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California Leads Nation with Sound Money — in 1865

Mises Daily: Tuesday, August 24, 2010 by

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In March of 1865, less than 30 days after his appointment as treasury secretary, Hugh McCulloch touched off a political firestorm. He said that it was the duty of California to conform her policy to the federal Legal Tender Act of 1862.[1]

The Legal Tender Act allowed the US Treasury to print paper money that was backed only by the good faith of the US government. The first printing of this fiat currency, in early 1862, yielded 25.5 million[2] pieces of currency. These became known as "greenbacks" due to the green ink used on the back of the bill. Of the 36 states, 35 recognized the greenbacks as money, equal with gold and silver; only California made a distinction.[3]

In the spring of 1863, California created a law that allowed any business contract to identify the kind of money or currency to be used in the fulfillment of the contract. If the contract required payment in gold, for example, then only a gold payment fulfilled the contract. In the other states, greenbacks could be a substitute for gold or silver payments.

By the time McCulloch was appointed treasury secretary, just 37 months after the Legal Tender Act, greenbacks were worth less than half of their original value.[4] California's hesitancy to use these demand notes as an equal exchange for gold was proving wise.

It wasn't that California didn't recognize greenbacks as money. The California law simply allowed a contract to name the form of money to be used. For example, if an 1864 contract required the payment of $1,000 in gold in 1865, a payment in greenbacks would not be the same value as a payment in gold. (The party delivering the paper money would be paying the debt at a deep discount.) So the California Supreme Court upheld that a contract stating "$1000 in gold" required the delivery of gold. The contract could have just as easily read "$1,000 in greenbacks" and thus required greenbacks. Few California contracts were being written for payment in fiat currency.[5]

McCulloch was in a difficult position. As an Indiana banker in 1857, his bank "paid coin for all its issues" at a time when "banks throughout the whole country suspended payments."[6] Before his appointment as treasury secretary, the London Daily News reported that McCulloch "declared himself against inconvertible paper money."[7] In an April 4, 1865, letter, McCulloch wrote, "A resumption to specie (gold or silver) payments is with me a 'cardinal point,' because I believe that the specie basis is the only safe and healthy one for business; and because I am clearly, of the opinion that the interests of capitalists and working men will be promoted by a return to it."[8]

So why did McCulloch declare that California had a duty to conform its policies to the federal Legal Tender Act? First and foremost, McCulloch was a Unionist. In his open letter about the California law, McCulloch wrote, "The legal tender acts were war measures; and California could not place herself, as she has done apparently, in opposition to these war measures, without indirectly assailing the national credit, and casting her influence in no small degree on the side of those, who, with bloody hands, were attempting the dismemberment of the Union."[9]

McCulloch also had an economic position:

Paper money has been found to be a necessity in all commercial countries, and especially in the United States; and what is true elsewhere must be true in California. … California needs a well-regulated credit system; she needs a paper circulation to quicken enterprise, and give impetus to business … she needs to be cured of the mania for an exclusive metallic currency; in a word, she needs, in addition to the recognition of United States notes as a currency, a sound banking system — such as provided for by the national currency act.[10]

Neither of these arguments were found compelling. The Saturday Evening Post wrote,

It is natural that the people of California should prefer the nobler currency, when it is so especially their own, and it is a matter of congratulation, it seems to us, that there is one corner of the Union in which gold and silver, now utter strangers and absolute curiosities to the people of all the other states should yet be used as a measure of value in the common transactions between man and man. If the people of California can keep such currency afloat … if they can employ it as conveniently as paper, there is no reason why they should not. Trade will regulate all this.[11]

A World article, dated April 10, 1865, points out that the federal government mandated specific gold or silver payments for the purchase of government cotton, for interest payments on a certain portion of the public debt, and for import taxes. The article declares, "If the government constrains the community, with one hand, to look upon gold as currency, for certain purposes, it certainly ought not, with the other, to brand as disloyal attempts on the part of the state to protect transactions made in silver and gold!"[12]

The Saturday Evening Post had this to say about McCulloch's economic argument:

Why should not California, asks Mr. McCulloch, be a commercial and manufacturing state? He seems to imply that it is because the state has a metallic currency. The true reason is that the people are engaged in other occupations which bring them larger returns. They are digging in the gold mines, searching for nuggets of the precious metal among the sands … planting orange and lemon groves, covering the hills with vineyards. … It is not paper credit they want, but people. … When California is filled up with inhabitants, and the gold mines begin to yield small returns, and the fields are all in tillage, the manufacturer may come in. Till then we will manufacture for California on this side of the Rocky Mountains.[13]

Hugh McCulloch seems to have been a humble man. In his personal financial scrapbook, where he cut out and pasted newspaper and journal articles, he gave the same prominence to his critics' articles as he did to his own. Perhaps these critics had an influence on the treasury secretary.

During his first term as secretary, McCulloch oversaw the consolidation of the majority of government debt into long-term gold bonds. Currency reforms were underway, calling in the interest-bearing legal tenders and reducing the circulation of greenbacks. Nearly half-a-billion greenbacks had been paid off by the end of his term.[14] Ultimately McCulloch was instrumental in the transition from fiat money to the gold standard, culminating in the Gold Standard Act of 1900.

Meanwhile, California continued to use their specified-contract law through the rest of the 1800s.

But somewhere in the 1900s, it seems they were, as McCulloch admonished them to be, "cured of the mania for an exclusive metallic currency."[15]

And today, California is the largest debtor state.

Notes

[1] Reprint of McCulloch correspondence dated March 28, 1865: reply to Thompson Campbell, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[2] "Lincoln's Greenback Mill: Civil War Financing and the Start of the Bureau of Engraving and Printing, 1861–1863," by Franklin Noll, Federal History.Download PDF

[3] "Letter of Thompson Campbell, Esq., to the Secretary of the Treasury," dated March 24, 1865, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection. Campbell writes, "The State of California is the only loyal State in the Union where the national currency is not used as a circulating medium. The supreme court of that State decided at an early day that legal tender notes were not receivable in payment of taxes, on the ground that a tax is not a debt, in the legal and technical sense of that term, as used in the legal-tender law."Download PDF

[4] "Letter of Thompson Campbell, Esq., to the Secretary of the Treasury," dated March 24, 1865, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection. Campbell writes, "One effect of this law (California's Specific Contract Act of 1863) … is that all Federal officers, and the army and navy, are forced to convert, at a great sacrifice, the currency in which they are paid, into gold, at the market rate of greenbacks, before it can be made available to them, sometimes reducing their pay more than one-half."Download PDF

[5] "Legal Tender Notes In California," by Bernard Moses, The Quarterly Journal of Economics, Vol. 7, No 1 (October 1892), page 4, 22–25.

[6] "The New Secretary of the Treasury," The Economist, March 1865, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[7] London Daily News, February 1865, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[8] "Interesting Correspondence, McCulloch's reply to Henry Carey," April 4, 1865, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[9] Reprint of McCulloch correspondence dated March 28, 1865: reply to Thompson Campbell, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[10] Reprint of McCulloch correspondence dated March 28, 1865: reply to Thompson Campbell, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[11] "Secretary McCulloch's California Letter," The Saturday Evening Post, April 5, 1965, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[12] World, April 10, 1865, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[13] "Secretary McCulloch's California Letter," The Saturday Evening Post, April 5, 1965, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF

[14] Hugh McCulloch and the Treasury Department, 1865–1869, by Herbert S. Schell, The Mississippi Valley Historical Review, Vol. 17, No. 3 (Dec., 1930), p. 421.

[15] Reprint of McCulloch correspondence dated March 28, 1865: reply to Thompson Campbell, Chronicle, from the McCulloch Financial Scrapbook, Lilly Library McCulloch Manuscript Collection.Download PDF