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XIV. Central Banking in the United States II: The 1820s to the Civil War


Out of the debacle of the Panic of 1819 emerged the beginnings of the Jacksonian movement dedicated to laissez-faire, hard money, and the separation of money and banking from the State. During the 1820s, the new Democratic Party was established by Martin Van Buren and Andrew Jackson to take back America for the old Republican program. The first step on the agenda was to abolish the Bank of the United States, which was up for renewal in 1836. The imperious Nicholas Biddle, head of the BUS who was continuing the chain of control over the Bank by the Philadelphia financial elite,1 decided to force the issue early, filing for renewal in 1831. Jackson, in a dramatic message, vetoed renewal of the Bank charter, and Congress failed to pass it over his veto.

Triumphantly reelected on the Bank issue in 1832, President Jackson disestablished the BUS as a central bank by removing Treasury deposits from the BUS in 1833, placing them in a number of state banks (soon called “pet banks”) throughout the country. At first, the total number of pet banks was seven, but the Jacksonians, eager to avoid a tight-knit oligarchy of privileged banks, increased the number to 91 by the end of 1836. In that year, as its federal charter ran out, Biddle managed to get a Pennsylvania charter for the Bank, and the new United States Bank of Pennsylvania managed to function as a regular state bank for a few years thereafter.

Historians long maintained that Andrew Jackson, by his reckless act of eliminating the BUS and shifting government funds to pet banks, freed the state banks from the restraints imposed upon them by a central bank. In that way, the banks allegedly were allowed to pyramid money on top of specie, precipitating an unruly inflation later succeeded by two bank panics and a disastrous inflation.

Recent historians, however, have demonstrated that the correct picture was precisely the reverse.2 First, under the regime of Nicholas Biddle, BUS notes and deposits had risen, from January 1823 to January 1832, from $12 million to $42.1 million, an annual increase of 27.9 percent. This sharp inflation of the base of the banking pyramid led to a large increase in the total money supply, from $81 million to $155 million, or an annual increase of 10.2 percent. Clearly, the driving force of this monetary expansion of the 1820S was the BUS, which acted as an inflationary spur rather than as a restraint on the state banks.

The fact that wholesale prices remained about the same over this period does not mean that the monetary inflation had no ill effects. As “Austrian” business cycle theory points out, any bank credit inflation creates a boom-and-bust cycle; there is no need for prices actually to rise. Prices did not rise because an increased product of goods and services offset the monetary expansion. Similar conditions precipitated the great crash of 1929. Prices need not rise for an inflationary boom, followed by a bust, to be created. All that is needed is for prices to be kept up by the artificial boom, and be higher than they would have been without the monetary expansion. Without the credit expansion, prices would have fallen during the 1820S, as they would have a century later, thereby spreading the benefits of a great boom in investments and production to everyone in the country.

Recent historians have also demonstrated that most of the state banks warmly supported recharter of the Bank of the United States. With the exception of the banks in New York, Connecticut, Massachusetts, and Georgia, the state banks overwhelmingly backed the BUS.3 But if the BUS was a restraining influence on their expansion, why did they endorse it?

In short, the BUS had a poor inflationary record in the 1820S, and the state banks, recognizing its role as a spur to their own credit expansion, largely fought on its behalf in the recharter struggle of the early 1830S.

Furthermore, the inflationary boom of the 1830S began, not with Jackson’s removal of the deposits in 1833, but three years earlier, as an expansion fueled by the central bank. Thus, the total money supply rose from $109 million in 1830 to $155 million at the end of 1831, a spectacular expansion of 35 percent in one year. This monetary inflation was sparked by the central bank, which increased its notes and deposits from January 1830 to January 1832 by 45.2 percent.4

There is no question, however, that the money supply and the price level rose spectacularly from 1833 to 1837. Total money supply rose from $150 million at the beginning of 1833 to $276 million four years later, an astonishing rise of 84 percent, or 21 percent per annum. Wholesale prices, in turn, rose from 84 in the spring of 1834 to 131 in early 1837, a rise of 52 percent in a little less than three years—or an annual rise of 19.8 percent.

The monetary expansion, however, was not caused by state banks going hog wild. The spark that ignited the inflation was an unusual and spectacular inflow of Mexican silver coins into the United States—brought about by the minting of debased Mexican copper coins which the Mexican government tried to keep at par value with silver. The system of fractional reserve banking, however, fundamentally was to blame for magnifying the influx of specie and pyramiding notes and deposits upon the specie base. In 1837, the boom came to an end, followed by the inevitable bust, as Mexico was forced to discontinue its copper coin issue by the outflow of silver, and the Bank of England, worried about inflation at home, tightened its own money supply and raised interest rates.5 The English credit contraction in late 1836 caused a bust in the American cotton export trade in London, followed by contractionist pressure on American trade and banks.

In response to this contractionist pressure—demands for specie—the banks throughout the United States (including the old BUS) promptly suspended specie payments in May 1837. The governments allowed them to do so, and continued to receive the notes in taxes. The notes began to depreciate at varying rates, and interregional trade within the United States was crippled.

The banks, however, could not hope to be allowed to continue on a fiat basis indefinitely, so they reluctantly began contracting their credit in order to go back eventually on specie. Finally, the New York banks were compelled by law to resume paying in specie, and other banks followed in 1838. During the year 1837, the money supply fell from $276 million to $232 million, a large drop of 15.6 percent in one year. Specie continued to flow into the country, but increased public distrust in the banks and demands to redeem in specie put enough pressure on the banks to force the contraction. In response, wholesale prices fell precipitately, by over 30 percent in seven months, declining from 131 in February 1837 to 98 in September of that year.

This healthy deflation brought about speedy recovery by 1838. Unfortunately, public confidence in the banks returned as they resumed specie payment, so that the money supply rose slightly and prices rose by 25 percent. State governments ignited the new boom of 1838 by recklessly spending large Treasury surpluses which President Jackson had distributed pro rata to the states two years earlier. Even more money was borrowed to spend on public works and other forms of boondoggle. The states counted on Britain and other countries purchasing these new bonds, because of the cotton boom of 1838. But the boom collapsed the following year, and the states had to abandon the unsound projects of the boom. Cotton prices fell and severe deflationist pressure was put upon the banks and upon trade. Moreover, the BUS had invested heavily in cotton speculation, and was forced once again to suspend specie payments in the fall of 1839. This touched off a new wave of general bank suspensions in the South and West, although this time the banks of New York and New England continued to redeem in specie. Finally, the BUS, having played its role of precipitating boom and bust for the last time, was forced to close its doors forever in 1841.

The crisis of 1839 ushered in four years of massive monetary and price deflation. Many unsound banks were finally eliminated, the number of banks declining during these years by 23 percent. The money supply fell from $240 million at the beginning of 1839 to $158 million in 1843, a seemingly cataclysmic drop of 34 percent, or 8.5 percent per annum. Wholesale prices fell even further, from 125 in February 1839 to 67 in March 1843, a tremendous drop of 42 percent, or 10.5 percent per year. The collapse of money and prices after 1839 also brought the swollen state government debts into jeopardy.

State government debt had totaled a modest $26.5 million in 1830. By 1835 it had reached $66.5 million, and by 1839 it had escalated to $170 million. It was now clear that many states were in danger of default on the debt. At this point, the Whigs, taking a leaf from their Federalist forebears, called for the federal government to issue $200 million worth of bonds in order to assume all the state debt.

The American people, however, strongly opposed federal aid, including even the citizens of the states in difficulty. The British noted in wonder that the average American seemed far more concerned about the status of his personal debts than about the debts of his state. To the worried question, Suppose foreign capitalists did not lend any further to the states? the Floridian replied, “Well who cares if they don’t. We are now as a community heels over head in debt and can scarcely pay the interest.”6

The implication was clear: The disappearance of foreign credit to the states would be a good thing; it would have the healthy effect of cutting off their further wasteful spending, as well as avoiding the imposition of a crippling tax burden to pay for the interest and principal. There was in this astute response an awareness by the public that they and their governments were separate and sometimes even hostile entities rather than all part of one and the same organism.

The advent of the Jacksonian Polk administration in 1845 put an end to the agitation for Federal assumption of the debt, and by 1847, four western and southern states had repudiated all or part of their debts, while six other states had defaulted from three to six years before resuming payment.7

Evidently, the 1839–43 contraction and deflation was a healthy event for the economy, since it liquidated unsound investments, debts, and banks, including the pernicious Bank of the United States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment—as we have generally been led to believe? Oddly enough, no. It is true that real investment fell by 23 percent during the four years of deflation, but, in contrast, real consumption increased by 21 percent and real GNP by 16 percent during this period. It seems that only the initial months of the contraction worked a hardship. And most of the deflation period was an era of economic growth.8

The Jacksonians had no intention of leaving a permanent system of pet banks, and so Jackson’s chosen successor Martin Van Buren fought to establish the Independent Treasury System, in which the federal government conferred no special privilege or inflationary prop on any bank; instead of a central bank or pet banks, the government was to keep its funds solely in specie, in its own Treasury vaults or “subtreasury” branches. Van Buren managed to establish the Independent Treasury in 1840, but the Whig administration repealed it the following year. Finally, however, Democratic President Polk installed the Independent Treasury System in 1846, lasting until the Civil War. At long last, the Jacksonians had achieved their dream of severing the federal government totally from the banking system, and placing its finances on a purely hard money, specie basis. From now on, the battle over money would shift to the arena of the states.


After the financial crises of 1837 and 1839, the Democratic Party became even more Jacksonian, more ardently dedicated to hard money, than ever before. The Democrats strived during the 1840s and 1850s, for the outlawing of all fractional reserve bank paper. Battles were fought during the late 1840s, at constitutional conventions of many western states, in which the Jacksonians would succeed in outlawing such banking, only to find the Whigs repealing the prohibition a few years later. Trying to find some way to overcome the general revulsion against banks, the Whigs adopted the concept of free banking, which had been enacted in New York and Michigan in the late 1830s. Spreading outward from New York, the free banking concept triumphed in 15 states by the early 1850S. On the eve of the Civil War, 18 out of the 33 states in the U.S. had adopted free banking laws.9

It must be emphasized that free banking before the Civil War was scarcely the same as the economic concept of free banking we have set forth earlier. Genuine free banking, as we have noted, exists where entry into the banking business is totally free, where banks are neither subsidized nor controlled, and where at the first sign of failure to redeem in specie, the bank is forced to declare insolvency and close its doors.

Free banking before the Civil War, however, was very different. Vera C. Smith has gone so far as to call the banking system before the Civil War, “decentralization without freedom,” and Hugh Rockoff labeled free banking as the “antithesis of laissez-faire banking laws.”10 We have already seen that general suspensions of specie payments were periodically allowed whenever the banks overexpanded and got into trouble; the last such episode before the Civil War being in the Panic of 1857. It is true that under free banking incorporation was more liberal, since any bank meeting the legal regulations could be incorporated automatically without having to lobby for a special legislative charter. But the banks were subject to a myriad of regulations, including edicts by state banking commissioners, along with high minimum capital requirements which greatly restricted entry into the banking business. The most pernicious aspect of free banking was that the expansion of bank notes and deposits was tied directly to the amount of state government bonds which the bank had invested in and posted as security with the state. In effect, then, state government bonds became the reserve base upon which the banks were allowed to pyramid a multiple expansion of bank notes and deposits. This meant that the more public debt the banks purchased, the more they could create and lend out new money. Thus, banks were induced to monetize the public debt, state governments were encouraged to go into debt, and government and bank inflation were intimately linked.

In addition to allowing periodic suspension of specie payments, federal and state governments conferred upon the banks the highly valuable privilege of having their notes accepted in taxes. And the general prohibition of interstate (and sometimes intrastate) branch banking greatly inhibited the speed by which one bank could demand payment from another in specie. The clearing of notes and deposits, and hence the free market limit on bank credit expansion, was thereby weakened.

The desire of state governments to finance public works was an important factor in their subsidizing and propelling the expansion of bank credit. Even Bray Hammond, scarcely a hard money advocate, admits that “the wildcats lent no money to farmers and served no farmer interest. They arose to meet the credit demands not of farmers (who were too economically astute to accept wildcat money) but of states engaged in public improvements.”11

Despite the flaws and problems in the decentralized nature of the pre-Civil War banking system, the banks were free to experiment on their own to improve the banking system. The most successful such device, which imposed a rapid and efficient clearing system on the banks of New England, was the privately developed Suffolk System.

In 1824, the Suffolk Bank of Boston, concerned for years about an influx of depreciated notes from various country banks in New England, decided to purchase country bank notes and systematically call on the country banks for redemption. By 1825, country banks began to give in to the pressure to deposit specie with the Suffolk, so as to make redemption of their notes by that bank far easier. By 1838, furthermore, almost every bank in New England was keeping such deposits, and was redeeming its liabilities in specie through the medium of the Suffolk Bank.

From the beginning to the end of the Suffolk System (1825–58), each country bank was obliged to maintain a permanent specie deposit of at least $2,000 ranging upward for larger sizes of bank. In addition to the permanent minimum deposit, each bank had to keep enough specie at the Suffolk Bank to redeem all the notes that Suffolk received. No interest was paid by the Suffolk Bank on these deposits, but Suffolk performed the invaluable service of accepting at par all the notes received from other New England banks, crediting the depositor banks' accounts the following day.

As the result of Suffolk acting as a private clearing bank, every New England bank could automatically accept the notes of any other bank at par with specie. In contrast to the general state bank approval of the Bank of the United States (and later of the Federal Reserve System), the banks greatly resented the existence of the Suffolk Bank’s tight enforcement of specie payments. They had to play by the Suffolk rules, however, else their notes would depreciate rapidly and circulate only in a very narrow area. Suffolk, meanwhile, made handsome profits by lending out the permanent, noninterest paying deposits, and by making overdrafts to the member banks.

Suffolk System members fared very well during general bank crises during this period. In the Panic of 1837, not one Connecticut bank failed, or even suspended specie payments; all were members of the Suffolk System. And in 1857, when specie payment was suspended in Maine, all but three banks (virtually all members of the Suffolk System) continued to pay in specie.12

The Suffolk System ended in 1858 when a competing clearing bank, the Bank of Mutual Redemption, was organized, and the Suffolk System petulantly refused to honor the notes of any banks keeping deposits with the new bank. The country banks then shifted to the far laxer Bank of Mutual Redemption, and the Suffolk Bank stopped its clearing function in October 1858, becoming just another bank. Whatever the error of management in that year, however, the Suffolk System would have been swept away in any case by the universal suspension of specie payments at the start of the Civil War, by the National Banking System installed during the war, and by the prohibitive federal tax on state bank notes put through during that fateful period.13

  • 1. See Philip H. Burch, Elites in American History: The Civil War to the New Deal (Teaneck, N.J.: Holmes and Meier, 1981).
  • 2. For an excellent survey and critique of historical interpretations of Jackson and the Bank War, see Jeffrey Rogers Hummel, “The Jacksonians, Banking and Economic Theory: A Reinterpretation,” The Journal of Libertarian Studies 2 (Summer 1978): 151–65.
  • 3. See Jean Alexander Wilburn, Biddle’s Bank: The Crucial Years (New York: Columbia University Press, 1970), pp. 118–19.
  • 4. See Peter Temin, The Jacksonian Economy (New York: W.W. Norton, 1969).
  • 5. Mexico was shown to be the source of the specie inflow by Temin, Jacksonian Economy, p. 80, while the cause of the inflow in the minting of debased Mexican copper coins is pinpointed in Hugh Rockoff, “Money, Prices, and Banks in the Jacksonian Era,” in R. Fogel and S. Engerman, eds., The Reinterpretation of American Economic History (New York: Harper & Row, 1971), p. 454.
  • 6. The Floridian, March 14, 1840. Quoted in Reginald C. McGrane, Foreign Bondholders and American State Debts (New York: Macmillan, 1935), pp. 39–40. Americans also pointed out that the banks, including the BUS, who were presuming to take the lead in denouncing repudiation of state debt, had already suspended specie payments and were largely responsible for the contraction. Let the bondholders look to the United States Bank and to the other banks for their payment declared the people. Why should the poor be taxed to support the opulent classes in foreign lands who, it was believed, held the bulk of these securities. (p. 48)

  • 7. The four states which repudiated all or part of their debts were Mississippi, Arkansas, Florida, and Michigan; the others were Maryland, Pennsylvania, Louisiana, Illinois, and Indiana.
  • 8. In a fascinating comparative analysis, Professor Temin contrasts this record with the disastrous contraction a century later, from 1929–33. During the latter four years, the money supply and prices fell by slightly less than in the earlier period, and the number of banks in existence by more. But the impact on the real economy was strikingly different. For in the later deflation, real consumption and GNP fell substantially, while real investment fell catastrophically. Temin properly suggests that the very different impact of the two deflations stemmed from the downward flexibility of wages and prices in the nineteenth century, so that massive monetary contraction lowered prices but did not cripple real production, growth, or living standards. In contrast, the government of the 1930s placed massive roadblocks on the downward fall of prices and particularly wages, bringing about a far greater impact on production and unemployment. Temin, Jacksonian Economy, pp. 155ff.
  • 9. Hugh Rockoff, The Free Banking Era: A Re-Examination (New York: Arno Press, 1975), pp. 3–4.
  • 10. Vera C. Smith, The Rationale of Central Banking (London: P.S. King & Son, 1936), p. 36, also ibid., pp. 148–49, Hugh Rockoff, “Varieties of Banking and Regional Economic Development in the United States, 1840–1860,” Journal of Economic History 35 (March 1975): 162, quoted in Hummel, “Jacksonians,” p. 157.
  • 11. Bray Hammond, Banks and Politics in America: From the Revolution to the Civil War (Princeton, N.J.: Princeton University Press, 1957), p. 627. On the neglected story of the Jacksonians versus their opponents on the state level after 1839, see William G. Shade, Banks or No Banks: The Money Issue in Western Politics, 1832–1865 (Detroit: Wayne State University Press, 1972); Herbert Ershkowitz and William Shade, “Consensus or Conflict? Political Behavior in the State Legislatures During the Jacksonian Era,” Journal of American History 58 (December 1971): 591–621; and James Roger Sharp, The Jacksonians versus the Banks: Politics in the States After the Panic of 1837 (New York: Columbia University Press, 1970).
  • 12. John Jay Knox, historian and former U.S. Comptroller of the Currency, concluded from his study of the Suffolk System that private clearing house service is superior to that of a government central bank: the fact is established that private enterprise could be entrusted with the work of redeeming the circulating notes of the banks, and that it could thus be done as safely and much more economically than the same service can be performed by the Government. John Jay Knox, A History of Banking in the United States (New York: Bradford Rhodes & Co., 1900), pp. 368–69.
  • 13. On the Suffolk System, see George Trivoli, The Suffolk Bank: A Study of a Free-Enterprise Clearing System (London: The Adam Smith Institute, 1979).
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