A currency backed by nothing

On February 25, 1862, United States President Abraham Lincoln signed the Legal Tender Act, a brainchild of Elbridge Spaulding. Those were terrifying times. The republic was at war with itself and would be till 1865.

Cause of the Civil War? Southern states wanted to continue with slavery while Northerners were opposed. The enormity of the divide was seen in the presidential elections results announced on November 7, 1860. Republican candidate Lincoln won without a single electoral college vote from the south. He would be inaugurated on March 4, 1861. But by then, so much would have happened.

A few days before Christmas in 1860, South Carolina voted to leave the Union. Mississippi was next on January 9 and others followed.

By February 4, a month to inauguration, a breakaway union, the Confederate States of America, was formed in Alabama. The war was on.

Inevitably, chaos ensued in the financial market as people handed back banknotes to the banks in exchange for gold, as was practice then. The stock market crushed as shares were dumped to settle debts. Banks scrambled to honour depositors. All this would have been a typical financial crisis and the US was going to have three such before the turn of the century. But this one had a civil war in it.

Treasury Secretary Salmon Chase struggled to fund the war — ammunitions, uniforms, navy vessels, food and so on. Money was running for cover, under mattresses. It got so bad that on December 30, 1861 banks agreed to stop honouring banknotes with gold.

Then came Elbridge Spaulding with his Legal Tender Act. He was a Republican and chair of the House of Representatives Subcommittee on Emergency Measures. Of him, historian TJ Stiles writes: "If Wall Street had saints, then the college of financial cardinals would surely canonise Elbridge G. Spaulding". What was in the Legal Tender Act to earn him such reverence even a century and a half later?

Through the Act, Treasury would issue federal dollars backed by nothing. The new currency was quickly nicknamed "greenback", The greenback was to be used for all local transactions except custom duties and interest on government bonds which were to be paid for in the old gold-backed dollars or gold. The National Banking Act in 1863 would make it clear that banks could still issue own banknotes only that now, with the Legal Tender Act, such notes had to be backed by the greenback and not gold as before.

Many were angry. Remember when the Bondnotes were introduced? And Statutory Instrument 142 of 2019? Likewise, emotions ran high in America. Hugh McCulloch who would become Treasury Secretary twenty year later fumed: "Gold and silver are the only true measure of value. These metals were prepared by the Almighty for this very purpose".

They were worried inflation would soar once the anchorless currency circulated. They were wrong. Why? Well, war can be good business. Factories keep running because a lot of stuff must be produced and moved quickly to make way for more stuff to be produced. With such activity, the anchorless currency did not chase few goods, it oiled industry.

In fact, a few weeks after President Lincoln signed the Legal Tender Act, Treasury issued $150 million worth of greenbacks and another $150 million in July. The banknotes were, initially, in large denominations of $1 000, then $500. Maybe the thinking in this was that banks would keep the large denominations as anchors of the banknotes that they, i.e., the banks, would issue in smaller denominations.

It worked. Some called it a miracle. Factories pumped. By the end of the Civil War in 1865, the annual federal budget had crossed $1 billion from $63 million years  earlier.

As with all human efforts, Spaulding's plan was not perfect. One problem was that the old gold-backed dollars were still in circulation and hadn't (or couldn't) be discontinued. As a result, an exchange rate of the new paper dollar, or "fiat currency" as economists call it, and the gold-dollar emerged. At some point during the war, 100 gold-dollars would buy 300 greenbacks, the difference being the "gold                                                                         premium".

A foremost entrepreneur and industrialist of the time, Cornelius Vanderbilt, testified after the war that he was never bothered by what some saw as terrible currency reforms. Instead, he considered the reforms "a minor change in the rules" in his far-sighted plans. He was in it for the long haul.

The greenback helped win the war. It was of course supported by other reforms such as the National Banking Act and a revamp of federal income tax administrative system.

Reflecting on the period, TJ Stiles notes that the reforms were "not a (Republican) Party platform but a war for national survival that drove this process and radically redefined what Americans accepted as legitimate federal activity. Perhaps the most revolutionary innovation of all was Elbridge Spaulding's "greenback".

Today the greenback is the most treasured global currency of which any boys' choir (and indeed girls') can sing of so yearningly as if to an awesome crush. Lest we forget: it came from nothing, it was an abstract idea that changed and challenges humanity's concept of money.

What made it work? Hastily, some will say trust and confidence. But, what we know and is irrefutable is that when the greenback was introduced in the early 1860s, industrial production, thanks in part to the war, made it work. We must, however, realise that production is an end, it is an outcome of peculiar knowledges and insights of what to produce and how to produce it. Zimbabwe and indeed Africa hasn't quite figured that out. In this is the mission of our    time.