Could Civil War era fiscal policy erase the U.S. national debt?Article added by Nicholas Paleveda MBA J.D. LL.M on July 12, 2012
Nick Paleveda MBA J.D. LL.M

Nicholas Paleveda MBA J.D. LL.M

Bellingham, WA

Joined: March 27, 2012

The U.S. can easily pull out of a recession by looking to the Legal Tender Act of 1862, where another crisis had come upon the states (the war between the states) and the solution was found in fiscal policy.

Tax and fiscal policy

Today, the national debt of the United States stands at more than $15 trillion. The GDP of the United States stands at approximately $15.2 trillion. The members of Congress cannot come up with a plan, let alone agree on a plan, to lower the national debt and restore tax and fiscal responsibility to the United States. However, the tax and fiscal policy history of the U.S. can guide us through a solution that will allow for economic growth and reduction of the national debt at the same time. A combination of tax and fiscal policy can allow the U.S. economy to grow and lower the potential ravages of a debt driven government.

Enter EGTRRA 2001

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), passed on June 7, 2001, was a sweeping piece of legislation in the United States promoted by President George Bush. It is commonly known by its abbreviation, often pronounced "egg-tra" or "egg-terra", and sometimes also known simply as the 2001 act (especially where the context of a discussion is clearly about taxes). But it is more commonly referred to as one of the two "Bush tax cuts." The tax act was passed prior to 9/11 and prior to the U.S. entering into two major, costly wars.

Historically, during wartime, tax rates are usually increased, not decreased, to help pay for the war. For example, during World War I, the highest marginal tax rate was increased to 77 percent to help pay for the war in Europe.

During World War II, the highest marginal tax rate was increased to 94 percent to pay for the second war in Europe. In 2001, the highest marginal tax rates were not raised, but lowered from 39.6 percent to 35 percent. The estate tax was reduced from 55 percent to -0- percent. The capital gains tax was reduced to 15 percent.

The U.S. bought into the myth that lower tax rates would generate jobs and stimulate the economy. In fact, the opposite occurred. The national debt expanded by more than $8 trillion, as funds were borrowed to finance the wars in Iraq and Afghanistan.

During this time, the economy was flat for 10 years and unemployment increased into the double digits. What also occurred was an increase in the national debt, as fiscal responsibility was shelved during the next three administrations.

EXIT EGTRRA 2012?

The EGTRRA tax cuts in 2001 and the increase in expenses due to two wars has left the U.S. government with a massive debt. The Bush administration began on the path to fiscal irresponsibility and the administration was re-elected to continue the path.

The Obama administration had the opportunity to seize the day and allow these cuts to expire and did not allow EGTRRA to sunset. Instead, the Obama administration extended the cuts, creating an even greater deficit and an increased debt.
A solution which will help lower the national debt is quite clear. The government must allow EGTRRA to sunset. What is the net result? It depends which study one refers to in determining the result. Today, estimates are that as much as $5.4 trillion in additional revenue will be received by the government over the next 10 years. These funds should be allocated to reduce the national debt.

The sunset of EGTRRA would allow a new sunrise in the American economy and place the U.S. on an unusual road to fiscal responsibility.

A new day in 2022

In 2022, with EGTRRA on its way out the door, the debt would end up being reduced, assuming Congress can balance a checkbook or their budget. This still will leave the U.S. taxpayer with approximately $10 trillion dollars in debt. The good news is that the U.S. is a sovereign country. The U.S. dollar is not tied to a currency, as Greece is to the euro. The U.S. can easily pull out of a recession by looking to the Legal Tender Act of 1862, where another crisis had come upon the states (the war between the states) and the solution was found in fiscal policy.

The Legal Tender Act of 1862

The Legal Tender Act of 1862 was enacted to issue paper money and funds to finance the Civil war without raising taxes. In 1862, funds were needed to finance the Civil War. To raise money, Congress passed the Legal Tender Act of 1862. A few months after the act was passed, the stock market began to rise. According to Edward Chancellor in his book "Devil Take the Hindmost - A History of Financial Speculation," it crashed whenever the Union was victorious, for fear that the supply of greenbacks would dry up, and climbed on news of defeat as the market anticipated further note issues.” The gold bulls whistled “Dixie” and the bears sang “John Brown’s Body”.

In any event, the greenbacks had a positive impact on the economy. The Act of July 17, 1861 allowed $50 million in Treasury notes to be issued. This was later expanded to $150 million, and by the third legal tender act, had expanded to $450 million. The notes were taken out of circulation on January 21, 1971 and the Riegle Improvement Act of 1994 released the treasury form its obligation to keep the notes in circulation and by 1996, they were destroyed. Even today, the U.S. treasury calculates that around $230 million of these notes are in circulation.

The Civil War created one of the greatest debt loads per GDP of any time in our history. The solution was to basically print money, and then over time, retire the funds printed.
Challenges

During that time, Salmon Chase was the Secretary of the Treasury and helped formulate the Legal Tender Act of 1862. The federal government had issued paper money as far back as 1791 where the First Bank of the United States began issuing paper notes. Paper notes were issued by the individual states and Continental Congress even before the Constitution was adopted. James Madison's notes from the Constitutional Convention in 1787 even included a footnote where the federal government could use paper as currency or legal tender.

When the U.S. Constitution was passed, Article I Section 10 forbade the states from “issuing bills of credit” or making anything but gold and silver coin. No corresponding provision existed with regard to the federal government. Article I Section 8 gave Congress the power to “borrow money” and also to “coin money” and “regulate the value” of U.S. and foreign coins.

Oddly enough, Salmon Chase became Chief Justice of the Supreme Court of the United States and proceeded to strike down the Legal Tender Act of 1862 in a famous case in 1870 known as Hepburn v. Griswold, 75 U.S. 603 (1870), in a 4-3 decision. The U.S. Government had issued nearly $400 million of “greenbacks,” which were paper money with a red stamp that states the funds are “legal tender” issued by the federal government, not the “Federal Reserve”.

On the same day, President Grant nominated two new justices, who subsequently voted to reverse the Hepburn decision in Knox v. Lee 79 U.S. 457 (1871) and Parker v. Davis. Both these decisions were 5-4. The constitutionality of this Act was reaffirmed in Juilliard v. Greenman, 110, U.S. 421 (1884), 13 years later.

What does the Legal Tender Act of 1862 mean? $1 trillion to China?

It means we can print money and pay the debt. It is estimated that China holds $1 trillion in U.S. debt. No problem. Print $1 trillion in legal tender, send it to China and say goodbye to the debt. Now the national debt stands at approximately $8.5 trillion. This may create an uproar in the international community; however, China is manipulating it’s currency and the world press is barely making any noise about this cozen behavior. However, it is not only China which holds U.S. debt obligations.

Legal tender to other countries: Can we do that?

About $3.5 trillion in U.S. debt is also owed to Japan, Brazil, Russia, Taiwan, OPEC countries, the United Kingdom and others. No problem. Print and send. This will lower our total national debt to close to $5 trillion. What will these countries do with all these funds? They could end up purchasing real estate in the U.S., which would drive up the value of our housing market. They could end up purchasing stocks and bonds in the private sector, driving up the stock market. They could use them to build more factories overseas (which would be here) or in their home country. In any event, we would be out of debt — or at least down to a more manageable $5 trillion.
What happened to legal tender after 1862?

As stated before, most of the bills have been taken out of circulation. Some are still available as collector’s items with extremely high markups. The “red seal” is an important indicator that you have real legal tender, as opposed to Federal reserve notes, which are the funds generally exchanged. Legal tender is issued by the U.S. Treasury; the notes in your pocket are issued by the Federal Reserve, a collection of private banks.

The Federal Reserve: helping banks, but not Main Street.

The Federal Reserve is obviously not working for Main Street. The creator of the mortgage crisis will not be the solution for the crisis, and would probably oppose the U.S. Treasury's direct intervention in the capital markets, as inflation would once again occur. But is inflation bad? A house worth $400,000 in 2007 is now worth $250,000. With inflation, it may be worth $400,000 again and stop the foreclosures and bankruptcies that are self imposed. More capital in the marketplace would stimulate jobs and not increase the national debt, as the funds are being used to retire the national debt. The economy would now have more funds circulating and the GDP should increase.

According to the board of governors, the Federal Reserve is independent within the government in that “its monetary policy decisions do not have to be approved by the president or anyone else in the executive or legislative branches of government." The United States Court of Appeals for the Ninth Circuit has stated, “The reserve banks are not federal instrumentalities for purpose of the federal Tort Claims Act (FTCA) but are independent, privately owned and locally controlled corporations.” The board of governors is, however, a federal agency even though the banks themselves are not.

Game theory

Once again, take out the Monopoly board. Play the game where the banker takes away $200 every time you pass “Go” and the game will end very soon. Play the game where you receive $200 every time you pass “Go” and the game will continue. Increase the amount to $400 and the game will go on even longer. The economic wounds are self inflicted. The problem with the Legal Tender Act is that it would create a society of non-debt; a society of apolaustic individuals.
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