After winning its independence in the American Revolution
(1775–83), the United States had a bewildering variety of forms of
money. American merchants who engaged in foreign trade dealt in
British pounds, Spanish dollars, Portuguese johannes, or French livres.
Each of the colonies also issued its own paper money, either in dollars or
pounds. In addition, private banks or other businesses issued notes that
circulated as yet another form of currency. Most of the American economy, however, was conducted in barter, or the trade of goods and services without any form of money passing hands. It was clear to the
nation’s first leaders that a new monetary system was needed.
In 1792, the new U.S. government adopted the Coinage Act, which
set up the U.S. Mint (the institution responsible for producing the nation’s coins) and created a “bimetallic” monetary system, meaning that
both gold and silver were used as money. In this monetary system, the
value of money was based on the value of the material—the gold or silver—from which the money was made. Because it was difficult to carry
around large amounts of gold and silver, local banks soon issued
banknotes. These were paper certificates promising to pay the bearer a
precise amount of gold or silver on demand. Thus for each banknote in
circulation, there was supposed to be a given amount of gold or silver
stored away in a vault.
Despite the Coinage Act, the American economy continued to use
other currencies: bartered products, foreign currencies, banknotes, and
bills of exchange (a sort of credit system). The nation would not issue its
own paper currency until the American Civil War (1861–65).
Pre–Civil War monetary policy
A uniform currency throughout the different states required a strong federal financial institution. A central bank of sorts did exist during the first
third of the nineteenth century—the First Bank of the United States
from 1791 to 1811 and the Second Bank of the United States from 1816
to 1836. Under Nicholas Biddle (1786–1844), a president of the Second
Bank, the bank actively managed currency exchange throughout the nation. But federal banking ceased with the presidency of Andrew Jackson
(1767–1845; served 1829–37), who hated banks due to unfortunate financial deals he had made early in his life.
Even with the presence of the first federal banks, state banks formed
the backbone of the nation’s money system, and they generally did not
work together. In 1816, there were 250 state banks, and many of these
institutions issued their own paper currency. By 1860, more than fifteen
hundred state banks were issuing an average of six different denominations of notes. Currency printed by local banks commanded up to twice
as much value as notes issued elsewhere, partly because people knew the
reputation of local banks and partly because of transportation costs to redeem “foreign” (from another state or territory) currency. Caution was
necessary with banknotes because counterfeits and notes of broken
banks corrupted the currency.
In 1837, the United States experienced a devastating financial panic
(a time when people fear their banks will be unable to pay, and therefore
many people withdraw their money at once, frequently breaking the
bank). Banks, finding the cost of precious metals much higher than anticipated, could not redeem their own notes for gold. This led to a major
loss of confidence among note holders.
Greenbacks help pay for war
When the Civil War began in 1861, financial demands quickly depleted
the nation’s supply of gold and silver. This forced the government to pass
the Legal Tender Act of 1862, which provided for the issue of paper
money that was not backed by gold or silver. About $430 million in
notes were issued. Because the bills were supported only by the government’s promise to pay, people observed that the bills were backed only
by the green ink with which they were printed. This resulted in the name
greenbacks being used. The Confederate States of America (or South) also financed its war with the printing press. Confederate notes had blue
security printing on the back, so they were called “bluebacks.”
The value of the greenbacks depended on the peoples’ confidence in
the U.S. government and its future ability to convert the currency to
coin. As the fighting between the Union (the North) and the
Confederacy raged, confidence in government went up and down.
When the Union suffered defeat, the value of the greenbacks dropped—
one time to as low as 35 cents on the dollar. In general, greenbacks
caused relatively high inflation—increases in costs of goods and services
and a low value to money.
Gold and silver standards
After the war, the United States needed a universally approved monetary
standard in order to resume international trading. Congress decided to
reinstate the metal standard by backing the nation’s greenbacks with a
specific amount of metal. The Coinage Act of 1873 eliminated the silver
dollar as a medium of exchange and placed the United States on a virtual
gold standard. The elimination of the silver dollar came about in part because Britain and other foreign countries had decided to adopt a gold
standard. In the United States, gold would remain the reigning medium
of exchange until the 1930s, but not without great controversy.
Gold standard advocates believed the nation’s money supply would
never be stabilized under the bimetallic standard. They contended that
because the open market value of each metal (gold and silver) was constantly changing, the undervaluation or overvaluation of either metal by
the mint would impact the supply of coins in circulation. For example,
when the U.S. Mint undervalued silver coins, people opted to sell their
silver coins on the open market for more than their face value. When silver was overproduced and the government issued too many silver coins,
the price of silver dropped and people eagerly traded in their silver coins
for gold coins, thereby exhausting federal reserves.
Those opposed to the gold standard were concerned about the nation’s continuing deflation, a general decrease in the cost of goods and
services that plagued the country in the last part of the nineteenth century. Demand for gold expanded greatly as a number of countries went
on the gold standard. Discoveries of gold deposits lagged behind, so
gold’s market value went up substantially. By 1896, the market value of
gold relative to silver was thirty to one. If the United States had kept a bimetallic standard, people simply would have sold their gold coins at
the market rate and used silver as a medium of exchange. Because
Americans could not switch to silver, deflation occurred. Prices fell at the
rate of nearly 5 percent annually from the end of the Civil War to 1879.
Foes of a gold-backed currency included silver producers and almost
anyone whose livelihood involved incurring debt. The deepest opposition to the gold standard came from farmers, who entered into loans at
a time when money was worth more and were forced to pay them back
in the deflated economy in which their crops were worth less. Silver
became the major issue of the 1896 presidential election. Democratic
candidate William Jennings Bryan (1860–1925) demanded that humankind not be “crucified on a cross of gold.” Bryan lost the election to
William McKinley (1843–1901; served 1897–1901), and in 1900 the
United States officially adopted the Gold Standard Act.
National bank
The federal financial crisis during the Civil War had pointed to a need for
a national bank system. In 1863, a bill calling for a banking system that
would provide the country with a truly national currency was introduced
in the Senate. Many people objected, fearing that the national government would gain too much control over local government by entering
into the banking business. Nevertheless, in 1865 a national bank system
was established. The federal government eliminated state banknotes, and
national banks issued currency amounting to $300 million.
A series of devastating economic panics between 1873 and 1907
drew public attention to the need for more extensive banking and monetary reform. As a result, in 1913 the U.S. government passed the
Federal Reserve Act to promote economic stability. The legislation established federal governmental regulation of currency supply and federal
distribution of currency to banks. The Federal Reserve Board was
charged with regulating the amount of gold reserves held against Federal
Reserve notes (paper money) and supervising the issue and retirement of
notes, among its many other functions.
Gold remained the standard of the U.S. monetary system until April
1933. In the midst of the Great Depression (1929–41; a worldwide economic downturn), Congress abandoned the gold standard because the
United States could no longer guarantee the value of the dollar in gold.
The 1933 legislation enabled the Federal Reserve to expand the nation’s money supply without regard to gold reserves. At the same time, structural changes were made to the Federal Reserve, giving it almost total
power over the nation’s currency. The Federal Reserve System continued
to grow and undergo adjustments, generally bringing stability to the
U.S. currency.