Before the War

The ante-bellum economy operated on the barter system and a system of hard money. For most folks (not all), it was rare that they would ever have more than several dollars in their hands at one time. Think of it this way. How many of us today routinely carry over $1000 in cash around with us? We don't need it, because most of our purchases when conducting our normal business are relatively small. The barter system was helped along by limited issues of bank notes. Paper money in the form of bank notes was issued by private and state banks, and was also used as a medium of exchange. It had no intrinsic value, and was only redeemable for hard money at the place of issue, i.e. the bank that had it printed. So bank note paper money had a very limited distribution, and was mainly used locally. Exceptions to this rule would be money from trade centers such as New Orleans and some eastern cities. Some folks claim that the word Dixie, meaning the South, comes from New Orleans money.

Because of the large French/Creole population, New Orleans banks' paper money was bilingual. Supposedly, the ten dollar note was referred to as a Dixie, dix being printed on the bill and also the French word for 10. I cannot confirm or refute this story. Anyway, because of the far reaching trade on the Mississippi, New Orleans notes were practically national currency all along the Mississippi basin. So while it might be uncommon to see Boston bank notes or Philadelphia bank notes in Minnesota, it would not be that uncommon to see New Orleans notes there, and thus spreading the term Dixie up and down the river.

To put things in modern perspective, private bank notes were similar to modern bank checks. They were issued in good faith, and other banks would usually honor them, but normally they could only be exchanged for hard currency at the issue bank. Sometimes, even the bank would not issue specie for its notes. The value of the note might be expressed in other economic staples, such as cotton or corn (remember the "Corn Exchange" regiment?). Look at it this way: I am a cotton farmer in the South, or a corn farmer in the Midwest. I raise my crop, harvest it, and take it to the local brokerage house. I receive fair market value for my crop, but not in hard money. I get notes, the ones that look like money to us today. The notes come from a local bank, or possibly even from the brokerage house itself. Everyone in town knows that the local brokerage house or bank backs its notes, and if you really wanted to, you could go and get the cotton or corn or specie from them for the notes. But in the mean time, you can use the notes to go to the grocers and trade your notes for some of his items, or go to some other place. The notes become a medium or exchange, because they are backed by the faith that the local folk have in the brokerage house or bank. These notes are basically no good 100 miles from home, but what do the locals care about that? Most of them aren't going that far away in their lifetimes anyway. If the local brokerage house or bank ever goes out of business, all the locals are in big trouble economically, but that's what happened anyway. The notes hold their value because everyone thinks that if everybody would all of a sudden get together and try to turn in their notes for hard money or a staple good (called a panic or a bank run), everyone will get the exact value of the amount printed on the bills. In fact this is not true, but few people care about this. Even in today's economy, we all think that if we decide to withdraw all of our money from a bank, there will be enough in the bank for all of us. Well, the fact is that banks, the last time I looked, only had to have in cash 17% (I think) of the total value of all deposits in the bank. Which is why the FDIC was created during the 1930's, but that is another topic.

If the brokerage house or bank would carelessly print notes without backing them with hard money or staples, then the perceived value of these notes would lessen, because everyone would know that you really couldn't get full value for the note. So instead of that item in the store costing you $1 in notes, it would cost you $2. this is called inflation, and while it can be caused by a number of factors in the modern world, the biggest cause of inflation in the 19th century was a surplus of paper currency. There was a great mistrust of paper currency which is why, with rare exception, it was not valuable outside the local economy. How could you tell if the bank issuing the notes was printing them like leaves, or issuing them out only for goods or specie actually received.

If I happen to conduct Mississippi river business, I might receive these notes from a New Orleans business concern at my destination. When I get back to Illinois, or Missouri, or Minnesota, I will still be able to use these notes as money because others will be making that trip also, and they know that when they get to New Orleans, the notes are good. So a local currency becomes a regional currency because of faith. And this is how "dixies" are spread around the region.

The beginning of the Civil War put tremendous pressure on the United States economic system. Goods and services were needed at rates never seen before, and there was no method in place for paying for them. In the South, a brand new government had no Treasury deposits to speak of, and needed to quickly get a system in place to handle and produce currency.

The Confederate Economy (or lack thereof)

In the Confederacy, the government needed to establish the trust and faith on a national level that had been the backbone of the state/bank system. The Confederate Treasury Department tried to do this in two ways, by issuing bonds and hoarding cotton. In the short run the government could build up cash reserves by borrowing from the citizens, thus bonds were issued. To handle long term currency needs, the government would base its currency on cotton. The government figured that if the Confederate currency was fixed to the price of cotton, and it could get the price to rise by hoarding, then the Confederate currency would be in good shape. Also, by issuing bonds, the government would obtain enough hard money to jump-start the faith in the notes.

The hoarding principle is based on the most fundamental law of economics, supply and demand. Think of the Cabbage Patch dolls of a few years ago. There was a fixed supply of dolls and the demand grew tremendously. Thus parents were willing to go anywhere and pay any price to get that Cabbage Patch doll for Christmas morning. People that can't get what they want will pay more for it when it's finally offered. So if I can't make more people want something (increase demand), the only way I can get the price to go up is to cut down or decrease the supply.

Bonds are promises to pay. Essentially, when a government issues a bond, they are borrowing money from you. They need the cash now, and will pay you (interest) for lending it to them. Those Confederate bonds you might have seen are all promises to pay "three years after a successful ratification of a treaty of peace between the governments of the Confederate States and the United States". That's the fine print. Of course, since there never was a "successful ratification of a treaty of peace", the bonds became worthless.

The cotton issue was another factor. The government tried to raise the world price of cotton by not selling it. The Confederate government figured that by saying "No, we're not selling cotton.", the European governments, especially England and France, would worry about the collapse of their respective textile industries and would beg to buy cotton at any price, not only economically but also including political factors like allying themselves to the Confederacy. The Confederate government bought up tremendous amounts of cotton and warehoused it. They embargoed (made it illegal to export) the rest. This hoarding did not have the effect the government anticipated. First, the textile industries in Europe had enough cotton to continue to produce goods in the short run, so there was no desperation for cotton. For the long run, a cotton producing industry sprang up in the British colony of India among other places, and the Confederate cotton was by-passed. The cotton in the warehouses became as world prices fell, and the notes issued that were backed by this cotton became less and less valuable.