A History of Money and Banking in the United States: The Colonial Era to World War II (10 page)

In accordance with Hamilton’s wishes, Congress quickly established the First Bank of the United States in February 1791.

The charter of the bank was for 20 years, and it was assured a monopoly of the privilege of having a national charter during that period. In a significant gesture of continuity with the Bank of North America, the latter’s longtime Bank of North America president and former partner of Robert Morris, Thomas Willing of Philadelphia, was made president of the new Bank of the United States.

The Bank of the United States promptly fulfilled its inflationary potential by issuing millions of dollars in paper money 32On the complex workings of fractional coins as against dollar coins in this period, see the excellent article by David A. Martin, “Bimetallism in the United States before 1850,”
Journal of Political Economy
76

(May–June 1968): 428–34.

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Before the Twentieth Century

and demand deposits, pyramiding on top of $2 million in specie. The Bank of the United States invested heavily in loans to the United States government. In addition to $2 million invested in the assumption of pre-existing long-term debt assumed by the new federal government, the Bank of the United States engaged in massive temporary lending to the government, which reached $6.2 million by 1796.33 The result of the outpouring of credit and paper money by the new Bank of the United States was an inflationary rise in prices. Thus, wholesale prices rose from an index of 85 in 1791 to a peak of 146 in 1796, an increase of 72 percent.34 In addition, speculation boomed in government securities and real estate values were driven upward.35 Pyramiding on top of the Bank of the United States’s expansion and aggravating the paper money expansion and the inflation was a flood of newly created commercial banks. Whereas there were only three commercial banks before the founding of the United States, and only four by the establishment of the Bank of the United States, eight new banks were founded shortly thereafter, in 1791 and 1792, and 10 more by 33Schultz and Caine are severely critical of these operations: “In indebting itself heavily to the Bank of the United States, the Federal Government was obviously misusing its privileges and seriously endangering the Bank’s stability.” They also charged that the Federalists had saddled the government with a military and interest budget that threatened to topple the structure of federal finances. Despite the addition of tax after tax to the revenue system, the Federal Government’s receipts through the decade of the ‘90s were barely able to cling to the skirts of its expenditures. (William J. Schultz and M.R. Caine,

“Federalist Finance,” in
Hamilton and the National Debt
, G.R.

Taylor, ed. [Boston: D.C. Heath, 1950], pp. 6–7) 34Similar movements occurred in wholesale prices in Philadelphia, Charleston, and the Ohio River Valley. U.S. Department of Commerce,
Historical Statistics of the United States, Colonial Times to 1957
(Washington, D.C.: Government Printing Office, 1960), pp. 116, 119–21.

35Nettels,
National Economy
, pp. 121–22.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

1796. Thus, the Bank of the United States and its monetary expansion spurred the creation of 18 new banks in five years.36

The establishment of the Bank of the United States precipitated a grave constitutional argument, the Jeffersonians arguing that the Constitution gave the federal government no power to establish a bank. Hamilton, in turn, paved the way for virtually unlimited expansion of federal power by maintaining that the Constitution “implied” a grant of power for carrying out vague national goals. The Hamiltonian interpretation won out officially in the decision of Supreme Court Justice John Marshall in
McCulloch v. Maryland
(1819).37

Despite the Jeffersonian hostility to commercial and central banks, the Democratic-Republicans, under the control of quasi-Federalist moderates rather than militant Old Republicans, made no move to repeal the charter of the Bank of the United States before its expiration in 1811 and happily multiplied the number of state banks and bank credit in the next two decades.38

Thus, in 1800 there were 28 state banks; by 1811, the number had escalated to 117, a fourfold increase. In 1804, there were 64 state banks, of which we have data on 13, or 20 percent of the banks.

These reporting banks had $0.98 million in specie, as against notes and demand deposits outstanding of $2.82 million, a 36J. Van Fenstermaker, “The Statistics of American Commercial Banking, 1782–1818,”
Journal of Economic History
(September 1965): 401; J. Van Fenstermaker,
The Development of American Commercial Banking 1782–1837

(Kent, Ohio: Kent State University, 1965), pp. 111–83; William M. Gouge,
A Short History of Paper Money and Banking in the United States
(New York: Augustus M. Kelley, [1833] 1968), p. 42.

37Marshall, a disciple of Hamilton, repeated some of Hamilton’s arguments virtually word for word in the decision. See Gerald T. Dunne,
Monetary Decisions of the Supreme Court
(New Brunswick, N.J.: Rutgers University Press, 1960), p. 30.

38On the quasi-Federalists as opposed to the Old Republicans, on banking and on other issues, see Richard E. Ellis,
The Jeffersonian Crisis:
Courts and Politics in the Young Republic
(New York: Oxford University Press, 1971), pp. 277 ff.

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Before the Twentieth Century

reserve ratio of 0.35 (or, a notes plus deposits pyramiding on top of specie of 2.88-to-1). By 1811, 26 percent of the 117 banks reported a total of $2.57 million; but the two-and-a-half-fold increase in specie was more than matched by an emission of $10.95 million of notes and deposits, a nearly fourfold increase.

This constituted a pyramiding of 4.26-to-1 on top of specie, or a reserve ratio of these banks of 0.23.39

As for the Bank of the United States, which acted in conjunction with the federal government and with the state banks, in January 1811 it had specie assets of $5.01 million, and notes and deposits outstanding of $12.87 million, a pyramid ratio of 2.57-to-1, or a reserve ratio of 0.39.40

Finally, when the time for rechartering the Bank of the United States came in 1811, the recharter bill was defeated by one vote each in the House and Senate. Recharter was fought for by the Madison administration aided by nearly all the Federalists in Congress, but was narrowly defeated by the bulk of the Democratic-Republicans, including the hard-money Old Republican forces. In view of the widely held misconception among historians that central banks serve, and are looked upon, as restraints upon state or private bank inflation, it is 39Van Fenstermaker notes that there has been a tendency of historians to believe that virtually all bank emissions were in the form of notes, but that actually a large portion was in the form of demand deposits. Thus, in 1804, bank liabilities were $1.70 million in notes and $1.12 million in deposits; in 1811 they were $5.68 million and $5.27 million respectively.

He points out that deposits exceeded notes in the large cities such as Boston and Philadelphia, sometimes by two- or threefold, whereas bank notes were used far more widely in rural areas for hand-to-hand transactions. Van Fenstermaker, “Statistics,” pp. 406–11.

40Of the Bank of the United States’s liabilities, bank notes totaled $5.04

million and demand deposits $7.83 million. John Jay Knox,
A History of
Banking in the United States
(New York: Bradford Rhodes, 1900), p. 39.

There are no other reports for the Bank of the United States extant except for 1809. The others were destroyed by fire. John Thom Holdsworth,
The
First Bank of the United States
(Washington, D.C.: National Monetary Commission, 1910), pp. 111ff., 138–44.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

instructive to note that the major forces in favor of recharter were merchants, chambers of commerce, and most of the state banks. Merchants found that the bank had expended credit at cheap rates and had eased the eternal complaint about a

“scarcity of money.” Even more suggestive is the support of the state banks, which hailed the bank as “advantageous” and worried about the contraction of credit if the bank were forced to liquidate. The Bank of New York, which had been founded by Alexander Hamilton, in fact lauded the Bank of the United States because it had been able “in case of any sudden pressure upon the merchants to step forward to their aid in a degree which the state institutions were unable to do.“41

THE WAR OF 1812 AND ITS AFTERMATH

War has generally had grave and fateful consequences for the American monetary and financial system. We have seen that the Revolutionary War occasioned a mass of depreciated fiat paper, worthless Continentals, a huge public debt, and the beginnings of central banking in the Bank of North America.

The Hamiltonian financial system, and even the Constitution itself, was in large part shaped by the Federalist desire to fund the federal and state public debt via federal taxation, and a major reason for the establishment of the First Bank of the United States was to contribute to the funding of the newly assumed federal debt. The Constitutional prohibition against state paper money, and the implicit rebuff to all fiat paper were certainly influenced by the Revolutionary War experience.

41Holdsworth,
First Bank
, p. 83. See also ibid., pp. 83–90. Holdsworth, the premier historian of the First Bank of the United States, saw the overwhelming support by the state banks, but still inconsistently clung to the myth that the Bank of the United States functioned as a restraint on their expansion: “The state banks,
though their note issues and discounts had been
kept in check by the superior resources and power of the Bank of the United
States,
favored the extension of the charter, and memorialized Congress to that effect.” Ibid., p. 90 (italics added).

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Before the Twentieth Century

The War of 1812–15 had momentous consequences for the monetary system. An enormous expansion in the number of banks and in bank notes and deposits was spurred by the dictates of war finance. New England banks were more conservative than in other regions, and the region was strongly opposed to the war with England, so little public debt was purchased in New England. Yet imported goods, textile manufactures, and munitions had to be purchased in that region by the federal government. The government therefore encouraged the formation of new and recklessly inflationary banks in the Mid-Atlantic, Southern, and Western states, which printed huge quantities of new notes to purchase government bonds. The federal government thereupon used these notes to purchase manufactured goods in New England.

Thus, from 1811 to 1815 the number of banks in the country increased from 117 to 212; in addition, there had sprung up 35

private unincorporated banks, which were illegal in most states but were allowed to function under war conditions. Specie in the 30 reporting banks, 26 percent of the total number of banks of 1811, amounted to $2.57 million in 1811; this figure had risen to $5.40 million in the 98 reporting banks in 1815, or 40 percent of the total. Notes and deposits, on the other hand, were $10.95

million in 1811 and had increased to $31.6 million in 1815

among the reporting banks.

If we make the heroic assumption that we can estimate the money supply for the country by multiplying by the proportion of unreported banks and we then add in the Bank of the United States’s totals for 1811, specie in all banks would total $14.9 million in 1811 and $13.5 million in 1815, or a 9.4 percent decrease.

On the other hand, total bank notes and deposits aggregated to $42.2 million in 1811 and $79 million four years later, so that an increase of 87.2 percent, pyramided on top of a 9.4 percent decline in specie. If we factor in the Bank of the United States, then, the bank pyramid ratio was 3.70-to-1 and the reserve ratio 0.27 in 1811; while the pyramid ratio four years later was 5.85-to-1 and the reserve ratio 0.17.

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A History of Money and Banking in the United States:
The Colonial Era to World War II

But the aggregates scarcely tell the whole story since, as we have seen, the expansion took place solely outside of New England, while New England banks continued on their relatively sound basis and did not inflate their credit. The record expansion of the number of banks was in Pennsylvania, which incorporated no less than 41 new banks in the month of March 1814, contrasting to only four banks which had existed in that state—all in Philadelphia—until that date. It is instructive to compare the pyramid ratios of banks in various reporting states in 1815: to only 1.96-to-1 in Massachusetts, 2.7-to-1 in New Hampshire, and 2.42-to-1 in Rhode Island, as contrasted to 19.2-to-1 in Pennsylvania, 18.46-to-1 in South Carolina, and 18.73-to-1

in Virginia.42

This monetary situation meant that the United States government was paying for New England manufactured goods with a mass of inflated bank paper outside the region. Soon, as the New England banks called upon the other banks to redeem their notes in specie, the mass of inflating banks faced imminent insolvency.

It was at this point that a fateful decision was made by the U.S. government and concurred in by the governments of the states outside New England. As the banks all faced failure, the governments, in August 1814, permitted all of them to suspend specie payments—that is, to stop all redemption of notes and deposits in gold or silver—and yet to continue in operation. In short, in one of the most flagrant violations of property rights in American history, the banks were permitted to waive their contractual obligations to pay in specie while they themselves could expand their loans and operations and force their own debtors to repay their loans as usual.