The American Banking System 1800-1810
Looking 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 bank’s charter was not renewed.
This paper will argue that the failure to renew the First Bank of the United State’s 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: http://odur.let.rug.nl/usa/E/usbank/bank03.htm).
This 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).
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 Bank’s 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 Century
It 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 “greatly influenced by the great 18th century Scottish economists, primarily David Hume, who considered the consequences and possibilities of the merger of their comparatively backwards, agrarian country with Britain, whose economy was largely mercantile” (http://financeservices.miningco.com/business/financeservices/gi/dynamic/offsite.htm?site=http://www.jmu.edu/polisci/madison/hamil19.htm%23Origins). As Hamilton knew, after the establishment of the Bank of England, the British economy operated on the basis of a funded national debt, it had a large paper capital’ base, and most importantly, the Bank of England issued notes that were considered superior to those offered by smaller banks. The prudence of the bank, though initially difficult to determine, ultimately proved very useful for the country. The position of the US, however, at least as Hamilton saw it, was similar to that that the Scots were facing. As such, what he firmly believed was that the banking system had to create the right conditions for the US, as a young and underdeveloped country, to be a competitor in the international market.
The first factor be perceived was that there were significant advantages to having a credit based economy. As Hume had noted, credit in the form of securities provided ready capital that could enable merchants to quickly develop the size and scope of their enterprises, leading in turn to economies of scale that would put downward pressure on prices and provide positive returns that could be used for reinvestment. Paper money, in the form of specie, could engender a more vigorous and outward oriented business culture that encouraged more impressive growth than landed wealth’. On the negative side, Hume also noted that funded debt made oppressive taxation necessary, as interest had to be paid. Moreover, it created disparities in wealth, indebted the nation to foreign powers, and promoted the idleness of the holders of securities because they had little to do other than play the market. Hume believed that the disadvantages of the credit based system greatly outweighed the advantages.
Hamilton, however, while considering Hume’s views, took more note of the success of the British system. To compete on a global scale, Hamilton felt that it was absolutely necessary for the US to fast-track to prominence. “Hamilton based his program primarily on the British model, with variations more suited to the United States’ unique characteristics. Public credit was to become the pillar of Hamilton’s fiscal reform package, the invigorating principle’ which would infuse the United States with the energy and international respectability he had envisioned. In order to stimulate the economy, Hamilton needed big investors. The support and capital of the nation’s wealthiest citizens would provide the foundation and security of his system. He wrote in 1780:
The only plan that can preserve the currency is one that will make it to the immediate interest of the monied men to cooperate with the government in its support….No plan could succeed which does not unite the interest and credit of rich individuals with that of the state(Flaherty, 1997).
Not surprisingly, many were critical of Hamilton’s idea. It seemed to many that he was in the business of creating an aristocracy. While this was not his express intention, it was neither his objective to create a society that was based on equality. He fully realized that the development of a strong central banking institution would not be equitable, but he did feel that the trickle down effect of re-investment would ultimately benefit the entire nation. Along this strain, he needed to secure the economic support of the wealthy, but this was not the extent of his plan. “He wanted to encourage the use of private wealth for beneficial enterprises. Hamilton envisioned a strong economy in which everyone could participate and profit. Landed wealth, represented by the Virginia opposition, was limiting and limited; whereas paper wealth was fluid, and opened up wider vistas in international trade and domestic industrialization. Industry would diversify labor, thus creating more jobs and income sources for a burgeoning population. Hamilton’s vision was dynamic and made use of all the possibilities of a young nation with unlimited resources and boundless potential(Flaherty, 1997). The problem the he soon faced, however, was that everyone did not share his vision.
By far the most boisterous opponent to Hamilton was Thomas Jefferson, though Hamilton’s long time friend and fellow federalist James Madison also had a number of retorts to make to his plan. The debates that ensued between these leading participants centered on Hamilton’s Reports on Public Credit’ that were presented to Congress in the last decade of the 18th century. There were several important elements to these reports that raised the backhairs of the opposition. The first was the widespread use of credit to secure rapid economic growth. The second, and more direct, tool was the revenue generating imposition of import tariffs and excise taxes. “To soften the blow of such a tax plan, Hamilton painted the items to be taxed as darkly as possible: They are all of them, in reality — luxuries — the greatest part of them foreign luxuriespernicious luxuries Spirits, which because of their cheapness’ are imbibed to an extreme, which is truly to be regretted, as well in regard to the health and the morals, as to the economy of the community”(http://financeservices.miningco.com/business/financeservices/gi/dynamic/offsite.htm?site=http://www.jmu.edu/polisci/madison/Twoviews.htm) A third controversial point was Hamilton’s belief that the federal debt, which was largely foreign, would be paid off in full. This, he believed, would inspire trust in the United State’s creditworthiness to both foreign and domestic investors upon whom the state may have to call upon in the future.
In response to this, Jefferson and Madison, both erstwhile friends and confidants of Hamilton, had several heated rebuffs. Most all of these came as a surprise to Hamilton,
and they left lasting personal and political scars from which he never quite recovered. Very briefly, Jefferson and Madison did not expressly object to paying back the national debt that had been accumulated during the war of independence, but they did not agree that it should be paid back in full, nor to all lenders. “During the course of the war and afterward, many holders of continental bonds, often veterans and farmers who had contributed goods and services to the war effort, sold their certificates at depreciated prices for much needed cash. Now that provisions had been made to fund the certificates, those who had bought bargain certificates would reap monstrous profits, leaving nothing for the original bearers. Madison argued that this was unfair, and only served to further enrich an already wealthy class of merchants and stock-jobbers’ at the expense of farmers, soldiers, and backwoodsmen. Madison favored a plan of discrimination, paying the original bearers the nominal value of the certificates they once held, while paying the current bearer the highest market value plus interest”( http://financeservices.miningco.com/business/financeservices/gi/dynamic/offsite.htm?site=http://www.jmu.edu/polisci/madison/Twoviews.htm).
More than this, what the debt repayment debate actually uncovered was the frothing tension between state and federal power. Hamilton’s plan inadvertently favored states that had retained large wartime debts over those that had quickly repaid. Wealthy states like Virginia had already paid back most of their debt and were therefore not advantaged by being prompt with their payment. Virginians retorted that there should be some balancing of the accounts between the states and the federal government. In the event of discrepancies or conflict, the ultimate decision should be based on the welfare of the state, not the federal government. The power that Hamilton had as the Secretary of the Treasury, however, gave him great leeway to act despite the arguments that Madison and Jefferson had made. Hamilton believed that the idea of trust and faith had to be at the root of any successful banking system. Employing the idea of discrimination against certain lenders completely undermined this necessity. “Investors needed faith in the strength of the system and the prospect of dividends before risking capital on an enterprise. It would be a breach of that faith if holders of public securities marked payable to the bearer’ were not given their due return. The United States needed to be consistent in its policies, and to uphold basic tenets of good faith from the outset in order to generate confidence with investors at home and abroad. In fact, the original bearers had already engaged in a speculation of their own. The current bearers, who had gambled on the certificates themselves, should not be penalized”( http://financeservices.miningco.com/business/financeservices/gi/dynamic/offsite.htm?site=http://www.jmu.edu/polisci/madison/Twoviews.htm). It was true that non-discrimination inherently strengthened the union, and this, one way or another, came at the expense of the strength of the states. The interests of public creditors had to be fused to the central government to ensure a consistent repayment of debts. Unlike the Bank of England, however, the central bank of the United States was, under the 2nd Report on Public Credit, aimed to be privately owned. This was intended to prevent the corruption that was evidently taking place at the Bank of England, as private ownership would encourage the board of directors to act in their own interests, which would ultimately make it a profitable institution with the requisite integrity to create the conditions necessary for growth.
Ultimately, Madison and Jefferson were successful in rallying this centralist effort to be a political monarchy. Madison claimed that the creation of such a central bank was unconstitutional, primarily because the constitution did not expressly allow for the United States government to create a bank or any other type of private corporation. Nevertheless, the plan was passed through Congress, with the north being distinctly in its favor, and the south being uniformly opposed.
The first decade of the 19th century was thus a continuation of this battle between the mercantilist centrists and those who advocated increased state power. At the helm of the first group was obviously Hamilton, and with increasing support, in the second boat were Jefferson and Madison. Previous to the arguments over the central bank, political parties were not an established part of the American landscape. However, what was perceived as inordinate power on the part of the Secretary of the Treasury, Hamilton, spurred Madison and Jefferson to rally for political support. They perceived that Hamilton’s victories were chipping into their own welfare, resulting in serious losses for their constituents and, probably even more importantly, themselves. This was construed as an emergency situation that demanded an organized resistance against Hamilton’s objectives. As we know, the result was the creation of the Republican Party.
To summarize the first decade of the 19th century is to basically reflect on the happenings of the last decade of the 18th century. As has been shown, this was a period of great upheaval in the US, primarily linked to the newness of the country. In the immediate years following the war of Independence, the US had racked up significant debts with both foreign and domestic creditors. The first controversy that marked the entire period was how this debt was to be repaid. Hamilton and his followers insisted that the creation of trust and good faith was essential to the development of a creditworthy country and a solid banking system. Following the British model, the development of a central bank was key towards this end. The problem, however, was that this explicitly gave the central government the upper hand over the states. Hamilton did not perceive this to be a problem. However, over time other politicians such as Madison and Jefferson did. In the last decade of the 18th century, each of these three men agreed that the confederation government was ineffective and needed to be altered if the US was to become a leading power. Each of them was in their own way dedicated to revamping the system in a way that would benefit the nation. The difference between their approaches, as has been made clear, was political. The key issue, incidentally the one that remains most controversial to this day, was and is states’ rights.
As an aside, it should be noted that the reasons for the state/federal controversy were probably rooted in the different personal experiences that the leading politicians of the late 18th, early 19th, century had. Hamilton was not attached in any way to a particular state. His eclectic experiences had focused him on efficiency and objectivity. He viewed strong local politics as destructive and inefficient. States could certainly participate in and perhaps even help achieve federal objectives, but the arguments for state sovereignty were to him completely absurd. In contrast stood Madison, who was a prominent member of the landed gentry. He and other Virginians widely referred to Virginia as their country’. He perceived it to be self-reliant and capable of ruddering its own political and economic destiny. While he did not expressly decry the idea of a central authority, over time the divisions between the mercantilist north and the planter society of the south became more clear, and more controversial. As pressure mounted, Madison’s position became more outwardly opposed to Hamilton’s, and the result was the birth of American political parties. Madison’s line was attractive to other political leaders, particularly in the southern states. Over the course of the 19th century, as we know, this led to the very divisive and bloody north/south debate.
In the final analysis, observing the first decade of the 19th century reveals that the banking system was basically in upheaval over the federal/state divide. Put another way, the decade was marked by the debate over central vs. state led banking. During the decade, the forces led by Alexander Hamilton were dominant, though consistently losing ground. The inordinate power bestowed upon Hamilton as the first Secretary of the Treasury, along with his ability to persuade Washington of his plan, allowed for the creation of a strong central bank that was efficiently run. Above all, Hamilton’s plan was to create a banking system that would allow the US to prosper, and gain integrity in the eyes of the international community. The operation of the First Bank of the US directly reflected these objectives. “The Bank carried a remarkable amount of liquidity. In 1809, for example, its specie/banknote ratio was about 40 percent (compared to a modern average reserve/deposit ratio of about 12 percent) making it probably the most liquid bank in the U.S. at the time. Despite the liquidity, the Bank was also profitable, earning most of its income through substantial loans to both government and private business. It helped to end several bank runs by transferring funds to banks in need of temporary liquidity”(Flaherty, 1997). As it turns out, the success of the bank was the factor that led to its demise. Roughly 20% of the bank notes in circulation throughout the United States belonged to the First Bank, making its money the closest thing to a national currency that existed. States were adverse to the relative power of this centralist institution, and based on the bitter conflicts between Madison and Hamilton over state vs. federal power, the bank itself became politicized. As state-led forces increased their popularity, it is wholly unsurprising that the First Bank of the US was one of the first things to go.
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