The American Banking System 1800-1810Essay Preview: The American Banking System 1800-1810Report this essayThe American Banking System 1800-1810INTRODUCTIONLooking back to the outset of the 19th century, it is impossible to say that any real banking system had really been developed in the US. This is to say that, though there were roughly 120 private commercial banks that had been chartered by new state governments, the so-called system was scarcely organized. It was ad hoc in nature and directly linked to the merchant banking practices of the pre-independence period. The years preceding the turn of the century were important because they brought a central banking authority onto the scene. In 1789 the new federal government established a position for the Secretary of the Treasury. As we know, the first to hold this prestigious title was Alexander Hamilton. He accomplished a great deal in the 11 years leading up to the year 1800. Most notably his actions were largely responsible for the creation of the First Bank of the United States, which was given a charter in 1791. This thrust towards central banking was only to last 20 years, however. Up for review in 1811, the banks charter was not renewed.
This paper will argue that the failure to renew the First Bank of the United States charter was a direct result of the strong ideological differences between state centered and federalist politics. Many were very skeptical about a strong centralized banking system, while others believed that the only way to create unity in the country was through a highly focused central banking system. Despite the relative efficiency of the First Bank of the United States, and despite the fact that it is widely considered to be a success by economic historians, the general suspicion of banking led to its demise. In other words, this paper will argue that the 1800-1810 period was one of exhaustive tension between centralists and de-centralists. This had important and lasting effects on the banking system, the most obvious being that, in the following century, state banks proliferated to the point where they were chartered with abandon. As John K. Galbraith noted, “every location large enough to have a church, a tavern, or a blacksmith shop was deemed a suitable place for setting up a bank. These banks issued notes, and other, more surprising enterprises, imitating the banks, did likewise. Even barbers and bartenders competed with banks in this respect” (Flaherty, 1997:
BackgrounderThis last statement might seem surprising to some readers, but it is far less outlandish when one digs back a little bit in pre-19th century US history. Before achieving independence, there were no commercial banks. The first commercial bank, the Bank of North America, was established in 1781. “British merchant banking houses stood at one end of a long chain of credit that stretched to the American frontier. They gave short-term (less than a year) credits to American merchants who then extended them to wholesalers of their imports, and the wholesalers passed them on to both urban and rural retailers – country stores and wandering peddlers” (Foner/Garraty, 1991: 191).
After the Constitution was enacted in 1789, the Bank of North America was chartered along with two state banks in Massachusetts and New York. Not surprisingly, following in the merchant traditions of previous years, the primary function of these banks and their followers was to make short term loans. They did this through the issuance of their own bank notes and/or by issuing a deposit account to the individual borrower and providing them with checks useful for withdrawl. Naturally, the issuance of bank notes was tantamount to the promise to pay specie to the bearer upon his demand. This meant that banks were responsible for keeping sufficient reserves to cover all demands. Maintaining sufficient reserves, however, was a very complicated task which ultimately forced many banks into bankruptcy because they had overexteded their loans and discounts(Foner/Garraty, 192).
Within the first few years of independence, it was almost natural that more trust was needed in the banking system. “The thinking of the time favored the establishment of a single quasi-governmental bank in each state that would operate in the public interest under private management. The overriding fear of political leaders was that excessive numbers of banks or loans too much in excess of specie reserves would hobble the taxing and spending functions of government by swamping the economy in depreciated paper. Political leaders also recalled very well the wild inflation resulting from unrestrained governmental issues of continental and state bills of credit (paper money) during the Revolution, and in the Constitution they barred the states from issuing them”(Foner/Garraty, 192).
”The Federal Reserve System was created in the second half of the 17th century. The Federal Reserve System was designed chiefly to provide cash for the banking system during a time of economic difficulties, unemployment, and inflation. The Federal Reserve System was designed to create a “money-making, credit-creating society, capable of growing new money for the benefit of all people.” The Fed was meant primarily to stimulate activity. (The Federal Reserve System, for example, was designed to provide an adequate reserve of a certain proportion of the outstanding government debt, but it also provided money for other business activity). Money could be put into the banks for the benefit of the government, and even an independent agency (a bank with some of the power to issue money, like the Bank of England) could act as a “money-making, credit-creating society” by establishing new money. The Federal Reserve was used primarily to raise money through a wide variety of government-owned businesses, all of which were financed by public money, including the Federal Reserve, which would be required to create new money each month, or to lend money to such businesses for further payment. (It is important to note that the Federal Reserve was never part of any financial system and was never central planner, and the Federal Reserve Bank established for that purpose by way of an independent agency was not central planner.) The purpose of the Fed was also an opportunity for commercialization. During these years, Federal Reserve Banks began to receive capital, generally in small denominations, as payment for certain industries during the periods of economic disruption in their respective regions of expertise. The Federal Reserve Bank became a “trust fund” because “the power of the bank, and of the government, to issue money for its benefit is absolute in both the central and local political and economic branches of governments, and is of such importance for the safety, security, and welfare of the nation, that the bank reserves it should be paid for, and is not subject to any taxation, interference, or duty on it.” (Elvandigham, Federal Reserve System, 1877.)„In the early decades of the twentieth century, a number of Federal Reserve Banks began to receive and pay for their own stock holdings. The Federal Reserve Bank of the United States established an independent agency that operated for the benefit of shareholders and employees. The independent agency was created under the terms of the Federal Reserve Act of 1913. It provided for the creation of “an agency of money by transactions of money transactions.” (The Federal Reserve Board consisted of four members—one deputy director, four officers, and one secretary and two chief officers—and held more than $3,000,000 in shares. For a report by the Federal Reserve to the Congress, June 2, 1909, entitled ‘Bureau of Money’, see A New Economy of the Federal Reserve System, The Federal Reserve, 1913, at p. 853–854.)‟The President and Vice-President of the Federal Reserve Board and Chairman of the Federal Advisory Committee to the People were also involved in making decisions on the Federal Reserve System. (See also ‘Consul to the Federal Reserve’
”The Federal Reserve System was created in the second half of the 17th century. The Federal Reserve System was designed chiefly to provide cash for the banking system during a time of economic difficulties, unemployment, and inflation. The Federal Reserve System was designed to create a “money-making, credit-creating society, capable of growing new money for the benefit of all people.” The Fed was meant primarily to stimulate activity. (The Federal Reserve System, for example, was designed to provide an adequate reserve of a certain proportion of the outstanding government debt, but it also provided money for other business activity). Money could be put into the banks for the benefit of the government, and even an independent agency (a bank with some of the power to issue money, like the Bank of England) could act as a “money-making, credit-creating society” by establishing new money. The Federal Reserve was used primarily to raise money through a wide variety of government-owned businesses, all of which were financed by public money, including the Federal Reserve, which would be required to create new money each month, or to lend money to such businesses for further payment. (It is important to note that the Federal Reserve was never part of any financial system and was never central planner, and the Federal Reserve Bank established for that purpose by way of an independent agency was not central planner.) The purpose of the Fed was also an opportunity for commercialization. During these years, Federal Reserve Banks began to receive capital, generally in small denominations, as payment for certain industries during the periods of economic disruption in their respective regions of expertise. The Federal Reserve Bank became a “trust fund” because “the power of the bank, and of the government, to issue money for its benefit is absolute in both the central and local political and economic branches of governments, and is of such importance for the safety, security, and welfare of the nation, that the bank reserves it should be paid for, and is not subject to any taxation, interference, or duty on it.” (Elvandigham, Federal Reserve System, 1877.)„In the early decades of the twentieth century, a number of Federal Reserve Banks began to receive and pay for their own stock holdings. The Federal Reserve Bank of the United States established an independent agency that operated for the benefit of shareholders and employees. The independent agency was created under the terms of the Federal Reserve Act of 1913. It provided for the creation of “an agency of money by transactions of money transactions.” (The Federal Reserve Board consisted of four members—one deputy director, four officers, and one secretary and two chief officers—and held more than $3,000,000 in shares. For a report by the Federal Reserve to the Congress, June 2, 1909, entitled ‘Bureau of Money’, see A New Economy of the Federal Reserve System, The Federal Reserve, 1913, at p. 853–854.)‟The President and Vice-President of the Federal Reserve Board and Chairman of the Federal Advisory Committee to the People were also involved in making decisions on the Federal Reserve System. (See also ‘Consul to the Federal Reserve’
These forces led to the creation of the First Bank of the United States. As will be noted below, this was a quasi-central bank that lent money to the government as well as to the private sector. The overriding focus was to operate the bank with conservative efficiency. “Balance sheets for the years 1792-1800 reveal a generally high degree of success in maintaining the Banks specie reserves. The ratio between bank notes in circulation and specie holdings was quite small”(Foner/Garraty, 193). The problem was that the bank could not keep up with the growing need for capital. As will be examined below, this was one of the factors that led to the proliferation of state banks. During the 1791 to 1811 period, the number of state banks increased from 5 to 117, and their combined capital stock appreciated from $4.6 to roughly $66.5 million(Foner/Garraty, 193). This spectacular growth gave strength to state oriented economic growth. Naturally, de-centralist political forces began to evolve and conflicts ensued between federalists. The rest, as is often said, is history.
The Banking Controversy at the Turn of the 19th CenturyIt is impossible to appreciate the dynamics of the banking system in the first century of the 19th century without commenting on the ideological and political battles that took place between Alexander Hamilton and Thomas Jefferson at the close of the 18th century. Indeed, the underpinnings of the entire American political economy can be traced back to that turbulent and important period.
It is probably useful to start by discussing the thoughts of A. Hamilton, as he was more directly involved with the creation of the banking system than was Jefferson. Appointed by George Washington to be the Secretary of the Treasury at the tender age of 34, Hamilton was quick to put his ideologies into practice. He was