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The Civil War and the National Banking System – The Birth of National Bank Notes

By Kevin Foley for CoinWeek….


On the eve of the Civil War in 1861, the financial and banking system in the United States bore little resemblance to current institutions and practices. There was no central bank. The Federal Reserve System had yet to come into existence. Banking was largely a state regulated function. Money consisted of a myriad of private bank issues of paper money, as well as merchant scrip and, at the core of the monetary system, coins issued by the federal government whose value in commerce was predicated on and closely related to its inherent metallic value.

Unlike today, when the Federal Reserve System can increase or decrease the money supply in response to perceived economic needs through such mechanisms as changes to mandatory bank reserve requirements or changes in interest rate policies, there was little to no central management or intervention possible through techniques that while today subject to vigorous political debate, are nonetheless largely accepted practice in our political and economic system.

Wars are expensive.  The take money to wage successfully and require a marshaling of resources to defend the political system under armed attack. Weapons  and munitions need to be purchased in large quantities. Naval forces need to be augmented. Such seemingly mundane actions as clothing and feeding large numbers of men enlisted for the defense effort need to be attended to. All these activities and functions take a considerable amount of money

The monetary system in effect on the eve of the Civil War simply failed to provide the necessary elasticity in the money supply to accommodate these needs.

Indeed, with the system of banks chartered and/or supervised by state banking departments that applied immediately prior to the Civil War, one couldn’t even be certain that the privately issued bank notes in circulation would or even could be redeemed by the issuing institution as promised on its printed obligations.

One of the responses of the federal government to the financing needs of the Civil War was to undertake a radical transformation of the banking and money issuing system that had applied prior to the outbreak of the war. While the Confederacy resorted largely to printing paper currency that amounted to little more than fiat money to finance its operations – with the result being substantial price inflation in the states in rebellion during the war, the Union undertook a more measured approach.

On February 25, 1863, President Lincoln signed what was known as the National Currency Act. Under its provisions a system was established under which the federal government issued charters – essentially a grant of authority to operate under the newly established national bank system — to banks that agreed to meet certain capital and other regulatory requirements.  But just how does this relate to the needs of the government to finance its war operations? One of the central features of the National Currency Act was a provision under which federally charted banks participating in the system were able to purchase federal government bonds – as actually any individual or institution could – but the federally chartered banks could then issue their own money, what we call National Bank Notes, that constituted obligations of the federal government and would be redeemed by the government itself in the event of a bank failure. The security for this pledge was the value of the federal bonds purchased by the issuing bank, which was authorized to print National Bank Notes up to 90% of the value of the federal securities left on deposit with the  government as security to back the bank issues.

While the right to issue such notes was discretionary with the bank, rather than mandatory, a federal charter was quite literally a license to create wealth and money from nothing. At the same time, the issuing privilege had the effect of creating new money that hadn’t existed before, i.e. it made possible an increase in the money supply to finance war needs. Moreover,  it prevented a contraction of local money supplies that might have resulted from capital flowing to Washington to finance the war and being removed from availability for the needs of local area commerce and in addition enabled bankers to collect interest on the same money twice, providing a considerable incentive to actually issue National Bank Notes.

The system was quite simple. A federally chartered bank would purchase federal government bonds and leave them on deposit with the Treasury Department. This resulted in a temporary decrease in local area capital in the area of the bank and an increase in capital available for the federal government. Money that had yesterday been available to finance commercial needs in Omaha or Schenectady was now in Washington, D.C. The chartered bank, however, now collecting interest on the money it had sent to Washington, could immediately issue National Bank Notes up to 90% of the value of the bonds it had purchased and left on deposit, loan the money represented by those notes out in its local community and begin collecting interest on those loans. Where before the bank had $100,000 to loan out, it now had $190,000, the original value of the bonds it had purchased, plus the $90,000 in new money it was able to create virtually out of thin air, now collecting interest on its original money as well as its newly issued National Bank Notes.

As an adjunct to this system was a tax was placed on the  banknote issues by other institutions outside the system, effectively operating as a death blow to the continuation of such issues. While they were not actually prohibited, there no longer remained any economic sense in a bank issuing paper currency that it would then be required to pay a tax or fee to issue that did not apply to the issuance of National Bank Notes.

The federal government reaped a considerable benefit from this newly formed system insofar as it created a virtually guaranteed customer base to purchase the bonds it needed to sell in order to finance its war operations. Likewise, the chartered banks benefitted because they could collect interest twice on the same money. In the process, the money supply was almost doubled.

Under the system originally established by the 1863 Act, 14,348 charter numbers were issued to qualifying banks.  Although the system was statutorily modified from time to time, the essential element, i.e. a money issuing privilege granted to participating institutions related to the value of their underlying purchases of federal debt obligations remained largely unchanged. One significant modification was the Aldrich-Vreeland Act of May 30, 1908, which permitted banks to issue on the basis of other securities left on deposit in addition to federal government debt obligations. This modification was occasioned by needs to increase the money supply in response to the economic contraction attendant on the Panic of 1907. The “other securities” privilege expired in 1915.

In excess of 12,000 individual banks took advantage of the issuing privilege prior to the end of the National Bank Note era on August 1, 1935, when the last bonds authorized to support the issue of what are called “Nationals” by collectors, were called for redemption.

As with any collectable, some Nationals are quite abundant and worth little more than face value, while other issuer’s notes are extremely rare and when available command prices well into the five figure range. Largely collected on the basis on issuing institution, with condition a secondary consideration, Nationals also enjoy a base of those who acquire on the basis of major design type, with condition for such buyers typically being a more important factor in their acquisition decisions.

Having introduced you to the general field and why “Nationals” exist at all, our next feature will focus on the notes themselves and especially discuss the major design types.

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  1. Under the National Currency Act of 1863, what did the banks use for money to purchase the federal gov’t bonds, since they needed the bonds before they could issue money?


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