Does Lincoln Hold the Key to the Debt Ceiling Crisis?

The looming American debt crisis is politically contrived. The Treasury could borrow all it needed if the Republican majority in the House acted responsibly and raised the debt ceiling.

But the notion that if the House fails to come to agreement the United States faces a default on its debt has been accepted far too casually, partly because Janet Yellen, the Treasury secretary, has been vague about whether interest payments would be maintained.

In fact, were the government to run short of cash, the Treasury should manage the shortfall by prioritizing interest payments and reducing funding on ordinary budget items such as national parks, the military and education. This would be painful and possibly extralegal, but it would be the best of bad options. Responsible nations honor their debts.

There is a historical precedent: The Civil War Congress faced a similar choice. President Abraham Lincoln and Republicans in Congress recognized that preserving America’s credit was the key to financing the Civil War and therefore to the government’s continued health and existence. President Biden and Secretary Yellen should heed their example.

Of course, much has changed since the Lincoln era. Importantly, in early 1862, the United States faced an actual financial crisis. As it became clear that the war would be longer (and bloodier) than expected, its cost quickly surged to $1 million and then $2 million a day — a level that would exhaust the government’s annual revenue base in only a month.

The only seeming solution was to borrow, but America’s credit was not held in high regard. The United States had recently agreed to 12 percent interest (a high rate that was an expression of investor mistrust), and even at that rate, offers of loans were scarce. In 1861, Lincoln’s Treasury secretary, Salmon P. Chase, dispatched an emissary to England and continental Europe to scope out interest in loans; the response was poor. The Economist smugly reported, “It is utterly out of the question, in our judgment, that the Americans can obtain, either at home or in Europe, any thing like the extravagant sums they are asking, for Europe won’t lend them; America cannot.” Unlike today, when the dollar is treated as a reserve currency, the United States could not simply print paper and expect the world to accept it.

But in December of that year, when America’s banks ran out of gold to lend to the Treasury (which had been supporting the war over its first months), the 37th Congress proposed to do just that: print paper. With neither private banks nor the government possessing enough gold to finance the war, Congress proposed a revolutionary expedient: “legal tender”— paper money — supported only by the full faith and credit of the U.S. government, not by gold. It would be money by government fiat, standard today but novel in 1862.

The notion of a paper money standard was shocking, including to many Republicans in Congress. As one had put it, paper could not be money any more than a contract to deliver flour was flour itself; it was only a promise to deliver the real thing.

Such philosophical qualms were trumped by the emergency: The Treasury was running out of cash. Congress nonetheless recognized that most of the war’s expenses would have to come from borrowing. Had the country simply printed money to cover the entire budget, it would have risked a ruinous inflation, as would indeed occur in the Confederacy. Therefore, Congress limited the issue of legal tender paper notes to $150 million. (Later it authorized two more issues.) But it still faced a dilemma: How to print legal tender and preserve the nation’s fragile credit?