A History of Money and Banking in the United States: The Colonial Era to World War II (12 page)

In Kentucky, Tennessee, and Missouri, stay laws were passed requiring creditors to accept depreciated and inconvertible bank paper in payment of debts, else suffer a stay of execution of the debt. In this way, quasi–legal tender status was conferred on the paper.51 Many states permitted banks to suspend specie payment, and four western states—Tennessee, Kentucky, Missouri, and Illinois—established state-owned banks to try to overcome the depression by issuing large issues of inconvertible paper money. In all states trying to prop up inconvertible bank paper, a quasi-legal status was also conferred on the paper by agreeing to receive the notes in taxes or debts due to the state. The result of all the inconvertible paper schemes was rapid and massive depreciation, disappearance of specie, succeeded by speedy liquidation of the new state-owned banks.52

An amusing footnote on the problem of banks being protected against their contractual obligations to pay in specie 50Ibid., pp. 64–68. Other compulsory par laws were passed by Ohio and Delaware.

51The most extreme proposal was Tennessee politician Felix Grundy’s scheme, never adopted, to compel creditors to accept bank notes of the state bank or forfeit the debt; that would have conferred full legal tender status on the bank. Ibid., p. 91; and Joseph H. Parks, “Felix Grundy and the Depression of 1819 in Tennessee,”
Publications of the East Tennessee
Historical Society
10 (1938): 22.

52Only New England, New York, New Jersey, Virginia, Mississippi, and Louisiana were comparatively untouched by the inconvertible paper contagion, either in the form of suspended specie banks continuing in operation or new state-owned banks emitting more paper. For an analysis of the events and controversies in each state, see Rothbard,
The Panic
of 1819,
pp. 57–111.

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

occurred in the course of correspondence between one of the earliest economists in America, the young Philadelphia state Senator Condy Raguet, and the eminent English economist David Ricardo. Ricardo had evidently been bewildered by Raguet’s statement that banks technically required to pay in specie often were not called upon to do so. On April 18, 1821, Raguet replied, explaining the power of banks in the United States: You state in your letter that you find it difficult to comprehend, why persons who had a right to demand coin from the Banks in payment of their notes, so long forebore to exercise it. This no doubt appears paradoxical to one who resides in a country where an act of parliament was necessary to protect a bank, but the difficulty is easily solved. The whole of our population are either stockholders of banks or in debt to them. It is not the
interest
of the first to press the banks and the rest are
afraid
. This is the whole secret. An independent man, who was neither a stockholder or debtor, who would have ventured to compel the banks to do justice, would have been persecuted as an enemy of society.53

THE SECOND BANK OF THE UNITED STATES,

1816–1833

The United States emerged from the War of 1812 in a chaotic monetary state, with banks multiplying and inflating ad lib, checked only by the varying rates of depreciation of their notes.

With banks freed from redeeming their obligations in specie, the number of incorporated banks increased during 1816, from 212 to 232.54 Clearly, the nation could not continue indefinitely with the issue of fiat money in the hands of discordant sets of 53Raguet to Ricardo, April 18, 1821, in David Ricardo,
Minor Papers on
the Currency Question
, 1809–23, Jacob H. Hollander, ed. (Baltimore: Johns Hopkins Press, 1932), pp. 199–201; Rothbard,
Panic of 1819
, pp. 10–11. See also Hammond,
Banks and Politics
, p. 242.

54New note issue series by banks reached a heavy peak in 1815 and 1816 in New York and Pennsylvania. D.C. Wismar,
Pennsylvania
Descriptive List of Obsolete State Bank Notes, 1782–1866
(Frederick, Md.:
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83

Before the Twentieth Century

individual banks. It was apparent that there were two ways out of the problem: one was the hard-money path, which was advocated by the Old Republicans and, for their own purposes, the Federalists. The federal and state governments would have sternly compelled the rollicking banks to redeem promptly in specie, and, when most of the banks outside of New England could not, to force them to liquidate. In that way, the mass of depreciated and inflated notes and deposits would have been swiftly liquidated, and specie would have poured back out of hoards and into the country to supply a circulating medium.

The inflationary experience would have been over.

Instead, the Democratic-Republican establishment in 1816

turned to the old Federalist path: a new central bank, a Second Bank of the United States. Modeled closely after the First Bank, the Second Bank, a private corporation with one-fifth of the shares owned by the federal government, was to create a national paper currency, purchase a large chunk of the public debt, and receive deposits of Treasury funds. The Second Bank of the United States’s notes and deposits were to be redeemable in specie, and they were given quasi–legal tender status by the federal government’s receiving them in payment of taxes.

That the purpose of establishing the Second Bank of the United States was to support the state banks in their inflationary course rather than crack down on them is seen by the shameful deal that the Second Bank made with the state banks as soon as it opened its doors in January 1817. At the same time that it was establishing the new bank in April 1816, Congress passed a resolution of Daniel Webster, at that time a Federalist champion of hard money, requiring that after February 20, 1817, the United States should accept as payments for debts or taxes only specie, Treasury notes, Bank of the United States notes, or state bank notes redeemable in specie on demand. In short, no irredeemable state bank notes would be accepted after that J.W. Stovell, 1933); and idem,
New York Descriptive List of Obsolete Paper
Money
(Frederick, Md.: J.W. Stovell, 1931).

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

date. Instead of using the opportunity to compel the banks to redeem, however, the Second Bank of the United States, in a meeting with representatives from the leading urban banks, excluding Boston, agreed to issue $6 million worth of credit in New York, Philadelphia, Baltimore, and Virginia before insisting on specie payments from debts due to it from the state banks. In return for that agreed-upon massive inflation, the state banks graciously consented to resume specie payments.55

Moreover, the Second Bank and the state banks agreed to mutually support each other in any emergency, which of course meant in practice that the far stronger Bank of the United States was committed to the propping up of the weaker state banks.

The Second Bank of the United States was pushed through Congress by the Madison administration and particularly by Secretary of the Treasury Alexander J. Dallas, whose appointment was lobbied for, for that purpose. Dallas, a wealthy Philadelphia lawyer, was a close friend, counsel, and financial associate of Philadelphia merchant and banker Stephen Girard, reputedly one of the two wealthiest men in the country. Toward the end of its term, Girard was the largest stockholder of the First Bank of the United States, and during the War of 1812

Girard became a very heavy investor in the war debt of the federal government. Both as a prospective large stockholder and as a way to unload his public debt, Girard began to agitate for a new Bank of the United States. Dallas’s appointment as secretary of Treasury in 1814 was successfully engineered by Dallas and his close friend, wealthy New York merchant and fur trader John Jacob Astor, also a heavy investor in the war debt. When the Second Bank of the United States was established, Stephen Girard purchased the $3 million of the $28 million that 55On the establishment of the Bank of the United States and on the deal with the state banks, see Ralph C.H. Catterall,
The Second Bank of the
United States
(Chicago: University of Chicago Press, 1902), pp. 9–26, 479–90. See also Hammond,
Banks and Politics
, pp. 230–48; and Davis R.

Dewey,
The Second United States Bank
(Washington, D.C.: National Monetary Commission, 1910), pp. 148–76.

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Before the Twentieth Century

remained unsubscribed, and he and Dallas managed to secure for the post of president of the new bank their good friend William Jones, former Philadelphia merchant.56

Much of the opposition to the founding of the Bank of the United States seems keenly prophetic. Thus, Senator William H.

Wells, Federalist from Delaware, in arguing against the bank bill, said that it was

ostensibly for the purpose of correcting the diseased state of our paper currency by restraining and curtailing the overissue of bank paper, and yet it came prepared to inflict upon us the same evil, being itself nothing more than simply a paper-making machine.57

In fact, the result of the deal with the state banks was that their resumption of specie payments after 1817 was more nominal than real, thereby setting the stage for the widespread suspensions of the 1819–21 depression. As Bray Hammond writes:

[S]pecie payments were resumed, with substantial short-comings. Apparently the situation was better than it had been, and a pretense was maintained of its being better than it was. But redemption was not certain and universal; there was still a premium on specie and still a discount on bank notes, with considerable variation in both from place to place. Three years later, February 1820, Secretary [of the Treasury] Crawford reported to Congress that during the greater part of the time that had elapsed since the resumption of specie payments, the convertibility of bank notes into 56On the Girard-Dallas connection, see Hammond,
Banks and Politics,
pp. 231–46, 252; Philip H. Burch, Jr.,
Elites in American History,
vol. 1,
The
Federalist Years to the Civil War
(New York: Holmes and Meier, 1981), pp.

88, 97, 116–17, 119–21; and Kenneth L. Brown, “Stephen Girard, Promoter of the Second Bank of the United States,”
Journal of Economic History
(November 1942): 125–32.

57
Annals of Congress
, 14th Cong., 1st sess., April 1, 1816, pp. 267–70.

See also ibid., pp. 1066, 1091, 1110 ff; cited in Murray N. Rothbard,
The
Case for a 100 Percent Gold Dollar
(Washington, D.C.: Libertarian Review Press, 1974), p. 18 n. See also Gouge,
Short History
, pp. 79–83.

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

specie had been nominal rather than real in the largest portion of the Union.58

One problem is that the Bank of the United States lacked the courage to insist on payment of its notes from the state banks.

As a result, state banks had large balances piled up against them at the Bank of the United States, totaling over $2.4 million during 1817 and 1818, remaining on the books as virtual interest-free loans. As Catterall points out, “so many influential people were interested in the [state banks] as stockholders that it was not advisable to give offense by demanding payment in specie, and borrowers were anxious to keep the banks in the humor to lend.” When the Bank of the United States did try to collect on state bank notes in specie, bank President Jones reported, “the banks, our debtors, plead inability, require unreasonable indulgence, or treat our reiterated claims and expostulations with settled indifference.”59

From its inception, the Second Bank launched a spectacular inflation of money and credit. Lax about insisting on the required payment of its capital in specie, the bank failed to raise the $7

million legally supposed to have been subscribed in specie; instead, during 1817 and 1818, its specie held never rose above $2.5 million. At the peak of its initial expansion, in July 1818, the Bank of the United States’s specie totaled $2.36 million, and its aggregate notes and deposits totaled $21.8 million. Thus, in a scant year and a half of operation, the Second Bank of the United States had added a net of $19.2 million to the nation’s money supply, for a pyramid ratio of 9.24, or a reserve ratio of 0.11.

Outright fraud abounded at the Second Bank of the United States, especially at the Philadelphia and Baltimore branches, 58Hammond,
Banks and Politics
, p. 248. See also Condy Raguet,
A
Treatise on Currency and Banking,
2nd ed. (New York: Augustus M. Kelley,

[1840] 1967), pp. 302–03; Catterall,
Second Bank
, pp. 37–39; and Walter Buckingham Smith,
Economic Aspects of the Second Bank of the United States
(Cambridge, Mass.: Harvard University Press, 1953), p. 104.

59Catterall,
Second Bank
, p. 36.

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Before the Twentieth Century

particularly the latter. It is no accident that three-fifths of all of the bank’s loans were made at these two branches.60 Also, the bank’s attempt to provide a uniform currency throughout the nation floundered on the fact that the western and southern branches could inflate credit and bank notes and that the inflated notes would wend their way to the more conservative branches in New York and Boston, which would be obligated to redeem the inflated notes at par. In this way, the conservative branches were stripped of specie while the western branches could continue to inflate unchecked.61

The expansionary operations of the Second Bank of the United States, coupled with its laxity toward insisting on specie payment by the state banks, impelled a further inflationary expansion of state banks on top of the spectacular enlargement of the central bank. Thus, the number of incorporated state banks rose from 232 in 1816 to 338 in 1818. Kentucky alone chartered 40 new banks in the 1817–18 legislative session. The estimated total money supply in the nation rose from $67.3 million in 1816 to $94.7 million in 1818, a rise of 40.7 percent in two years. Most of this increase was supplied by the Bank of the United States.62