A History of Money and Banking in the United States: The Colonial Era to World War II (14 page)

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

scarcely ideal. From the depths of the post-1819 depression in January 1820 to January 1823, under the regime of the conservative Langdon Cheves, the Bank of the United States increased its notes and deposits at an annual rate of 5.9 percent.

The nation’s total money supply remained about the same in that period. Under the far more inflationist regime of Nicholas Biddle, however, the Bank of the United States’s notes and deposits rose, after January 1823, from $12 million to $42.1 million, an annual increase of 27.9 percent. As a consequence of this base of the banking pyramid inflating so sharply, the total money supply during this period vaulted from $81 million to $155 million, an annual increase of 10.2 percent. It is clear that the driving force for monetary expansion was the Bank of the United States, which acted as an inflationary rather than a restraining force upon the state banks. Looking at the figures another way, the 1823 data represented a pyramid ratio of money liabilities to specie of 3.86-to-1 on the part of the Bank of the United States and 4-to-1 of the banking system as a whole, or respective reserve ratios of 0.26 and 0.25. By 1832, in contrast, the Bank of the United States’s reserve ratio had fallen to 0.17 and the country as a whole to 0.15. Both sets of institutions had inflated almost precisely proportionately on top of specie.72

The fact that wholesale prices remained about the same over this period is no indication that the monetary inflation was not improper and dangerous. As “Austrian” business cycle theory has pointed out, any bank credit inflation sets up conditions for boom-and-bust; there is no need for prices actually to rise. The reason that prices did not rise was that the increased production of goods and services sufficed to offset the monetary expansion during this period. But similar conditions of the 1920s precipitated the great crash of 1929, an event that 72For the Bank of the United States data, see Catterall,
Second Bank
, p. 503; for total money supply, see Peter Temin,
The Jacksonian Economy
(New York: W.W. Norton, 1969), p. 71.

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shocked most economists, who had adopted the proto-monetarist position of Irving Fisher and other economists of the day that a stable wholesale price level cannot, by definition, be inflationary. In reality, the unhampered free-market economy will usually increase the supply of goods and services and thereby bring about a gently falling price level, as happened in most of the nineteenth century except during wartime.

What, then, of the consequences of Jackson’s removal of the deposits? What of the fact that wholesale prices rose from 84 in April 1834, to 131 in February 1837, a remarkable increase of 52

percent in a little less than three years? Wasn’t that boom due to the abolition of central banking?

An excellent reversal of the orthodox explanation of the boom of the 1830s, and indeed of the ensuing panic, has been provided by Professor Temin.73 First, he points out that the price inflation really began earlier, when wholesale prices reached a trough of 82 in July 1830 and then rose by 20.7 percent in three years to reach 99 in the fall of 1833. The reason for the price rise is simple: The total money supply had risen from $109 million in 1830

to $159 million in 1833, an increase of 45.9 percent, or an annual rise of 15.3 percent. Breaking the figures down further, the total money supply had risen from $109 million in 1830 to $155 million a year and a half later, a spectacular expansion of 35 percent.

Unquestionably, this monetary expansion was spurred by the still-flourishing Bank of the United States, which increased its notes and deposits from January 1830 to January 1832 from a total of $29 million to $42.1 million, a rise of 45.2 percent.

Thus, the price and money inflation in the first few years of the 1830s were again sparked by the expansion of the still-dominant central bank. But what of the notable inflation after 1833?

There is no doubt that the cause of the price inflation was the 73Temin,
Jacksonian Economy
, passim. See also Hugh Rockoff, “Money, Prices, and Banks in the Jacksonian Era,” in
The Reinterpretation of
American Economic History,
R. Fogel and S. Engerman, eds. (New York: Harper and Row, 1971), pp. 448–58.

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A History of Money and Banking in the United States:
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remarkable monetary inflation during the same period. For the total money supply rose from $150 million at the beginning of 1833 to $267 million at the beginning of 1837, an astonishing rise of 84 percent, or 21 percent per annum.

But as Temin points out, this monetary inflation was not caused by the liberated state banks expanding to a fare-thee-well. If it were true that the state banks used their freedom and their new federal government deposits to pyramid wildly on the top of specie, then their pyramid ratio would have risen a great deal, or, conversely, their reserve ratio of specie to notes and deposits would have fallen sharply. Yet the banks’ reserve ratio was 0.16 at the beginning of 1837. During the intervening years, the reserve ratio was never below this figure. But this means that the state banks did no more pyramiding after the demise of the Bank of the United States as a central bank than they had done before.74

Conventional historians, believing that the Bank of the United States
must
have restrained the expansion of state banks, naturally assumed that they were hostile to the central bank.

But now Jean Wilburn has discovered that the state banks overwhelmingly supported the Bank of the United States: We have found that Nicholas Biddle was correct when he said, “state banks in the main are friendly.” Specifically, only in Georgia, Connecticut, and New York was there positive evidence of hostility. A majority of state banks in some states of the South, such as North Carolina and Alabama, gave strong support to the Bank as did both the Southwest states of Louisiana and Mississippi. Since Virginia gave some support, we can claim that state banks in the South and Southwest for the most part supported the Bank. New England, contrary to expectations, showed the banks of Vermont and New Hampshire behind the Bank, but support of Massachusetts was both qualitatively and quantitatively weak.

74Temin,
Jacksonian Economy
, pp. 68–74.

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The banks of the Middle states all supported the Second Bank except for those of New York.75

What, then, was the cause of the enormous monetary expansion of the 1830s? It was a tremendous and unusual expansion of the stock of specie in the nation’s banks. The supply of specie in the country had remained virtually constant at about $32 million, from the beginning of 1823 until the beginning of 1833. But the proportion of specie to bank notes, held by the public as money, dropped during this period from 23 percent to 5 percent, so that more specie flowed from the public into the banks to fuel the relatively moderate monetary expansion of the 1820s. But starting at the beginning of 1833, the total specie in the country rose swiftly from $31 million to $73 million at the beginning of 1837, for a rise of 141.9 percent or 35.5

percent per annum. Hence, even though increasing distrust of banks led the public to withdraw some specie from them, so that the public now held 13 percent of its money in specie instead of 5 percent, the banks were able to increase their notes and deposits at precisely the same rate as the expansion of specie flowing into their coffers.

Thus, the Jackson administration is absolved from blame for the 1833–37 inflation. In a sense, the state banks are as well; certainly, they scarcely acted as if being “freed” by the demise of the Bank of the United States. Instead, they simply increased their money issues proportionately with the huge increase of specie.

Of course, the basic fractional reserve banking system is scarcely absolved from responsibility, since otherwise the monetary expansion in absolute terms would not have been as great.76

75Jean Alexander Wilburn,
Biddle’s Bank: The Crucial Years
(New York: Columbia University Press, 1979), pp. 118–19, quoted in Hummel,

“Jacksonians,” p. 155.

76Moreover, if the Jacksonians had been able to move more rapidly in returning the banking system to a 100-percent-specie basis, they could have used the increase in specie to ease the monetary contraction required by a return to a pure specie money.

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

The enormous increase in specie was the result of two factors: first and foremost, a large influx of silver coin from Mexico, and second, the sharp cut in the usual export of silver to the Orient. The latter was due to the substantial increases in China’s purchase of opium instead of silver from abroad. The influx of silver was the result of paper money inflation by the Mexican government, which drove Mexican silver coins into the United States, where they circulated as legal tender. The influx of Mexican coin has been attributed to a possible increase in the productivity of the Mexican mines, but this makes little sense, since the inflow stopped permanently as soon as 1837. The actual cause was an inflation of the Mexican currency by the Santa Anna regime, which financed its deficits during this period by minting highly debased copper coins. Since the debased copper grossly overvalued copper and undervalued gold and silver, both of the latter metals proceeded to flow rapidly out of Mexico until they virtually disappeared. Silver, of course, and not gold, was flowing into the United States during this period.

Indeed, the Mexican government was forced to rescind its actions in 1837 by shifting the copper coinage to its proper ratio.

The influx of Mexican silver into the U.S. promptly ceased.77

A bank credit inflation the magnitude of that of the 1830s is bound to run into shoals that cause the banks to stop the expansion and begin to contract. As the banks expand, and prices rise, specie is bound to flow out of the country and into the hands of the domestic public, and the pressure on the banks to redeem in specie will intensify, forcing cessation of the boom and even monetary contraction. In a sense, the immediate precipitating cause is of minor importance. Even so, the Jackson administration has been unfairly blamed for precipitating the panic of 1837 by issuing the Specie Circular in 1836.

77Mexico was pinpointed as the source of the inflow of specie by Temin,
Jacksonian Economy
, p. 80, while the disclosure of the cause in Mexican copper inflation came in Rockoff, “Money, Prices, and Banks,” p. 454.

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Before the Twentieth Century

In 1836 the Jackson administration decided to stop the enormous speculation in Western public lands that had been fueled during the past two years by the inflation of bank credit. Hence, Jackson decreed that public land payments would have to be made in specie. This had the healthy effect of stopping public land speculation, but recent studies have shown that the Specie Circular had very little impact in putting pressure on the banks to pay specie.78 From the point of view of the Jacksonian program, however, it was as important as moving toward putting the U.S. government finances on a purely specie basis.

Another measure advancing the Jacksonian program was also taken in 1836. Jackson, embarrassed at the government having amassed a huge budget surplus during his eight years in office, ordered the Treasury to distribute the surplus proportionately to the states. The distribution was made in notes presumably payable in specie. But again, Temin has shown that the distribution had little impact on movements of specie between banks and therefore in exerting contractionist pressure upon them.79

What, then, was the precipitating factor in triggering the panic of 1837? Temin plausibly argues that the Bank of England, worried about inflation in Britain, and the consequent outflow of gold, tightened the money supply and raised interest rates in the latter half of 1836. As a result, credit contraction severely 78Public land sales by the federal government, which had been going steadily at approximately $4 million–$6 million per year, suddenly spurted upward in 1835 and 1836, to $16.2 million and $24.9 million respectively. The latter was the largest sale of public lands in American history, and the 1835 figure was the second largest. Temin,
Jacksonian Economy
, p. 124. The first demonstration of the negligible impact of the Specie Circular on the position of the banks was Richard H. Timberlake, Jr.,

“The Specie Circular and Distribution of the Surplus,”
Journal of
Political Economy
68 (April 1960): 109–17, reprinted in Timberlake,
Origins
, pp. 50–62. Timberlake defended his thesis in idem, “The Specie Circular and the Sale of Public Lands: A Comment,”
Journal of Economic
History
25 (September 1965): 414–16.

79Temin,
Jacksonian Economy
, pp. 128–36.

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

restricted the American cotton export trade in London, exports declined, cotton prices fell, capital flowed into England, and contractionist pressure was put upon American trade and the American banks. Banks throughout the United States—including the Bank of the United States—promptly suspended specie payments in May 1837, their notes depreciated at varying rates, and interregional trade within the country was crippled.

While banks were able to evade specie payments and continue operations, they were still obliged to contract credit in order to go back on specie eventually, since they could not hope to be creating fiat money indefinitely and be allowed to remain in business. Finally, the New York banks were compelled by law to resume paying their contractual obligations, and the other banks followed in the fall of 1838. During the year 1837, the money supply fell from $276 million to $232 million, a large drop of 15.6 percent in one year. Total specie in the country continued to increase in 1837, up to $88 million, but growing public distrust of the banks (reflected in an increase in the proportion of money held as specie from 13 percent to 23 percent) put enough pressure upon the banks to force the contraction. The banks’ reserve ratio rose from 0.16 to 0.20. In response to the monetary contraction, wholesale prices fell precipitately, by over 30 percent in seven months, declining from 131 in February 1837 to 98 in September of that year.