The Civil War and the Economics of Seigniorage

David Beckworth: Our guest today is Bryan Cutsinger. Brian is an economist affiliated with Angelo State and Texas Tech University and recently he published an article titled,“Seigniorage in the Civil War South.” Brian joins us today to talk about this article, the monetary history of the Civil War and the economics of seigniorage. Bryan, welcome to the show. 

While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

Bryan Cutsinger: Thank you so much for having me, David. It's a real honor to be here. 

David Beckworth: It was great to have you won. You wrote a really fascinating article. You co-authored it and we'll make it a link to it available online for our listeners. Before we get into the article, though, tell me, how did you get into this topic of Civil War finance? How did you stumble upon it and decide to write about it? 

Bryan Cutsinger: So it's a little bit of a roundabout story. The first is that I've always been interested in Civil War history in general. I grew up in New Hampshire. I was in a reenactment core in high school, so I went around every summer and dressed up in the garb and did all that. But fast forward a number of years, I'm in graduate school and I read E.A. Radford's famous article on the economics of a POW camp where cigarettes ended up serving as currency during World War II. And I wondered if there was anything similar happening in the U.S. Civil War in the various prison camps. And when I looked into it, what I was able to find is that both sides were too poor to really ever escape, basically barter. So there's some references to rats being used as currency in Andersonville. 

David Beckworth: Oh wonderful. 

Bryan Cutsinger: Yeah, I don't know. There was no way to corroborate that. But anyway, I started reading more about this and the first thing that got me interested in it is that the Confederacy passed three currency reforms over the course of the war. And that struck me just as kind of odd because if I'm using the printing press to fund the war and my alternative is print like crazy and maybe win and not print like crazy and probably lose, why not just print like crazy. But for some reason over the course of the war they adopt these three reforms. And that was kind of the first puzzle to me that I wanted to start looking into this. 

David Beckworth: Interesting and we'll get into that as we discuss your paper. But you found an interesting question that hadn't really been addressed in the literature as you know it in your article and a lot of fascinating stuff in there. And what I want to do today is kind of work our way through U.S. monetary history, starting with the Revolutionary War and then go up to the Civil War just so we have the context and people can understand kind of what's going on. But before we do that, I think we need to define what is seigniorage? It's a wonderful word that monetary economists like to talk about. But for many listeners, it's a very strange word. So can you define for us what is seigniorage? 

Bryan Cutsinger: Sure. I think the simplest definition you can think of is it's a tax on cash balances. So all of us make decisions about how much money or how much of our wealth we want to store in the form of money, and we make those decisions based on a variety of factors. Once we make those decisions, whoever is responsible for issuing money can basically engage in some type of surprise inflation that we weren't expecting if we would, or if we were, we obviously would have already made the adjustment. If we're not expecting it, then what ends up happening is that the prices end up rising and the size of the tax is that actual rise in the price that reduces the real value of our tax balances. So really just first and foremost, the seigniorage is a tax, simply a tax on cash balances. 

Bryan Cutsinger: In the Middle Ages for example, you would have kings that would every so often say, "Hey, the gold coins, the quality of the gold coins is deteriorated from everybody trading them. I'm issuing a decree, we're going to bring them all in and we're going to re-mint them." Well really what was happening is that he was taking 10 percent of the gold content out of the coins, replacing it with some less valuable material, re-minting the coins and then sending them all back out there. That would be like a physical example of seigniorage, but even with a fiat type of money, simply it would be you print a bunch of money, spend it for what it is that you need and the next thing you know, prices rise and that would be the size of the tax. 

David Beckworth: Okay. So there's an understanding in this literature on seigniorage is very similar to the Laffer Curve which was a big part of the debate in the 80s in the U.S. and it still is the debate I guess from many people. The Laffer Curve says, look if your income tax is at 0 percent, the government's going to get no revenue. If income taxes at 100 percent, it's going to get no revenue. So somewhere between those two extremes, there's some optimal tax rate, of course, Republicans and Democrats, progressives and more free market types, they'll argue where the optimal point is and the same idea can be applied to this inflation tax or seigniorage. Is that right? 

Bryan Cutsinger: That is correct. And in fact the notion of a curve actually predates Arthur Laffer, in least in the context of seigniorage it goes to Martin Bailey's famous article in 1956 in the Journal of Political Economy where he actually draws a basically a seigniorage Laffer Curve. So you can think, just your example is great. You can think in the context when we debate taxes, we think of a tax base and a tax rate, right? And the whole argument over this is where we want to find the point at which the increase in tax revenue brought on by a higher tax rate is just offset by the reduction in tax revenue brought on by a reduced tax base. 

Bryan Cutsinger: The same thing is true for seigniorage. The challenge for a seigniorage maximizing government is to select a rate of base money growth that creates a rate of inflation that makes people, makes the demand from on a unit elastic, right? So another way since I assume most of your listeners are economists, another way you can think of this is think of a monopoly producer of a good, and it can produce it at zero cost and constant marginal cost. It would maximize profits where the demand for that good is unit elastic, it'd be where marginal revenue crosses the X axis. So that's what a seigniorage maximizing government is trying to do. And what the seigniorage Laffer Curve or Bailey curves simply traces out is that if we move along a given long run money demand curve, at what point do we find the maximum amount of revenue that can be raised via the printing press? 

David Beckworth: Yeah. And Phillip Cagan has a famous article on this too, right? 

Bryan Cutsinger: That is correct. So that is actually in Milton Friedman's “Studies in the Quantity Theory of Money.” So that was kind of the article that laid it down. Bailey took Cagan's approach. Cagan verbally described the Bailey curve, but it was Bailey taking what he did and formalizing it. 

David Beckworth: And Arthur Laffer for better or for worse, gets the credit. In fact, I've had people criticize me for saying a “Laffer Curve” and implant it in different contexts such as this. And they don't like the fact that he gets the credit, poor Professor Bailey, he doesn't get the credit, but just to be clear again, so the government can raise the rate of monetary base growth or the rate of money creation. And they can do it up to a point where people are still willing to hold on to it enough that they can squeeze out more profits for the government. But at some point they make too much money too fast and people are unloading their money balances quicker and the government can create an inquiry. 

Bryan Cutsinger: That's exactly right. So what could happen, for example, is the government could actually reduce the rate of monetary expansion and actually get people to hold more money and that increase from doing so would exceed the lost revenue from lowering the tax rate, which in this case would be the inflation rate. 

David Beckworth: Yeah. So we have a colleague here, Steph Miller who recently has a paper in our program here at Mercatus Monetary Policy Program where he looked in Zimbabwe in 2008, whether it was on the wrong or right side of the Laffer Curve, the inflation tax Laffer Curve. So it's a very interesting question. But now we've got this established, let's move forward to talk about some history. And I want to begin with the U.S. Revolutionary War. Tell us about the war. How was it financed? What was money like back then? What was going on? 

Bryan Cutsinger: So as far as the financing goes, the Continental Congress issued what are called continentals. Some people may remember the phrase “not worth a continental.” The reason is, is that they ended up issuing approximately $241 million worth of them over the course of the war. But the issue for the Continental Congress is that they had no formal taxing authority. So the idea was that each of the 13 colonies would provide the fiscal resources to fight the war. But of course, this creates a free rider problem because everybody expects everybody else to pay for it. So Congress really had no choice but to resort to the 'printing press' by issuing continentals. 

Bryan Cutsinger: So that was one thing that they did, and then the other thing that they did, they kind of created America's 'first central bank' It's actually the Bank of North America, not the First Bank of the United States. And partly what that bank was there to do was essentially to buy bonds issued by the continental congress. So they used both of those. They used both of those approaches. 

David Beckworth: And that's interesting. So I've taught U.S. economic history back when I was in the university and kind of the standard story which I myself have taught was that we've had three central banks, the First Bank of the United States, the Second Bank of the United States, and the Federal Reserve. But technically there was a bank before then. Tell me the name again. 

Bryan Cutsinger: It's the Bank of North America. 

David Beckworth: And it was used to buy the continentals. 

Bryan Cutsinger: Well, it was used to buy bonds. 

David Beckworth: Buy bonds, okay. 

Bryan Cutsinger: Yeah, so to keep in mind, back in this point in time, America does not have a very developed banking system in part because the economy is itself not very developed. So the continental government such as it was, did not have access to private capital markets to finance the war. So they essentially created one. They created an entity that could ... So they sponsored the majority of the capital for the creation and the bank and whatnot. So those were kind of the two approaches that they used in addition to whatever they were able to collect from each of the individual colonies. 

David Beckworth: Maybe it's worthwhile just stepping back for our listeners who aren't economists or even some who are economists and think of all the ways that a government can raise revenue or collect real resources to fight a war or pursue some endeavor. And you think back to the Continental Congress, it was a rebellion. So the amount of resources, very limited to it, and if you can think of the normal ways it could get revenue, you could borrow funds, but who would want to lend to a rebellious group of colonists, not very good credit standing. So that often wasn't really very well tractable. You mentioned taxes really weren't an option. so you resort to this third option of the seigniorage. Another option, which was used to some extent, was simply just putting a gun to someone's head and saying, "I'm going to take your cows, your pigs, your horses." It’s appropriation of property, real assets. 

Bryan Cutsinger: Yeah. So in general, I think when economists study those topics, so I forget the word that's actually… impressment, that's the word for that type of revenue collection. I think economists typically just lump that into taxes. It's just a tax in kind rather than a tax in currency. Those, as you might imagine, are very distortionary. I think in general, governments do well to avoid those. And in fact one of the problems in the south, for example, is they implemented price controls to fight the inflation and then at the same time would rove around and try to impress the best agricultural products being produced. But of course, if you're a farmer, you hold the good cabbage off the market and you give them the cabbage and it's a day away from rotting. Right? So it's not the most effective way to raise revenue. 

David Beckworth: Okay. And so what we have here is a case where they resorted to this. And one of the popular books I've read about the Revolutionary War is that the U.S. was very dependent and you've kind of confirmed this, the U.S. was very dependent upon seigniorage or this inflation tax to win the war. In fact, this author has this phrase, and I've used it with a previous guest on a podcast that Uncle Sam rode the wave of hyperinflation into existence. And in my mind, when I read this, it really resonated. I had this picture of Uncle Sam on a surf board with this big tsunami of dollars behind and propelling him into existence. So is that a fair assessment of kind of the literature? 

Bryan Cutsinger: As far as I understand it that is correct. Benjamin Franklin, in fact, more or less said as much where he basically said that the hyperinflation caused by the issuance of the continentals had essentially acted as a tax to finance the war. I mean, I think they understood in real-time what they were doing and they may not describe it how you or I do using like a formal model, but they understood in the back of their minds whatever they were up to, Right? So I think another interesting historical point to drive home why this is important and how important it was for the revolutionary government. It was so important that the British recognize that that's how they were funding the war and the British engaged in counterfeiting continentals. 

David Beckworth: Really? 

Bryan Cutsinger: So you're not going to earn seigniorage revenue on money issued by somebody else, right? Because you're not the one spending it. If you're the government that wants the revenue, you need to be the one buying the muskets with your currency. If somebody else's dumping hundreds of thousands or millions of currency units into your economy that are counterfeit, that's actually going to undermine, especially if the average money holder can't distinguish between the two, right? That's going to move them around on their money demand curve in a way that may be inconsistent with your goals of collecting as much tax revenue as possible. So the British, even the British understood this too, and they actually tried to undermine the U.S. or the continental government’s reliance on seigniorage. 

David Beckworth: Very interesting. Okay, so we have that. That's our first example of this, the price level goes way up, after the war it comes back down. There's a history of two central banks, the First Bank of the United States, the Second Bank of the United States, and the Second Bank of the United States, I think it's well known, was kind of put out of existence by Andrew Jackson. Tell us though, how was money created during this period? How, in general, if you're a person and you wanted some money to buy something, transaction balances, where did you get money or how was money created during this peak time? 

Bryan Cutsinger: Sure. So when you have alongside the First Bank of the United States, you have essentially state chartered banks. So the way this would work is, let's say the two of us would like to ... We're in New York, we'd like to create a bank, we go to the state legislature. We typically had to buy a charter from them. This was actually a great revenue mechanism for the states and we can charter a bank, we'd be subject to certain rules like we'd have limited liability. There'd be other things that the state might require us to do usually that you were required to lend money to the state on favorable terms, that had problems in terms of the stability of the banking system. But that is what would happen. And then in addition to, you had the first bank of the United States that was opening branches in the various states as you might expect. That did not go over very well. Both with, if you and I, right? Being a chartered bank in New York, we're not happy about this. 

Bryan Cutsinger: But then also the state legislators aren't happy about this because now you essentially have competition for one of the ways that you're collecting revenue, right? Because again, keep in mind income tax or anything like that just does not exist right now. So states have to find ways of raising revenue that are probably, or they're somewhat foreign to the way we think about the way in which governments finance themselves today. So you had the first national bank it has branches throughout the country. Those banks are issuing currency notes that's redeemable for gold, you also have state banks that are issuing notes also redeemable for gold. There were certain laws essentially saying that you had to honor redeemability, if you were to suspend redeemability, you might be subject to fines or penalties and whatnot. 

Bryan Cutsinger: But yeah, that's basically what's going on. And then the first national bank eventually goes away. I think it's in 1812, maybe, I forget, 1811 is when it goes away, but then the second national bank comes back in 1816 in part to help finance the debts incurred for the war of 1812. And again, you had the same type of situation, which is that the second national bank served as the primary depository institution for the U.S. Treasury. So the U.S. Treasury is depositing its money in each of these banks. They have branches across all of the states, of course, there's kind of bristles the state banks as well as the state legislatures. So that creates the kind of the showdown with Jackson of why he wanted to get rid of that. 

Bryan Cutsinger: Again, I think there's an interesting political economy story thereof, it's not Jackson versus the big evil banks. It's that Jackson had a core constituency who were being harmed by these branch banks and he advocated along with others to try to get rid of it. And then I think another interesting thing was that at least in the case of the second bank, they did not have to pay interests on the deposits that they got from the U.S. Treasury. So they're essentially getting loans that they don't have to pay for from the Treasury. And then another interesting historical fact about this is that when this was being debated, one of the things that the state banks really pushed for in the federal legislation was that these branch banks and the bank as a large organization itself was when necessary to help out the state banks in a credit crunch. So this is actually one of the first times we see essentially a lender of last resort in the United States, like a bank set up to at least do part of that. 

David Beckworth: Okay. So the Second Bank of the United States was really doing the central bank roles we know today, lender of last resort to the state banks, the money you used, whether it was the state bank note or a Second Bank of the United States note, you believed ultimately was redeemable in some commodity, silver or gold- 

Bryan Cutsinger: Correct. 

David Beckworth: ... In the background, but you just, you did this, these transactions. And other thing I think it's worth mentioning is there were literally many, many different notes, they were all dollars. But you could have the Bank of Bryan, the Bank of David and because there weren't branches… I think this is important political economy point to go back to what you were saying earlier. If my bank was based in Nashville, Tennessee, where I live, the farther my note went away from my bank, the greater the discount on it because there wasn't a Bank of David in Washington D.C. where you could redeem it at face value. So that makes it important and it adds to the understanding of why they didn't like the Second Bank of the United States. The Second Bank literally had branches throughout the U.S. And as you said, it competed with the state banks. 

David Beckworth: And in the history of banking in the United States, one of the biggest defining characteristics is unit banking laws. So you could only set up one branch and the idea was to keep out competition and so the Second Bank comes along. And that is a big competitive threat. 

Bryan Cutsinger: That's correct. 

David Beckworth: So that is an interesting story. It's more than just Andrew Jackson not liking big banks. It's Andrew Jackson having a constituency as you mentioned that it doesn't like competition. So it's a complicated story, but it's a fun story. And we could spend a whole podcast because Andrew Jackson makes an entire presidential campaign in 1832 around a central bank. So it'd be the equivalent of Ron Paul running for office and his key issue would be, end the Fed. 

Bryan Cutsinger: Yes, exactly. Yes, exactly. 

David Beckworth: And he actually did. And unlike a modern politician he actually did end the central bank. So we get to the period between, which is 1836 till the Civil War. We got state banks issuing notes and let's move up to the Civil War period now. So the Civil War begins and we have the north, we have the south, the north has the dollar, has the greenbacks that emerge. And we're going to talk about the south in a minute. Any thoughts about the north's currency before we get into the south? 

Bryan Cutsinger: Well, I think it's an interesting comparative study. It's a paper that I want to do once, I'm finishing up my dissertation, once that's done is why is it that the north and south ultimately ended up using two very different means of financing the war. I mean, you have to keep in mind that many of the people that served in Congress, many of the policymakers that existed in this time, they had served with one another in the United States Congress. Right? And so even after they split, what we have is we have a group of legislators in Washington. We have a group of legislators in Richmond. These guys work together. So if you think of economic policy as like a technology, it seems like they both had access to the same technology, but for whatever reason they adopted very different approaches. So a common misconception with the north is that they used greenbacks to finance the war throughout the war. That's incorrect. 

Bryan Cutsinger: They did three issuance of green greenbacks in the beginning of the war, each issuance was approximately $150 million. But once they passed the National Banking Acts, they stopped relying on seigniorage as a method of finance and substituted over into long-term bonds. Because what they essentially did was created a ready market and we can talk about that if you want, the National Bank system, they essentially created a ready market for their debt. 

David Beckworth: Okay. And to be clear, the greenbacks were fiat currency. So it'd be like what we use today as cash, which was novel back then because again, they'd been on the gold standard and suddenly you've got this money that's circulating that's not backed but the national banking system, just to be clear, this is a now a federally chartered banking system, which had not existed. It was all issued at the state level. So now we got the federal government in banking. And in order to issue a national charter, you had to have your deposits backed by bonds. 

Bryan Cutsinger: Correct. 

David Beckworth: And that's where this kind of captive market comes. 

Bryan Cutsinger: Yes, exactly. 

David Beckworth: Okay. So we have green backwards of seigniorage and then we'd go to back to bond finance. Just a quick, interesting bit of history here. So Salmon Chase, who was Treasury secretary at the time, I've looked a little bit at this. He is the individual who issued the greenbacks. What's interesting is that later he became a supreme court judge and he actually ruled against the greenbacks. 

Bryan Cutsinger: That's correct. He ruled they were unconstitutional. 

David Beckworth: Which is interesting. Now someone has told me, I'm going to have to talk to them again. That he was actually, he thought he was consistent in his views and I don't know the details, we’ll have to look at a later time, but very interesting history there. He thought he was being consistent, at least with the way things were defined. But so we have the greenbacks in the north that create some seigniorage with north relies upon bond financing. So let's go to the south. Tell us about how the south financed the civil war. 

Bryan Cutsinger: Okay. So at least at the beginning, the south wanted to rely on bonds. That was partly what their hope was. In the spring of 1861, the Confederate Congress approves a large bond issuance and they go to the farmers the planter class and essentially ask them, "Will you buy these bonds?" And they say, "Yes. However, it's spring, we're planting our crop, which means we do not have a lot of money to invest right now. So we will pledge to buy your bonds in August of 1861." Well for the listeners that know their history, they'll know that one of the things that the Confederacy tried to do to induce Europe and England in particular join the war, was they adopted a cotton embargo where they refused to sell cotton to Europe. This didn't work the way that they hoped for two reasons. One, it didn't get England to come into the war, but two, it actually created a glut of cotton in the south. 

Bryan Cutsinger: So by the time August rolls around, there's a glut of cotton. The price of cotton has fallen through the floor. And so not only were the planters not able to make good on their promises to buy the bonds, they actually, many of them went to the Confederate government, asked for a bailout because they had become insolvent as a result of the price of cotton crashing. So the Confederate government didn't really have a whole lot of choice, right? They had to go back to the kind of time honored method of financing during a war, which is you start printing money. Now, one of the things that they did that I think makes the currency a little unique, and we have this in the paper. I know he's been on the show a lot, but I want to give him a shout out here. George Selgin pointed this out to me when I was talking to him about this project, which is that their notes were not a pure fiat currency, right? 

Bryan Cutsinger: One of the things that they did on their notes. And as I said, we've got one here in the studio that you can look at. But if you go to Wikipedia for example, and look at Confederate Treasury notes, you'll see that they were actually a credit form of money. They were a promise to redeem at some point in the future. 

David Beckworth: The first Treasury bill. 

Bryan Cutsinger: Yes, they are essentially a Treasury bill that was redeemable for gold at some point in the future. And so the first notes I believe issued said something like the following, “The Confederate States of America will pay out whatever the dollar value is on the piece of paper to the bearer on demand six months after a peace treaty with the Union." So this kind of goes back to, Bordo and Kydland have a paper in explanations and economic history on the gold standard as a rule, as a way of getting around the time and consistency problem. And what they argue is that so long as the government's commitment to redeemability after the emergency is credible with the public, that keeps the price level from ballooning out of control. So this promise can kind of anchor the price level. The problem though is that if people start expecting you're not going to be able to make good on the promise, either you're just not going to do it. Or in the case of the Confederacy, you may cease to exist as a political entity, right? 

Bryan Cutsinger: They're going to start discounting the value of those securities and that's partly what started to happen as the war progressed. 

David Beckworth: Okay, so the Treasury bills is what they turn to and these Treasury bills become effectively currency. 

Bryan Cutsinger: That's correct. 

David Beckworth: And they're called greybacks, so in the north, we got the greenbacks in the south, we've got the greybacks and just a little aside, in California, they got the yellowbacks. So the yellowbacks were in California and they were effectively dollars that were still backed by gold. That's the yellowback name. But so the dollars in the north, the greenbacks were fiat, greybacks became fiat, and then out west, the dollars were backed by gold. So you have interestingly three currencies circulating simultaneously and what was the United States and temporarily in north and the south, an interesting period. Anyhow, so let's go back to the greybacks. And you mentioned they go from 2 percent to 90 percent of the south's money stock by the end of the war. So the south also had this myriad system of different forms of money. You mentioned state bank notes, they had private bank notes, there's deposits, and then these Confederate Treasury bills began and it began to grow rapidly. And the price level there, it explodes. You mentioned it gets up to 5000 percent or the price level skyrocketed 5000 percent between 1861 in 1865.  

Bryan Cutsinger:  That’s correct. 

David Beckworth: So you mentioned that's equivalent to 10 percent growth a month or 10 percent inflation a month, which doesn't maybe sound like a lot, but if you think of what we have today, I was just trying to do the math. So let's say we hit 2 percent a year. That's our target here. That's about 0.17 percent a month. So think of that compared to 10 percent a month. And then, and of course it wasn't an even 10 percent, there was- 

Bryan Cutsinger: Spikes of course. 

David Beckworth: ... Very strong periods about it. But tell us what drove ... Now you're going to talk about the currency reform is affecting this, but what were the kind of the things that have been studied that really drove the value of the currency? 

Bryan Cutsinger: Sure. So there's a debate in the literature on this and actually it started with the greenbacks. In fact, I think Wesley Clair Mitchell was the first one to point this out at the beginning of the 20th century, that the value of the greenbacks seem to fluctuate on people's expectations of the Union's success. Because the greenbacks were supposed to be redeemable for gold, of course during the war, the north abandoned that the same way that the ... I mean the south never committed to it, but the north abandoned it. But there's this debate of is it all about the quantity theory or is there something else going on? And fast forward about 40 years after Mitchell and one of Milton Friedman students, Eugene Lerner has an article in that same book we mentioned earlier, “The Studies in the Quantity Theory of Money” examining this period in the Confederacy. 

Bryan Cutsinger: And Milton Friedman in fact pointed to the Confederacy as being an example of look, the quantity theory holds even here. And he was pointing to Lerner’s examination of the third currency reform, which we'll get to in a second. But now there's been some more research on this. And partly what we find is that because the value of the note was a function of people's expectations of the government's ability to honor the agreement, essentially printed on the note, it was no longer the case that the value of the currency was determined by the quantity of notes in circulation. It was also determined by people's expectations of Confederate defeat. So the most recent paper that I'm aware of or papers that I'm aware of are from a Paquette and some co-authors in 2004 and then Weidenmayer in 2002 and the four major 'turning points' that they find in the data are the following. 

Bryan Cutsinger: The first is the battle of Antietam. So that happens in the fall of 1862. It really was a draw, it was the like the bloodiest battle in terms of deaths per hour. It wasn't really a clear win here, but it was also the first time that the south didn't clearly beat the north. So it serves as the impetus for the Emancipation Proclamation. So one of the things that you need to keep in mind at this point is that it's not clear to either side exactly what victory looks like. Is this going to be a negotiated settlement? Do we have two countries living side by side? Does the north say, "All is forgiven, come back and you get to keep slavery." Whatever. So there's a lot of uncertainty here. So once Lincoln issued the Emancipation Proclamation, which I think is January 1st, 1863 what he's essentially, it's again, it's a great political economy point. 

Bryan Cutsinger: What he's signaling to the south is if you want to win, that means you have to beat us right, like your institutions are done right? This is going to be a drastic reform to what's going to happen. You're going to have to outright beat us or you're going to have to make this last so long that we tire of the war. And what Paquette, for example, finds in this case cases you brought up the different notes that were circulating in the south. In a sense it's not entirely correct even though I use the term to call it the money stock because really you had basically imperfect substitute. So one ends up happening is that the greyback starts trading at a discount against state issued notes and privately issued bank notes and what they arguing that papers that that discount kicks in following the Emancipation Proclamation. 

Bryan Cutsinger: So it reflected people's expectations of, oh wow, this is not just some like family squabble, right. This is very serious. And it could go on for, I mean, at least through Lincoln's election year. 

David Beckworth: Stakes are higher. 

Bryan Cutsinger: Yes. The stakes are much higher than I think any that. So prior to that point, I think everyone was kind of like, "Well, we'll get over it." Now the other three turning points are more or less anybody familiar with the history you might expect the battles of Gettysburg and Vicksburg. So Gettysburg is obviously important because it's Lee is, it's one of his first advances into the north or one of them, I think the second advance into the north, he's obviously repelled and he has to go back down to Virginia. And then Vicksburg is important because it actually cuts the Confederacy and half. So what ends up happening there is that once Vicksburg is lost, the Confederacy consists of west of the Mississippi of Texas and a few other, I think Missouri, I'd have to look at a map, but something like that. And then right of the Mississippi. So that actually cuts it in half. And then the two other major turning points, one was the Union’s financing conscription bill. 

Bryan Cutsinger: So this is an interesting point about the national banking act. When the Union pass the National Banking Act and a law essentially creating a draft, which they did, investors started discounting the value of Confederate banknotes. And the intuition there is pretty straightforward, which is that you said, oh, wow. The United States government, just laid the financial infrastructure necessary to sustain this for the long haul. They're not going to rely on greenbacks anymore. They've created a ready market for their long-term debt and that's a much more sustainable way to fight a war. Likewise, they've just created a law essentially drafting people into their army, which again is another way of them kind of signaling, look, we're going to fight this long haul. And then the final one, final turning point in the value is the final and most significant currency reform in 1864 which we can talk about shortly. 

David Beckworth: Yeah. So there's a graph that has been shown many times, and I'll try to explain it to our listeners, but it's really neat graph. You can see the value of the greyback fluctuate based on particular battles. 

Bryan Cutsinger: Correct. 

David Beckworth: In fact you see it change, kind of in inflection point at Gettysburg pivotal. So it's really fascinating. So people are reading the newspapers, "Oh my goodness, Gettysburg was a disaster. Unload these greybacks." So it's very interesting to see kind of in real time and the data. 

Bryan Cutsinger: Sure. It actually an interesting point about this and I think this kind of bolsters, again, there's no amount of econometric evidence that can ever prove that this is what they were thinking in terms of explicitly. But I think one of the things that's interesting is that the, the south actively tried to delay war news and in the case of Gettysburg they'd try to delay it for I think up to two or three weeks. So it actually took some time. So if you go look at the newspapers right after Gettysburg in the south, that was actually, there were great victory for Lee. Everything's- 

David Beckworth: Oh really? 

Bryan Cutsinger: Yes, exactly. So the southern government was actively involved in information suppression about what's going on in the war front. And again, if you're- 

David Beckworth: You're desperate, I guess. 

Bryan Cutsinger: And if your primary method of finance is seigniorage, which was, right, you need to stem the tide of the inflation that's going on with your currency. 

David Beckworth: Yeah, very interesting. Now I do want to give a brief mention to some bonds that were issued by the south because you mentioned that the north got smart and turned to bond issuance and this was actually brought to my intention by a colleague here, but there is this bond issuance to folks in Europe because there's probably no hope of issuing bonds in the south. Things were deteriorating pretty fast. And what what's fascinating is although most of the financing did come from through seigniorage, and you have a chart and your paper that shows is there was a nontrivial amount of financing coming through bonds in 1863 and 1864 which is pretty late into the war. 

Bryan Cutsinger: Correct. 

David Beckworth: And the Europeans, they jump on these bonds and they're called the Erlanger Cotton Loans. And these bonds were backed by cotton as well as my understanding. And they went to Europe. They sold, it did pretty well. And interestingly enough, people continue to hold on to them for some time after the war. Is that right? 

Bryan Cutsinger: That's correct. My understanding is that they actually continued to trade in European financial markets for at least 10, maybe even up to 20 years after the war. And in fact, for the students of history or students of the Constitution, part of the Fourteenth Amendment says something to the effect that the sovereignty of the United States debt will not be questioned. And I forget the exact verbiage, but Civil War scholars actually point to why that was included there is that basically it's a signal to Europe that don't think that if anybody tries this again, that we the United States government are going to assume the debt of the states engaged in rebellion. 

Bryan Cutsinger: So if you want to loan them money, that's fine, but don't come asking us for a payback because there was some expectation, I think among European investors that they might be able to get something back from the United States government following the end of the war. 

David Beckworth: Yeah. So the Fourteenth Amendment was almost a signal. Part of it was a signal for the Europeans as much as it was for the people in the US. And I've also heard that the election of Grover Cleveland in 1885 and is also an important signal. He said, "No, I'm not going to give you any money." And it was trading a few cents and the dollars in Europe until that time. And what's interesting, they had stockpiled that I found an article, news article from 1987 an AP article and the title is, "US Civil War Bonds Found in London Vault.” I want to read just a few paragraphs here. It says, “More than 75,000 bonds issued by the Confederate States of America to raise money during the Civil War had been founded in a London Vault where they had been placed in storage in 1920. It was announced Saturday.” And this is 1987. “The bonds, which had a total face value of some 60 million when they were issued between 1861 and 1964 will be sold in one lot in London at an auction house.” 

David Beckworth: It then says, “When the Civil War ended in 1965, bondholders tried to obtain repayment from United States authorities. This word was assembled in the 1880s in a vain attempt to coordinate and rationalize European claims.” So these Europeans, they bought the bonds in 1863 they held on to them. As you mentioned, they continue to hold off from the 1880s but it didn't last. So anyways, let's go back to the grey bills, which is really the point of your discussion. So what you said so far is the expectation of the outcome of the war weighed heavily on the value in addition to the quality. So quality wasn't unimportant, but clearly the fiscal backing was also very important. So you had multiple things driving the value. And one of the things driving the value, which is really the center of your paper, is the currency reforms. 

Bryan Cutsinger: That's correct. 

David Beckworth: So tell us about that. 

Bryan Cutsinger: Sure. So the south, as I mentioned, the beginning, the south adopted three currents reforms over the course of the war. The first happens pretty early in October 1862 so secretary Memminger, he was the Treasury secretary, he goes to Congress. He was working with kind of a crude quantity theory of money in the back of his mind and says something like the following, I think that the southern economy is capable of supporting '$150 million' worth of currency in circulation. And I think at the time they were like a 300 or 450, so he viewed the total circulating media of being about double of what he felt the economy could support. He never makes it clear, I think by that he meant without generating serious amounts of inflation or something like that. But basically what happened, so he goes to Congress, Congress says, fine. 

Bryan Cutsinger: And what they do is they do something on the following. They say notes issued prior to December 1862 they can be exchanged for 8 percent bonds up until April 1863 after that point, those notes can only be exchanged for 7 percentbonds. So this isn't a sense actually kind of like a partial default because there was always this underlying promise that you could exchange and what they're now coming along and saying, it's like, "No, that's actually not gonna be true. If you wait until after April, you're not gonna be able to exchange." Now Memminger essentially defended this breach of contract using, again a quantity theory argument. Of course, he doesn't put it in this way, but he basically says, look, there's going to be a real balance effect. And that once the full effect of the reform is in place, you will be no worse off in real terms once we get inflation under control. But that's not what happens. 

David Beckworth: Just to be clear- 

Bryan Cutsinger: I'm sorry. 

David Beckworth: ... Let me step back. So he's saying what he's saying is some of these bills will be collected, which will therefore increase the value of the remaining bills. So you won't actually experience any kind of loss, that's his argument. 

Bryan Cutsinger: That's his argument. 

David Beckworth: Well that's a tough argument that making the Civil War, but go ahead. 

Bryan Cutsinger: Yes. So that's the argument. So one of the things they do though that's kind of odd is that if you're going to do something like this, well you should probably do, is surprise people. You probably shouldn't announce it. Well, they announced it. They gave them a bunch of time to make the adjustment. And so what people did is and some of them exchanged them for bonds, but a lot of, a lot of people did is they just went out and bought durable goods with their money before it lost value in April 1863. So they actually increased velocity making inflation even worse, at least temporarily. Now, inflation again, temporarily abated once the first reform went into effect after April, 1863. But of course it kicked right back in because the south hadn't addressed the underlying structural causes of why it needed to rely on seigniorage, which is that it lacked the fiscal. Its revenue requirements were so out of whack with its fiscal capacity that it had no choice but to continue printing notes. 

Bryan Cutsinger: So before the first reform even goes into effect, Memminger goes back to Congress in January of 1863 and he says, look, we need another one. Like things are getting out there. They're already out of control. The first one hasn't gone into effect yet. We need another one. So Congress again agrees and this one does the following and I apologize to listener, try to keep with me. These things can get a little mundane in the details, but basically what happens it says notes printed prior to December 1862 could be exchanged for 8 percent bonds until April, 1863, like before, 7 percent bonds until August 1863 and after which point they could no longer be exchanged for bonds period. They would still be tax receivable and the little contract printed on the note saying, you could get gold for this after the war ends. That still holds, but no more getting to switch this over into bonds, now notes printed between December 1862 and April 1863, those could be exchanged for 7 percent bonds until August 1863, but then only 4 percent bonds thereafter. 

Bryan Cutsinger: So what they're doing is they're trying to tax the notes in such a way that induces people to shift over into bonds rather than holding money to try to fight inflation. That's essentially what they're doing, but they're doing it in a form that basically is like a partial default because they're not honoring what they originally said that they would do. 

David Beckworth: So it's partly a debt repudiation, defaulting on a contract at the same time trying to get people out of high powered money into less liquid long-term debt instruments. 

Bryan Cutsinger: That's exactly right. That's exactly right. So of course these don't have the desired effects. In fact, the second currency reform, if you go look at the growth rate of base money over this time period, it actually increased. So the second currency reform really can't be said to have had any effect and in fact, econometrically it didn't, we don't see any reduction in inflation. So the second currency reform didn't really have any effect. So we get to February 1864, and Memminger, I think, well, let me take a step back. December 1863, January 1864, Memminger once again goes to Congress at this point, prices in the Confederacy are 2000 percent above their prewar level. And he's saying the currency has to be reduced. We have to do something about it. Now there's a variety of proposals that get offered by the Confederate congress. All of them are a form of debt repudiation in various forms. 

Bryan Cutsinger: And in fact the financial historian, his name is Douglas Ball. He has a book called Financial Failure and Confederate Defeat, excuse me. And he estimates that the average proposal, so he looked at all the different proposals that were offered. The average proposal would have had the note holders in the south taking a 10 to one haircut. So every one for every $10 they had lent the government, they were really only going to get $1 back following these reforms. So again, these things are kind of, there's a lot of minutia in the details, but basically what happens in the final and most significant currency reform, $5 notes, they're still going to be tax receivable and fundable at par for 4 percent bonds until July of 1864 after which point they're only fundable at two thirds, their face value. So it's like a 33 percent tax. 

Bryan Cutsinger: Until January 1865 at which point they're gonna be taxed at 100 percent. Notes between five and $10 were treated similarly. And then $100 notes could be exchanged for par until April 1864 after which point they were no longer tax receivable and subject to an immediate 33 percent tax as well as a 10 percent tax per month until they were exchanged for bonds. So cut the currencies stock by a third, and you can see that in the graphs in the paper when that reform went into effect. It was so significant, in fact that it actually brought on a temporary deflation. This is what Milton Friedman kind of hangs his hat on when he's talking about his student learners work. When he says, "Look, the quantity theory predicted that if you drastically reduce the growth rate of base money, you're going to get a reduction in inflation." And sure enough, that's what we find. 

David Beckworth: Okay. So the reason this is interesting and the reason this is tied to the title of your paper, “Seigniorage” that the Confederate congress actually attempted to reduce the production and the amount of money in circulation. And there's a number of historians, Civil War historians, who've argued the south actually could have gotten more revenue, could have extracted more real resources had they not pursued these three currency reforms. Is that right? 

Bryan Cutsinger: That's correct. So there is Christopher Schwab writing in 1901. So he was one of the first early Civil War historians essentially argued that these currency reforms wrecked the government finances beyond any repair. More recently Godfrey who was his dissertation, was on estimating. We use his estimates of the money supply. He was at the University of Georgia and this was his dissertation that we use this data. He made the same claim when he investigated this. He didn't do any econometric investigations, but he just kind of from looking at it qualitatively, he said, "Look, they kind of shot themselves in the foot here. Why would you do this?" Yeah. And some perfect world maybe you would rely on less distortionary means of government finance. But that's not the world that they lived in. And for some reason, they chose to abandon their most effective means of government finance in the thick of the war. 

David Beckworth: And so they did not maximize their seigniorage revenue. And of course, be clear. We're maybe grateful for that, that judgment they made. But from a purely public finance perspective, there must've been a reason why and your article it tends to answer why did they shoot themselves in the foot by putting themselves on the wrong side of that inflation tax Laffer Curve. So what is your answer? 

Bryan Cutsinger: Okay. So quickly to summarize, so what my coauthor and I do is we use the currency reforms as events studies to see how the flow of seigniorage had responded because a Laffer Curve has a very clear implications about how tax revenue should respond to changes in the tax rate. Our findings be very clear. They just suggest no formal causality here, but they do suggest that they were on the left side of the Laffer Curve. So the current reforms did limit the amount of resources they could raise. Now why would they do something like that? Well, I think it's important to keep in mind when we talk about 'seigniorage maximization', we don't actually know what the objectives of the Confederate legislators were. Right? So we don't know that they in fact wanted to do something like that. So our answer is the following that if you go look at maps of the Civil War and incursion by the Union into the south, what you see is that as the war progressed, of course the Union’s advancing more and more into the south. 

Bryan Cutsinger: And what's happening as that's happening is the north had a policy of pushing greybacks out of circulation in the areas that the occupied, in fact greenbacks started circulating in the Union occupied areas of the Confederacy. Well, what's happening then is that the primary holders of greybacks live in the interior of the Confederacy. So essentially the Atlantic coast states in Alabama. Whereas everybody who is living on kind of the periphery of the Confederacy, greybacks are no longer part of their asset portfolios. So you can think of these currency reforms as essentially a reduction in the future tax liability. Remember, because the notes themselves are a promise to pay gold after the war is over. And so that means that the government, conditional on them winning, the government is going to have to use tax revenue or something to buy gold from gold markets to then honor these promises to pay. So if you reduce the rate at which you're printing these notes, it's a reduction in the populace’s future tax liability. Now, the issue is that not everybody would have benefited equally from this reduction in the future tax liability. 

Bryan Cutsinger: The people who live on the periphery of the Confederacy who no longer had greybacks in their asset portfolio, so to speak, wouldn't bear the brunt of this debt repudiation. On the other hand, those people who were concentrated in the interior of the Confederacy would bear it full force. And so what we argue, we look at the roll call votings for the final currency reform, and we have a number of control variables about the various characteristics of the legislators, including political party views on succession, prominence of slavery in their district, so on and so forth. We find that the overwhelming factor that influences whether or not a member of the Confederate House of Representatives voted for the final currency reform was whether or not they occupy or excuse me, represented an area occupied by the Union. So the argument there is a kind of a public choice type one, which is that look, the legislators were voting their district, the legislators that were representing the areas no longer under Confederate control. 

Bryan Cutsinger: Were basically saying, "I'm voting for a tax cut for my constituents." The problem is that it came at the expense of the constituents in the Confederacy's interior. But as the Union advanced and kind of shifted the interest groups that were making up the Confederate legislature, it started to make sense of why this would work. Now the challenge is, is that we only have evidence on the final currency reform because the first two votes were taken in secret. So we actually don't know who voted for the first two currency reforms. Now, so as we mentioned in the paper, we're not trying to overstate our claim here. There's probably a lot of things going on, but our results do seem to suggest that that legislators were heavily influenced by whether or not they represented an area that was no longer under Confederate control. And our argument is that it really, it was basically about voting for tax cuts and who's going to benefit from the tax cut. 

David Beckworth: Let's go back and flesh this out a little bit to make sure we're clear about the links here. So if I'm on the periphery of the Confederacy, so I've been overtaken by the northern forces. Greybacks no longer are consequential. I don't use them anymore. What you're saying is I won't benefit or I won't bear the cost of the tax future tax bills, is that right? 

Bryan Cutsinger: Well, so conditional on the south winning, you would benefit, right? Because- 

David Beckworth: Oh, you would benefit. 

Bryan Cutsinger: You would benefit in that sense because you are not going to have to pay taxes to buy gold to honor the promise. 

David Beckworth: Because you're in captured territory. 

Bryan Cutsinger: Well, no. So, let's say the south won the war. 

David Beckworth: Okay. 

Bryan Cutsinger: Right. If the south had won the war, I the south had won the war and they wanted to honor the contract on their notes, what they would have had to have done is buy gold and they're going to have to do that presumably by raising taxes. 

David Beckworth: Right, right, right. 

Bryan Cutsinger: So if I reduce the rate at which I'm printing money, I reduce the amount of gold I'm going to need to buy to honor the contract in the future. So everybody, no matter where they would live, conditional on the south winning would benefit from the reducing the growth rate. Yes. So kind of a Ricardian equivalence type point, right? The issue though is that if you live on the periphery of the Confederacy, your asset portfolio no longer contained greybacks, right? The Union had that policy of pushing them out. And oftentimes what people would do too is they'd load them up into chess and they would ship say you knew somebody that lived in Alabama, right? Or you got an uncle in the Alabama, you send them the greybacks but the problem is, is that if you lived in the interior of the Confederacy, a substantial amount of your asset portfolio consisted of greybacks. And since this was a partial debt repudiation where you're only getting $1 for every 10 you lent the government, you're clearly not going to be super stoked about this tax cut. Right? 

Bryan Cutsinger: And so what happened is, is that as the Union advanced enough such that the various interest groups in the legislature shifted in favor of those no longer under Union occupation, it became essentially the dominant strategy from the legislator's perspective to vote for the currency reforms. Now and of course I'm thankful that this happened. But it's an interesting point which is to say that a lot of this literature on 'seigniorage maximization' sort of takes for granted that we know who the decision maker is around public finance. But in reality, of course, and at least in a democracy, those decisions are emergent from hundreds of people interacting with one another. And so it's important to go look at what are the factors I think that influence governments’ decisions around different modes of public finance. 

David Beckworth: And this is a great point, because as my colleague Steph Miller has shown in some work he's doing in the case of Venezuela which is the current poster child for hyperinflation that their government is actually on the wrong side of that inflation Laffer Curve. They're actually growing the monetary base too quickly. The government is actually losing real resources, losing revenue. And this is a political process now, we don't know all the dynamics but your point is there's leadership, there's dynamics. Maduro is probably threatened from many sides. President Maduro is not sitting down there looking at his Laffer curve pieces and thinking, "Oh, where should I be?" Your point is well taken. Where you end up is a lot more complicated than some social plan or optimizing a math problem on a computer. 

Bryan Cutsinger: Exactly. And so, but that doesn't mean that the model is not important. Right? Because what the model allows us to do is to say, well, let's assume that Maduro was seigniorage maximizer, well clearly he's failing at that. Now, the more interesting question is why? Now I think you're probably familiar with this article Thomas Sargent’s article on the end of four big hyperinflations. So his argument is that what drives these sorts of being on the 'wrong side' of the seigniorage Laffer Curve is when you have budget deficits that exceed the amount of money that the government can raise via taxes and bonds. 

Bryan Cutsinger: But the problem with seigniorage, if you think about the government's budget constraint in real terms, right? It's like drinking saltwater. The more you drink of it, the more you need to do it because it actually undermines the real resources you collect from taxes and bonds, right? So think about collecting income taxes and hyperinflation. The real resources the government's collecting from income taxes is actually lower than what they would be if there wasn't as much hyperinflation. So Mankiw has his great paper on optimizing seigniorage. And so that's kind of a slightly different model where the government's trying to balance at the margin the dead weight losses from the various forms of government finance. 

Bryan Cutsinger: That has mixed empirical support. But like the Kagan Bailey model, it's a great way to kind of frame the way we analyze applied cases and then maybe dig in to see, okay they're not doing it. Why? And I think there can be some interesting questions there. 

David Beckworth: To make sure I understand what you just said. Let me repeat in another way, when you run hyperinflation, it's not just a static exercise, there's dynamics involved. In other words, it's one thing to say let's maximize seigniorage revenue. But what might be happening is even at that initial maximizing point, it could have side effects on the real economy. It destroys the productive capacity of the economy. So there becomes a place where maybe the original seigniorage maximizing point may not exist anymore because you've destroyed the productive base of the economy like Venezuela. 

Bryan Cutsinger: Exactly, exactly. 

David Beckworth: So it's not clear, even if you knew initially where to be, it's going to be a kind of a moving target over time because you're destroying what the country can produce. 

Bryan Cutsinger: Exactly. And I think there's a reason that for example, Kagan, so Kagan's great insight think was that that when he picked the samples of countries that he looked at, he basically said, look, we have every reason to think that real income in those countries was more or less stable. This would be, in fact, if I was going to critique my own paper, this would be the biggest critique I would have if it, which is that it seems unreasonable to assume that real income was more or less stable in the Confederacy during the war. But Kagan's insight is that during periods of significant hyperinflation, that the primary determinant of people's demand for money is the rate at which that stock depreciates the inflation rate. So it's not so much that the real income is changing. 

Bryan Cutsinger: It's the size of the inflation relative to the size of the change in real income. And I think when we look at countries, I mean the Confederacy is obviously a great example. It's essentially a failed state. Venezuela is another example. They are essentially a failed state that you have a whole host of structural problems that are going on there as well, which are just going to exasperate the hyperinflation problem and in that sense, the model kind of breaks down, right? Because we don't really know where the long run demand for money is, is it stable? Things like that. 

David Beckworth: So the dynamic issue comes in. 

Bryan Cutsinger: Exactly. 

David Beckworth: Can't do static analysis. 

Bryan Cutsinger: Exactly. 

David Beckworth: Okay. With that, our time is up. Our guest has been Bryan Cutsinger. Bryan, thank you so much for coming on the show. 

Bryan Cutsinger: Thank you so much for having me. Really appreciate it. 

David Beckworth: Macro Musings is produced by the Mercatus Center at George Mason University. If you haven't already, please subscribe via iTunes or your favorite podcast app and while you're there, please consider rating us and leaving a review. This helps other thoughtful people like you find the podcast. Thanks for listening. 

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