By this time, the northern banking community was nearing collapse. Doubts about the Federals’ ability to win the war and a possible European recognition of Confederate independence had prompted panic buying of precious metals, resulting in a gold shortage. This shortage hindered Federal efforts to obtain loans or repay debts. The national debt had reached $100 million, and another $300 million was needed to fund the war until June 30. Congress had imposed unprecedented taxes on property, incomes, and various goods, but they would not be enough to generate the exorbitant funds needed.
In a message to Congress, Treasury Secretary Salmon P. Chase finally conceded, “I came with reluctance to the conclusion that the legal tender clause is a necessity. Immediate action is of great importance. The Treasury is nearly empty.” The “legal tender clause” was a measure that would enable the U.S. Treasury to print paper money that was not backed by specie (i.e., precious metals such as gold or silver). Prior to this, all American currency had value based on its ability to be converted to specie. The printing of this new paper money would be financed by bond sales.
Chase called the issuance of paper money “indispensably necessary” as a means to increase the money supply and help pay for the war. Printing money out of thin air sparked intense debate in Congress, with most Democrats opposing and most Republicans favoring the move. Republican William P. Fessenden of Maine, chairman of the Senate Finance Committee, acknowledged that it was “of doubtful constitutionality… It is bad faith… It shocks all my notions of political, moral, and national honor…” however, “to leave the government without resources in such a crisis is not to be thought of.”
Republican Congressman Thaddeus Stevens of Pennsylvania, chairman of the House Ways and Means Committee, declared, “This bill is a matter of necessity, not of choice.” Fellow committee member and Republican Elbridge C. Spaulding of New York proposed printing $150 million in paper money. This would pay for all debts except import tariffs and interest on the national debt. Spaulding declared, “The bill before us is a war measure, a necessary means of carrying into execution the power granted in the Constitution ‘to raise and support armies’… These are extraordinary times, and extraordinary measures must be resorted to in order to save our Government and preserve our nationality.”
Leading Democratic Congressman George H. Pendleton of Ohio countered:
“The wit of man has never discovered a means by which paper currency can be kept at par value, except by its speedy, cheap, certain convertibility into gold and silver… prices will be inflated… incomes will depreciate; the savings of the poor will vanish; the hoardings of the widow will melt away; bonds, mortgages, and notes–everything of fixed value–will lose their value.”
A banker argued that “gold and silver are the only true measure of value. These metals were prepared by the Almighty for this very purpose.” Constitutionalists asserted that Congress only had the power to “coin” money, which meant creating coin, not money based on worthless paper. Moreover, allowing for the payment of debts with this paper violated the Constitution’s contracts clause.
Republican Congressman Samuel Hooper of Massachusetts contended, “Every intelligent man knows that coined money is not the currency of the country,” because state banknotes were the prime medium of exchange, and they often depreciated in value. Hooper stated that the real question was whether national paper money would have “as much virtue… as the notes of banks which have suspended specie payments.”
Lawmakers added a provision authorizing payment of bond interest in specie, up to six percent. It was hoped that this would encourage more bond sales, which would finance the new currency. Tariffs would also continue to be paid in specie to finance interest payments on the bonds.
The Republican-dominated Congress, influenced by increasing pressure from the Treasury, business leaders, and bankers, ultimately cast the votes needed to approve the bill. Three-fourths of congressional Democrats opposed the measure, but their minority status could not overcome the three-fourths of Republicans in favor. President Abraham Lincoln, admittedly no expert in finance, signed the measure into law.
The Legal Tender Act created the first national monetary system based on paper, or fiat, currency. The new U.S. notes, which featured the image of Treasury Secretary Chase, were called “greenbacks” due to the green ink used to print them. Issuing paper money in place of specie was intended as a wartime emergency measure only. Attorney General Edward Bates wrote a legal opinion arguing the law’s validity because it fell under the Constitution’s “necessary and proper” clause. Ironically, Chase himself would later rule this measure unconstitutional as Supreme Court chief justice after the war.
The first $150 million in notes were to begin issuance in April; ultimately $400 million was circulated. The paper money helped restore enough investor confidence to sell the $500 million in six-percent bonds issued at the same time. It also provided access to the funds that had been hoarded since the financial crisis of December. Paper money circulation ended when specie currency was finally restored in 1879.
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