Currency and Banking

America’s first Treasury Secretary, Alexander Hamilton, is charged with transitioning from Britain’s Lb Sterling to a new U.S. currency. His first act is to establish a Mint to produce a range of metal coins.

17.0 Hamilton’s Minted Coins Hard Currency

But Hamilton is well aware that the domestic supply of gold and silver is far short of what he needs to create the economy he envisions based on capital investments in manufacturing and infrastructure projects. So he reluctantly turns to soft money “Bills of Credit” already being issued by state banks across the colonies. Given widespread doubt as to the “true value” of these notes, Hamilton demands that each bank maintain $1 in minted coins for every $3 worth of notes they print.

In 1791 he also establishes the First Bank of the United States dedicated to depositing the nation’s revenue and paying its bills, along with stabilizing the currency by insuring state bank compliance with the 3:1 ratio on reserves.

Beginning with Jefferson, the Anti-Federalists oppose the First Bank, arguing that it undercuts the state banks and that, as a private corporation not owned by the government, it is vulnerable to corruption by insiders. In 1811 President James Madison closes it down.

Meanwhile, formal chartering of banks rests mainly with state legislatures and their numbers grow year after year according to the U.S. Census.

17.1 Number of U.S. Chartered Banks

The Census also shows that the amount of outstanding loans signals that Hamilton’s wish for an expanded money supply is being met.

17.2 Amount of Loans Outstanding ($000)

But “boom and bust” cycles impact year to year variations. These typically involve external shocks which cause speculative loans to spike up and then fail. One example involves the up and down cycle surrounding America’s wars. From the War of 1812 to the 1846 Mexican War and the 1861 Civil War, banks make speculative loans to back investments in military supplies, often not covered by sufficient reserves. These pay out until the battles end and the demand for goods dries up, often leaving both bankers and lenders broke.

The conclusion of wars also brings on a downturn in the overall national economy. After the War of 1812, the negative impact is so severe that, in 1816, Treasury Secretary Albert Gallatin convinces Madison to charter the Second Bank of the United States to oversee the 3:1 reserves ratio. Like its predecessor, the bank is again a privately owned corporation, and under Nicholas Biddle, its third president, it becomes a leading force in supporting America’s remarkable economic success in the 1820’s.

Biddle’s leadership continues until Andrew Jackson arrives in the White House in 1829 eager to terminate the Second Bank. He regards all banks as the source of reckless speculation, issuing shady soft money notes and fueling growth of the federal debt. As historian Paul Kahan points out in his book, The Bank War, Jackson assaults the banks on two fronts. First he shuts down the Second Bank in 1836 by withdrawing all government revenue; then follows in 1837 with an Executive Order, the Specie Circular, requiring that new land bought from the government must be paid for in gold or silver coins (i.e. specie) not in banknotes.

The Specie Circular backfires, setting off the Panic of 1837, a “run on the banks” with spooked depositors attempting to cash in their “suspicious” soft money for gold or silver, only to find that many banks lack enough reserves to cover the demand.

Efforts to restore monetary stability by Jackson’s successor, Martin Van Buren, in 1840 and by James Knox Polk in 1846, lead to establishment of America’s first Independent Treasury. Historian John D.R. Platt recaps its operation as follows in his 1986 book commissioned by the New York branch:

• All money coming into the government will be deposited in the Independent Treasury.
• Across six locations: New York, Boston, Philadelphia, Charleston, St. Louis and New Orleans.
• The Secretary of the Treasury will be accountable for all payments out.
• Both incoming and outgoing transfers will be made in gold or silver specie.

The Independent Treasury remains until 1913 when President Woodrow Wilson initiates a plan to replace it with the Federal Reserve System which opens in 1920.

Economists tend to agree that the Independent Treasury was successful in supplying the capital Hamilton sought to support economic growth, while also holding down speculative loans and the levels of inflation.

Its demise ends the age of gold and silver as the monetary standard in favor of dollar bills, backed by the “full faith and credit of the U.S. Treasury.”

17.3 History of the Federal Banks