We’re celebrating Presidents’ Day instead of Lincoln’s birthday. But Lincoln’s birthday isn’t the only part of his history we’ve forgotten.
We all know Lincoln as the president who saved the Union and ended slavery.
But did you know that Lincoln also instituted the nation’s first income tax and created the IRS?
Lincoln also pursued a deliberate policy of inflation to finance the Civil War.
That’s today’s topic. We welcome your feedback!
The Civil War cost about $6.65 BILLION dollars total – more than an entire year’s Gross National Product, measured in 1860 dollars. (This measures only the direct monetary cost of the war, not the cost of the 750,000 American lives, or the opportunity cost of goods/services that were never produced.) The devastating war had to be financed somehow – and Lincoln chose not only to institute an income tax, but to print paper money. And print it. And print it.
The Legal Tender Act of 1862 authorized the federal government to literally print paper money, called “greenbacks.” Lincoln suspended the gold standard, and the government forced citizens to accept these greenbacks as legal tender. Congress issued about $450 million total in greenbacks by the end of the war.
Prior to the printing of the greenbacks, the gold standard meant that pieces of paper traded for goods had to be backed by gold. The pieces of paper were not themselves money. They were certificates that represented money – gold. The government would redeem paper notes for gold upon demand.
But with the printing of the greenbacks, greenbacks and other paper currency was no longer redeemable for gold.
Of course, merely printing money didn’t create any real value. But printing did create purchasing power. Spending the new money without increasing the supply of real goods/services caused a huge price increase, and transferred value from the people who created the goods and services, to the government.
Prices doubled between 1861 and 1865, as can be seen in the graph below.
As bad as it was in the North, the South fared much worse. The South also decided to issue its own currency, unbacked by gold. That currency rapidly depreciated. According to the Lerner Price Index, commodity prices in confederate dollars increased 90 times (by 9,000%) over the four years of the Civil War.
By the end of the Civil War, Southern currency wasn’t worth anything at all. Thousands who had, in good faith, accepted this paper in exchange for their goods and service were left penniless.
Both the North and the South suffered great economic ruin. But after Lincoln and his successor General US Grant left office, the US government, under pressure from Congress, restored the gold standard. In 1875, the Specie Resumption Act was passed, stating that the government would begin redeeming greenbacks for gold at face value in 1879.
President Rutherford B. Hayes realized that the government would have to increase its reserves of gold if it were to make good on its promise. Through careful financial management, Hayes and his administration managed to run a budget surplus (yes, apparently it’s possible for the US government to run a budget surplus!) and accumulated gold with which to redeem the greenbacks.
The intentional policy of inflation operated as a hidden, unlegislated tax on everyone who (many had no choice) accepted the depreciating paper money.
The inflation stopped and was reversed, because the government stopped its excess spending, and eventually restored the gold standard. During the roughly 30 years following the restoration of the gold standard, the US (and the developed world, which was also on a gold standard) experienced one of the greatest periods of economic growth in the entire history of the world.
In fact, most of the technologies that define modern life were developed and commercialized during this “golden age.” Among these are electricity, air travel, the automobile, trucks, the telephone, radio, and even plastics.
The Civil War was devastating. But the country recovered. A large contributor to that recovery was severe shrinkage of federal spending, and restoration of a non-inflationary dollar.
We’re uniquely qualified to offer you insight on inflation. Roger D. Silk holds a Ph.D. in applied economics from Stanford, and is the author of the recently published book explaining inflation: Politicians Spend, We Pay, available here.