A History of Money and Banking in the United States: The Colonial Era to World War II (11 page)

Indeed, the number of banks, and bank credit, expanded rapidly during 1815 as a result of this governmental carte 42Van Fenstermaker, “Statistics,” pp. 401–09. For the list of individual incorporated banks, see Van Fenstermaker,
Development
, pp. 112–83, with Pennsylvania on pp. 169–73.

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Before the Twentieth Century

blanche. It was precisely during 1815 when virtually all the private banks sprang up, the number of banks increasing in one year from 208 to 246. Reporting banks increased their pyramid ratios from 3.17-to-1 in 1814 to 5.85-to-1 the following year, a drop of reserve ratios from 0.32 to 0.17. Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary impetus during the War of 1812 came during the year 1815 after specie payments had been suspended throughout the country by government action.

Historians dedicated to the notion that central banks restrain state or private bank inflation have placed the blame for the multiplicity of banks and bank credit inflation during the War of 1812 on the absence of a central bank. But as we have seen, both the number of banks and bank credit grew apace during the period of the First Bank of the United States, pyramiding on top of the latter’s expansion, and would continue to do so under the Second Bank, and, for that matter, the Federal Reserve System in later years. And the federal government, not the state banks themselves, is largely to blame for encouraging new, inflated banks to monetize the war debt. Then, in particular, it allowed them to suspend specie payment in August 1814, and to continue that suspension for two years after the war was over, until February 1817. Thus, for two and a half years banks were permitted to operate and expand while issuing what was tantamount to fiat paper and bank deposits.

Another neglected responsibility of the U.S. government for the wartime inflation was its massive issue of Treasury notes to help finance the war effort. While this Treasury paper was interest-bearing and was redeemable in specie in one year, the cumulative amount outstanding functioned as money, as it was used in transactions among the public and was also employed as reserves or “high-powered money” by the expanding banks.

The fact that the government received the Treasury notes for all debts and taxes gave the notes a quasi–legal tender status. Most of the Treasury notes were issued in 1814 and 1815, when their outstanding total reached $10.65 million and $15.46 million,
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A History of Money and Banking in the United States:
The Colonial Era to World War II

respectively. Not only did the Treasury notes fuel the bank inflation, but their quasi–legal tender status brought Gresham’s Law into operation and specie flowed out of the banks and public circulation outside of New England, and into New England and out of the country.43

The expansion of bank money and Treasury notes during the war drove up prices in the United States. Wholesale price increases from 1811 to 1815 averaged 35 percent, with different cities experiencing a price inflation ranging from 28 percent to 55

percent. Since foreign trade was cut off by the war, prices of imported commodities rose far more, averaging 70 percent.44 But more important than this inflation, and at least as important as the wreckage of the monetary system during and after the war, was the precedent that the two-and-a-half-year-long suspension of specie payment set for the banking system for the future.

From then on, every time there was a banking crisis brought on by inflationary expansion and demands for redemption in specie, state and federal governments looked the other way and permitted general suspension of specie payments while bank operations continued to flourish. It thus became clear to the banks that in a general crisis they would not be required to meet the ordinary obligations of contract law or of respect for property rights, so their inflationary expansion was permanently encouraged by this massive failure of government to fulfill its obligation to enforce contracts and defend the rights of property.

Suspensions of specie payments informally or officially per-meated the economy outside of New England during the panic 43For a perceptive discussion of the nature and consequences of Treasury note issue in this period, see Richard H. Timberlake, Jr.,
The
Origins of Central Banking in the United States
(Cambridge, Mass.: Harvard University Press, 1978), pp. 13–18. The Gresham Law effect probably accounts for the startling decline of specie held by the reporting banks, from $9.3 million to $5.4 million, from 1814 to 1815. Van Fenstermaker,

“Statistics,” p. 405.

44
Historical Statistics
, pp. 115–24; Murray N. Rothbard,
The Panic of 1819:
Reactions and Policies
(New York: Columbia University Press, 1962), p. 4.

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Before the Twentieth Century

of 1819, occurred everywhere outside of New England in 1837, and in all states south and west of New Jersey in 1839. A general suspension of specie payments occurred throughout the country once again in the panic of 1857.45

It is important to realize, then, in evaluating the American banking system before the Civil War, that even in the later years when there was no central bank, the system was not “free” in any proper economic sense. “Free” banking can only refer to a system in which banks are treated as any other business, and that therefore failure to obey contractual obligations—in this case, prompt redemption of notes and deposits in specie—must incur immediate insolvency and liquidation. Burdened by the tradition of allowing general suspensions that arose in the United States in 1814, the pre–Civil War banking system, despite strong elements of competition when not saddled with a central bank, must rather be termed in the phrase of one economist, as “Decentralization without Freedom.”46

45On the suspensions of specie payments, and on their importance before the Civil War, see Vera C. Smith,
The Rationale of Central Banking
(London: P.S. King and Son, 1936), pp. 38–46. See also Dunne,
Monetary
Decisions
, p. 26.

46Smith,
Rationale
, p. 36. Smith properly defines “free banking” as a regime where note-issuing banks are allowed to set up in the same way as any other type of business enterprise, so long as they comply with the general company law. The requirement for their establishment is not special conditional authorization from a government authority, but the ability to raise sufficient capital, and public confidence, to gain acceptance for their notes and ensure the profitability of the undertaking. Under such a system all banks would not only be allowed the same rights, but would also be subjected to the same responsibilities as other business enterprises. If they failed to meet their obligations they would be declared bankrupt and put into liquidation, and their assets used to meet the claims of their creditors, in which case the share-holders would lose the whole or part of their capital, and the penalty for failure would be paid, at least for the most part, by those responsible for the policy of the bank. Notes issued
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A History of Money and Banking in the United States:
The Colonial Era to World War II

From the 1814–1817 experience on, the notes of state banks circulated at varying rates of depreciation, depending on public expectations of how long they would be able to keep redeeming their obligations in specie. These expectations, in turn, were heavily influenced by the amount of notes and deposits issued by the bank as compared with the amount of specie held in its vaults.

In that era of poor communications and high transportation costs, the tendency for a bank note was to depreciate in proportion to its distance from the home office. One effective, if time-consuming, method of enforcing redemption on nominally specie-paying banks was the emergence of a class of professional “money brokers.” These brokers would buy up a mass of depreciated notes of nominally specie-paying banks, and then travel to the home office of the bank to demand redemption in specie. Merchants, money brokers, bankers, and the general public were aided in evaluating the various state bank notes by the development of monthly journals known as “bank note detectors.” These “detectors” were published by money brokers and periodically evaluated the market rate of various bank notes in relation to specie.47

“Wildcat” banks were so named because in that age of poor transportation, banks hoping to inflate and not worry about redemption attempted to locate in “wildcat” country where money brokers would find it difficult to travel. It should be noted that if it were not for periodic suspension, there would under this system would be “promises to pay,” and such obligations must be met on demand in the generally accepted medium which we will assume to be gold. No bank would have the right to call on the government or on any other institution for special help in time of need. . . . A general abandonment of the gold standard is inconceivable under these conditions, and with a strict interpretation of the bankruptcy laws any bank suspending payments would at once be put into the hands of a receiver. (Ibid., pp. 148–49) 47See Richard H. Timberlake, Jr.,
Money, Banking, and Central Banking
(New York: Harper and Row, 1965), p. 94.

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have been no room for wildcat banks or for varying degrees of lack of confidence in the genuineness of specie redemption at any given time.

It can be imagined that the advent of the money broker was not precisely welcomed in the town of an errant bank, and it was easy for the townspeople to blame the resulting collapse of bank credit on the sinister stranger rather than on the friendly neighborhood banker. During the panic of 1819, when banks collapsed after an inflationary boom lasting until 1817, obstacles and intimidation were often the lot of those who attempted to press the banks to fulfill their contractual obligation to pay in specie.

Thus, Maryland and Pennsylvania, during the panic of 1819, engaged in almost bizarre inconsistency in this area. Maryland, on February 15, 1819, enacted a law “to compel . . . banks to pay specie for their notes, or forfeit their charters.” Yet two days after this seemingly tough action, it passed another law relieving banks of any obligation to redeem notes held by money brokers,

“the major force ensuring the people of this state from the evil arising from the demands made on the banks of this state for gold and silver by brokers.” Pennsylvania followed suit a month later. In this way, these states could claim to maintain the virtue of enforcing contract and property rights while moving to prevent the most effective method of ensuring such enforcement.

During the 1814–1817 general suspension, noteholders who sued for specie payment seldom gained satisfaction in the courts. Thus, Isaac Bronson, a prominent Connecticut banker in a specie-paying region, sued various New York banks for payment of notes in specie. He failed to get satisfaction, and for his pains received only abuse in the New York press as an agent of

“misery and ruin.”48

48Hammond,
Banks and Politics
, pp. 179–80. Even before the suspension, in 1808, a Bostonian named Hireh Durkee who attempted to demand specie for $9,000 in notes of the state-owned Vermont State Bank, was met by an indictment for an attempt by this “evil-disposed person” to “realize
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A History of Money and Banking in the United States:
The Colonial Era to World War II

The banks south of Virginia largely went off specie payment during the panic of 1819, and in Georgia at least general suspension continued almost continuously to the 1830s. One customer complained during 1819 that in order to collect in specie from the largely state-owned Bank of Darien, Georgia, he was forced to swear before a justice of the peace in the bank that each and every note he presented to the bank was his own and that he was not a money broker or an agent for anyone else; he was forced to swear to the oath in the presence of at least five bank directors and the bank’s cashier; and he was forced to pay a fee of $1.36 on each note in order to acquire specie on demand.

Two years later, when a noteholder demanded $30,000 in specie at the Planters’ Bank of Georgia, he was told he would be paid in pennies only, while another customer was forced to accept pennies handed out to him at the rate of $60 a day.49

During the panic, North Carolina and Maryland in particular moved against the money brokers in a vain attempt to prop up the depreciated notes of their states’ banks. In North Carolina, banks were not penalized by the legislature for suspending specie payments to “brokers,” while maintaining them to others. Backed by government, the three leading banks of the state met and agreed, in June 1819, not to pay specie to brokers or their agents. Their notes immediately fell to a 15-percent discount outside the state. However, the banks continued to require—ignoring the inconsistency—that their own debtors pay them at par in specie. Maryland, during the same year, moved to require a license of $500 per year for money brokers, in addition to an enormous $20,000 bond to establish the business.

a filthy gain” at the expense of the resources of the state of Vermont and the ability of “good citizens thereof to obtain money.” Ibid., p. 179. See also Gouge,
Short History
, p. 84.

49Gouge,
Short History
, pp. 141–42. Secretary of the Treasury William H. Crawford, a Georgia politician, tried in vain to save the Bank of Darien from failure by depositing Treasury funds there during the panic. Rothbard,
Panic of 1819
, p. 62.

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Maryland tried to bolster the defense of banks and the attack on brokers by passing a compulsory par law in 1819, prohibiting the exchange of specie for Maryland bank notes at less than par. The law was readily evaded, however, with the penalty merely adding to the discount as compensation for the added risk. Specie furthermore was driven out of the state by the operation of Gresham’s Law.50