Chapter 4 The US Monetary System

The evolution of the monetary system in the United States is a fascinating journey that reflects the nation’s economic, political, and social transformations. Heres is a concise overview of the key developments, focusing on Abraham Lincoln’s debt-free monetary policy and the eventual establishment of the Federal Reserve System:

4.1 Lincoln’s Greenbacks (1861-1865)

During the Civil War, President Abraham Lincoln faced the challenge of financing the war effort without relying heavily on foreign loans or high-interest debt.
To address this, the U.S. government issued “Greenbacks”, a form of fiat currency that was not backed by gold or silver but by the credit of the government.
These legal tenders were debt-free and allowed the government to fund the war without incurring significant debt to private banks.
While Greenbacks helped stabilize the economy during the war, they also sparked debates about inflation and the role of government-issued currency.

4.2 Post-Civil War Monetary Policy

After the Civil War, there was a push to return to a gold-backed currency, leading to the Resumption Act of 1875, which aimed to redeem Greenbacks for gold.
This period saw tensions between advocates of “hard money” (gold and silver) and “soft money” (fiat currency), with farmers and laborers often favoring the latter to combat deflation and promote economic growth.

4.3 Rise of Private Banking and the National Banking System

The National Banking Acts of 1863 and 1864 established a system of nationally chartered banks that could issue banknotes backed by U.S. government bonds.
This system centralized currency issuance but still relied on private banks, creating a hybrid model of public and private monetary control.

4.4 Panic of 1907 and the Push for Reform

Financial panics, particularly the Panic of 1907, exposed the weaknesses of the decentralized banking system and the lack of a central authority to manage liquidity and stabilize the economy.
This led to calls for a central bank to oversee monetary policy and provide a lender of last resort.

4.5 Creation of the Federal Reserve System (1913)

In 1913, the Federal Reserve Act was passed, establishing the Federal Reserve System as the central bank of the United States.
The Federal Reserve was designed to manage the money supply, stabilize the banking system, and address economic fluctuations.
Unlike Lincoln’s Greenbacks, the Federal Reserve operates on a debt-based system, where money is created through loans issued by private banks and backed by the Federal Reserve.

4.6 Key Differences

Greenbacks: Government-issued, debt-free currency directly controlled by the Treasury.
Federal Reserve System: A hybrid public-private system where money is created as debt through loans, with the Federal Reserve overseeing monetary policy.

This evolution reflects a shift from government-issued, debt-free money to a system where private banks play a central role in money creation, with the Federal Reserve acting as a regulatory and stabilizing entity.