How to fight inflation in wartime

By Roger Lowenstein

Many Americans have never experienced rapid inflation, and they are looking for lessons from history about how to tame it.

That’s why the late 1970s and early 1980s are an increasingly popular topic of discussion among policymakers, particularly the experience of Paul Volcker, the former Federal Reserve chair who quashed high inflation in those years with aggressive rate increases. Jerome Powell, current chair of the Fed, which began raising rates this past week to fight persistently rising prices, recently called Volcker “one of the great public servants” of his era.

Recent inflation is getting harder to explain away as a temporary symptom of supply chain disruptions and trillions of dollars in emergency government stimulus. And it’s now being fueled by Russia’s invasion of Ukraine, which is pushing up energy prices in particular.

War has always spelled inflation. And looking back further — much further — into history provokes some ideas about how to contain it.

During the American Civil War, the Union and the Confederate governments each spent tremendous sums. Leaders on both sides were deeply worried about the possibility of runaway inflation. But the ways they addressed it were starkly different, as were the results.

In the Union, inflation over the course of the war totaled 80%. This was a serious burden for working families — then, as now, wages did not keep pace. Still, inflation was kept within reasonable limits given the circumstances and did not destabilize the economy.

The Confederacy fared much worse. It has been estimated that by the end of the fighting, in 1865, the South’s inflation rate overall was an unfathomable 9,000%.

Granted, the U.S. economy has changed a lot since the 1860s. For one thing, it now has a central bank, which has a mandate to maintain stable prices. During the pandemic, the Fed under Powell has pushed its powers, which steadied markets but also stoked inflation. Now, much of the focus is on the Fed to unwind these programs, and raise rates, to bring prices down.

But fiscal policy is also a factor, as shown by the increasing worry over deficits as President Joe Biden enacts an ambitious, and still unfinished, spending program. During the Civil War, the fiscal policies of the North and South markedly diverged.

Up North

Annual spending in the Union reached a staggering 16 times its prewar budget. Despite the need for funds, there was great fear in Congress of increasing taxes because of Americans’ well-known antipathy to taxation.

But Salmon P. Chase, the fiscally conservative Treasury secretary, was mortally afraid of inflation. He recognized that without revenue the government would have to resort to the printing press. After the Southern states seceded, interest rates on the country’s debt soared and foreigners refused to lend.

Thaddeus Stevens, chair of the House Ways and Means Committee, went further than Chase imagined by inventing an entirely new tax code. Previously, the Union had funded itself with tariffs on foreign trade, which it raised several times. Alongside that, it created a system of “internal taxes,” on everything from personal income to leaf tobacco, liquor, slaughtered hogs and fees on auctioneers. Congress also created a new bureau to collect taxes, a forerunner of the IRS, underscoring its commitment to raising revenue this way.

Stevens had no idea how much revenue the taxes would raise, or if people would even pay them. (“Everything on the earth and under the earth is to be taxed,” one Ohioan groused.) But by 1865, the Treasury netted $300 million from customs and internal taxes — six times its prewar tax revenue.

That revenue helped moderate the inflation created by the issuance of “greenbacks,” notes that circulated as money, to pay for the war. The country’s credit improved and Chase was able to borrow prodigious sums. Ultimately, inflation in the Union was no greater than during the two World Wars in the following century.

Down South

The Confederacy faced similar financial challenges. Christopher Memminger, its German-born Treasury secretary, warned that printing notes was “the most dangerous of all methods of raising money.” But the South was ideologically opposed to taxation, especially by the central government.

The South approved a very modest tax (a half-percent on real estate), but collection was left to the states and few tried to collect it. With cotton shipments to Europe pinched by the Union blockade, Memminger soon found he had little choice but to print notes to cover the cost of the war. These inflated at a catastrophic rate.

The military governor of Richmond imposed price controls — an old idea that has gained renewed attention recently — but farmers refused to sell food at the stipulated prices and the controls were dropped.

During the first nine months of 1863, the Confederacy reported revenue of $600 million, of which only $5 million was generated by taxes. (Most of the rest was printed notes.) When the government belatedly acknowledged the need for revenue, it turned to so-called in-kind taxes, such as by seizing crops from farmers, which was extremely unpopular.

The South eventually imposed a 5% tax in 1864 on land, slaves and other property, but it was too little too late. The government printed so many notes that it ran out of supplies and printed them on wallpaper. As the war wound down, instead of shuttling cartloads of notes around the streets, people exchanged cotton, bacon and salted pork for goods and services; their money was worthless.

The economic experience of the Civil War went far beyond anything facing the United States today. Decisive action from the Fed may yet cool inflation, despite government spending, trade disruptions and war. Raising taxes remains politically unpopular, but the lessons of history suggest that when inflation gets uncomfortably high, the country’s fiscal stewards have an important role to play.