A Short History of Paper Money and Banking

When the uninitiated hear of Banks having capitals of 500,000 or of 1,000,000 dollars, they suppose that these institutions had at their commencement, or some time after, real money to this amount. It is a very natural supposition; but not a true one. The Banks create their own capitals in the same manner that they create the money they lend to the people.

The usual method of proceeding is as follows:

An act is passed by the Legislature to authorize the establishment of a Bank, and certain persons, called Commissioners, are appointed to receive subscriptions. It is provided in the act that the amount subscribed shall be paid in instalments of five or ten dollars in specie, or the notes of specie-paying Banks, and that after one or two instalments shall have been paid in, the Bank shall commence operations.

The first instalment, which we shall suppose to be five dollars on a share, enables the Bank to purchase desks and a counter, and to pay for engraving and printing its notes. It has then the necessary apparatus for commencing operations, and has, perhaps, a specie fund in reserve of three or four dollars for each share of stock, to meet contingencies.

It then begins to discount notes and circulate paper. The spare cash of those who have dealings with it, are deposited in its vaults. This fund enables it to extend its operations. As the Bank notes will serve the purposes of trade in the neighborhood, the specie is sent to distant places to procure commodities. This leaves open a new channel for the circulation of paper: and the Bank increases the amount of its issues. Then comes the time for paying the second, third, or fourth instalment. The Bank makes a call on the stockholders. Some of them hypothecate their stock, that is, pledge it to the Bank, and with the means obtained from the Bank itself pay in their proportion. Others have obtained the means by discounts of accommodation notes, without any hypothecation of stock. Some few pay in real money: but they generally pay in the notes of the Bank itself, or of similar institutions.

It is by this kind of hocus-pocus that Bank capitals are formed. After the first instalment is paid, the Bank by its own operations, facilitates the paying of the others.

The Bank of Pennsylvania and that of the United States have more pretensions than most others to solidity of capital. It was provided in their charters, that a portion of their instalments should be paid in Government stock. This is not a convenient form for loanable capital, which, it might be supposed, is what Banks should possess. But the peculiar profits of Banks are derived from credit and circulation, and they want no more real capital of any kind than is necessary to support their credit.

It is difficult to say in what the capitals of the other Banks ever consisted, unless it be in what it consists at present—in the promissory notes of individuals. Now, the Banks did not obtain these promissory notes by lending real money of their own, for they had it not to lend. They obtained these promissory notes of the stockholders, by giving in exchange for them the promissory notes of the Bank. Thus Bank capitals are formed by exchanging one kind of promises to pay for another kind of promises to pay.

This mode of forming Bank capitals, with the stock notes of the subscribers, is not peculiar to Banks of the second and third order. The Banks of the most approved standing have formed their capitals in the same way.

The nominal capital of the old Bank of the United States, was ten millions of dollars. One-fifth part of this, or two millions of dollars, was subscribed by the National Government; but the National Government having no money to pay its subscription, professed to borrow from the Bank. And the Bank having no money to lend, passed a credit of two millions in its books to the Government on which it paid six per cent. The Government, in its turn, received the dividends on 5,000 shares of stock of 400 dollars each at par value.

The residue of the capital, or eight millions, was subscribed by individuals, and was to be paid, three-fourths in six per cent. stock, and one-fourth in specie, in four six-monthly instalments of five hundred thousand dollars each. “No more,” says Dr. Erick Bollman, “or little more than the first instalment, can ever be considered as having been received by the Bank actually in hard money.”1

The capital of the present Bank of the United States was fixed by its charter at thirty-five millions, of which Government subscribed seven; but Government having, as in the former instance, no money, the Bank granted it a credit to this amount.

The remaining twenty-eight millions of stock were subscribed for by individuals. On each share of the stock, they were, agreeably to the terms of charter, to pay five dollars in gold or silver coin at the time of subscribing; at the expiration of six months the further sum of ten dollars: and at the expiration of twelve months, the further sum of ten dollars. At each of those three periods, twenty-five dollars more were to be paid, on each share, either in United States stock, or in gold and silver coin, at the option of the sub scribers.

No more or very little more, than the first instalment of five dollars on each share, was paid in gold or silver coin. The Directors, indeed, proceeded on the principle that no more was necessary. “It is clear,” says one of them, “that having commenced business, and put its paper in circulation, it (the Bank) could not enforce the specie part of the second and third instalments of the capital, in new acquisitions of specie. *  *  *  * The Directors acted wisely in discounting the notes of the stockholders, payable in specie, sixty days after date, for the payment of the second instalment.”2

It is contended by the founders of these institutions, that this mode of forming Bank stock, is perfectly correct. If it is, stock may be created to almost any amount. The Bank risks nothing, and does not increase its circulation; for the notes which it pays out at one counter in discounting stock notes, are paid in at another counter in subscriptions. The subscribers pay a certain sum to the Bank as borrowers: but they receive back the same amount as stockholders. The whole business, is nothing but a paper transaction between the Bank and its stockholders.

Many of the present owners of stock have paid their hundred dollars’ worth of property, or perhaps given an advance of twenty per cent. for the shares they hold: but what they paid, never went to form the capitals of the Banks. They paid it to the original subscribers or to those who bought script from the original subscribers.

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3 Paragraphs on Banks, Philadelphia, 1811. Dr. Bollman was a zealous advocate for the renewal of the charter of the Bank.

4 “A Friendly Monitor,” Philadelphia, published December 15,1819, and re-published September 17, 1822.

• 1* Letter to Mr. Gallatin, by Publicola, New York, 1815.
• 2* See Say, Book, Chap. xxi, Section 2.
• 3“In most disquisitions upon the noxious tendency of Banks,” says another writer* “much stress has been laid upon the injuries they have a power to inflict, by excessive loans and consequent bankruptcy, and by creating and circulating a permanent excess of currency. Could these two evils be avoided, many believe that Banks would be innoxious. I regret to differ. I am not of those who imagine that Banks incorporated with a liberal capital, will ever endanger their solvency by extending their loans; nor of those who believe that Banks controlled by specie payment, can circulate a permanent excess of paper. And yet, I think I can perceive a portentous power that they exercise over commercial enterprize. I am of opinion that they can circulate a temporary excess of paper, which, from time to time, finds a corrective, in a run upon the Banks for specie; that this temporary excess is succeeded by a temporary deficiency, one extreme invariably tending to another; that the consequences of this alternate excess and deficiency are, in the former case to impart an undue excitement, and in the latter an undue depression to commercial enterprize; that the effect of the former is to create an unnatural facility in procuring money, and to enhance unnaturally the price of commodities; while that of the latter is to produce an artificial scarcity, and to cheapen prices artificially; that the victims of these vibrations are the great body of merchants, whose capital and average deposits cannot always command discounts; that the gainers are a few intelligent and shrewd capitalists, the magnitude of whose deposits commands enormous discounts at all times, and who, being behind the curtain, know when to buy and when to sell. I am of opinion that these vibrations inflict evils which close not with mercantile speculation; that they tend to unhinge and disorder the regular routine of commerce, and introduce at one moment a spirit of wild and daring speculation, and at another, a prostration of confidence, and stagnation of business: that these feelings are transferred from the counting-house to the fire-side; that the visionary profits of one day stimulate extravagance, and the positive losses of another engender spleen, irritation, restlessness, a spirit of gambling and domestic inquietude.
• 4Because they are divisible into extremely minute portions, and capable of re-union without any sensible loss of weight or value; so that the quantity may be easily apportioned to the value of the articles of purchase.*