Inflation and the Demand for Money: The Confederacy in the Civil War

When the Civil War broke out in 1861, the Confederacy, like any government in any situation, had three sources of money: taxing, borrowing, or printing.

Taxing

The Confederacy struggled throughout to extract taxes from its citizens. “Congress enacted a tiny tariff in 1861,” historian James M. McPherson writes, “but it brought in only $3.5 million during the entire war,” partly a result of the federal blockade. “In August 1861,” he continues:

…a direct tax of one-half of one percent on real and personal property became law. The Richmond government relied on states to collect this levy. Only South Carolina actually did so; Texas confiscated northern-owned property to pay its assessment; all the other states paid their quotas not by collecting the tax, but by borrowing the money or printing it in the form of state notes!

In April 1863, more comprehensive fiscal measures were enacted, including a progressive income tax, an 8% levy on certain goods held for sale, excise, and license duties, and a 10% profits tax on wholesalers intended to punish “speculators.” But the Confederacy needed real resources, not depreciating paper, so a 10% “tax in kind” was imposed on agricultural produce, alienating large swathes of the population. Many willing to die for the Confederacy, few were willing to pay for it.

Borrowing

The Confederacy’s ability to borrow tracked its prospects of victory. “The first bond issue of $15 million was quickly subscribed,” McPherson writes:

Subsequent action by Congress in May and August of 1861 authorized the issuance of $100 million in bonds at 8 percent interest. But these sold slowly. Even those southerners with spare cash to invest had to dip deeply into their reserves of patriotism to buy bonds at 8 percent when the rate of inflation had already reached 12 percent a month by the end of 1861.

Besides, both taxation and borrowing sought to extract cash from a relatively cash poor society. Most of the Confederacy’s capital was tied up in the non-liquid form of land and slaves. “While the Confederate states possessed 30 percent of the national wealth (in the form of real and personal property),” McPherson writes, “they had only 12 percent of the circulating currency and 21 percent of the banking assets.”

Printing

Thus, despite Treasury Secretary Christopher Memminger warning that printing it was “the most dangerous of all methods of raising money,” the Confederacy had little choice. Congress authorized the issuance of $20 million in treasury notes in May 1861, $100 million in August, $50 million in December, and a further $50 million in April 1862. “During the first year if its existence,” McPherson writes:

…the Confederate government obtained three-quarters of its revenues from the printing press, nearly a quarter from bonds (purchased in part with these same treasury notes), and less than 2 percent from taxes. Although the proportion of loans and taxes increased slightly in later years, the Confederacy financed itself primarily with a billion and half paper dollars…

Memminger warned that “The large quantity of money in circulation today must produce depreciation and financial disaster” and it did. “At first the currency depreciated slowly, because Confederate victories in the summer of 1861 bolstered confidence,” McPherson writes. Economist Eugene M. Lerner noted that, in June 1862, the real value of the money stock was 2% higher than in January 1861 as the money stock had increased faster than commodity prices. After that, prices rose more rapidly than the money stock and its real value fell: by January 1864, it was 58% lower than in January 1861 and was around 80% below it at the start of 1865.

As military setbacks dimmed Confederate fortunes, holders of Confederate notes began to doubt the promise to redeem them in specie at face value within two years of the war’s end and started offloading them as quickly as possible. “She asked me 20 dollars for five dozen eggs and then said she would take it in ‘Confederate,’” the diarist Mary Chestnut wrote in 1864: “When they ask for Confederate money, I never stop to chafer. I give them 20 or 50 dollar cheerfully for anything.”

In terms of the equation of exchange, the demand to hold Confederate money balances collapsed and velocity (V) surged, augmenting the inflationary pressures of the increases in the money supply (M) and fall in production (y) as war ravaged the Confederacy. Milton Friedman famously argued that:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.

This leaves out the role of the demand for money. Elsewhere, Friedman summarized inflation (P) as too much money (M) chasing (V) too few goods (y). This better fits the story of the Confederate hyperinflation.

Readers may also be interested in this poetry collection on the Civil War.