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a history of money and banking in the United States the colonial era to world war ii by marie n rothbard part 1 a history of money and banking in the United States before the 20th century as an outpost of Great Britain colonial America of course used the British pounds pence and shillings as its money Great Britain was officially on a silver standard with the shilling defined as equal to 86 pure troy grains of silver and with silver as so defined legal tender for all debts that is creditors were compelled to accept silver at that rate however Britain also coined gold and maintained a bimetallic standard by fixing the gold Guinea weighing one hundred and twenty-nine point four grains of gold as equal in value to a certain weight of silver in that way gold became in effect legal tender as well unfortunately by establishing bimetallism Britain became perpetually subject to the evil known as Gresham's law which states that when government compulsorily over values one money and undervalues another the undervalued money will leave the country or disappear into hoards while the overvalued money will flood into circulation hence the popular catchphrase of Gresham's law bad money drives out good but the important point to note is that the triumph of quotes bad money is the results not of perverse free market competition but of government's using the compulsory legal tender power to privilege one money above another in 17th and 18th century Britain the government maintained a mint ratio between gold and silver that consistently overvalued gold and undervalued silver in relation to world market prices with the resultant disappearance and outflow of full-bodied silver coins and an influx of gold and the maintenance and circulation of the eroded and quotes lightweight silver coins attempts to rectify the fixed bimetallic ratios were always too little and too late in the sparsely settled American colonies money as it always does arose in the market as a useful and scarce commodity and began to serve as a general medium of exchange thus beaver fur and wampum were used as money in the north for exchanges with the Indians and fish and corn also served as money rice was used as money in South Carolina and the most widespread use of commodity money was tobacco which served as money in Virginia the pound of tobacco was the currency unit in Virginia with warehouse receipts in tobacco circulating his money back to 100% by the tobacco in the warehouse while commodity money continued to serve satisfactorily in rural areas as the colonial economy grew Americans imported gold and silver coins to serve as monetary media in urban centers and in foreign trade English coins were imported but so too were gold and silver coins from other European countries among the gold coins circulating in America with a French Guinea the Portuguese Joe the Spanish doubloon and Brazilian coins while silver coins included French crowns and livre it is important to realize that gold and silver are international commodities and that therefore when not prohibited by government decree foreign coins are perfectly capable of serving as standard money's there is no need to have a national government monopolized the coinage and indeed foreign gold and silver coins constituted much of the coinage in the United States until Congress outlawed the use of foreign coins in 1857 thus if a free market is allowed to prevail in a country foreign coins will circulate naturally silver and gold coins will tend to be valued in proportion to their respective weights and the ratio between silver and gold will be set by the market in accordance with their relative supply and demand shilling and dollar manipulations by far the leading species circulating in America was the Spanish silver dollar defined as consisting of 387 grains of pure silver the dollar was divided into pieces of eight or bits each consisting of one-eighth of a dollar Spanish dollars came in to the North American colonies through lucrative trade with the West Indies the Spanish silver dollar had been the world's outstanding coin since the early sixteenth century and was spread partially by dint of the vast silver output of the Spanish colonies in Latin America more important however was that the Spanish dollar from the 16th to the 19th century was relatively the most stable and least the base coin in the Western world since the Spanish silver dollar consisted of 387 grains and the English shilling consisted of 86 grains of silver this meant the natural free market ratio between the two coins would be four shillings six pence per dollar constant complaints both by contemporaries and by some later historians arose about an alleged scarcity of money especially if species in the colonies allegedly justifying numerous colonial paper-money schemes to remedy that shortage in reality there was no shortage it is true that England in a mercantilist attempt to hoard species kept minting for its own prerogative and outlawed minting in the colonies it also prohibited the export of English coin to America but this did not keep species from America for as we have seen Americans were able to import Spanish and other foreign coin including English from other countries indeed as we shall see it was precisely paper money issues that led by Gresham's law to outflows and disappearance of species from the colonies in their own mercantilism the colonial governments early tried to hoard their own species by debasing their shilling standards in terms of Spanish dollars whereas their natural weights dictated a ratio of four shilling sixpence to the dollar Massachusetts in 1642 began a general colonial process of competitive debasement of shillings Massachusetts arbitrarily decreed that the Spanish dollar be valued at five shillings the idea was to attract an inflow of Spanish silver dollars into that colony and to subsidize Massachusetts exports by making their prices cheaper in terms of dollars soon Connecticut and other colonies followed suit eats persistently upping the ante of debasement the result was to increase the supply of nominal units of account by debasing the shilling inflating domestic prices and thereby bringing the temporary export stimulus to a rapid end finally the English government brought a halt to this futile and inflationary practice in 1707 but the colonial governments had already found another and far more inflationary arrow for their bow the invention of government Fiat paper money government paper money apart from medieval China which invented both paper and printing centuries before the West the world had never seen government paper money until the colonial government of Massachusetts emitted a Fiat paper issue in 1690 Massachusetts was accustomed to launching plunder expeditions against the prosperous French colony in Quebec generally the expedition's were successful and would return to Boston sell their booty and pay off the soldiers with the proceeds this time however the expedition was beaten back decisively and the soldiers returned to Boston in ill humor grumbling for their pay discontented soldiers are ripe for mutiny so the Massachusetts government looked around in concern for a way to pay the soldiers it tried to borrow three thousand four thousand pounds from Boston merchants but evidently the Massachusetts credit rating was not the best finally Massachusetts decided in December 1692 prints 7,000 pounds in paper notes and to use them to pay the soldiers suspecting that the public would not accept irredeemable paper the government made a two-fold pledge when it issued the notes that it would redeem them in gold or silver out of tax revenue in a few years and that absolutely no further paper notes would be issued characteristically however parts of the pledge went quickly by the board the issue limit disappeared in a few months and all the bills continued unredeemed for nearly 40 years as early as February 16 91 the Massachusetts government proclaimed that it's issue had fallen far short and so it proceeded to emit 40,000 pounds of new money to repay all of its outstanding debt again pledging falsely that this would be the absolute final note issue but Massachusetts found that the increase in the supply of money coupled with a fall in the demand for paper because of growing lack of confidence in future Redemption and species led to a rapid appreciation of new money in relation to species indeed within a year after the initial issue the new pay per pound had depreciated on the market by 40% against species by 1692 the government moved against this market evaluation by use of force making the paper money compulsory legal tender for all debts at par with species and by granting a premium of 5% on all payment of debts to the government made in paper notes this legal tender law had the unwanted effect of Gresham's law the disappearance of species circulation in the colony in addition the expanding paper issues drove up prices and hampered exports from the colony in this way the species or tidge became a creature rather than the cause of Fiat paper issues thus in 1690 before the orgy of paper issues began 200,000 pounds of silver money was available in New England by 1711 however with Connecticut and Rhode Island having followed suit in paper money issue 240,000 pounds of paper money had been issued in New England but the silver had almost disappeared from circulation ironically then Massachusetts and her sister colonies issue of paper money created rather than solved any scarcity of money the new paper drove out the old species the consequent driving up of prices and depreciation of paper scarcely relieved any alleged money scarcity among the public but since the paper was issued to finance government expenditures and pay public debts the government not the public benefited from the Fiat issue after Massachusetts had emitted another huge issue of 500,000 pounds in 1711 to pay for another failed expedition against Quebec not only was the remainder of the silver driven from circulation but despite the legal tender law the pay per pound appreciated 30 percent against silver Massachusetts pounds officially 7 shillings to the silver ounce had now fallen on the market to 9 shillings per ounce depreciation proceeded in this and other colonies despite fierce governmental attempts to outlaw it backed by fines imprisonment and total confiscation of property for the high crime of not accepting the paper at par faced with the further shortage of money due to the money issues Massachusetts decided to press on in 1716 it formed a government land bank and issued 100,000 pounds and notes to be loaned on real estate in the various counties of province prices rose so dramatically that the tide of opinion in Massachusetts began to turn against paper as writers pointed out that the result of issues was a doubling of prices in the past 20 years depreciation of paper and the disappearance of Spanish silver through the operation of Gresham's law from then on Massachusetts pressured by the British crown tried intermittently to reduce the bills in circulation and return to a species but was hampered by its assumed obligations to honor the paper notes at par of his sister New England colonies in 1740 for another losing expedition against the French led Massachusetts to issue an enormous amount of paper money over the next several years from 1740 for to 1748 paper money in circulation expanded from 300 thousand pounds to 2.5 million pounds and the depreciation in Massachusetts was such that silver had risen on the market to 60 shillings an ounce ten times the price at the beginning of an era of paper money in 1690 by 1740 every colony but Virginia had followed suit in fiat paper money issues and Virginia succumbed in late 1750s in trying to finance part of the French and Indian War against the French similar consequences traumatic inflation shortage of species massive depreciation despite compulsory poor laws and sued in each colony thus along with massachusetts depreciation of eleven to one of its notes against species compared to the original par connecticut's notes had sunk to nine to one and the Carolinas at ten to one in 1740 and the paper of errantly inflation estrade island to 23 to one against species even the least inflated paper that of Pennsylvania had suffered an appreciation of species to eighty percent over par a detailed study of the effects of paper money in New Jersey shows how it created a boom bust economy over the colonial period when new paper money was injected into the economy an inflationary boom would result to be followed by a deflationary depression when the paper money supply contracted at the end of King George's War with France in 1748 Parliament began to pressure the colonies to retire the mass of paper money and return to a species in 1751 Great Britain prohibited all further issues of legal tender paper in New England in order to move toward redemption of existing issues in species finally in 1764 parliament extended the prohibition of new issues to the remainder of the colonies and required the gradual retirement of outstanding notes following the lead of parliament the New England colonies apart from Rhode Island decided to resume species a minh and retire their paper notes rapidly at the current depreciated market rate the panicky opponents of species emption and monetary contraction made the usual predictions in such a situation that the result would be a virtual absence of money in New England and the consequent ruination of all trade instead and however after a brief adjustment the resumption and retirement led to a far more prosperous trade in production the harder money and lower prices attracting an inflow of species in fact with Massachusetts on species and Rhode Island still on depreciated paper the result was that Newport which had been a flourishing Center for West Indian imports for Western Massachusetts lost this trade to Boston and languished in the doldrums in fact as one student of colonial Massachusetts has pointed out the return to speciation remarkably little dislocation recession or price deflation indeed wheat prices fell by less in Boston than in Phil Delphia which saw no such return to species in the early 1750s foreign exchange rates after the resumption of species were highly stable and the restored species system operated after 1750 with remarkable stability during the Seven Years War and during the dislocation of international payments in the last year's before the Revolution not being outlawed by governmental decree species and circulation throughout the colonial period even during the operation of paper money despite the inflation booms and busts and shortages of species cause by paper issues the species system worked well overall quote here was a silver standard in the absence of institutions of the central government intervening in a silver market and in the absence of either a public or private central bank adjusting domestic credit or managing the reserve of species or foreign exchange with which to stabilize exchange rates the market kept exchange rates remarkably close to the legislative par what is most remarkable in this context is the continuity of the species system through the 17th and 18th centuries private banknotes in contrast the government paper private banknotes and deposits redeemable in species had begun in Western Europe in Venice in the 14th century firms granting credit to consumers and businesses had existed in the ancient world and in medieval Europe but these were quote moneylenders who loaned out their own savings quote banking in a sense of lending out the savings of others only began in England with the quote scriveners of the early 17th century the scriveners were clerks who read contracts and bonds and were therefore in a position to learn of mercantile transactions and engage in money lending and borrowing there were however no banks of deposit in England until the Civil War in the mid 17th century merchants had been in the habit of storing their surplus gold in the Kings mint for safekeeping that habit proved to be unfortunate for when Charles the first needed money in 1638 shortly before the outbreak of the Civil War he confiscated a huge sum of two hundred thousand pounds of gold
calling it a quote loan from the owners although the merchants finally got their gold back they were understandably shaken by the experience and forsook the mint depositing their gold instead in the coffers of private Goldsmith's who like the mint were accustomed to storing the valuable metal the warehouse receipts of the Goldsmith's soon came to be used as a surrogate for the gold itself by the end of the Civil War in the 1660s the Goldsmith's fell prey to the temptation to print pseudo warehouse receipts not covered by gold and lend them out in this way fractional reserve banking came to England very few private banks existed in colonial America and they were short-lived most prominent was the Massachusetts land bank of 1740 issuing notes and lending them out on real estate the land bank was launched as an inflationary alternative to government paper which the royal governor was attempting to restrict the land bank issued irredeemable notes and fear of its unsound issue generated a competing private silver bank which emitted notes redeemable in silver the land bank promptly issued over 49,000 pounds in irredeemable notes which depreciated very rapidly in six months time the public was almost universally refusing to accept the banks notes and land banks sympathizers vainly accepting the notes the final blow came in 1741 when Parliament acting at the request of several Massachusetts merchants and the royal governor outlawed both the land and the silver banks one intriguing aspect of both the Massachusetts land Bank and other inflationary colonial schemes is that they were advocated and lobbied for by some of the wealthiest merchants and land speculators in the respective colonies debtors benefit from inflation and creditors lose realizing this fact older historians assumed that the debtors were largely poor agrarians and creditors were wealthy merchants and that therefore the former were the main sponsors of inflationary nostrils but of course there are no rigid quote classes of debtors and creditors indeed wealthy merchants and land speculators are often the heaviest debtors later historians have demonstrated that members of the latter group were the major sponsors of inflationary paper money in the colonies Revolutionary War finance to finance the Revolutionary War which broke out in 1775 the Continental Congress early hit on the device of issue in Fiat paper money the leader in the derive for paper money was governor Morris the highly conservative young scion of the New York landed aristocracy there was no pledge to redeem the paper even in the future but it was supposed to be retired in seven years by taxes levied pro rata by the separate states thus a heavy future tax burden was supposed to be added to the inflation brought about by the new paper money the retirement pledge however was soon forgotten as Congress and chanted by this new seemingly costless form of Revenue escalated its emissions of fiat paper as a historian has phrased that quote such was the beginning of the federal trough one of America's most imperishable institutions the total money supply of the United States at the beginning of the revolution has been estimated at twelve million dollars Congress launched its first paper issue of two million dollars in late June 1775 and before the notes were printed it had already concluded that another 1 million dollars was needed before the end of the year a full six million dollars in paper issues was issued or authorized a dramatic increase of 50% in the money supply in one year the issue of this fiat quote continental paper rapidly escalated over the next few years Congress issued six million dollars in 1775 and nineteen million dollars in 1776 thirteen million dollars in 1777 sixty-four million dollars in 1778 and 125 million dollars in 1779 this was a total issue of over two hundred and twenty-five million dollars in five years superimposed upon a pre existing money supply of twelve million dollars the result was as could be expected a rapid price inflation in terms of the paper notes and a corollary accelerating depreciation of the paper in terms of species thus at the end of 1776 the Continentals were worth $1 to $1 25 cents in species but a fall of the following year its value had fallen to 3 to 1 by December 7 1878 the value was six point eight to one and by December 1779 to the negligible forty two to one by the spring of 1781 the Continentals were virtually worthless exchanging on the market at one hundred and sixty eight paper dollars to one dollar in species this collapse of the continental currency gave rise to the phrase not worth a continental to top this calamity several states issued their own paper money and each depreciated at varying rates Virginia and the Carolinas led the inflationary move and by the end of the war state issues added a total of 210 million depreciated dollars to the nation's currency in an attempt to stem the inflation in depreciation various states levied maximum price controls and compulsory par loss the result was only to create shortages and impose hardships on large sections of the public thus soldiers were paid in Continentals but farmers understandably refused to accept payment in paper money despite legal coercion the Continental Army then moved a quote impress food and other supplies seizing the supplies and forcing the farmers and shopkeepers to accept depreciated paper in return by 1779 with continental paper virtually worthless the Continental Army stepped up its impressment s-- quote paying for them in newly issued paper tickets or quote certificates issued by the army quartermaster and commissary departments the states followed suit with their own massive certificate issues it understandably took little time for these certificates a federal and state to depreciate in value to nothing by the end of the war federal certificate issues alone totaled 200 million dollars the one redeeming feature of this monetary calamity was that the federal and state governments at least allowed these paper issues to sink into worthlessness without insisting the taxpayers shoulder another grave burden by being forced to redeem these issues species at par or even to redeem them at all Continentals were not redeemed at all and state paper was only redeemed at depreciating rates some at the greatly depreciated market value by the end of the war all the wartime state paper been withdrawn from circulation unfortunately the same policy was not applied to another important device that Congress turned to after its continental paper had become almost worthless in 1779 loan certificates technically loan certificates were public debt but they were scarcely genuine loans they were simply notes issued by the government to pay for supplies and accepted by the merchants because the government would not pay anything else and the loan certificates became a form of currency and rapidly depreciated as early as the end of 1779 they had depreciated to twenty four to one in species by the end of the war 600 million dollars of loans certificates had been issued some of the later loans certificate issues were liquidated at a depreciated rate but the bulk remained after the war to become the substantial core of the permanent peacetime federal debt the mass of federal and state debt could have depreciated and passed out of existence by the end of the war but the process was stopped and reversed by Robert Morris wealthy Philadelphia merchants and virtual economic and financial czar of the Continental Congress in the last years of the war Morris leader of the nationalist forces in American politics moved to make the depreciated federal debt ultimately redeemable in par and also agitated for federal assumption of the various state debts the reason for this was twofold a to confer a vast subsidy on speculators who had purchased the public debt at highly depreciated values by paying interest and principal at par in species 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 decentralize policy of 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 Nationals 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 massive public debt fastened permanently upon the taxpayers shortly after he assumed total economic power in Congress in the spring of 1781 Morse 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 Morse 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 species but with a controlled monetary inflation pyramiding an expansion of money and credit upon a reserve of species the Bank of North America which quickly received a federal Charter and open its doors at the beginning of 1780 to receive the privilege from the government of its notes being receivable in all duties and taxes to all governments at par with species in addition no other banks were to be permitted to operate in the country in return for its monopoly license to issue paper money the bank would graciously lent 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 dollars to the Congress headed also by Robert Morse despite Robert Morris's power and influence and the monopoly privileges conferred upon his bank it was perceived in the market that the banks notes were being inflated compared with species despite the nominal redeem ability of the Bank of North America's notes in species the markets 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 species 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 the federal government stock in the Bank of North America which had the previous year amounted to 5/8 of its capital had been sold by Morris into private hands and all US government debt to the bank had been repaid the first experiment with a central bank in the United States had ended 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 quote shortage of money Andrey inflate 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 quote shortage by stimulating the export of species 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 species a historian discusses what happened to the paper issues of North Carolina quote in 1787 to seventeen eighty eight the species of the paper had shrunk by more than 50 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 end quote 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 of Boston followed two years later with each institution enjoying a monopoly of banking in its region their expansion of banknotes and deposits helped to drive out species and in the following year the expansion was succeeded by a contraction of credit which aggravated the problems of recession 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 quotient dollar would be the basic currency unit of the new United States of America article 1 section 8 of the new constitution gave Congress the power quote to coin money regulate the value thereof and a foreign coin the power was exclusive because the state governments were prohibited in article 1 section 10 from coining money omitting 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 the coinage act established a bimetallic dollar standard for the United States the dollar was defined as both a weight of 370 1.25 grains of pure silver and/or a weight of 24 0.75 brains of pure gold a fixed ratio of 15 grains of silver to 1 grain of gold 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 $10.00 Eagle containing two hundred and forty seven point five grains of pure gold the 15 to one fixed bimetallic ratio almost precisely correspond to the market gold silver ratio of the early 1790s 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 expressed desire to keep both metals in circulation in order to increase the supply of money was doomed to failure unfortunately for the bimetallic goal in 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 point 5 to 1 by the 1790s and after 1805 fell to approximately fifteen point seven five to one 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 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 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 species 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 Spanish dollars however soon began to be heavier in weight by one to five 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 a 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 coin as the major currency to make matters still more complicated American silver dollars the lighter weight than the Spanish circulated equally by name in the West Indies as a result 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 the first bank of the United States 1791 to 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 such a bank to be owned privately with a government owning one-fifth of the shares Hamilton argued that the alleged quote scarcity of species C 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 banknotes were to be legally redeemable in species on demand and its notes were to be kept at par with species by the federal governments 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 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 and demand deposits pyramiding on top of two million dollars in species the Bank of the United States invested heavily in loans to the United States government in addition to two million dollars 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 dollars in 1796 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 in addition speculation boomed in government securities and real estate values were driven upward pyramiding on top of the Bank of the United States 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 ten more by 1796 thus the Bank of the United States and its monetary expansion spurred the creation of 18 new banks in five years 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 quote implied a grant of power for carrying out vague national goals the Hamiltonian interpretation went out officially in the decision of Supreme Court Justice John Marshall in McCulloch V Maryland in 1819 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 thus in 1800 there were 28 state banks by 1811 the number had escalated to 117 a four-fold increase in 1804 there were 64 state banks of which we have data on 13 or only percent of the banks these reported banks had 0.9 eight million dollars in species as against notes and demand deposits outstanding of 2.8 two million dollars a reserve ratio of 0.35 or a notes plus deposits pyramiding on top of species of 2.8 8 to 1 by 1811 26 percent of the 117 banks reported a total of 2.5 7 million dollars but the two and a half fold increase in species was more than matched by an omission of ten point nine five million dollars of notes and deposits a nearly four-fold increase this constituted a pyramiding of four point two six to one on top of species or a reserve ratio of these banks of 0.23 as for the Bank of the United States which acted in conjunction with the federal government and with the state banks in January 18 11 it had species a sets of 5.0 1 million dollars and notes and deposits outstanding of 12.8 7 million dollars a pyramid ratio of 2 point 5 7 to 1 or a reserve ratio of 0.39 finally when the time for recharging the Bank of the United States came in 1811 the recharter bill was defeated by one vote each in the House and Senate retarder 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 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 external complained about a quote scarcity of money even more suggestive is the support of the state banks which hailed the bank is quote 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 quote 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 the war of 1812 and it's 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 in 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 Federalists 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 experienced the war of 1812 to 1815 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 reason was strongly opposed to the war with England so little public debt was purchased in New England yet imported goods textile manufacturers 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 thirty-five private unincorporated banks which were illegal in most states but were allowed to function under war conditions species in the thirty reporting banks twenty six percent of the total number of banks of 1811 amounted to two point five seven million dollars in 1811 this figure had risen a five point four million dollars in the 98 reporting banks in 1815 or 40% of the total notes and deposits on the other hand were ten point nine five million dollars in 1811 and had increased the thirty-one point six million dollars 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 totals for 1811 species in all banks would total fourteen point nine million dollars in 1811 and thirteen point five million dollars in 1815 or a nine point four percent decrease on the other hand total bank notes and deposits aggregated to 42 point two million dollars in 1811 and 79 million dollars four years later so that an increase of eighty-seven point two percent pyramid on top of a nine point four percent decline in species if we factor in the Bank of the United States then the bank pyramid ratio was three point seven to one and the reserve ratio zero point two seven in 1811 while the pyramid ratio four years later was five point eight five to one and the reserve ratio zero point one seven but the aggregate 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 the 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 instructed to compare the pyramid ratios of banks in various reporting states in 1815 the only one point nine six to one in Massachusetts two point seven to one in New Hampshire and two point four two to one in Rhode Island as contrasted to nineteen point two to one in Pennsylvania eighteen point four six to one in South Carolina and eighteen point seven three to one in Virginia this monetary situation meant that the United States government was paying for New England menu goods with a massive inflated bank paper outside the region soon as the New England banks called upon the other banks to redeem their notes and species the mass of inflating banks faced imminent insolvency it was at this point that a fateful decision was made by the US government and concurred in by the governments of the states outside New England as the banks all faced failure the government's in August 1814 permitted all of them to suspend species 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 species while they themselves could expand their loans and operations and force their own debtors to repay their loans as usual indeed the number of banks and bank credit expanded rapidly during 1815 as a result of this governmental cart blush 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 three point one seven to one in 1814 to five point eight five to one 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 species had been suspended throughout the country by government action historians dedicated to the notion that central bank's restrained 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 monetised the war debt then in particular it allowed them to suspend species a man 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 US 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 species in one year the cumulative amount outstanding function is money as it was used in transactions among the public and was also employed as reserves or quote 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 ten point six five million dollars and fifteen point four six million dollars respectively not only did the Treasury notes fuel the bank inflation but their quasi legal tender status brought Gresham's law and operation and species flowed out of the banks and public circulation outside of New England and into New England and out of the country 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 average 35% 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 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 payments 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 species 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 they're 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 species informally or officially permeated the economy outside of New England during the panic 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 it is important to realize then in evaluating the Amer
can banking system before the Civil War that even in the later years when there was no central bank the system was not quote 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 species 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 were not saddled with a central bank must rather be turned in the phrase of one economist as quote decentralization without freedom from the 1814 to 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 species these expectations in turn were heavily influenced by the amount of notes and deposits issued by the bank as compared with the amount of species held in sports in that era of poor communications and high transportation costs the tendency for a banknote was to depreciate in proportion to its distance from the home office one effective if time-consuming method of enforcing redemption on nominally species was the emergence of a class of professional quote money brokers these brokers would buy up a massive depreciated notes of nominally species and then travel to the home office of the bank to demand Redemption in species merchants money brokers bankers and the general public were aided in evaluating the various State banknotes by the development of monthly journals known as quote banknote detectors these detectors were published by money brokers and periodically evaluated the market rate of various banknotes in relation to species quote 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 wild cat country where money brokers would find it difficult to travel it should be noted that if it were not for periodic suspension there would have been no room for wild cat 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 lesson until 1817 obstacles and intimidation were often a lot of those who attempted to press the banks to fulfill their contractual obligation to pay in species thus Maryland and Pennsylvania during the panic of 1819 engaged in almost bizarre inconsistency in this area Maryland On February 15th 1819 enacted a law quote to compel banks to pay species 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 quote 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 insurance that's enforcement during the 1814 to 1817 general suspension note holders who sued for species a man's seldom gained satisfaction in the courts thus Isaac Bronson a prominent Connecticut banker in a species a and region sued various New York banks for payment of notes and species he failed to get satisfied action and for his pains received only abuse in the New York press as an agent of quote misery and ruin the bank south of Virginia largely went off species of 1819 and in Georgia at least general suspension continued almost continuously to the 1830s one customer complained her in 1819 that in order to collect in species 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 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 cents on each note in order to acquire species on demand tears later when a note holder demanded $30,000 in species 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 up to him at a rate of $60 a day 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 state's banks in North Carolina banks were not penalized by the legislature for suspending species payments to quote 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 species to brokers or their agents their notes immediately fell to a 15% discount outside the state however the banks continued to require ignoring the inconsistency that their own debtors pay them at par and species Maryland during the same year moved to require license of $500 per year for money brokers in addition to an enormous twenty thousand dollar bond to establish the business Maryland tried to bolster the defense of banks and the attack on brokers by passing a compulsory parla in 1819 prohibiting the exchange of species for Maryland banknotes at less than par the law was readily available t merely adding to the discount as compensation for the added risk species for more was driven out of the state by the operation of Gresham's law in Kentucky Tennessee and Missouri state laws were passed requiring creditors to accept depreciate in convertible bank paper in payment of debts I'll suffer a stay of execution of the debt in this way quasi legal tender status was conferred on the paper many states permitted banks to suspend species and for 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 species succeeded by speedy liquidation of the new state-owned banks an amusing footnote on the problem of banks being protected against their contractual obligations to pay and species occurred in the course of correspondence between one of the earliest economists of America the young Philadelphia state senator Kahn year ago and the eminent English economist David Ricardo Ricardo had evidently been bewildered by Rigo statement that banks technically required to pay in species often were not called upon to do so on April 18th 1821 Rigo replied explaining the power of banks in the United States quote 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 for bore to exercise it this no doubt appears paradoxical to one who resides in a country where an act of Parliament was necessary to protect the 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
