Phillip Patrick: The First Time the U.S. Defaulted on Its Debts

By Phillip Patrick for Birch Gold Group

I learned a lot during my webinar with Ron Paul last month, including one thing that really surprised me… I had no idea the U.S. had defaulted on its debts once before – had temporarily suspended the gold standard, and then returned to it.

After Dr. Paul mentioned this episode, I did a little research and I’ve got to tell you, it’s a fascinating story…

The first time the U.S. government defaulted on its debts

As Alex Pollock tells us, every time Treasury Secretary Yellen says, “The U.S. has always paid its bills on time,” or “The U.S. has never defaulted. Not once,” she’s wrong.

She’s ignoring the Demand Note, the first paper currency issued by the U.S. government back in August 1861. According to the Bureau of Engraving and Printing:

…Demand Notes were essentially government IOUs and were called Demand Notes because they were payable “on demand” in gold coin at certain Treasury facilities.Demand Notes were a part of an early plan to fund the Union’s efforts in the Civil War.  Around a month after the Union defeat at First Manassas or Bull Run (August 1861), Secretary of the Treasury Salmon P. Chase negotiated a loan from the big northeastern banks for $150 million in gold. The Demand Notes were issued as a stopgap measure until the first installment of $50 million arrived in the Treasury.

At first, individual notes were hand-signed by the Treasury Department’s Treasurer – but this wasn’t physically possible, because five million were to be issued in months. So an awful lot of them are signed by random Treasury Department employees “for the Treasurer.”

They don’t look terribly different from modern dollars:

U.S. demand note, twenty dollars, August 10, 1861

Public domain image. Note that the bill isn’t perfectly rectangular – sheets of demand notes were trimmed by hand, presumably by the same clerks who signed them…

These Demand Notes represent the actual money (gold) payable on demand to the bearer. Theoretically, you could take your $20 Demand Note down to the Philadelphia Treasury branch and exchange it for a $20 Liberty Head Double Eagle.

Interestingly, these Demand Notes were not legal tender! That means no one was legally obligated to accept them as payment – however, they were “receivable in payment for all public dues,” so you could pay your taxes with them.

Almost immediately, the government began paying federal employees and Union soldiers in Demand Notes rather than real money. And guess what? Nobody wanted them. No one had to accept them as payment (except federal employees and soldiers, who weren’t given a choice).

Demand Notes were printed as a temporary solution to help finance the Civil War. Let’s remember, when those eleven states seceded from the union, they stopped paying taxes. The government had a legitimate revenue crisis to solve.

Regardless, Demand Notes were a total failure. In response, the federal government made an even bigger mistake.

The invention of the greenback

Remember that “loan from the big northeastern banks for $150 million in gold” I mentioned earlier? In the wake of the SVB and First Republic and Credit Suisse collapses, it may not exactly surprise you that the banks didn’t have the money! 

Not in gold, at least. Dr. Ron Paul explains in his book The Case for Gold how quickly the situation unraveled. Below, he uses the word specie to describe “hard money,” or real gold and silver to explain why bank vaults were empty. This is from page 75:

…as an increased public demand for specie due to a well-deserved lack of confidence in the banks, brought about a general suspension of specie payments a few months later, at the end of December 1861. This suspension was followed swiftly by the Treasury itself, which suspended specie payments on its Treasury notes.

In times of crisis, people want real money. Even the government wanted gold rather than a paper promise!

But there wasn’t enough gold – so banks stopped letting people withdraw their real money. And the government followed suit.

That was the first U.S. debt default. The promise to exchange real money for paper was broken. The “demand” part of those Demand Notes lasted just four months.

The Demand Note project was a total failure. But the idea behind it, the idea of offering paper promises instead of real money as payment, that didn’t go away.

Dr. Paul continues:

In the Legal Tender Act of February 1862, Congress authorized the printing of $150 million in new “United States Notes” (soon to be known as “greenbacks”) to pay for the growing war deficits. The greenbacks were made legal tender for all debts, public and private…In creating greenbacks in February, Congress resolved that this would be the first and last emergency issue. But printing money is a heady wine, and a second $150 million issue was authorized in July, and still a third $150 million in early 1863. Greenbacks outstanding reached a peak in 1864 of $415.1 million.

These new-fangled greenbacks were not redeemable for real money, for gold or silver coins. As you might expect, the greenback immediately fell below its face value in gold. People preferred real money, as did the banks and the federal government.

Congress continued to print money. During the U.S. Civil War, the government increased the money supply 38x from $45.4 million to $1.773 billionmore than doubling the money supply every single year. They had a war to finance, after all!

But making more money does not make more value – instead, it simply lowers the currency’s purchasing power, and prices rose an average of 22% per year during the war. Don’t forget that greenbacks were worth less than their face value in gold (their actual value varied depending on how well the war was going, from 39-59 cents on the dollar). Despite the greenback’s official status as “legal tender,” the government was too busy fighting a war to enforce the law.

The states of California and Oregon categorically refused to accept greenbacks at all. Banks wouldn’t accept deposits of greenbacks, and tax assessors insisted on payment in real money. 

And if their constituents complained about rising prices, they had an easy response: “You’re a patriot, aren’t you? You want us to win this war, don’t you? People suffer during war. Stop whining about the price of bread and be grateful you haven’t been drafted.”

Nothing stifles protest like the threat of conscription.

In 1865, the Civil War ended. The union was preserved. The crisis was over. Right?

Well, not quite. Even winning a war is expensive, and both government and banks preferred to keep the real money, the gold and silver, to fund more important projects. Like rebuilding the factories and railroads destroyed during battles.

Only in 1879 did the Treasury Department finally began honoring redemptions of Demand Notes and greenbacks for real money once again. Nearly 20 years after that initial default.

So how is this history lesson relevant today?

Nothing beats “cold, hard cash”

Here’s what was true in 1861 and is still true today.

In times of crisis, the rules go out the window. Promises made during normal times are just no longer relevant – “Don’t you know there’s a war on?”

When there’s not enough money, the government will always print more. Both the Union and the Confederates engaged in massive, reckless money-printing to fund their war efforts, at the expense of their citizens.

Gold and silver are the preferred forms of money. Why else would both the government and banks hoard them? Why else would entire states simply reject the greenback as money?

Finally, the U.S. left (and returned!) to the gold standard once before. It’s not just possible to do so, there’s historical precedent. Maybe it’s not too late for the U.S. to return to economic reality, end the debt-based government spending spree and adopt sound money once again?

Let’s hope so. In the meantime, I’m stocking up on the preferred form of money, physical gold and silver.

2023, Featured, gold as money, gold standard, phillip patrick, us debt