By Roger Lowenstein
The looming American debt crisis is politically contrived. The Treasury could borrow all it needed if the Republican majority in the House acted responsibly and raised the debt ceiling.
But the notion that if the House fails to come to agreement the United States faces a default on its debt has been accepted far too casually, partly because Janet Yellen, the Treasury secretary, has been vague about whether interest payments would be maintained.
In fact, were the government to run short of cash, the Treasury should manage the shortfall by prioritizing interest payments and reducing funding on ordinary budget items such as national parks, the military and education. This would be painful and possibly extralegal, but it would be the best of bad options. Responsible nations honor their debts.
There is a historical precedent: The Civil War Congress faced a similar choice. President Abraham Lincoln and Republicans in Congress recognized that preserving America’s credit was the key to financing the Civil War and therefore to the government’s continued health and existence. President Biden and Secretary Yellen should heed their example.
Of course, much has changed since the Lincoln era. Importantly, in early 1862, the United States faced an actual financial crisis. As it became clear that the war would be longer (and bloodier) than expected, its cost quickly surged to $1 million and then $2 million a day — a level that would exhaust the government’s annual revenue base in only a month.
The only seeming solution was to borrow, but America’s credit was not held in high regard. The United States had recently agreed to 12 percent interest (a high rate that was an expression of investor mistrust), and even at that rate, offers of loans were scarce. In 1861, Lincoln’s Treasury secretary, Salmon P. Chase, dispatched an emissary to England and continental Europe to scope out interest in loans; the response was poor. The Economist smugly reported, “It is utterly out of the question, in our judgment, that the Americans can obtain, either at home or in Europe, any thing like the extravagant sums they are asking, for Europe won’t lend them; America cannot.” Unlike today, when the dollar is treated as a reserve currency, the United States could not simply print paper and expect the world to accept it.
But in December of that year, when America’s banks ran out of gold to lend to the Treasury (which had been supporting the war over its first months), the 37th Congress proposed to do just that: print paper. With neither private banks nor the government possessing enough gold to finance the war, Congress proposed a revolutionary expedient: “legal tender”— paper money — supported only by the full faith and credit of the US government, not by gold. It would be money by government fiat, standard today but novel in 1862.
The notion of a paper money standard was shocking, including to many Republicans in Congress. As one had put it, paper could not be money any more than a contract to deliver flour was flour itself; it was only a promise to deliver the real thing.
Such philosophical qualms were trumped by the emergency: The Treasury was running out of cash. Congress nonetheless recognized that most of the war’s expenses would have to come from borrowing. Had the country simply printed money to cover the entire budget, it would have risked a ruinous inflation, as would indeed occur in the Confederacy. Therefore, Congress limited the issue of legal tender paper notes to $150 million. (Later it authorized two more issues.) But it still faced a dilemma: How to print legal tender and preserve the nation’s fragile credit?
William Pitt Fessenden, a Maine Republican and the chairman of the Senate Finance Committee, was shocked by the idea of paper money (he claimed it “tormented” him night and day) and grievously worried about its effect on the country’s ability to borrow, especially overseas. He proposed a radical amendment. In the original bill, legal tender would be lawful “in payment of all debts”; as amended, government debts, and only they, would be payable in gold.
The exception raised a storm of protest. Thaddeus Stevens, the fiery chairman of the House Ways and Means Committee, objected that the Fessenden amendment would create two classes of citizens: investors (who would get gold) and soldiers and other government payees, who would get paper. As Stevens noted, “It creates two classes of currency, one for bankers and brokers and another for the people.” Stevens was a progressive and — not unlike Secretary Yellen today, perhaps — was sensitive to creating distinctions of class. An ally of Stevens threatened to junk the entire bill.
But the Treasury needed the money. The legal tender bill passed and was signed by Lincoln — with the amendment — and the government’s financial crisis, at least for the moment, subsided. Troops were happy to get the new greenbacks, as they were called, and so were merchants and others.
Fessenden’s amendment was critical to winning the war. Although inflation in greenbacks was serious, ultimately about 80 percent, the United States had surprisingly little trouble borrowing money, because bondholders (many of them overseas) knew that interest payments would be in specie.
The public debt climbed to $2.68 billion by the end of the war — 41 times its level at the onset of Southern secession. Yet the United States emerged with its credit improved at home and abroad, able to borrow more and at lower interest rates. A Confederate leader ruefully concluded, “The Yankees did not whip us in the field. We were whipped in the Treasury Department.”
After the war, the 14th Amendment to the Constitution (stipulating that the validity of the public debt of the United States “shall not be questioned”) implicitly treated the debt as sacrosanct.
Today, when the Treasury market is vastly larger and more central to the world economy, preserving America’s credit is even more important. Hopefully, the debt ceiling will be raised, and the crisis fabricated by House Republicans will be averted.
If not, Secretary Yellen could meet the Treasury’s debt service obligations by reducing other funding. In April, for instance, government receipts were $639 billion, compared with $62 billion in interest payments. According to the Bipartisan Policy Center, revenue expected in June will be enough to cover 80 percent of projected spending that month. Clearly, something will have to give, and some government services might be suspended. Even temporary cuts to ordinary budget items would be painful. With a recession potentially in the wings, it could be extremely painful.
But as the 37th Congress recognized, the United States has a paramount interest in preserving its long-term ability to borrow. President Biden and Secretary Yellen should be guided by their example.