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

by Murray N. Rothbard

  Return to the gold standard in 1879 was almost blocked, in the last three years before resumption, by the emergence of a tremendous agitation, heavily in the West but also throughout the country, for the free coinage of silver. The United States mint ratios had been undervaluing silver since 1834, and in 1853 de facto gold monometallism was established because silver was so far undervalued as to drive fractional silver coins out of the country. Since 1853, the United States, while de jure on a bimetallic standard at 16-to-1, with the silver dollar still technically in circulation though nonexistent, was actually on a gold monometallic standard with lightweight subsidiary silver coins for fractional use.

  In 1872, it became apparent to a few knowledgeable men at the U.S. Treasury that silver, which had held at about 15.5-to-1 since the early 1860s, was about to suffer a huge decline in value. The major reason was the realization that European nations were shifting from a silver to a gold standard, thereby decreasing their demand for silver. A subsidiary reason was the discovery of silver mines in Nevada and other states in the West. Working rapidly, these Treasury men, along with Senator Sherman, slipped through Congress in February 1873 a seemingly innocuous bill which in effect discontinued the minting of any further silver dollars. This was followed by an act of June 1874, which completed the demonetization of silver by ending the legal tender quality of all silver dollars above the sum of $5. The timing was perfect, since it was in 1874 that the market value of silver fell to greater than 16-to-1 to gold for the first time. From then on, the market price of silver fell steadily, declining to nearly 18-to-1 in 1876, over 18-to-1 in 1879, and reaching the phenomenal level of 32-to-1 in 1894.

  In short, after 1874, silver was no longer undervalued but overvalued, and increasingly so, in terms of gold, at 16-to-1. Except for the acts of 1873 and 1874, labeled by the pro-silver forces as “The Crime of 1873,” silver would have flowed into the United States, and the country would have been once again on a de facto monometallic silver standard. The champions of greenbacks, the champions of inflation, saw a “hard-money” way to increase greatly the amount of American currency: the remonetization of a flood of new overvalued silver. The agitation was to remonetize silver by “the free and unlimited coinage of silver at 16-to-1.”

  It should be recognized that the silverites had a case. The demonetization of silver was a “crime” in the sense that it was done shiftily, deceptively, by men who knew that they wanted to demonetize silver before it was too late and have silver replace gold. The case for gold over silver was a strong one, particularly in an era of rapidly falling value of silver, but it should have been made openly and honestly. The furtive method of demonetizing silver, the “crime against silver,” was in part responsible for the vehemence of the silver agitation for the remainder of the century.148

  Ultimately, the administration was able to secure the resumption of payments in gold, but at the expense of submitting to the Bland-Allison Act of 1878, which mandated that the Treasury purchase $2 million to $4 million of silver per month from then on.

  It should be noted that this first silver agitation of the late 1870s, at least, cannot be considered an “agrarian” or a particularly Southern and Western movement. The silver agitation was broadly based throughout the nation, except in New England, and was, moreover, an urban movement. As Weinstein points out:

  Silver began as an urban movement, furthermore, not an agrarian crusade. Its original strongholds were the large towns and cities of the Midwest and middle Atlantic states, not the country’s farming communities. The first batch of bimetallist leaders were a loosely knit collection of hard money newspaper editors, businessmen, academic reformers, bankers, and commercial groups.149

  With the passage of the Silver Purchase Act of 1878, silver agitation died out in America, to spring up again in the 1890s.

  THE GOLD STANDARD ERA WITH THE NATIONAL BANKING SYSTEM, 1879–1913

  The record of 1879–1896 was very similar to the first stage of the alleged great depression from 1873 to 1879. Once again, we had a phenomenal expansion of American industry, production, and real output per head. Real reproducible, tangible wealth per capita rose at the decadal peak in American history in the 1880s, at 3.8 percent per annum. Real net national product rose at the rate of 3.7 percent per year from 1879 to 1897, while per-capita net national product increased by 1.5 percent per year.

  Once again, orthodox economic historians are bewildered, for there should have been a great depression, since prices fell at a rate of over 1 percent per year in this period. Just as in the previous period, the money supply grew, but not fast enough to overcome the great increases in productivity and the supply of products. The major difference in the two periods is that money supply rose more rapidly from 1879 to 1897, by 6 percent per year, compared with the 2.7 percent per year in the earlier era. As a result, prices fell by less, by over 1 percent per annum as contrasted to 3.8 percent. Total bank money, notes, and deposits rose from $2.45 billion to $6.06 billion in this period, a rise of 10.45 percent per annum—surely enough to satisfy all but the most ardent inflationists.150

  For those who persist in associating a gold standard with deflation, it should be pointed out that price deflation in the gold standard 1879–1897 period was considerably less than price deflation from 1873 to 1879, when the United States was still on a fiat greenback standard.

  After specie resumption occurred successfully in 1879, the gold premium to greenbacks fell to par and the appreciated greenback promoted confidence in the gold-backed dollar. More foreigners willing to hold dollars meant an inflow of gold into the United States and greater American exports. Some historians have attributed the boom of 1879–1882, culminating in a financial crisis in the latter year, to the inflow of gold coin to the U.S., which rose from $110.5 million in 1879 to $358.3 million in 1882.151 In a sense this is true, but the boom would never have taken on considerable proportions without the pyramiding of the national banking system, the deposits of which increased from $2.149 billion in 1879 to $2.777 billion in 1882, a rise of 29.2 percent, or 9.7 percent per annum. Wholesale prices were driven up from 90 in 1879 to 108 three years later, a 22.5 percent increase, before resuming their long-run downward path.

  A financial panic in 1884, coming during a mild contraction after 1882, lowered the supply of bank money. Total bank notes and deposits dropped slightly, from $3.19 billion in 1883 to $3.15 billion. The panic was triggered by an overflow of gold abroad, as foreigners began to lose confidence in the willingness of the United States to remain on the gold standard. This understandable loss of confidence resulted from the inflationary sop to the pro-silver forces in the Bland-Allison Silver Purchase Act of 1878. The shift in Treasury balances from gold to silver struck a disquieting note in foreign financial circles.152

  Before examining the critical decade of the 1890s, it is well to point out in some detail the excellent record of the first decade after the return to gold, 1879–1889.

  America went off the gold standard in 1861 and remained off after the war’s end. Arguments between hard-money advocates who wanted to eliminate unbacked greenbacks and soft-money men who wanted to increase them raged through the 1870s until the Grant administration decided in 1875 to resume redemption of paper dollars into gold at prewar value on the first day of 1879. At the time (1875) greenbacks were trading at a discount of roughly 17 percent against the prewar gold dollar. A combination of outright paper-money deflation and an increase in official gold holdings enabled a return to gold four years later, which set the scene for a decade of tremendous economic growth.

  Economic recordkeeping a century ago was not nearly as well developed as today, but a clear picture comes through nonetheless. The Encyclopedia of American Economic History calls the period under review “one of the most expansive in American history. Capital investment was high;... there was little unemployment; and the real costs of production declined rapidly.”

  PRICES, WAGES, AND REAL WAGES

  This is shown most grap
hically with a look at wages and prices during the decade before and after convertibility. While prices fell during the 1870s and 1880s, wages only fell during the greenback period, and rose from 1879 to 1889.

  The figures tell a remarkable story. Both consumer prices and nominal wages fell by about 30 percent during the last decade of greenbacks. But from 1879–1889, while prices kept falling, wages rose 23 percent. So real wages, after taking inflation—or the lack of it—into effect, soared.

  No decade before or since produced such a sustainable rise in real wages. Two possible exceptions are the periods 1909–1919 (when the index rose from 99 to 140) and 1929–1939 (134 to 194). But during the first decade real wages plummeted the next year—to 129 in 1920, and did not reach 1919’s level until 1934. And during the 1930s real wages also soared, for those fortunate enough to have jobs.

  In any event, the contrast to this past decade is astonishing. And while there are many reasons why real wages increase, three necessary conditions must be present. Foremost, an absence of sustained inflation. This contributes to the second condition, a rise in savings and capital formation.

  People will not save if they believe their money will be worth less in the future. Finally, technological advancement is obviously important. But it is not enough. The 1970s saw this third factor present, but the absence of the first two caused real wages to fall.

  INTEREST RATES

  Sidney Homer writes in his monumental History of Interest Rates, 2000 B.C. to the Present that “during the last two decades of the nineteenth century (1880–1900), long-term bond yields in the United States declined almost steadily. The nation entered its first period of low long-term interest rates,” finally experiencing the 3- to 3.5-percent long-term rates which had characterized Holland in the seventeenth century and Britain in the eighteenth and nineteenth: in short, the economic giants of their day.

  To gauge long-term rates of the day, it is best not to use the long-term government bonds we would use today as a measure. The National Banking Acts of 1863–1864 stipulated that these bonds had to be used to secure bank notes. This created such a demand for them that, as Homer says, “by the mid 1870s [it] put government bond prices up to levels where their yields were far below acceptable rates of long-term interest.” But the Commerce Department tracks the unadjusted index of yields of American railroad bonds. We list the yields for 1878, the year before gold, and for 1879, and 1889.

  We stress that with consumer prices about 7 percent lower in 1889 than they had been the decade before, the real rate of return by decade’s end was well into double-digit range, a bonanza for savers and lenders.

  Short-term rates during the last century were considerably more skittish than long-term rates. But even here the decennial averages of annual averages of both three- to six-month commercial paper rates and (overnight) call money during the 1880s declined from what it had been the previous decades:

  A BURST IN PRODUCTIVITY

  By some measures the 1880s was the most productive decade in our history. In their A Monetary History of the United States, 1867–1960, Professors Friedman and Schwartz quote R.W. Goldsmith on the subject:

  The highest decadal rate [of growth of real reproducible, tangible wealth per head from 1805 to 1950] for periods of about ten years was apparently reached in the eighties with approximately 3.8 percent.

  The statistics give proof to this outpouring of new wealth.

  This dollar growth was occurring, remember, in the face of general price declines.

  Gross domestic product almost doubled from the decade before, a far larger percentage jump decade-on-decade than any time since.

  The 26.5-percent increase here ranks among the best in our history. Labor productivity reflects increased capital investment.

  CAPITAL FORMATION

  From 1869 to 1879 the total number of business establishments barely rose, but the next decade saw a 39.4-percent increase. Nor surprisingly, a decade of falling prices, rising real income, and lucrative interest returns made for tremendous capital investment, ensuring future gains in productivity.

  This massive 500-percent decade-on-decade increase has never since been even closely rivaled. It stands in particular contrast to the virtual stagnation witnessed by the 1970s.

  These five-year averages are not as “clean” as some other figures, but still show a rough doubling of total capital formation from the ‘70s to the ‘80s.

  It has repeatedly been alleged that the late nineteenth century, the “golden age of the gold standard” in the United States, was a period especially harmful to farmers. The facts, however, tell a different story. While manufacturing in the 1880s grew more rapidly than did agriculture (“The Census of 1890,” report Friedman and Schwartz, “was the first in which the net value added by manufacturing exceeded the value of agricultural output”), farmers had an excellent decade.

  So farms, farmland, productivity, and production all increased in the 1880s, even while commodity prices were falling. And as we see below, farm wage rates, even in nominal terms, rose during this time.

  This phenomenal economic growth during the decade immediately after the return to gold convertibility cannot be attributed solely to the gold standard. Indeed all during this time there was never a completely free-market monetary system. The National Banking Acts of 1863–1864 had semi-cartelized the banking system.

  Only certain banks could issue money, but all other banks had to have accounts at these. The financial panics throughout the late nineteenth century were a result of the arbitrary credit-creation powers of the banking system. While not as harmful as today’s inflation mechanism, it was still a storm in an otherwise fairly healthy economic climate.

  The fateful decade of the 1890s saw the return of the agitation for free silver, which had lain dormant for a decade. The Republican Party intensified its longtime flirtation with inflation by passing the Sherman Silver Purchase Act of 1890, which roughly doubled the Treasury purchase requirement of silver. The Treasury was now mandated to buy 4.5 million ounces of silver per month. Furthermore, payment was to be made in a new issue of redeemable greenback currency, Treasury notes of 1890, which were to be a full legal tender, redeemable in either gold or silver at the discretion of the Treasury. Not only was this an increased commitment to silver, it was a significant step on the road to bimetallism which—at the depreciated market rates—would mean inflationary silver monometallism. In the same year, the Republicans passed the high McKinley Tariff Act of 1890, which reaffirmed their commitment to high tariffs and soft money.

  Another unsettling inflationary move made in the same year was that the New York Subtreasury altered its longstanding practice of settling its clearinghouse balances in gold coin. Instead, in August 1890, it began using the old greenbacks and the new Treasury notes of 1890. As a result, these paper currencies largely replaced gold paid in customs receipts in New York.153

  Uneasiness about the shift from gold to silver and the continuing free-silver agitation caused foreigners to lose further confidence in the U.S. gold standard, and to cause a drop in capital imports and severe gold outflows from the country. This loss of confidence exerted contractionist pressure on the American economy and reduced potential economic growth during the early 1890s.

  Fears about the American gold standard were intensified in March 1891, when the Treasury suddenly imposed a stiff fee on the export of gold bars taken from its vaults so that most gold exported from then on was American gold coin rather than bars. A shock went through the financial community, in the U.S. and abroad, when the United States Senate passed a free-silver coinage bill in July 1892; the fact that the bill went no further was not enough to restore confidence in the gold standard. Banks began to insert clauses in loans and mortgages requiring payment in gold coin; clearly the dollar was no longer trusted. Gold exports intensified in 1892, the Treasury’s gold reserve declined, and a run ensued on the U.S. Treasury. In February 1893, the Treasury persuaded New York banks, which had drawn dow
n $6 million on gold from the Treasury by presenting Treasury notes for redemption, to return the gold and reacquire the paper. This act of desperation was scarcely calculated to restore confidence in the paper dollar. The Treasury was paying the price for specie resumption without bothering to contract the paper notes in circulation. The gold standard was therefore inherently shaky, resting only on public confidence, and that was giving way under the silver agitation and under desperate acts by the Treasury.

  Poor Grover Cleveland, a hard-money Democrat, assumed the presidency in the middle of this monetary crisis. Two months later, the stock market collapsed, and a month afterward, in June 1893, distrust of the fractional reserve banks led to massive bank runs and bank failures throughout the country. Once again, however, many banks, national and state, especially in the West and South, were allowed to suspend specie payments. The panic of 1893 was on. In a few months, Eastern bank suspension occurred, beginning with New York City. The total money supply—gold coin, Treasury paper, national bank notes, and national and state bank deposits—fell by 6.3 percent in one year, from June 1892 to June 1893. Suspension of specie payments resulted in deposits—which were no longer immediately redeemable in cash—going to a discount in relation to currency during the month of August. As a result, deposits became less useful, and the public tried its best to intensify its exchange of deposits for currency.

  By the end of 1893, the panic was over as foreign confidence rose with the Cleveland administration’s successful repeal of the Sherman Silver Purchase Act in November of that year. Further silver agitation of 1895 endangered the Treasury’s gold reserve, but heroic acts of the Treasury, including buying gold from a syndicate of bankers headed by J.P. Morgan and August Belmont, restored confidence in the continuance of the gold standard.154 The victory of the free-silver Bryanite forces at the 1896 Democratic convention caused further problems for gold, but the victory of the pro-gold Republicans put an end to the problem of domestic and foreign confidence in the gold standard.