Economically, the Civil War was not a contest between equals. The South had no factories to produce guns or ammunition, and its railroads were small and not interconnected, meaning that it was hard for the South to move food, weapons and men quickly and over long distances. In addition, though agriculture thrived in the South, planters focused on cash crops like tobacco and cotton and did not produce enough food to feed the southern population. The North, on the other hand, had enough food and enough factories to make weapons for all of its soldiers. It also had an extensive rail network that could transport men and weapons rapidly and cheaply. At first, this superiority of the North didn't seem to make much of a difference; like many wars in history, those involved thought it would be over quickly. But northern advantages would prove crucial as the war dragged on.
The differences in manpower and industrial capacity were so profound that the fact that the South almost won the war was a shock to observers all over the world. On paper, there was no way that the South could possibly have stood up to the North, which had all of the material and financial advantages, and which did an excellent job of closing off the only advantage the South did have: cotton. Since most of the South's money came from exporting cotton the North aimed to shut this trade down. One of the very first things the Union government did was to blockade southern ports. The blockade took some time to become operational, but after the capture of New Orleans the amount of southern cotton exported to England plummeted. With it went the South's only consistent form of income, something it desperately needed to defeat the North.
With the loss of its cotton exports, the South was in big trouble. It had lost its banking system—which had been headquartered in New York—and held no gold or silver reserves. There were various forms of paper money printed by the states and even by some private banks, but overall people did not trust paper money, unless it was explicitly backed by gold. Without gold and without banks, the Confederacy did the only thing it could: it printed money. Lots and lots of money. However, it could not do much to collect taxes to support this huge printing effort because the Confederate Constitution forbade the central government from imposing taxes on the states, and left it up to each individual state to tax its citizens. As in the American Revolution decades before, states collected little money and, thus, the Confederacy was left nearly broke. The Confederate government levied taxes in 1864, but by that time it was too late to do much good. With money flooding the market, its value fell dramatically, and horrendous inflation dogged the Confederate war effort from beginning to end.
With so many family heads away in fighting the war, much of the southern agricultural land was left idle or insufficiently farmed. The South, then, could not manage to feed both the civilian and military populations. Food was scarce throughout the war and, by the end, parts of the South suffered from starvation. The final dissolution of the Confederate army came when men realized that their families were starving to death and they left the army to try to help.
Arms and ammunition were also chronically in short supply in the South. Men had to bring their own guns, and soldiers scavenged the battlefields to take Union weapons and ammunition. Soldiers also lacked simple necessities such as shoes. In fact, the quest for shoes brought both the North and the South together at the town of Gettysburg which housed a shoe factory. Uniforms, tents, wagons and horses were also rare in the South, and these problems only increased toward the end of the war. In the end, the South lost the war primarily because it ran out of men, money, and supplies.
The picture was much rosier north of the Mason-Dixon Line. In addition to having a population that was more than twice that of the South, the North had enough food to feed all of its people, including its armies. Plus, it boasted many factories that produced much of what those armies needed. The federal arsenal at Springfield, Massachusetts alone produced over one million rifles for the army, and countless rounds of ammunition. The Union armies had wagons, tents, and its factory-produced blue uniforms. (Southern uniforms were generally of a brownish grey homespun color.) The North enjoyed 69% of the railroad capacity compared to only 31% in the South, and held all of the currency reserves of the federal government. The Midwest and Northeast were the most industrialized areas of the country, and those factories quickly turned to making war supplies that kept the massive Union armies relatively well-equipped.
Despite these advantages, the government needed money, and it went to great lengths to get it. First, it issued a massive bond measure in which citizens and financial institutions were asked to buy bonds to fund the war. When this failed to yield enough money for the war, the Secretary of the Treasury, Salmon P. Chase, decided to print paper money. The "greenbacks," as paper money became known, were initially backed by gold, and then later by the bonds that the government sold. In a complicated scheme, the government sold bonds for greenbacks but repaid the interest in gold, making them attractive investments. The value of the paper money varied according to the fortunes of the Union Army, and at times they were worth almost one-third less than face value. In contrast to the economic plan in the Confederacy, the Union made the greenbacks "legal tender for all debts public and private," which helped lower inflation since, by law, everyone had to accept them for goods and services.
Still searching for ways to gather more money, the federal government introduced the first income tax in 1862, and the Bureau of Internal Revenue, later known as the IRS, was established. All of this worked relatively well, and the Union dealt with a rate of inflation that never topped 80% per year, while the South suffered a rate that reached 9,000% by the end of the war.