax measures in 1861, including the Union war bonds. Preexisting banks redemption ratio for small bills after first federal income tax in U.S. history, were given very strong incentives to the deadline. As people tried to get the Union passed the Internal become nationally chartered. Once rid of their large notes, velocity Revenue Act of 1862 which raised the chartered they were subject to federal spiked and in the months prior to the income tax, enacted luxury and con- reserve requirements, had to accept all deadline, inflation rose to 23 percent sumption taxes, and created the other national banks’ currencies at a month. In the summer of 1864, Bureau of Internal Revenue. In con- face value, and had to hold federal though, price levels in the trast to the Confederate bureaucracy bonds as collateral against note issue. Confederacy finally stabilized and where central control was weak and Both the Legal Tender Act and the even declined slightly, just as mone- administrative capability lacking, the National Banking Act were intended tary theory would predict following a Bureau of Internal Revenue stream- to be temporary measures to meet the contraction in the money supply. lined federal tax collection, a process exigencies of war. However, both sets However, in the face of continuing so effective that the North raised 20 of reforms lasted long after the con- pressure to meet war obligations, percent of its wartime revenue flict ended. More broadly, these acts, Congress authorized the printing of through taxation. coupled with the expansion of taxa- an additional $275 million in August The Union Congress also passed tion and the creation of the Bureau of of 1864, mostly reversing the effects several important pieces of financial Internal Revenue, marked an impor- of the Currency Reform Act. legislation during the Civil War. In tant shift in the power of the U.S. In contrast with the South, the 1861, the financial demands of the war government. After the Civil War, the Union successfully raised the $2.3 began to deplete the gold reserves of federal government had much more billion necessary to fund its war both the banking sector and the control over banking regulation and effort without causing hyperinfla- Treasury. In response, private banks monetary policy, and much more tion. Though inflation was high in ceased redeeming currency for gold, power over the states generally. the North during the war — prices and soon the Treasury followed suit. In hindsight it is easy to point out doubled in most Northern cities — it The government passed the Legal where the South went wrong and what paled in comparison to the hyperin- Tender Act of 1862, which allowed the the government could have done bet- flation that plagued the Confederacy. issuance of legal tender currency not ter. However, at the time the situation The North drastically changed its backed by gold. This marked the first was much less clear to government tax collection system and financial time in U.S. history that a fiat curren- officials. Politicians and generals on infrastructure to accommodate the cy, or a currency not backed by some both sides of the conflict began the burdens of a long, expensive war. war with extremely optimistic These wartime changes ultimate- Money Supply and Inflation assessments of its outcome and ly helped reshape the economic duration. Southern confidence in face of America. in the Confederacy a quick victory, coupled with a As the South increased its money supply during the Whereas the South was mostly political climate that distrusted first three years of the war, inflation followed. Later, unable to raise funds through loans, taxation and centralized authority, battlefield events led to soaring prices. the North financed roughly 65 per- meant that short-term expedients cent of its war effort through 10000 were repeatedly selected as borrowing. Wealthy Philadelphia 9000 Money Supply fiscal problems arose. Had the 8000 Price Level

financier Jay Cooke successfully NDEX Confederates known that the war I 7000 , Grant s Virginia Campaign orchestrated the sale of huge num- 6000 would take years instead of ONEY

bers of war bonds. In order to sell M 5000 months, they may well have seri- Battle of Gettysburg these issues, Cooke launched a 4000 ously attempted to overhaul their Fall of Vicksburg 3000 massive advertising campaign RICE AND Fall of Atlanta banking and tax collection sys- P aimed at middle- and working-class 2000 tems instead of relying so heavily 1000 families who traditionally were not Currency Reform Act of 1864 on the printing press. 0 seen as a major source of funds. His 0 102030405060 One major reason the South was campaign was a success, with MONTHS SINCE JAN. 1861 reluctant to reform its financial almost 1 million working families SOURCE: Roger Ransom, “The Economics of the Civil War” system was the faith its leaders and purchasing war bonds. This adver- citizens placed in the ability of

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“King Cotton” to win the economic side of the war for them. The South had planned to use the good to finance the war and to induce Great Britain, heavily dependent on cotton for its textile mills, to grant the Confederacy diplomatic recognition. The effective- ness of the Union blockade prevented the South from realizing either of these goals. The Confederate experience lends considerable support to the thesis that inflation is largely a function of in Richmond. As Sherman and Grant The vignette in the center of this 1862- the growth in the supply of money. steadily fought their way into the issued $5 Confederate note shows the Economists Richard Burdekin and Confederacy, expectations of a Capitol building in Richmond. Marc Weidenmier of Claremont Southern victory must have fallen. The portrait on the right is of Secretary McKenna College have taken advan- People should then have become of the Treasury Christopher Memminger. tage of a geographic peculiarity after more eager to spend Southern notes the 1864 Currency Reform Act to fur- (trading a potentially worthless cur- and wrought tremendous destruction ther examine this relationship. The rency for real goods), thereby raising in the South and border states. The act removed one-third of the currency inflation by increasing velocity. Even war was also extremely expensive, and in circulation once it went into effect. with the external military threat the enormous and unprecedented However, by this time the South had looming ever larger, a reduction in the expenditures severely strained the lost the battle for Vicksburg, and with currency stock halted and then financial systems of both govern- it the Mississippi River, thus isolating reversed inflation. ments, spurring innovation and the eastern and western halves of the However, it should be noted that centralization in one and monetary Confederacy. After the Currency following the fall of Atlanta in suicide in the other. The wartime Reform Act went into effect in September 1864, inflation grew very finance policies of the North set the Richmond, inflation slowed and even rapidly despite relatively stable stage for much more modern currency reversed for a short time as the cur- growth in the money supply. It had and banking systems. At the same rency stock decreased. Yet in become clear that the Confederacy time, the defeated Confederacy Houston, the major Confederate was on the verge of collapse, so showed the dangers of excessive financial center in the West, inflation Southerners wanted to spend their money creation. Shortsightedness, continued virtually unabated since currency while it still had some value. political resistance to taxation, and a transportation difficulties severely In April 1865, Robert E. Lee and his lack of liquidity led the South down muted the effect of the currency Army of Northern Virginia surren- the disastrous path of the printing reform. dered at Appomattox, effectively press. The Southern experience should Given that by mid-1864 the military ending the war. serve as a cautionary tale to policy- situation had begun to look rather In many ways, the Civil War was a makers about the dangers of bad grim for the Confederacy, it is partic- watershed in U.S. history. It brought a financial institutions and rampant ularly notable that the price level fell sudden end to slavery in the South, money creation. RF FEDERAL RESERVE BANK OF RICHMOND FEDERAL RESERVE

R EADINGS Burdekin, Richard C.K., and Marc Weidenmier. “Inflation Is __. “The Historical Statistics of the Confederacy.” In Carter, Always and Everywhere a Monetary Phenomenon: Richmond vs. Susan, and Richard Sutch (eds.), The Historical Statistics of the Houston in 1864.” American Economic Review, December 2001, United States, Millennial Edition. New York: Cambridge University vol. 91, no. 5, pp. 1621-1630. Press, 2002. Eugene M. Lerner. “The Monetary and Fiscal Programs of the “Weidenmier, Marc. “The Market for Confederate Cotton Confederate Government, 1861-65.” Journal of Political Economy, Bonds.” Explorations in Economic History, January 2000, December 1954, vol. 62, no. 6, pp. 506-522. vol. 37, no. 1, pp. 76-97.

__. “Money, Prices, and Wages in the Confederacy, 1861-65.” Visit www.richmondfed.org for links to relevant sites. Journal of Political Economy, February 1955, vol. 63, no. 1, pp. 20-40. Roger L. Ransom. “The Economics of the Civil War.” In Whaples, Robert (ed.), EH.Net Encyclopedia of Economic and Business History.

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