Marc Weidenmier, Claremont McKenna College
The Nobel Laureate Milton Friedman once noted that wars have provided laboratories to examine the behavior of money, prices, and income (Friedman, 1952). The Confederate experience during the American Civil War is no exception. Between January 1861 and April 1865, the Lerner Commodity Price Index of leading cities in the Eastern Confederacy increased from 100 to over 9000. Price inflation in the South during the Civil War ranks second only to the American Revolution in U.S. history.
Confederate Revenue Sources during the War
There are three sources of government revenue: taxation, borrowing, and printing money. Given that the Confederate States of America was established on the principle of states’ rights, many Southerners were suspicious of granting the central government powers to impose and collect taxes. Governor Moore of Alabama summarized this position, “The collection of this tax, by the state would be an onerous and unpleasant duty as it imposes upon the state the necessity of enforcing the laws of the Confederate government against her own citizens” (quoted in Lerner, 1956, p. 165 and Weidenmier, 1999a). With opposition from the general public as well as leading political figures, it is not surprising that the Confederate government collected approximately only 8.2% of its total revenues from taxes (Ball, 1991). Tariffs, another potential source of tax revenue, were hampered by the Union blockade of Southern ports.
The Confederacy then turned to debt issue as a means of war finance. The South successfully sold some long-term government securities during the early stages of the war. Bond issues proved a limited source of war financing as Southern prospects diminished, however. Investors increasingly shied away from purchasing securities offered by a government with little or no tax base and a deteriorating military situation. The government resorted to money financing as their primary source of revenue. Overall, debt issue and the printing press accounted for nearly 32 and 60 percent of the South’s total real revenues during the war (Ball, 1991). In the following section, I will briefly analyze the economic effects of the Confederacy’s reliance on note issue as a source of war finance.
The Confederate Inflation
Lerner (1954, 1955, 1956) used the quantity theory of money to analyze the Confederate inflation. The quantity theory of money can be described by the following equation:
M = K*(P*Y), (1)
where P is the price level, Y is real (i.e., inflation-adjusted) output, and M is money. Equation (1) assumes that people hold some fraction, K, of their nominal income, P*Y, in the form of money. For example, if your income was $10,000 per year and K=1/5, then you would hold $2,000 in the form of money. To study inflation, it is useful to express equation (1) in growth rates, using equation (2):
p = m – y – k (2)
Lerner decomposed the influence of changes in money, velocity — the number of times a dollar bill turns over in a year (mathematically velocity is the inverse of k) — and real output on the inflation rate — the rate at which prices rise. Lerner showed that the Confederate money supply increased 11.5 times between January 1861 and October 1864 while commodity prices increased 28 times in the same period (also see Godfrey, 1978). Rising velocity contributed to the runaway price level as people reduced their holdings of money balances and purchased commodities and non-monetary assets. Lerner also inferred from periodic Treasury reports that the South experienced a forty percent fall in real output during the war.
More recent contributions, notably by Burdekin and Langdana (1993) and McCandless (1996), have emphasized the importance of war news and fiscal confidence in price level determination (also see Schwab, 1901). The basic idea is that Confederate citizens were forward-looking and incorporated all available information in forming their expectations of the price level. In the event of a Confederate defeat, for example, people forecasted higher government spending and money growth in the future and bid up prices immediately. Moreover, mounting Confederate defeats also drove up prices as people were unsure about the fate of the fledging nation. War news, a measure of fiscal confidence, was an important determinant of the Confederate price level and helps to explain the low correlation between the money stock and price level.
Pecquet (1987) and Burdekin and Weidenmier (2001) have attempted to disentangle the effects of war news and money supply changes in Confederate prices. They compare fluctuations in the Confederate money price of gold, the Grayback, in the leading gold market in the eastern (Richmond) and western (Galveston/Houston) Confederacy. The two studies focus on the Confederate Currency Reform Act of 1864, which repudiated one-third of the Confederate money supply. The monetary reform act took effect April 1, 1864 east of the Mississippi River, but did not take effect until July 1, 1864 in the Trans-Mississippi Confederacy. For practical purposes, the reform did not take effect until January 1865 in the west because of difficulties in transporting the new currency across the enemy-controlled Mississippi River. As shown in Figure 2, there was a large divergence in the prices for new money trading in Richmond and old money in Houston. Even after the currency reform took effect in the west, there was a fifty percent difference in the value of the same currency in Richmond and Houston. The results strongly suggest that war news alone cannot explain the behavior of Confederate prices during the war.
Davis and Pecquet (1990) and Burdekin and Weidenmier (2002) have focused on different aspects of the Confederacy’s fiscal and monetary policies. Davis and Pecquet (1990) argue that the Confederacy fixed nominal interest rates though a special monetary instrument, call certificates, to reduce the cost of debt service. Burdekin and Weidenmier (2002b) examine the effects of three monetary reforms on Confederate asset and commodity prices. Each reform authorized that currency be exchanged for bonds by a certain date. After the funding date, noteholders could only exchange their money into lower yielding bonds — or in some cases their notes would no longer be convertible at all. As shown in Figure 3, monetary reforms in early 1863 and 1864 led to a sharp rise in the ratio of commodity to currency prices as Confederate citizens unloaded their money balances and purchased goods before the funding date. Currency prices temporarily stabilized as the money stock was reduced through the forced funding of notes into bonds. Only the August 1863 reform did not have a noticeable effect on the ratio of commodity to currency prices. This exception can be explained in part by the much smaller quantity of notes that were exchanged for bonds and by the fact that this reform occurred in the aftermath of Confederate defeats at Gettysburg and Vicksburg.
Event Studies and War News
How did contemporaries view the American Civil War? This question has traditionally been answered by reading diaries, newspapers, and first-hand accounts of the conflict. An alternative method is to examine how financial market participants reacted to war, fiscal, and political events (see Willard, Guinnane, and Rosen, 1996). To investigate this issue, we need a financial instrument that accurately reflected Confederate victory prospects. Fortunately for our purposes, the South issued Grayback money to purchase goods and services during the war. The value of Confederate money depended on victory or at least on a negotiated peace settlement with the United States. Contemporaries of the Civil War noted that “financial matters fluctuated under the successes and reverses of the war like ebb and tide” (Richmond Examiner, July 9, 1863, p. 1, quoted in Weidenmier, 2002a).
Figure 4 plots the Grayback price of a gold dollar during the Civil War. Large movements in Grayback money prices are labeled and associated with important military, fiscal, and political events to determine events important to contemporaries of the Civil War. Grayback prices depreciated following battle defeats at Antietam and Gettysburg/Vicksburg. The gold premium also rose following the passage of the US Conscription/Finance Bill that increased the North’s ability to finance the war and draft soldiers. A final breakpoint occurred in late spring 1864 when the Confederate government repudiated one-third of the money supply with a currency reform act. The monetary legislation’s positive effect on currency prices was short-lived, however, as the Confederacy cranked up the printing press again in the fall of 1864. Graybacks renewed their depreciation and continued to actively trade until early February 1864. At this point, many Richmond bankers and gold traders packed their wagons and left the besieged capital (Weidenmier, 2002a).
Confederate Debt Operations Abroad
The Confederacy floated two small loans in Europe during the American Civil War: cotton bonds in London and unbacked, high-risk “junk bonds” in Amsterdam. These two loans accounted for less than one percent of Confederate military expenditures during the war. Funds from the two loans were used to build ships in Europe, purchase supplies, and finance overseas operations (Gentry, 1970). Weidenmier (2002b) also argues that the South floated the cotton bonds for political gain. The Confederacy believed the war debt could open the way for sovereign recognition or aid from England or France.
The cotton bonds were unique in that they were denominated in British currency (the pound sterling), and could be converted into cotton on demand. The only catch was that investors had to take delivery of the cotton in the Confederacy. The South honored the provisions of the debt issue for the entire war. The bonds were initially oversubscribed three times when they came to market in March 1863. Holders of the bonds allegedly included several members of British Parliament and the Right Honourable William Gladstone, Chancellor of the Exchequer and future Prime Minister of England.
The junk bonds, on the other hand, were floated in Amsterdam in the summer of 1863, weeks before news of Confederate defeats at Gettysburg and Vicksburg reached European markets. The Dutch bonds contained a default clause that allowed the Confederacy to postpone interest payments on the debt issue until after the war. Indeed, the South never serviced the junk bonds and pursued a debt management policy of selective default (Weidenmier, 2002b).
Figure 5 plots cotton and junk bond prices. The cotton bonds retained a large premium to the junk bonds for the entire war. The discrepancy is largest during 1864 when the cotton bonds rose from a price of 36 pounds sterling in December 1864 to nearly 90 in late August 1864. The junk bonds, in contrast, lost nearly 50 percent of their value during this period. Weidenmier (2001) and Burdekin and Brown (2001) examine the large runup in Confederate bond prices during this period. Brown and Burdekin (2001) attribute the rise to the belief that George McClellan would be elected President of the United States on a peace party platform in November 1864. Weidenmier (2001) traces the large increase in bond prices to an increase in the underlying collateral of the war bonds, New Orleans cotton prices. Since a win for the peace party should have strengthened the price of junk bonds as well as the price of cotton bonds, the decline in junk bond prices during this
period suggests that the decline was largely due to the runup in cotton prices.
Confederate debt prices in Europe plummeted following news of the South’s defeat at Atlanta in late September 1864. By June 1865, cotton bond prices were trading for about 6 pounds sterling and the junk bonds at 1-2 pounds. The small positive price for the cotton bonds can perhaps be explained by the (unlikely) possibility that England might put pressure on the United States or individual Southern states to pay off the bonds. As for the junk bonds, the Dutch firm underwriting the issue offered investors a small credit for exchanging their defaulted Confederate debt for “good bonds” (Weidenmier, 2002b). The investment house’s reputation was apparently tarnished by their dealings in Southern war debt.
Counterfeit Money and the Yankee Scoundrel
Economic and monetary historians have largely ignored the role of counterfeit money in the Confederate inflation because data are not available on the amount of bogus notes. Nevertheless, contemporaries and scholars of the Civil War have noted that counterfeit money posed a serious problem for the Confederacy (Hughes, 1992). More money chasing the same number of goods created inflation, reducing the central government’s take from the inflation tax. The Confederacy was unable to curtail counterfeiting because they lacked the resources and equipment to produce high quality money. Counterfeiting was such a widespread problem that people sometimes joked that fake money was of higher quality than government issued currency.
Weidenmier (1999b) studied the effects of counterfeit money on the Confederate price level by examining the history of the war’s most famous counterfeiter, Sam Upham. The Philadelphia lithographer, printed nearly 15 million dollars of bogus Confederate notes during the war. Upham claims that he originally printed bogus “rebel” notes as souvenirs. Although this may have been initially true, Upham certainly became aware of the fact that smugglers were using his notes to buy cotton in the South. The businessman expanded his business to include mail orders and placed advertisements for his bogus notes in leading Northern cities, including Louisville and St, Louis. Upham’s venture was so successful that the Confederate Treasury Secretary Memminger made the following comments about the “Yankee scoundrel” in June 1862:
“Organized plans seem to be in operation for introducing counterfeiting among us by means of prisoners and traitors, and printed advertisements have been found stating that the counterfeit notes, in any quantity, will be forwarded by mail from Chestnut Street
[Sam Upham’s address], in Philadelphia to the order of any purchaser.” (Secretary of the Treasury Memminger to Confederate Speaker of the House of Representatives, Thomas Bocock, quoted in Todd, 1954, p. 101).
President Jefferson Davis and the Confederate government placed a $10,000 bounty on Upham. The bogus money maker was never caught and some have suggested that the U.S. government protected the businessman with secret service agents.
Weidenmier (1999b) attempted to quantify Upham’s effect on the Confederate price level by making different assumptions about the proportion of Upham’s notes that ended up in the South. Weidenmier estimates that Upham printed between 1.0-2.5 percent of the Confederate money supply between June 1862 and August 1863. Upham stopped printing bogus notes once Confederate money had depreciated so much that it was no longer accepted as a medium of exchange in cotton smuggling. Given that the Philadelphia businessman was one of many counterfeiters, it is probably safe to assume that bogus money makers had a large impact on the Confederate price level. The actions of bogus money makers fueled the Confederate inflation via a large increase in the money stock.
There are very few instances in monetary history where governments have issued currency that pays interest. Governments tend to issue interest-bearing money during crises to increase the demand for money — it is more attractive to hold money if it pays interest. Twenty-percent of the South’s money supply paid interest, providing an opportunity to test theories of interest/non-interest-bearing money. Legal restrictions theory, for example, predicts that interest-bearing money will drive non-interest bearing money out of circulation unless there are laws — legal restrictions — that prevent this from happening. Burdekin and Weidenmier (2002a) examine why non-interest-bearing money remained the predominant medium of exchange in the Southern Confederacy despite the existence of large quantities of interest-bearing money. They find that state and Confederate governments forced banks to accept both types of money through de facto legal restrictions. The Confederate and state governments threatened to resume specie convertibility if banks did not accept Grayback interest and non-interest bearing liabilities at par. Banks obviously went along with this policy as they feared losing their gold stocks with specie resumption. In turn, banks held a disproportionate amount of their reserves in interest-bearing money. Non-interest bearing money enjoyed greater circulation in the Confederate economy as banks rationally chose to hold money that paid interest (Makinen and Woodward, 1999).
Weekly data on Confederate cotton bond prices in London and junk bond prices in Amsterdam can be found here. (You may have to right-click and choose Save As to open this file with Excel)
Biweekly data on the Confederate Grayback note price of a gold dollar in Richmond and Houston can be found here. (You may have to right-click and choose Save As to open this file with Excel)
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