Monetary Theory During Reconstruction

(October 27, 2016.) – In 1976 economist Milton Friedman won the Nobel Prize for work on monetary theory, which can be revealing when applied to Southern Reconstruction.

A common measure of a country’s economic wealth is the total value of goods and services it produces annually, termed the Gross National Product (GNP). Friedman’s insight was to express GNP in terms that made it amenable to monetary analysis. To illustrate, American GNP might also be expressed as the product of our money supply multiplied by the rate at which the average dollar changes hands. In algebraic terms:

(M) x (V) = GNP

The above equation is an algebraic tautology where (M) represents the supply of money and (V) is the velocity-of-money, which is the pace at which individual dollars are spent. The equation is revealing because it may be applied to any region, as well as to the entire country. Thus, ceteris paribus, parts of America with larger bank deposits create greater economic output. Similarly, regions with faster rates of dollar turnover generate more economic output. Geographic areas with both greater bank deposits and quicker rates of dollar turnover are doubly blessed.

Milton Friedman

Milton Friedman

For many decades after the Civil War national banking policy favored the North over the South—and to a lesser extent the West—on factors affecting both bank deposits and money velocity. The 1863 National Banking Act authorized a maximum of $354 million in National Banknotes. Banks located chiefly in the Northeast had already issued $300 million by the end of 1866, which was the year after the war ended. Moreover, the ceiling was not raised for the final $54 million until 1870. Although the ceiling was entirely removed in 1875, it was no longer profitable for banks to issue new national banknotes because of technicalities relating to reserve requirements that did not affect pre-existing banknotes.

As a result, at the turn of 19th to the 20th century thirty-five years after the Civil War, the South had only 6% of America’s bank deposits although the eleven former Confederate states had 18% of America’s population. Like Westerners, Southern politicians sought remedies to the persistent over-concentration of banking in the North, but to no avail.

Unfortunately, the lower population density in the South and West also tended to cause a detrimental lower velocity of money in such geographic areas. Even though Milton Friedman would not win his Nobel Prize for another hundred years, Indiana Governor Oliver Morton recognized the consequences of regionally slow money velocity:

The ten-dollar bill which is used in a county in Iowa will not change hands half a dozen times while the same ten-dollar bill would change hands a hundred times in Massachusetts…because the [Western] population [is] comparatively sparse, money does not pass from hand to hand so readily, and the actual currency must supply the place of bank credits, bank checks, and savings institutions.

Despite repeated Southern objections to money supply maldistribution little was accomplished until 1900 when the reserve technicalities noted above were adjusted by the bond refunding terms of Gold Standard Act. Even though Republican Westerners like Governor Morton were aware of the injury to their own states caused by Northeast banking concentration, their support for the status quo was secured by means of protective tariffs, federal public works spending, and generous Union veterans pensions, which did not stop growing until 1921. Persistent banking concentration in the Northeast through artificial restrictions is one example of seldom-discussed Reconstruction factors that lasted far beyond 1877, which is the year conventionally—but erroneously—accepted as the end of the era.


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