Prior to the Civil War, many banks in the United States issued their own paper money. Banknotes carried a promise to pay the bearer on demand in gold or silver coin -- as did Federal Reserve Notes until recent decades.

Some Americans distrusted any of these promissory notes, which were worthless if the bank failed. However, many consumers considered some state banknotes just as desirable as their national bank counterparts.

• During the 1850s and early 1860s, many banks enjoyed solid reputations, demonstrating the issuance of "sound currency" was not beyond the reach of the states' administrative powers.

• Most state banks refused to join the national bank system voluntarily because public demand for state-bank currency remained relatively strong.

• And, at the beginning of the Civil War, paper currency in the U.S. consisted of more than $200 million in banknotes issued by nearly 1,500 state-charted banks.

But during the war, the U.S. Congress imposed a 10 percent tax on any notes issued by state-chartered or incorporated banks, deliberately forcing state banks out of the paper currency business and making the regulation and issuance of currency a prerogative of the federal government and of federally-chartered national banks.

The tax had the desired effect: five years later, the U.S. currency system had changed dramatically -- fewer than 300 state banks remained, none of which issued notes.

One "benefit" of the tax was that by reducing the amount of competing currency in circulation it offset the inflationary effects of the new greenbacks -- fiat currency that wasn't redeemable in gold or silver.

And it is generally believed the tax helped finance the Civil War by stimulating bond sales to national banks. But some economists think the public might have been better off had state banks retained their right to issue currency.

Source: George Selgin, "The Suppression of State Banknotes: A Reconsideration," Economic Inquiry, Western Economic Association International, October 2000.

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