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

by Murray N. Rothbard

  The huge expansion of money and credit impelled a full-scale inflationary boom throughout the country. Import prices had fallen in 1815, with the renewal of foreign trade after the war, but domestic prices were another story. Thus, the index of export staples in Charleston rose from 102 in 1815 to 160 in 1818; the prices of Louisiana staples at New Orleans rose from 178 to 224 in the same period. Other parts of the economy boomed; exports rose from $81 million in 1815 to a peak of $116 million in 1818. Prices rose greatly in real estate, land, farm improvement projects, and slaves, much of it fueled by the use of bank credit for speculation in urban and rural real estate. There was a boom in turnpike construction, furthered by vast federal expenditures on turnpikes. Freight rates rose on steamboats, and shipbuilding shared in the general prosperity. Also, general boom conditions expanded stock trading so rapidly that traders, who had been buying and selling stocks on the curbs on Wall Street for nearly a century, found it necessary to open the first indoor stock exchange in the country, the New York Stock Exchange, in March 1817. Also, investment banking began in the United States during this boom period.63

  Starting in July 1818, the government and the Second Bank began to see what dire straits they were in; the enormous inflation of money and credit, aggravated by the massive fraud, had put the Bank of the United States in real danger of going under and illegally failing to sustain specie payments. Over the next year, the bank began a series of heroic contractions, forced curtailment of loans, contractions of credit in the south and west, refusal to provide uniform national currency by redeeming its shaky branch notes at par, and seriously enforcing the requirement that its debtor banks redeem in specie. In addition, it purchased millions of dollars of specie from abroad. These heroic actions, along with the ouster of bank President William Jones, managed to save the Bank of the United States, but the massive contraction of money and credit swiftly brought the United States its first widespread economic and financial depression. The first nationwide “boom-bust” cycle had arrived in the United States, impelled by rapid and massive inflation, quickly succeeded by contraction of money and credit. Banks failed, and private banks curtailed their credits and liabilities and suspended specie payments in most parts of the country.

  Contraction of money and credit by the Bank of the United States was almost unbelievable, total notes and deposits falling from $21.9 million in June 1818 to $11.5 million only a year later. The money supply contributed by the Bank of the United States was thereby contracted by no less than 47.2 percent in one year. The number of incorporated banks at first remained the same, and then fell rapidly from 1819 to 1822, falling from 341 in mid-1819 to 267 three years later. Total notes and deposits of state banks fell from an estimated $72 million in mid-1818 to $62.7 million a year later, a drop of 14 percent in one year. If we add in the fact that the U.S. Treasury contracted total Treasury notes from $8.81 million to zero during this period, we get the following estimated total money supply: in 1818, $103.5 million; in 1819, $74.2 million, a contraction in one year of 28.3 percent.64

  The result of the contraction was a massive rash of defaults, bankruptcies of business and manufacturers, and liquidation of unsound investments during the boom. There was a vast drop in real estate values and rents and in the prices of freight rates and slaves. Public land sales dropped greatly as a result of the contraction, declining from $13.6 million in 1818 to $1.7 million in 1820.65 Prices in general plummeted: The index of export staples fell from 158 in November 1818 to 77 in June 1819, an annualized drop of 87.9 percent during those seven months. South Carolina export staples dropped from 160 to 96 from 1818 to 1819, and commodity prices in New Orleans dropped from 200 in 1818 to 119 two years later.

  Falling money incomes led to a precipitous drop in imports, which fell from $122 million in 1818 to $87 million the year later. Imports from Great Britain fell from $43 million in 1818 to $14 million in 1820, and cotton and woolen imports from Britain fell from over $14 million each in 1818 to about $5 million each in 1820.

  The great fall in prices aggravated the burden of money debts, reinforced by the contraction of credit. Bankruptcies abounded, and one observer estimated that $100 million of mercantile debts to Europe were liquidated by bankruptcy during the crisis. Western areas, shorn of money by the collapse of the previously swollen paper and debt, often returned to barter conditions, and grain and whiskey were used as media of exchange.66

  In the dramatic summing up of the hard-money economist and historian William Gouge, by its precipitous and dramatic contraction “the Bank was saved, and the people were ruined.”67

  THE JACKSONIAN MOVEMENT AND THE BANK WAR

  Out of the bitter experiences of the panic of 1819 emerged the beginnings of the Jacksonian movement, dedicated to hard money, the eradication of fractional reserve banking in general, and of the Bank of the United States in particular. Andrew Jackson himself, Senator Thomas Hart “Old Bullion” Benton of Missouri, future President James K. Polk of Tennessee, and Jacksonian economists Amos Kendall of Kentucky and Condy Raguet of Philadelphia, were all converted to hard money and 100-percent reserve banking by the experience of the panic of 1819.68 The Jacksonians adopted, or in some cases pioneered in, the Currency School analysis, which pinned the blame for boom-bust cycles on inflationary expansions followed by contractions of bank credit. Far from being the ignorant bumpkins that most historians have depicted, the Jacksonians were steeped in the knowledge of sound economics, particularly of the Ricardian Currency School.

  Indeed, no movement in American politics has been as flagrantly misunderstood by historians as the Jacksonians. They were emphatically not, as historians until recently have depicted, either “ignorant anti-capitalist agrarians,” or “representatives of the rising entrepreneurial class,” or “tools of the inflationary state banks,” or embodiments of an early proletarian anticapitalist movement or a nonideological power group or “electoral machine.” The Jacksonians were libertarians, plain and simple. Their program and ideology were libertarian; they strongly favored free enterprise and free markets, but they just as strongly opposed special subsidies and monopoly privileges conveyed by government to business or to any other group. They favored absolutely minimal government, certainly at the federal level, but also at the state level. They believed that government should be confined to upholding the rights of private property. In the monetary sphere, this meant the separation of government from the banking system and a shift from inflationary paper money and fractional reserve banking to pure specie and banks confined to 100-percent reserves.

  In order to put this program into effect, however, the Jacksonians faced the grueling task of creating a new party out of what had become a one-party system after the War of 1812, in which the Democrat-Republicans had ended up adopting the Federalist program, including the re-establishing of the Bank of the United States. The new party, the Democratic Party, was largely forged in the mid-1820s by New York political leader, Martin Van Buren, newly converted by the aging Thomas Jefferson to the laissez-faire cause. Van Buren cemented an alliance with Thomas Hart Benton of Missouri and the Old Republicans of Virginia, but he needed a charismatic leader to take the presidency away from Adams and what was becoming known as the National Republican Party. He found that leader in Andrew Jackson, who was elected president under the new Democratic banner in 1828.

  The Jacksonians eventually managed to put into effect various parts of their free-market and minimal-government economic program, including a drastic lowering of tariffs, and for the first and probably the last time in American history, paying off the federal debt. But their major concentration was on the issue of money and banking. Here they had a coherent program, which they proceeded to install in rapidly succeeding stages.

  The first important step was to abolish central banking, in the Jacksonian view the major inflationary culprit. The object was not to eliminate the Bank of the United States in order to free the state banks for inflationary expansion, but, on the contrary, to eliminate t
he major source of inflation before proceeding, on the state level, to get rid of fractional reserve banking. The Bank of the United States’s charter was up for renewal in 1836, but Jackson denounced the bank in his first annual message, in 1829. The imperious Nicholas Biddle,69 head of the Second Bank, decided to precipitate a showdown with Jackson before his re-election effort, so Biddle filed for renewal early, in 1831. The host of National Republicans and non-Jacksonian Democrats proceeded to pass the recharter bill, but Jackson, in a dramatic message, vetoed the bill, and Congress failed to pass it over his veto.

  Triumphantly re-elected on the bank issue in 1832, President Jackson lost no time in disestablishing the Bank of the United States as a central bank. The critical action came in 1833, when Jackson removed the public Treasury deposits from the Bank of the United States and placed them in a number of state banks (soon labeled as “pet banks”) throughout the country. The original number of pet banks was seven, but the Jacksonians were not interested in creating a privileged bank oligarchy to replace the previous monopoly; so the number of pet banks had increased to 91 by the end of 1836.70 In that year, Biddle managed to secure a Pennsylvania charter for his bank, and the new United States Bank of Pennsylvania functioned as a much-reduced but still influential state bank for a few years thereafter.

  Orthodox historians have long maintained that by his reckless act of destroying the Bank of the United States and shifting government funds to the numerous pet banks, Andrew Jackson freed the state banks from the restraints imposed on them by a central bank. Thus, the banks were supposedly allowed to pyramid notes and deposits rashly on top of existing specie and precipitate a wild inflation that was later succeeded by two bank panics and a disastrous deflation.

  Recent historians, however, have totally reversed this conventional picture.71 In the first place, the record of bank inflation under the regime of the Bank of the United States was 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 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 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. 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

  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