by Roger Lowenstein (Penguin Press, 445 pp., $21.99)
Warfare is as old as human civilization and it has always been an expensive activity. In ancient times, the funds would come from the pocket of the reigning Caesar or Pompey, or from a national treasury. After the Middle Ages, warfare involved ever greater sums, of which the sovereign had to borrow a portion, for instance, from bankers. Each negotiation was unique in its own way, but they all were generically similar—in the end, the money had to be forthcoming and the king had at least to promise to repay what he’d borrowed. What, then, makes the financing of the American Civil War so interesting it warrants a book by an author of Roger Lowenstein’s standing? Lowenstein’s answer is that the Civil War was a shock that moved the nation to an entirely new, more centralized governance. Salmon Chase was History’s instrument in that he supervised the financial dimension of that move as secretary of the Treasury under President Lincoln. When he arrived in public office, the federal government was at best a spectator to the national economy. By the time he left, it was an established player, a role it would never again surrender. Chase left behind him a remodeled monetary system: He set up an active market in U.S. Treasury securities that today makes borrowing so easy it has all but broken the link between the actions of the federal government and what the electorate is asked to pay for.
Chase, in all likelihood, didn’t intend to sponsor a financial revolution. To the extent that he had any, his thoughts on finance were self-contradictory. As a good Republican, he adhered to Alexander Hamilton’s view of national progress and the government’s strong supporting role toward that end, but he was Jacksonian in his suspicion of finance in general and in his moralistic attachment to hard money. Chase, above all else, was out to win the war for the Union, and he had the self confidence to do whatever was necessary in that regard. The narrative of his innovations and of the military and political events that at once motivated and facilitated them, comprise the substance of Lowenstein’s engrossing Ways and Means.
Numbers are important to this story, and Lowenstein could have assisted his readers by providing enough context to give them a sense of proportion. In 1860, the gross domestic product (GDP) of the United States, by modern estimate, was about $4 billion, divided between two-thirds in the Union States and roughly one-third in the Confederacy. The value of the cotton crop, the South’s greatest asset, was about $200 million, or 15 percent of the annual GDP of the rebel states. In today’s economy, only health care and pharmaceuticals would be of comparable importance. The federal government’s tax receipts were $50 million—little more than 1 percent of GDP—derived almost exclusively from import duties. This number would fall below $40 million once the war commenced. There was no income tax. In his first day on the job, Chase was the chief financial officer of a government that, as Lincoln warned him, had an empty treasury and a war to fight. Chase, while a man of considerable talent, was just oblivious enough to remain unfazed. He eventually would sell over $500 million in government bonds per year, a Herculean feat at the time.
Throughout history, lending to the sovereign in a time of war has been risky business, and people who have tried it often lived to regret it. Some, like the Peruzzi Bank of Florence whose partners financed Edward IV of England, lost everything when the king decided it was beneath the royal dignity to repay the loan. Others, like the patriotic citizens who bought the 2 percent U.S. Treasury Bond in 1942, got back their money only to discover it was worth half of what it was when they bought the bond. Inflation is part of war.
Bankers of course know this, which explains why their reception of Chase was less than warm when he came to them in August of 1861 with the preposterous request of an uncollateralized loan of $150 million (just under a trillion today) in gold. (For those who have never done it, surrendering gold for paper always puts a knot in the stomach.) Chase softened the deal a bit by asking for the money in three tranches of $50 million between then and the end of the year. His best argument was that the war would not last long, and that he might not need the entire sum. The New York bankers swallowed hard and came up with the first $50 million, but they demanded an interest rate of 7.3 percent. At the time, the world standard for risk-free lending was the British gilt security, which traded at about 5 percent. Chase had to pay up 230 basis points. By today’s standards, that would be at best a solid Baa-rated security, one grade above a junk bond rating. Sales of the bonds got off to a slow start, and after the battle of Bull Run vaporized the fantasy of a brief war, bonds sold hardly at all. The bankers had to eat a good part of the second tranche and all of the third, at which point their depositors became alarmed seeing bank vaults overflowing with paper but no gold. They initiated a bank run.
It’s been said that 1862 was the worst year in American history. It certainly started poorly for Chase, who as of January 1 was all but bereft of means to fulfill his mission for the president. He was spending more than $1 million every day on the war, and the bond market was closed to him. Congress had authorized $100 million in short term notes, which amounted to cash, but he had spent them all, already. He now had to pay both troops and contractors with IOU’s—a temporary expedient at best.
At this point the Republican Congress intervened. Elbridge Spaulding of New York proposed to grant the Treasury power to issue non-interest bearing notes. These notes would not be convertible into gold but would be designated as legal tender sufficient to satisfy any debt. In other words, it was a national currency. After much political and moral arm wrestling, the bill was signed into law in May of 1862. The notes, with Chase’s portrait engraved on the front and green ink on the back, immediately were called greenbacks. To the surprise of many, they were immediately accepted throughout the North and even circulated in parts of the South. While greenbacks were not convertible into gold, citizens could use them to buy gold, and they did. At times during the war, the price of a gold dollar rose as high as two greenbacks, a level that, for reasons of his own, Chase took as a personal affront.
The greenbacks gave the money supply a much needed supplement, and within weeks the Northern economy had a more vigorous step. Their greater significance, however, was not immediately recognized. Once the public accepted greenbacks, the U.S Treasury had the power, for the first time, to issue truly default-free bonds. The bonds were payable in greenbacks, and the Treasury, with the consent of Congress, had the printing press. It took some time to develop a fluent secondary market, but once it appeared the Treasury was free to issue the vast sums we now recognize as the National Debt.
In the immediate instance, the greenbacks gave Chase another $150 million to spend, but they did not resolve his abiding problem. The investing public was still reluctant to accept his bonds, probably because they were skeptical about the eventual purchasing power of the money. Coupon interest rates, at the time, were not set by the market. Rates, at least initially, were set by what Chase thought he had to pay, but his congenital suspicion of bankers combined with a Christian ambivalence about receiving interest sometimes impeded his view of reality. Bond sales would remain problematic throughout the war. Not unreasonably they became correlated with the performance of the Union Army in the field. Whenever the war seemed closer to ending, bonds sold; when the South prevailed in a battle, they didn’t. Chase eventually had to enlist the aide of the Philadelphian broker, Jay Cooke, a mildly lubricious man, but who was a creative bond salesman who served the country well throughout the war.
Also in 1862, the Congress further empowered Chase’s position by passing the nation’s first income tax. For a nation that was born in a dispute over taxation and whose Constitution did not specifically grant income taxing power to the government, an income tax was a large oyster to swallow. The eventual bill had 315 amendments, but on July 1 Lincoln signed a law that set a flat 3 percent tax on all income over $600 dollars, thereby exempting about half of all wage earners, and a confiscatory 5 percent tax on income over $10,000. These provisions would eventually raise total tax receipt to something over $100 million per year and thereby allayed concerns about the Treasury’s ability to service its debt.
However daunting might have been the task before Chase, it was light work compared to that of his Confederate counterpart, Christopher Memminger. Lowenstein is at times unfair to Memminger in not appreciating the difficulty of the latter’s assignment. Were they Olympic divers, the difficulty of Chase’s dive might have been judged an eight or nine. On a scale of one to ten, Memminger’s was a fifteen. His expenditure rate was about the same as Chase’s, between $1 million and $2 million per day, but what investor would buy his bonds? In the event of a Southern victory in the war, Chase’s investors would always have a U.S. Government to redeem their bonds. If the South lost, Memminger’s investors lost everything. It was a bookie’s bet, not a banker’s.
Moreover, Memminger was the treasurer of an assemblage of states whose bonding document was called a constitution, but which was closer to the weaker Articles of Confederation. The central authority had no power to tax nor any interest in doing so. Memminger managed to sell a few bonds in London in the days just after the battle of Bull Run, when a Southern victory appeared imminent, and he managed to trickle out a few to a small number of domestic true believers. Beyond that, he had only the printing press, which he used liberally, printing some $4 billion in Confederate currency over the course of the war. Memminger did succeed in raising a few million dollars with a farfetched scheme of selling a bond backed by cotton. At their discretion, bondholders could convert the bond into cotton at a price between one-third and one-quarter of the prevailing market. Their only problem: the bondholders were in London; the cotton was in New Orleans; and the Union Navy stood between both. Blockade running was a profitable game at the time, and the bond did gather a few million dollars, probably from the types who played the long-shot windows at Ascot.
Over the course of the Civil War, the general cost of living in the Northern states, to the extent we can measure it, more or less doubled. In the Confederate States prices rose be a factor between fifty and ninety. Lowenstein wants to blame the South’s runaway inflation on Memminger’s financing method, but it is more accurately seen as a gauge of the economic mismatch that lay beneath the war. As Gavin Wright has pointed out in Slavery and Economic Development, leaving aside the slave economy, per capita wealth in the South as of 1860 was between a third and a half of wealth in the North. At the war’s outset, Confederate leaders must have expected a brief campaign, and with better leadership in the North, they might have been right. They could not have hoped the South could manufacture the guns, wagons, blankets, leather, and other goods that would be needed to sustain a war effort. Nor did they have railroads to move things around. By the war’s end, the South was in a desperate condition. Its population was starving, and the Confederate government was commandeering grain from upland farmers who had opposed the war from its beginning.
By the time Grant and Lee reached Appomattox, Chase was no longer part of Lincoln’s cabinet. The abiding tensions between himself and Lincoln, during his three years in office, had on various occasions caused him to offer his resignation four times. At the fifth instance, Lincoln accepted it. Chase, as Lowenstein portrays him, can be thought of as a man who was working two jobs. His day job was secretary of Treasury; his spare time he devoted to getting himself elected President. Indeed, one of the subsidiary pleasures of reading Lowenstein's book is speculating on how the world might have been different had Chase succeeded in his side hustle. It wasn’t so much that he disapproved of Lincoln’s policies, but Chase lacked Lincoln’s patience in cultivating consensus. The two men were philosophically aligned, but Chase was more a Republican Radical. For instance, he was convinced that the Emancipation Proclamation had been a good year overdue, and it was his editing of the penultimate draft that finally excised any mention of sending the freedmen to some distant location. Even though he bungled the first good opportunity, Chase strongly advocated seizing Southern plantations and distributing them among the former slaves. One can imagine how the Reconstruction under a President Chase would have been a good bit more prescriptive than Lincoln had in mind. Lincoln had always been anxious to have the Southern states reinstated in the Union as before. Chase saw them as conquered territory. Eric Foner’s landmark book Reconstruction offers a portrait of the Reconstructed South as a region unwilling to grant the former slaves equal rights at anything short of the point of a gun. Lincoln seems to have been a good distance from that resort. Chase was not so far.
All of Chase’s reforms survive to this day. After the war, a few of his successors tried to undo them but the power implicit in Chase’s changes was too great for the government to surrender. Before President Regan in the 1980’s, most administrations treated deficit financing as a wartime expedient, but trading in Treasury securities continued to grow. Today, it serves as the core of a capital market whose depth and liquidity are matched only by that of Great Britain.
Chase himself had reservations about breaking the link between gold and the dollar, and in 1878, such convertibility was restored. After 1933, however, the Roosevelt administration decided Chase had been correct, and brought back the fiat currency. Secretary Chase probably was disappointed with his system of national banks, which he had hoped to stuff with Treasury securities, but, after some modification, the Banking Act of 1864 established the format for banking as we know it in the United States. State-chartered banks still exist, but now all of the nation’s major institutions are chartered and supervised by agencies of the federal government.
Paul DeRosa has taught economics at Columbia, ran a hedge fund for some thirty years, served on the research staff of the Federal Reserve Bank of New York, and has written extensively on topics related to economics.
Image: A U.S. one-dollar legal tender note "greenback" from 1862, featuring Salmon Chase's portrait. (The Historic New Orleans Collection)
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