We don’t think much about our money. We may worry about how much of it we need; but we’re not concerned about what it looks like or where it came from. Rarely do we remember that this is a modern phenomenon. Until the Civil War, Americans were very aware of the origin and relative safety of their money.
The best money in early nineteenth-century America was gold, but there was a limit to how much of it you could conveniently carry. And there wasn’t enough of it to go around, especially in towns and villages far from financial centers like New York and Philadelphia. So local people exchanged promissory notes that were basically IOUs stating, for example, that Miller Jones owed Farmer Smith $50 for his wheat harvest, payable sixty days after Smith delivered the bushels of grain to the mill. If Farmer Smith needed to pay someone else sooner than sixty days, he had several options. He could write his own promissory notes (if people trusted him), endorse the Miller Jones’s note to a third party (if people trusted Miller Jones), or take Jones’s note to the bank for cash. The banker would exchange the note for cash, at a “discount” representing interest for the sixty days he would have to hold Jones’s note before he could redeem it. The “cash” the banker would give Farmer Smith could include gold coins if Smith insisted on it, but if the banker had his way it would be—and this is where it gets interesting—bank notes.
Bank notes were initially just like promissory notes, except that they were issued by the bank. They were usually written to a named recipient for a specific amount. But they were much more easy to endorse to a second party, because in most cases everyone knew and trusted the bank. Over time, banks were able not only to write a lot of these types of notes, but to begin writing general notes for smaller denominations, that were immediately payable to anyone “on sight.” Of course the details of how this developed varied from place to place, but these small denomination sight notes became “circulating currency,” or what we think of as money.
When banks gained the ability to issue their own notes, they basically began creating money. In many states, there were laws requiring the bankers to invest in a state insurance fund, or to deposit securities (government bonds or mortgages) with the state comptroller in order to issue notes, but very rarely was there a substantial specie requirement. In other words, the money these state banks printed was usually backed by something other than piles of gold in the vaults of the banks, because there were no piles of gold.
Confidence in the banker issuing a note was crucial to the note’s acceptance. This confidence was naturally greater in states that had a “safety fund” or that required securities to back note issues. Everyone knew that there was never enough gold at the bank to pay all the notes. The expectation was rather that there would be enough to conduct regular business, and pay the notes brought in for redemption on any given day, rather than all the notes outstanding. This differential between everyday redemptions and all the notes outstanding was all-important: this was how the bank literally made money.
The money-making ability of the local bank was not only profitable for the banker, but was essential to the community. Without the money printed by local banks, farmers and millers would have had a much more difficult time doing their business. Especially in remote areas, which was where most of the farm products destined for city dinner tables were grown. Most of the “real money” (that is, gold) was hoarded in the big eastern cities, or after Andrew Jackson’s 1837 Specie Circular was used to buy land at the frontier Land Offices. Very little was available in the settled farmlands that made up the middle of the country. Local banks provided the cash and credit that allowed farmers to plant, tend, and harvest their crops, at a time when 90 percent of Americans were farmers.
All this changed during the Civil War. The Lincoln administration first issued their own notes, called Greenbacks because they were printed with green ink, to help pay for the war. Between 1863 and 1865, Lincoln’s Treasury Secretary, Salmon Chase, led a campaign to centralize control of American banking by creating a system of national banks and by taxing the notes of local banks, to make them too expensive to use relative to the new national notes. Chase and his supporters claimed that local banks were unsafe, and that the extreme variety of notes floating around in the economy (it has been claimed there were over 9,000 different types in circulation in the early 1860s) provided too much opportunity for counterfeiters. While both of these arguments were valid up to a point, Chase’s solution wasn’t the only possible response. Our current system of national currency was not inevitable; by nationalizing the power to make money, Chase added a nearly immeasurable new source of revenue for the central government. This aspect of the change to national notes has gone largely unrecognized, and we now treat our national currency as a completely natural and inevitable part of our national economy--except in a few places like far western Massachusetts, where local people have taken advantage of changes and loopholes in the banking laws, to once again begin making their own money.