The Legal Tender Acts (1862 -1865): How The Federal Government Disrupted Retail Trade

There are some things that governments do very well. John Locke said societies unite and form governments for the mutual preservation of their lives, liberties and property. When governments stay this course and focus on protecting man’s inalienable rights, societies flourish.

However, when governments try to manipulate the marketplace and economic law, unintentional negative consequences usually result.

Such was the case with the first Legal Tender Law passed by the United States Congress on February 25, 1862 during the first year of the American Civil War.

By the end of 1861, the Union military had suffered several key defeats. Its financial fortunes were also suffering. Several New York, Philadelphia and Boston banks subscribed to a $150 million loan issued by the federal government. The transfer of $150 million in gold to the federal government coupled with poor bond sales severely weakened bank bullion reserves. By the end of the year bullion reserves fell below 25% forcing the banks to suspend payments in gold. The federal government followed suit on December 31, 1861.

Case BustIn early December, Secretary of the Treasury Salmon P. Chase in his report to Congress revealed that he had substantially underestimated the cost of the war. His initial estimate was $320 million, but his report of December 9, 1862 increased the cost to $530 for the first year alone. He also had underestimated revenues by $25 million. If Chase’s final estimates were correct, the federal government would need an additional $214 million to continue the war up to July 1, 1862.

Historian William Marvel wrote that by early 1862:

“The war was costing $1.5 million per day and more; by the end of February contractors were clamoring for payment of nearly $27 million in outstanding requisitions. Soldiers, who could afford it less than most, had to bear much of the treasury deficit in the form of unconscionably tardy paymasters. Chase…estimated that the government faced about $45 million in ‘floating debt’ at that time, incurred mainly by the War Department.”[1]

Militarily the Union Army was stalled around Washington, D.C. General McClellan was recovering from typhoid and was in no rush to commence an offensive.

Lincoln lamented to General Montgomery Meigs,

“General, what shall I do? The people are impatient; Chase has no money, and he tells me he can raise no more; the General of the Army has typhoid fever. The bottom is out of the tub. What shall I do?” [2]

In order to continue the war against the Confederacy, significant new sources of revenue needed to be found.

On January 7, 1862, Congressman and former banker Elbridge Spaulding proposed legislation for funding the war that at the time was considered revolutionary. It was called the Legal Tender Bill.

The bill called for the U.S. Treasury to issue $150 million of non-interest bearing legal tender notes, backed only by the credit of the United States.

Since the notes were legal tender, they had to be accepted by everyone for all debts public and private and, because the notes were not backed by specie (gold or silver), they were a pure fiat currency. The notes, designated as U.S. notes, soon became known as “greenbacks”.

Years later Congressman James G. Blaine from Maine called the Legal Tender Bill,

“The most momentous financial step ever taken by Congress,”[3]

The bill was revolutionary because a fiat currency had not been employed in the country since the time of the Revolutionary War. Between 1775-1780, the Continental government issued Continental dollars that were un-backed by specie. The result was an eventual depreciation of the notes to zero value.

Not surprisingly, the framers of the Constitution, aware of the dangers of a fiat currency, made sure that it would be extremely difficult, if not impossible, for the federal government to issue fiat currency. Article 1, section 8 of the U.S. Constitution states,

“The Congress shall have Power To… coin Money,”

Up to the time of the Civil War, it was generally agreed that this constitutional stipulation prevented the federal and state governments from printing a fiat currency. However, the Congressional debate over the Legal Tender Bill in January through February 1862 demonstrated that while some political leaders still accepted this view, it was no longer dominant amongst a majority. The bill passed Congress and was signed by President Lincoln on February 25, 1862. The legislation allowed for the printing of $150,000,000 in greenbacks in denominations not less than $5.

At the time of the passage of the legal tender bill, gold bullion was already in short supply. There was, however, about $29.7 million in silver coinage available in circulation. In April 1862, greenbacks started to enter circulation and by June 7, 1862 there was almost $90,000,00 outstanding in denominations no lower that $5.[4]

The results were predictable as Gresham’s Law took affect. Gresham’s law states,

“Money overvalued artificially by government will drive out of circulation artificially undervalued money.”[55]

In late June and early July 1862, most of the silver coinage was withdrawn from use as currency.

On July 2, 1862, the Springfield Republican reported,

“The ruling premium of five to six per cent on silver coin as compared to the paper currency in use, is fast driving it out of circulation.”[6]

The newspaper went on to state that speculators were shipping silver out of the country where they could command 6-7% on silver compared to greenbacks. Mitchell states that large amounts of silver were transported to Canada and South America.

The effects of the scarcity of silver coinage became apparent quickly. The New York Times exclaimed,

“The annoyances suffered in this city and through out the country in the last two or three weeks, on account of the scarcity of specie have been unspeakable, and in many lines of business the loss of custom and profit has been heavy.”[7]

What exactly were the annoyances suffered by the disappearance of silver? Since the lowest denomination greenback was $5 and silver coins were now scarce, it became almost impossible for people to make small change. As could be expected, retail trade was severely hampered. Many necessaries of life sold for less than a dollar, but making change for a $1 banknote became enormously difficult.

WestBankfactionalAs always, markets find creative and sometimes not so creative ways to adapt to problems. Some places of business refused to make change for paper currency or charged a premium for silver returned. In Philadelphia, Spanish quarters resurfaced. Dollar bills were often cut into halves or quarters and passed off as change.  “Shinplasters” became a common method of solving the problem. Most states had laws that prohibited banks fromissuing a currency less than a dollar. However, some banks ignored the law and issued their own fractional currency.

Fractional-Currency-rootMost of the shinplasters, though, seemed to have been issued by private businesses. For example, in Chicago, the city railway company issued 25-cent tickets, which they exchanged for dollars and accepted for fares.[8] In Boston, hotels instituted a system of checks in the amounts of 15, 25 and 50 cents with the owner’s signature attached. This practice was followed by numerous saloons, restaurants, and retail stores. As could be expected, rampant fraud developed and business losses were high. Some local communities in an effort to assist their citizens also issued their own fractional currency.

ShinplasterwstapsOn July 14, Secretary Chase informed Congress of the severity of the situation. Three days later, Congress authorized the use of postage stamps as currency. In New York, the average sale of stamps was around $3000. The day after authorization, sales jumped to $10,000. The following day it was $16,000. Postage stamps, however, proved inadequate for solving the problem because they were small and difficult to handle since their glue made them stick together.

postalCurrency1.001Temporary relief came when Chase directed a fractional postage currency without glue to be issued in late August. With the issuance of these stamps, state and local governments began to force private firms and individuals to cease issuing shinplasters.

It seems that the postage currency still insufficiently satisfied the needs of business.  The Saint Louis Republican on December 10, 1862 reported, “There is still much complaint of the scarcity of small change.”[9] However, by the winter of 1863, it seems the amount of fractional postage currency finally fulfilled most of the demands of retail trade. Mitchell notes that by March 1863, $19,000,000 in postage currency was issued. The government ceased issuing the currency in May 1863. The total amount issued was $20,000,000.

FractionalCurrencyBlogpic.001To take the place of postage currency, Chase issued a “fractional currency” on March 23, 1863. These new notes were made of thinner but stronger paper than the previous notes, were difficult to counterfeit, and were not easily damaged by water. Eventually, these fractional notes replaced the postage currency with the total combined issuance of the notes amounting to $25,000,000. In 1876 Congress authorized the minting of fractional silver coins to replace the outstanding fractional currency.

During the congressional debate on the Legal Tender Bill, Congressman George Pendleton warned that gold and silver would flee the country if the bill were enacted.  Apparently, the supporters of the bill never considered the impact it would have on the ability to make small change and the damage it would do to retail trade. Unintended consequences are rarely anticipated. How much money businesses and citizens lost because of the Legal Tender Act is impossible to determine, but we expect it was considerable.


[1] William Marvel, Lincoln’s Darkest Year: The War in 1862, p. 27.

[2] Don E. and Virginia Fehrenbacher, The Recollected Words of Abraham Lincoln, p. 328.

[3] James G. Blaine, Twenty Years of Congress, p. 407.

[4] Wesley Clair Mitchell, A History of the Greenbacks, p.155.

[5] Murray N. Rothbard, What Has Government Done to Our Money? p.19.

[6] Mitchell, p.158.

[7] Mitchell, p.159.

[8] Mitchell, p. 160.

[9] Mitchell, p.163.



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