Legal Tender Act Creates Unbacked Greenback Currency Enabling Speculation and Inflation Despite Constitutional Questions

Congress passes the Legal Tender Act on February 25, 1862, authorizing the issuance of $150 million in United States Notes (popularly called “greenbacks” for their distinctive color) to finance the Union war effort after spiraling costs rapidly deplete gold and silver reserves. The legislation, signed by President Lincoln following January 1862 meetings with Edmund Dick Taylor who suggests issuing unbacked paper money, creates the first national fiat currency—money backed solely by government credit rather than precious metals. The greenbacks are declared lawful money for all payments except interest on public debt and import duties, those exceptions designed to maintain some connection to hard currency and prevent complete devaluation. By 1863, Congress expands authorization to $450 million through the Second and Third Legal Tender Acts, tripling the initial amount. The massive increase in unbacked currency creates significant inflation, with greenbacks trading at substantial discounts from gold—prompting Congress to pass the short-lived Anti-Gold Futures Act of 1864, which is quickly repealed after it accelerates rather than arrests greenback devaluation.

The greenback system generates intense controversy and creates opportunities for speculation while raising fundamental constitutional questions. Wall Street and the metropolitan press oppose the measure, fearing runaway inflation that indeed materializes as the currency supply triples. Many contemporary observers and later critics argue that creating fiat currency is unconstitutional since the Constitution considers only gold and silver legal tender, viewing the greenback as an illegitimate expansion of federal power. The currency’s partial acceptance—exempting debt interest and import duties from greenback payment—creates a two-tier monetary system that favors creditors and international traders who demand hard currency while forcing ordinary citizens to accept depreciating paper money. Speculators exploit the dual system by hoarding gold Demand Notes, and as these notes are used to pay import duties, they are removed from circulation, creating artificial scarcity. By mid-summer 1862, Demand Notes command an 8 percent premium over United States Notes, enabling profitable arbitrage for those with capital and access.

The greenback era exemplifies how wartime financial crises create opportunities for wealth extraction through monetary manipulation. The legislation establishes government’s power to create unbacked currency, setting precedents for fiat money that extend far beyond the war emergency. The dual currency system—greenbacks for ordinary transactions, gold for favored purposes—demonstrates class-based monetary policy where the wealthy can demand hard currency while common citizens absorb inflation from depreciating paper money. Speculation in gold futures and currency arbitrage allows financiers to profit from monetary instability while soldiers fight with depreciating pay. The greenback system reveals tensions between democratic governance and financial interests: Congress must choose between Wall Street’s hard money preferences and the practical need to finance the war, ultimately choosing financial expediency over constitutional concerns and monetary stability. While the greenbacks successfully finance Union victory and work “much better than expected” in greasing “the wheels of Northern commerce,” they also demonstrate how crisis conditions enable radical changes to monetary systems that concentrate financial power and create new forms of economic inequality through inflation and speculation.