Archive for October 6th, 2009

The development of the national banking system 1791-1836

The First Bank of the United States was born in 1791 in the aftermath of the Revolutionary War, and was part of Secretary of the Treasury Alexander Hamilton’s plan to unite the country economically. In 1811, the First Bank of the US ceased operations when Congress allowed its charter to expire in light of continued arguments about its constitutionality and charges that it was undemocratic. However, after the United States fought the War of 1812, and once again, as in the Revolution, faced problems with inflation and paying war expenses, a Second Bank of the United States was chartered. Problems facing the country included a lack of a national currency and spiraling inflation. The headquarters of the Bank was in Philadelphia, which helped make this city the financial center of the growing US economy.

The First BUS had helped check unregulated state banks demanding than any worthless paper money issued by these banks would have to be redeemed in gold or silver coin. Once the First BUS was gone, however, worthless paper money once again was issued and inflation exploded again. Businesses and manufacturers would often refuse to accept this money outright or would sometimes discount its value by as much as 40%.

By the end of the War of 1812, the US Treasury teetered on the verge of bankruptcy because it was forced by law to accept this useless paper currency as tax payments—thus, it became a kind of repository of worthless money. In addition, often, federal officials were unable to use money collected in one part of the country to pay debts owed in other parts of the country. This situation forced even Congressmen who had previously opposed the First BUS to support the creation of the Second BUS. It was argued that solving the crisis was a matter of patriotism. Speaker of the House Henry Clay, who had led the charge against the First BUS, admitted publicly that he had been wrong and that he now believed that Congress had the power to charter a national bank after all. The Second BUS was given a twenty-year charter capitalized with the then-enormous sum of $35 million, and was the holder of all federal deposits. It was empowered to issue paper currency and had the ability, essentially, to set interest rates for the nation. It was able to use its power to halt the issuance of worthless paper currency by some state banks, thus curtailing their ability to make loans and placing them at a competitive disadvantage with the BUS. Although it could make short-term loans to state banks, its primary function was  to limit the amount of credit issued by those same state banks.The second Bank of the United States would grow in power – so much power, that, once again, when its charter neared expiration in the early 1830s, it had become the object of much hatred.

The Panic of 1819 was blamed upon the actions of the Second BUS in attempting to limit credit. Andrew Jackson made opposition to the BUS one of his first priorities upon his election. Jackson’s great adversary decided to try to forestall any action by Jackson against the Bank by pushing the Bank’s chairman, Nicholas Biddle, into seeking an early renewal of the Bank’s charter since there was support in both the House and the Senate as well as support in Jackson’s cabinet for the Bank (barring Jackson and his Attorney General, Roger Taney). When Jackson was presented with the recharter bill, he initiated the Bank War of 1832-34 when he vetoed  the bill and vehemently criticized the bank as the tool of a wealthy eastern elite.

In his veto message, Jackson even criticized the growing power of the Supreme Court, which had declared the Bank constitutional in the 1819 case of McCulloch v.Maryland. He claimed, “The opinion of the judges has no more authority over Congress than the opinion of Congress has over the judges, and on that point the President is independent of both.” Jackson believed that as someone elected by the people, he, rather than appointed judges, should be able to determine the constitutionality of laws and institutions. This position would have magnified the current understanding of executive power far beyond what any previous president had claimed. This astounding stance even caused rivals like Clay, Webster, and Calhoun to denounce Jackson’s attempted power grab, and many began to denounce Jackson as King Andrew. Despite the criticism from politicians, many of the common people that Jackson claimed he represented were willing to agree with his criticism of what he called  “the hydra headed monster,” and Jackson overwhelmingly won re-election in 1832. In November of that year, Jackson announced his intention to withdraw all federal funds from the BUS and placing all federal money in smaller state banks, known as “pet banks.” Nicholas Biddle tried to force Jackson’s hand by tightening credit under the explanation of having to deal with the withdrawal of funds, but he continued the policy even after the temporary crisis had passed as a political ploy. This triggered a recession, and some people from all over the country called on the Jackson to reverse his policy and restore the bank’s deposits. Jackson refused, and the crisis backfired on Biddle when the Bank was then the subject of a series of harsh resolutions criticizing the Bank for the chaos caused by shrinking the credit market. All Jackson then had to do was wait until the charter expired in 1836. The Second Bank of the US then itself became a state bank—the United States Bank of Pennsylvania—which would go bankrupt just five years later.

The end result of Jackson’s fiscal policies included an inundation of questionable paper money into the economy once the BUS was no longer there to check this destructive habit. Land speculation in the West became so superheated that Jackson eventually tried to use his Specie Circular of July 1836 to slow inflation as he demanded that all federal lands be bought with specie of silver or gold rather than paper money. This had the consequence of shutting all but wealthy speculators out of the land market in the West, and left eastern banks perilously short of specie as it was used to purchase Western lands. The government had meanwhile accumulated a surplus of funds from its high tariffs, and Jackson decided to distribute the extra funds to the states under the Distribution Act (since there was no longer a national bank in which to deposit this money). These so-called “loans” were quickly spent, mostly on internal improvements, with no intention of being paid back. Although this helped expand the transportation system nationally, it also led to more inflation as more specie was once again drained from the “pet banks” to pay for investments in the West. It would be nearly three decades before another national banking system was even attempted.