A History of Money and Banking in the United States: The Colonial Era to World War II (9 page)

17In Virginia and Georgia, the state paper was redeemed at the highly depreciated market rate of 1,000-to-1 in specie.

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

par in specie;18 and (b) to build up agitation for taxing power in the Congress, which the Articles of Confederation refused to allow to the federal government. The decentralist policy of the states’ raising taxes or issuing new paper money to pay off the pro rata federal debt as well as their own was thwarted by the adoption of the Constitution, which brought about the victory of the nationalist program, led by Morris’s youthful disciple and former aide, Alexander Hamilton.

THE BANK OF NORTH AMERICA

Robert Morris’s nationalist vision was not confined to a strong central government, the power of the federal government to tax, and a massive public debt fastened permanently upon the taxpayers. Shortly after he assumed total economic power in Congress in the spring of 1781, Morris introduced a bill to create the first commercial bank, as well as the first central bank, in the history of the new Republic. This bank, headed by Morris himself, the Bank of North America, was not only the first fractional reserve commercial bank in the U.S.; it was to be a privately owned central bank, modeled after the Bank of England. The money system was to be grounded upon specie, but with a controlled monetary inflation pyramiding an expansion of money and credit upon a reserve of specie.

The Bank of North America, which quickly received a federal charter and opened its doors at the beginning of 1782, received the privilege from the government of its notes being receivable in all duties and taxes to all governments, at par with specie. In addition, no other banks were to be permitted to operate in the country. In return for its monopoly license to issue paper 18As Morris candidly put it, this windfall to the public debt speculators at the expense of the taxpayers would cause wealth to flow “into those hands which could render it most productive.” Ferguson,
Power of
the Purse
, p. 124.

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Before the Twentieth Century

money, the bank would graciously lend most of its newly created money to the federal government to purchase public debt and be reimbursed by the hapless taxpayer. The Bank of North America was made the depository for all congressional funds.

The first central bank in America rapidly loaned $1.2 million to the Congress, headed also by Robert Morris.19

Despite Robert Morris’s power and influence, and the monopoly privileges conferred upon his bank, it was perceived in the market that the bank’s notes were being inflated compared with specie. Despite the nominal redeemability of the Bank of North America’s notes in specie, the market’s lack of confidence in the inflated notes led to their depreciation outside its home base in Philadelphia. The bank even tried to shore up the value of the notes by hiring people to urge redeemers of its notes not to ruin everything by insisting upon specie—a move scarcely calculated to improve ultimate confidence in the bank.

After a year of operation, however, Morris, his political power slipping after the end of the war, moved quickly to end his bank’s role as a central bank and to shift it to the status of a private commercial bank chartered by the state of Pennsylvania. By the end of 1783, all of the federal government’s stock in the Bank of North America, which had the previous year amounted to five-eighths of its capital, had been sold by Morris into private hands, and all U.S. government debt to the bank 19When Morris failed to raise the legally required specie capital to launch the Bank of North America, Morris, in an act tantamount to embezzlement, simply appropriated specie loaned to the U.S. by France and invested it for the government in his own bank. In this way, the bulk of specie capital for his bank was appropriated by Morris out of government funds. A multiple of these funds was then borrowed back from Morris’s bank by Morris as government financier for the pecuniary benefit of Morris as banker; and finally, Morris channeled most of the money into war contracts for his friends and business associates. Murray N.

Rothbard,
Conceived in Liberty
, vol. 4,
The Revolutionary War, 1775–1784

(New Rochelle, N.Y.: Arlington House, 1979), p. 392.

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

had been repaid. The first experiment with a central bank in the United States had ended.20

At the end of the Revolutionary War, the contraction of the swollen mass of paper money, combined with the resumption of imports from Great Britain, combined to cut prices by more than half in a few years. Vain attempts by seven state governments, in the mid-1780s, to cure the “shortage of money” and reinflate prices were a complete failure. Part of the reason for the state paper issues was a frantic attempt to pay the wartime public debt, state and pro rata federal, without resorting to crippling burdens of taxation. The increased paper issues merely added to the “shortage” by stimulating the export of specie and the import of commodities from abroad. Once again, Gresham’s Law was at work. State paper issues—despite compulsory par laws—merely depreciated rapidly, and aggravated the shortage of specie. A historian discusses what happened to the paper issues of North Carolina:

In 1787–1788 the specie value of the paper had shrunk by more than fifty percent. Coin vanished, and since the paper had practically no value outside the state, merchants could not use it to pay debts they owed abroad; hence they suffered severe losses when they had to accept it at inflated values in the settlement of local debts. North Carolina’s performance warned merchants anew of the menace of depreciating paper money which they were forced to receive at par from their debtors but which they could not pass on to their creditors.21

Neither was the situation helped by the expansion of banking following the launching of the Bank of North America in 1782. The Bank of New York and the Massachusetts Bank 20See ibid., pp. 409–10. On the Bank of North America and on Revolutionary War finance generally, see Curtis P. Nettels,
The Emergence
of a National Economy, 1775–1815
(New York: Holt, Rinehart, and Winston, 1962), pp. 23–34.

21Nettels,
National Economy
, p. 82.

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Before the Twentieth Century

(Boston) followed two years later, with each institution enjoying a monopoly of banking in its region.22 Their expansion of bank notes and deposits helped to drive out specie, and in the following year the expansion was succeeded by a contraction of credit, which aggravated the problems of recession.23

THE UNITED STATES: BIMETALLIC COINAGE

Since the Spanish silver dollar was the major coin circulating in North America during the colonial and Confederation periods, it was generally agreed that the “dollar” would be the basic currency unit of the new United States of America.24 Article I, section 8 of the new Constitution gave to Congress the power

“to coin money, regulate the value thereof, and of foreign coin”; the power was exclusive because the state governments were prohibited, in Article I, section 10, from coining money, emitting paper money, or making anything but gold and silver coin legal tender in payment of debts. (Evidently the Founding Fathers were mindful of the bleak record of colonial and Revolutionary paper issues and provincial juggling of the weights and denominations of coin.) In accordance with this power, Congress passed the Coinage Act of 1792 on the recommendation of Secretary of Treasury Alexander Hamilton’s “Report on the Establishment of a Mint” of the year before.25

22See Hammond,
Banks and Politics
, pp. 67, 87–88.

23Nettels,
National Economy
, pp. 61–62. See also Hammond,
Banks and
Politics
, pp. 77–80, 85.

24As Jefferson put it at the time: “The unit or dollar is a known coin, and the most familiar of all to the mind of the public. It is already adopted from South to North, has identified our currency, and therefore happily offers itself a unit already introduced.” Cited in J. Laurence Laughlin,
The History of Bimetallism in the United States
, 4th ed. (New York: D. Appleton, 1901), p. 11, n. 3.

25The text of the Coinage Act of 1792 may be found in ibid., pp. 300–01.

See also pp. 21–23; and A. Barton Hepburn,
A History of Currency in the
United States with a Brief Description of the Currency Systems of all Commercial
Nations
(New York: MacMillan, 1915), pp. 43–45.

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

The Coinage Act established a bimetallic dollar standard for the United States. The dollar was defined as
both
a weight of 371.25 grains of pure silver
and/or
a weight of 24.75 grains of pure gold—a fixed ratio of 15 grains of silver to 1 grain of gold.26 Anyone could bring gold and silver bullion to the mint to be coined, and silver and gold coins were both to be legal tender at this fixed ratio of 15-to-1. The basic silver coin was to be the silver dollar, and the basic gold coin the $10 eagle, contain-ing 247.5 grains of pure gold.27

The 15-to-1 fixed bimetallic ratio almost precisely corresponded to the market gold/silver ratio of the early 1790s,28 but of course the tragedy of any bimetallic standard is that the fixed mint ratio must always come a cropper against inevitably changing market ratios, and that Gresham’s Law will then come inexorably into effect. Thus, Hamilton’s express desire to keep both metals in circulation in order to increase the supply of money was doomed to failure.29

Unfortunately for the bimetallic goal, the 1780s saw the beginning of a steady decline in the ratio of the market values of silver to gold, largely due to the massive increases over the next three decades of silver production from the mines of Mexico. The result was that the market ratio fell to 15.5-to-1 by the 1790s, and after 1805 fell to approximately 15.75-to-1. The latter figure was enough of a gap between the market and mint ratios to set Gresham’s Law into operation so that by 1810 gold 26The current Spanish silver dollars in use were lighter than the earlier dollars, weighing 387 grains. See Laughlin,
History of Bimetallism
, pp.

16–18.

27Golden half-eagles (worth $5) and quarter-eagles (worth $2.50) were also to be coined, of corresponding proportional weights, and, for silver coins, half-dollars, quarter-dollars, dimes, and half-dimes of corresponding weights.

28Silver had declined in market value from the 14.1-to-1 ratio of 1760, largely due to the declining production of gold from Russian mines in this period and therefore the rising relative value of gold.

29See Laughlin,
History of Bimetallism
, p. 14.

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Before the Twentieth Century

coins began to disappear from the United States and silver coins began to flood in. The fixed government ratio now significantly overvalued silver and undervalued gold, so it paid people to bring in silver to exchange for gold, melt the gold coins into bullion and ship it abroad. From 1810 until 1834, only silver coin, domestic and foreign, circulated in the United States.30

Originally, Congress provided in 1793 that all foreign coins circulating in the United States be legal tender. Indeed, foreign coins have been estimated to form 80 percent of American domestic specie circulation in 1800. Most of the foreign coins were Spanish silver, and while the legal tender privilege was progressively canceled for various foreign coins by 1827, Spanish silver coins continued as legal tender and to predominate in circulation.31 Spanish dollars, however, soon began to be heav-ier in weight by 1 to 5 percent over their American equivalents, even though they circulated at face value here, and so the American mint ratio overvalued American more than Spanish dollars. As a result, the Spanish silver dollars were re-exported, leaving American silver dollars in circulation. On the other hand, fractional Spanish silver coins—half-dollars, quarter-dollars, dimes, and half-dimes—were considerably overvalued in the U.S., since they circulated at face value and yet were far lighter weight. Gresham’s Law again came into play, and the result was that American silver fractional coins were exported and disappeared, leaving Spanish silver fractional coins as the major currency. To make matters still more complicated, American silver dollars, though lighter weight than the Spanish, circulated equally by name in the West Indies. As a result, 30For a lucid explanation of the changing silver-gold ratios and how Gresham’s Law operated in this period, see ibid., pp. 10–51. See also J. Laurence Laughlin,
A New Exposition of Money, Credit and Prices
(Chicago: University of Chicago Press, 1931), pp. 93–111.

31These “Spanish” coins were almost exclusively minted in the Spanish colonies of Latin America. After the Latin American nations achieved independence in the 1820s, the coins circulated freely in the United States without being legal tender.

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

American silver dollars were exported to the Caribbean. Thus, by the complex workings of Gresham’s Law, the United States was left, especially after 1820, with no gold coins and only Spanish fractional silver coin in circulation.32

THE FIRST BANK OF THE UNITED STATES: 1791–1811

A linchpin of the Hamiltonian financial program was a central bank, the First Bank of the United States, replacing the abortive Bank of North America experiment. Hamilton’s “Report on a National Bank” of December 1790 urged such a bank, to be owned privately with the government owning one-fifth of the shares. Hamilton argued that the alleged “scarcity” of specie currency needed to be overcome by infusions of paper and the new bank was to issue such paper, to be invested in the assumed federal debt and in subsidy to manufacturers. The bank notes were to be legally redeemable in specie on demand, and its notes were to be kept at par with specie by the federal government’s accepting its notes in taxes—giving it a quasi–legal tender status. Also, the federal government would confer upon the bank the prestige of being the depository for its public funds.