24. Comment on “A Tale of Two Dollars: Currency and Competition and the Return to Gold, 1865 – 1879” by Robert L. Greenfield and Hugh Rockoff

CHAPTER 24

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Comment on A Tale of Two Dollars: Currency Competition and the Return to Gold, 1865–1879

By Robert L. Greenfield and Hugh Rockoff

The stated purpose of the paper by Robert L. Greenfield and Hugh Rockoff¹ is to attempt to derive a lesson for public policy from a less-than-dramatic monetary experiment which was initiated in the United States in 1870. This experiment concerns the attempt by the U.S. Congress to establish national gold banks throughout the country in order to assist in the resumption of the gold standard after the Civil War. In contrast to an ordinary national bank, which could satisfy the 25-percent reserve requirement by holding fiat-currency greenbacks the notes they issued, a national gold bank was required to hold its reserves exclusively in gold (or silver) coin.

While I believe that Greenfield and Rockoff have identified a potentially fruitful experiment, I have questions about their interpretation of the factual background of the experiment and the conclusions they draw from it. Most significantly, I question their main thesis that the national gold banks authorized by the amendment to the National Currency Act of July 12, 1870 represented an attempt by the U.S. government to “launch an alternative monetary unit.” Despite my reservation on this crucial point, however, I do consider the period during which the experiment occurred to hold valuable lessons concerning the possibilities and the institutional preconditions of currency competition.

Before we are able to determine whether national gold bank notes or “yellowbacks,” as they were called, can be classified as an independent alternative to existing monies in the United States, we must be clear about what those monies were. From the breakdown of bimetallism in 1853 until the U.S. Treasury and state bank suspensions of specie payment on December 30, 1861, the gold dollar, legally defined as 23.22 grains of pure gold, effectively served as the uniform medium of exchange for the entire United States.²

In the states east of the Rocky Mountains, these dollars circulated in the form of gold coins as well as of state bank notes and deposits redeemable in gold coin upon demand. In the Pacific states, the medium of exchange was embodied almost exclusively in gold coin. In California and Oregon, for example, banks of issue were expressly prohibited by the state constitutions and there were only a few banks of deposit. Also in circulation were the U.S. Treasury notes redeemable in gold and fractional silver coins.³

After the first Legal Tender Act of February 25, 1862, United States notes or “greenbacks” swiftly became the “domestic currency,” that is, the medium of exchange used in everyday transactions, of the Eastern states. Although gold coins disappeared from circulation as a result of the operation of Gresham’s Law, gold continued as a parallel currency in the East, because of its use in foreign trade. In fact, in order to accommodate foreign exchange dealers, New York national banks among others offered demand deposits denominated and payable in gold dollars as an alternative to greenback-denominated deposits.⁴ In addition, the federal government continued to pay interest on a large portion of its debts in gold and to require import duties to be paid in gold.⁵ There is evidence that uncoined gold was used as the medium of exchange in large domestic transactions.⁶

The extensive employment of the gold dollar as an alternative currency in the East naturally led to its use alongside the greenback dollar as a unit of pricing and of economic calculation. Thus Benjamin M. Anderson⁷ concluded that, during the greenback era, “People thought in both standards.” Circumstances differed considerably west of the Rockies during this era. By all accounts residents of the Pacific states made little or no use of greenbacks in exchanges or in cash balances.⁸ Merchants refused to accept the greenback dollar at par in current transactions and deposit banks in California and Oregon refused to accept greenback deposits under any circumstances. Instead, people clung tenaciously to the gold dollar as their domestic currency. Thus gold continued to be used for everyday purchases of consumer goods and wage payments, and as the stipulated means of repayment in credit transactions.

There was, however, a foreign-exchange demand for greenbacks on the part of those importing goods from the East. Technically, therefore, a regime of parallel currencies also existed in the Pacific states, with greenback dollars exchanging for gold dollars at a marketdetermined exchange rate. It is doubtful, however, that, outside of a narrow circle of currency speculators, money brokers, and those directly involved in trade with the Eastern states, economic calculation took place in terms of both dollars to the same extent as it did in the East.

My account of the facts is substantially in agreement with the account given by Greenfield and Rockoff. However, Greenfield and Rockoff draw an important inference from these facts which appears to me to be questionable although it is the main prop upon which much of their argument rests. The questionable inference is embodied in the authors’ statement, “No particular medium of exchange defined California’s unit of account. Instead, the standard weight of gold served as a kind of independently-defined unit of account.”⁹ This is a startling conclusion given the facts as the authors present them, because they clearly recognize that, in the Pacific states, the gold dollar was not only the standard pricing unit, but, in the form of gold coin, was physically present in almost every domestic exchange. Indeed, there was an estimated $25 million of gold and silver coin in circulation on the Pacific Coast during the greenback era.¹⁰ Moreover, there was no bank note circulation and, with very few banks of deposit, presumably little use of checks.

Of course, the authors do not intend to deny that gold coin was used almost exclusively as the medium of exchange in California. Their point is that no particular brand of gold dollar had achieved dominance in circulation in California, where the issuance of exchange media denominated in the gold dollar was undertaken by a number of competing institutions, including private mints. Moreover, none of these institutions was responsible for originating the standard weight of gold as the unit of account. This contrasted with the situation in the East, where the greenback dollar, which was solely the creation of the U.S. Treasury, dominated as medium of exchange and defined the accounting unit. From these facts the authors’ conclude that, in California, media of exchange were denominated in, but did not define, the gold dollar, which therefore existed as an “independently-defined unit of account.”

While plausible, Greenfield and Rockoff’s argument is based on an apparent confusion, which could have been avoided had they addressed the issue of the evolution of the gold and greenback dollars. Contrary to what the authors seem to imply, a thing does not attain the position of a general medium of exchange by virtue of its brand name but by virtue of its qualities as a specific commodity.

Without going into great depth, the theory of the evolution of money as formulated by Carl Menger¹¹ and later refined by Ludwig von Mises¹² and Murray Rothbard¹³ tells us that the general medium of exchange originated on the market as the most saleable commodity in the pre-existing state of barter. Money thus initially circulated as a generic and unbranded commodity. The unit of account then naturally emerged as a standard weight unit of the money commodity that is most convenient for calculation, for example, pound, ounce, or gram. It is only later with the advent of coinage that the money commodity was branded to certify weight and purity and to distinguish between different issuers. It was only then that coins of particular weights came to be designated by distinctive names.

But regardless of the emergence of special currency names and the proliferation or dominance of specific currency brands, the generic money commodity itself retained the position of the general medium of exchange, and the unit of account continued to be rigidly defined as a weight of this commodity. Thus, contrary to Greenfield and Rockoff, the medium of exchange and unit of account in California were inextricably linked together and embodied in gold. In its various shapes and forms gold functioned as the “dominant” medium of exchange and the unit of account “defined” as a “dollar,” which was another name for the standard weight of gold.

This analysis also sheds light on the evolution of the greenback dollar. Whether it was a credit money, for which the public from the first entertained reasonable expectations of an eventual resumption of specie redeemability, or whether it was a pure fiat currency, for which such expectations were entirely absent, the greenback dollar could only emerge as a general medium of exchange and accounting unit by virtue of its previous link with gold. Indeed the forerunners of the irredeemable greenbacks were U.S. Treasury notes redeemable on demand in specie, whose issue was authorized by the act of July 17, 1861 and even “… these notes were acceptable with reluctance” by banks and the public.¹⁴ It was only after state banks had suspended specie payments on December 31, 1861, in effect forcibly shaking gold loose from its dominant position as a medium of exchange, that the Treasury suspended specie payments and the greenback dollar came into being as an independent entity. The passage of the first Legal Tender Act on February 26, 1862, which authorized a fresh issue of the irredeemable notes, cemented the greenback’s standing as the dominant medium of exchange east of the Rockies.

The point is that the greenback dollar never could have attained its standing by political fiat alone, independently of a pre-existing relationship with market-chosen commodity money. The greenback dollar did not emerge ex nihilo as a pure brand name.

Moreover, it is clear that, as a medium of exchange, the generic gold dollar was more dominant on the Pacific Coast than the greenback dollar was in the rest of the Union. The gold dollar was well entrenched as a medium of exchange and unit of account in the East, since it did function as an intermediary in some types of domestic exchanges and was held in business cash balances and as part of the monetary reserves of banks. In contrast, greenbacks in California played almost no role in domestic exchanges and were not held in cash balances by the public. As Greenfield and Rockoff¹⁵ themselves point out, even Californians who were bullish on the prospects for resumption and inclined to speculate on the long-term appreciation of the greenback did not need to hold greenbacks, since speculative gains could have been secured by acquiring and holding any interest-bearing greenback-denominated asset.

Once we recognize that the generic gold dollar was a medium-of-exchange as well as a unit-of-account dollar in California and in the East, we are able to evaluate Greenfield and Rockoff’s main thesis: that the bank notes issued by the national gold banks constituted a new and independent currency.

The national gold bank notes were redeemable upon demand in gold coin and the issuing institution was required to maintain a reserve of gold and silver coin equal to twenty-five percent of the notes in circulation.¹⁶ In drafting this legislation, the government intended that the gold notes would displace the full-bodied gold coin circulation of the Pacific Coast and perhaps also would be used in foreign-exchange transactions in the East in place of Treasury gold certificates and gold deposits of New York banks, both of which were effectively if not legally backed by one hundred percent gold reserves.¹⁷ It was thus the hope of the government that the fractionalreserve yellowbacks would help to facilitate resumption of the gold standard by economizing on the gold in circulation and in the monetary reserves of financial institutions, thereby reducing the premium on gold and permitting the Treasury to lay in the needed stock of gold at a lower cost. However, this hope was never realized, because only ten national gold banks were organized, one in Boston, which never issued any gold notes, and nine in California.¹⁸

Greenfield and Rockoff’s attempt to square the absence of gold note circulation in the East with its development, albeit limited, in California rests on their thesis that the national gold bank note was an independent and self-subsisting medium of exchange. Thus they argue that, in California, which lacked a “dominant” medium of exchange, the gold note was able to easily “hitch onto” the independently-defined unit of account, that is, the standard weight of gold. Conversely, they attribute the failure of gold notes to gain currency in the East to the fact that there the greenback already dominated as the medium of exchange. Somewhat inconsistently, the authors attribute the inability of the greenback to catch on in the West and of the gold note to catch on in the East to the fact that each “lacked a connection to the established unit of account,” rather than to the lack of a connection to the dominant medium of exchange.¹⁹

In any case, Greenfield and Rockoff conclude that the general lesson to be learned from the national gold bank episode is that for an item to gain acceptance as a medium of exchange, it must be denominated in units of the dominant medium of exchange, where one exists. This implies that, from the standpoint of current U.S. monetary policy, the issue of an alternative medium of exchange denominated in something other than Federal Reserve notes would fail to gain currency among the American public.²⁰

The essential problem with Greenfield and Rockoff’s explanation of the varying fortunes of the gold note on the opposite sides of the Rocky Mountains is based on what I have just argued above is a misinterpretation of the facts. Once it is recognized that the generic gold dollar was both the medium of exchange and the unit of account in California during the greenback era, there ceases to be mystery about why the gold note achieved acceptability. The gold note was accepted in exchange and held in cash balances precisely because it was redeemable in gold coin, the general and exclusive medium of exchange The gold note therefore was not a newly issued medium of exchange. Given confidence in the issuing institution’s ability to maintain convertibility of the gold notes, market forces insured a rigidly uniform purchasing power for gold coins and gold notes of equal denominations. The gold notes therefore substituted to some extent for gold coin in people’s cash balances because they represented a more convenient way to hold and pay gold dollars.

Regarding the status of greenbacks in California, it is not quite correct to say, as the authors do, that they did not “catch on.” Despite the fact that they were not denominated in units of the dominant medium of exchange (or in the established unit of account), the greenback dollar did emerge as a parallel currency by virtue of the interlocal trade relations existing between California and the Eastern states. As Ludwig von Mises²¹ was the first to note, from the point of view of the theory of exchange-rate determination, there is no difference between two currencies used side by side in the same region and two currencies each of which is considered to be the domestic currency of one region and the foreign exchange of the other.

The same general analysis can be applied to explain the failure of the gold note to catch on in the East. The explanation does not lie, as Greenfield and Rockoff claim, in the fact that gold notes were not denominated in terms of the dominant greenback dollar—after all, Treasury gold certificates and gold deposits at national banks also had no link with the greenback dollar and yet each achieved circulation. Rather, it is probable that the absence of national gold bank notes in the East was due to the fact that, for certain transactions, these notes were considered less convenient than checks drawn on a national bank gold deposit and that, for transactions better served by goldbacked currency, Treasury gold certificates were preferred because they were perceived to have a lower default risk.

Despite this criticism, I believe that the policy lesson which Greenfield and Rockoff uphold is both true and important. Currency competition can only emerge out of an evolutionary market process and cannot be implemented in one fell swoop by legal fiat or by a private entrepreneurial scheme. Certainly, this is the lesson we learn from the extreme reluctance of the residents of the bankless Pacific states to accept the greenback as their domestic currency, while the greenback gained swift acceptance among the residents of the remaining (loyal) states whose attachment to the gold dollar had long been attenuated by their repeated subjection to depreciated and inconvertible state bank notes.

Bibliography

Anderson, Benjamin M., Jr. [1917] 1936. The Value of Money. NewYork: Richard R. Smith.

Dillistin, William H. 1950. “National Gold Banks and Bank Notes.” The Numismatist (March): pp. 133–39.

Friedman, Milton, and Anna Jacobson Schwartz. 1963. A Monetary History of the United States, 1867–1960. Princeton: Princeton University Press.

Greenfield, Robert L., and Hugh Rockoff. 1995. “A Tale of Two Dollars: Currency Competition and the Return to Gold, 1865–79.” In The George Edward Durell Foundation, Money and Banking: The American Experience. Fairfax, Va.: George Mason University Press. pp. 207–19.

Lester, Richard A. [1939] 1970. Monetary Experiments: Early American and Recent Scandinavian. Devon, Great Britain: David and Charles Reprints.

Menger, Carl. [1950] 1981. Principles of Economics. James Dingwall and Bert F. Hoselitz, trans. New York: New York University Press.

Mises, Ludwig von. [1952] 1971. The Theory of Money and Credit, 2nd ed. Irvington-on-Hudson, N.Y.: The Foundation of Economic Education, Inc.

Mitchell, Wesley Clair. 1903. A History of the Greenbacks: With Special Reference to the Economic Consequences of Their lssue 1862–65. Chicago: The University of Chicago Press.

Moses, Bernard. 1892. “Legal Tender Notes in California.” The Quarterly Journal of Economics 7 (October): pp. 1–25.

Paul, Ron, and Lewis Lehrman. 1982. The Case for Gold: A Minority Report of the U.S. Gold Commission. Washington, D.C.: Cato Institute.

Philpott, W.A., Jr. 1934. “National Gold Bank Notes.” The Numismatist (November): pp. 717–19.

Robbins, Lord. 1971. Money, Trade and International Relations. London: The Macmillan Press Ltd.

Rothbard, Murray N. 1974. What Has Govemment Done to Our Money? 2nd ed. Novato, Cal.: Libertarian Publishers.

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From: Comment on “A Tale of Two Dollars: Currency Competition and the Return to Gold, 1865–1879,” by R.L. Greenfield and Hugh Rockoff, in The George Edward Durell Foundation, ed., Money and Banking: The American Experience (Fairfax, Va.: George Mason University Press, 1995), pp. 221–28.

¹ Robert L. Greenfield and Hugh Rockoff, “A Tale of Two Dollars: Currency Competition and the Return to Gold, 1865–79,” in The George Edward Durell Foundation, Money and Banking: The American Experience (Fairfax, Va.: George Mason University Press, 1995), pp. 207–19.

² Ron Paul and Lewis Lehrman, The Case for Gold: A Minority Report of the U.S. Gold Commission (Washington, D.C.: Cato Institute, 1982), pp. 63–66.

³ Richard A. Lester, Monetary Experiments: Early American and Recent Scandinavian (Devon, Great Britain: David and Charles Reprints, 1970), p. 163; Wesley Clair Mitchell, A History of Greenbacks: With Special Reference to the Economic Consequences of Their Issue: 1862–65 (Chicago: University of Chicago Press, 1903), pp. 141–42.

⁴ Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton, N.J.: Princeton University Press, 1963), pp. 28–29 fn. 17; Mitchell, A History of Greenbacks, p. 142.

⁵ Mitchell, A History of Greenbacks, p. 142.

⁶ Benjamin M. Anderson, Jr., The Value of Money (New York: Richard R. Smith, [1917] 1936), pp. 148–49.

⁷ Ibid., p. 422.

⁸ Bernard Moses, “Legal Tender Notes in California,” The Quarterly Journal of Economics 7 (October 1892): pp. 1–25; Mitchell, A History of Greenbacks, p. 142; Lester, Monetary Experiments, pp. 164–65.

⁹ Greenfield and Rockoff, “A Tale of Two Dollars,” pp. 216–17.

¹⁰ Lester, Monetary Experiments, p. 162.

¹¹ Carl Menger, Principles of Economics, trans. Dames Dingwall and Bert F. Hoselitz (New York: New York University Press, [1950] 1981), pp. 257–85.

¹² Ludwig von Mises, The Theory of Money and Credit, 2nd ed. (Irvington-on-Hudson, N.Y.: The Foundation of Economic Education, Inc., [1952] 1971), pp. 30–37, 108–24.

¹³ Murray Rothbard, What Has Government Done to Our Money? 2nd ed. (Novato, Calif.: Libertarian Publishers, 1974).

¹⁴ Mitchell, A History of the Greenbacks, p. 26.

¹⁵ Greenfield and Rockoff, “A Tale of Two Dollars,” p. 15.

¹⁶ William H. Dillistin, “National Gold Banks and Bank Notes,” The Numismatist (March 1950): pp. 133–34.

¹⁷ Friedman and Schwartz, A Monetary History of the United States, p. 25 fn. 11, pp. 28–29 fn. 17.

¹⁸ W.A. Philpott, Jr., “National Gold Bank Notes,” The Numismatist (November 1934): pp. 717–18; Dillistin, “National Gold Banks,” pp. 134–35.

¹⁹ Greenfield and Rockoff, “A Tale of Two Dollars,” p. 16.

²⁰ Ibid., p. 17.

²¹ Mises, Theory of Money and Credit, pp. 179–80; Lord Robbins, Money, Trade and International Relations (London: Macmillan, 1971), p. 22.