Greenbacks were the fiat money that the United States government issued during the Civil War. Fiat money, or inconvertible paper money, is money that cannot be converted or redeemed into a precious metal such as gold or silver. By the close of the Civil War greenbacks and related U.S. government notes accounted for about 75 percent of the money in circulation, largely displacing bank notes of state banks, the principal currency in circulation before the Civil War.
The United States government was not the first to issue inconvertible paper money during the Civil War, but was preceded by commercial banks. The secretary of the Treasury of the new Lincoln administration, Salmon Portland Chase, who came to that office without financial experience, possessed a naïve faith in “hard money.” The government borrowed heavily from banks to finance the difference between $6 million in tax revenue and $25 million in expenditures. When the government took out bank loans, it demanded payment in specie, and the specie was not redeposited in banks, but was removed from the banking system. Fears about the ultimate success of the war led the public to hoard specie. On 30 December 1860 banks in New York suspended specie payments on bank notes and deposits, and banks in other parts of the country soon followed. The government began issuing “demand notes” and the country was effectively put on an inconvertible paper standard.
On 30 December 1860 Congress entertained the first proposal for issuing legal-tender notes (fiat money) to defray government expenses. Bankers raised a howl about the government issuing fiat money and dispatched a delegation to advise the secretary of the Treasury and Congress on ways to finance the war. This delegation urged a program of heavy taxation and borrowing in long-term capital markets to finance government spending as an alternative to the issuance of fiat money.
Government officials weighed the alternatives: the issuance of legal-tender fiat money, or an issue of long-term government bonds. Given the poor credit reputation of the government, the paper money was bound to depreciate in value, but bonds would have to pay high interest rates to attract buyers. The government chose the issuance of fiat money, and the only remaining question for debate was whether Congress would clothe the fiat money with the legal status of legal-tender money.
On 25 February 1862 Congress adopted an act providing for the issuance of notes that were lawful money and legal tender in payment of all debts public and private. The government issued $150 million of these notes, $50 million of which went to retire demand notes the government had already issued. The new notes were called greenbacks. The legal-tender provision contained two noteworthy exceptions. The government demanded payment of import duties in gold coin, and the government committed itself to paying in gold coin the interest earned from government bonds.
To dampen inflationary pressures the government devised means of diverting greenbacks from the spending stream. The greenbacks could be used to buy Treasury bonds paying 6 percent interest redeemable after 5 years, and maturing after 20 years. Also the Treasury accepted deposits of greenbacks, paying 5 percent interest, and redeemable with 10 days’ notice. The option of converting greenbacks to Treasury bonds was removed in subsequent bills that authorized the issuance of additional greenbacks.
Prices more than doubled during the Civil War. In June 1864 Congress set a limit of $450 million on the issuance of greenbacks, a limit that was never exceeded. After the Civil War various interest groups dreaded the deflation that would likely follow the reduction of the supply of fiat money in circulation.
It was 1879 before the federal government began redeeming greenbacks with specie, and joined the world’s major trading partners on a worldwide gold standard. The greenback experience was prophetic in light of the twentieth century’s widespread adoption of inconvertible paper money.