A Short History of Paper Money and Banking

Mr. John F. Watson, the Cashier of the Bank of Germantown, in his “Annals of Philadelphia,” gives the following testimony of an ancient lady, respecting the manner in which commercial affairs were conducted previous to the Revolutionary War. “If a citizen failed in business, it was a cause of general and deep regret. Every man who met his neighbor, spoke of his chagrin. It was a rare occurrence, because honesty and temperance in trade were then universal.”

In another part of his book, Mr. Watson speaks of the changes which have in this respect taken place, within his own short period of observation. “When I was a boy, as none got suddenly rich by monopolies, they went through whole lives gradually but surely augmenting their estates, without the least fear of misfortune or bankruptcy. When it did rarely occur, such was the surprise and general sympathy of the public, that citizens saluted each other with sad faces, and made their regrets and condolence a matter of common concern. An aged person has told me, that, when the proprietor of that large house, formerly the Post Office (now the National Hotel) at the corner of Chesnut street and Carpenter’s Court, suddenly failed in business, the whole house was closely shut up. for one week, as an emblem of the deepest family mourning, and all who passed the house instinctively stopped, and mingled the expressions of their liveliest regret. Now how are changed matters in those particulars.”

They are so changed, that a certain number of bankruptcies and insolvencies in the course of a year, are regarded as being as much within the order of nature as a certain number of deaths. Periodical redundancies and scarcities of money are looked for as naturally as cold in winter or heat in summer. If a great storm occurs, or a pestilence sweeps over the land, the journalists record it: and so they record great pressures for money, but they think no more of noting the effects of ordinary “expansions” and “contractions “than of noting the ordinary variations of the weather.

A gentleman who resided for twenty-five years in the town of Barcelona, a town which does most of the import and export business of the fertile and industrious province of Catalonia, has told us that during the whole period of his residence there, but one bankruptcy occurred. It may be difficult for many Americans of the present day to conceive such a state of things to be possible. But it is possible; and a faithful relation of the pecuniary vicissitudes of one of our ordinary years, might be received as incredulously by many plain Swiss and Hollanders, as some Americans receive accounts of countries and cities where bankruptcies and insolvencies are events of rare occurrence.

But, to return to our narrative. By September, 1826, the violence of the reaction which followed the expansion of 1824–25, had subsided: and through the year 1827, things went on smoothly. The two first months of 1828 also passed over without any convulsion: but in the beginning of March, a sudden and unexpected scarcity of money was felt in Philadelphia.

If we were engaged in frequent wars, or if the state of the world at large was such as it was in the twenty years which followed the French Revolution, ingenuity might be able to give a plausible view of the causes of the frequent scarcities of money, independent of the operations of Banking institutions. But we have enjoyed peace for seventeen years in succession. Most other commercial countries have been in the enjoyment of peace. It has, therefore, become impossible to conceal from observers, the effects which paper money Banking institutions have on commercial affairs. That the scarcity of money in 1828 was owing to their operations, was so evident, that no body doubted, nobody disputed it. No other cause could be assigned for it. And Mr. Biddle, the President of the United States’ Bank, published an essay in the National Gazette, on the 10th of April, in which he gave the following elegant and lucid exposition of one of the causes of the evils the community was then suffering.

“The question is, what is the cause and the nature of the present scarcity of money?

“The answer is easy.

“The currency of the United States consists of coin, and of Bank notes promising to pay coin. As long as the Banks can always pay the coin they promise they are useful, because, in a country where the moneyed capital is disproportioned to the means of employing capital, the substitution of credits for coins enables the nation to make its exchanges with less coin, and of course, saves the expense of that coin. But this advantage has by its side a great danger. Banks are often directed by needy persons, who borrow too much, or by sanguine persons, anxious only to increase the profits, without much pecuniary interest or personal responsibility in the administration. The constant tendency of Banks is, therefore, to lend too much, and to put too many notes in circulation. Now, the addition of many notes, even while they are as good as coin by being always exchangeable for coin, may be injurious, because the increase of the mixed mass of money generally occasions a rise in the price of all commodities. The consequence is, that the high price of foreign productions tempts foreigners to send a large amount of their commodities, while the high price of domestic productions prevents these foreigners from taking in exchange a large amount of our commodities. When, therefore, you buy from foreigners more than they buy from you, as they cannot take the paper part of your currency, they must take the coin part. If this is done to a considerable extent, the danger is that the Banks will be obliged to pay so much of their coin for their notes as not to leave them a sufficient quantity to answer the demand for it, in which case the Banks fail, and the community is defrauded. To prevent this, a prudent Bank, the moment it perceives an unusual demand for its notes, and has reason to fear a drain on its vaults, should immediately diminish the amount of its notes, and call in part of its debts. So, on a large scale, when the Banks of a country perceive such a demand for coin for exportation as diminishes too much the stock of coin necessary for their Banking purposes, they should stop the exportation. This they can always do if their affairs have been well managed: and here lies the test of Bank management.

“The law of a mixed currency of coin and paper is, that when, from superabundance of the mixed mass, too much of the coin part leaves the country, the remainder must be preserved by diminishing the paper part, so as to make the mixed mass more valuable in proportion. It is this capacity of diminishing the paper which protects it. Its value consists in its elasticity—its power of alternate expansion and contraction, to suit the state of the community; and when it loses its flexibility, it no longer contains within itself the means of its own defence, and is full of hazard. In truth, the merit of a Bank is nearly in proportion to the degree of this flexibility of its means. If a Bank lends its money on mortgages, on stocks—for long terms, and to persons careless of protests, it incurs this great risk, that, on the one hand, its notes are payable on demand, while, on the other, its debts cannot be called in without great delay—a delay fatal to its credit and character. This is the general error of Banks, who do not always discriminate between two things essentially distinct in Banking, a debt ultimately secure, and a debt certainly payable. But a well-managed Bank has its funds mainly in short loans to persons in business—the result of business transactions—payable on a day named, which the parties are able to pay and will pay at any sacrifice, in order to escape mercantile dishonor. Such a Bank has its funds, therefore, constantly repaid into it, and is able to say whether it will or will not, lend them out again.

“A Bank so managed, if it finds too much demand for its coin to go abroad, begins by not lending more than it receives every day, and then goes farther, by not lending as much as its income, declining to renew the notes of its debtors, and obliging them to pay a part or the whole: making it a rule to keep its discounts within its income. The operation proceeds thus: by issuing no new notes, but requiring something from your debtors, you oblige them to return to you the Bank notes you lent them, or their equivalents. This makes the Bank notes scarcer—this makes them more valuable—this makes the goods for which they are generally exchanged less valuable—the debtor, in his anxiety to get your notes, being willing to sell his goods at a sacrifice—this brings down the prices of goods, and makes every thing cheaper. Then the remedy begins. The foreigner, finding that his goods must be sold so low, sends no more. The American importer, finding that he cannot make money by importing them, imports no more. The remainder of the coin, of course, is not sent out after new importations, but stays at home, where it finds better employment in purchasing these cheap articles; and when the foreigner hears of this state of things, he sends back the coin he took away. He took it away merely because your own domestic productions were so high that he could not make any profit in his country by taking them. But when the news reaches him that his productions are very cheap in our country, he will also learn that our productions are cheap too, and he sends back the coin to buy these cheap productions of ours. We, therefore, get back our coin by diminishing our paper, and it will stay until drawn away by another superabundance of paper. Such is the circle which a mixed currency is always describing. Like the power of steam, it is eminently useful in prudent hands, but of tremendous hazard when not controlled; and the practical wisdom in managing it lies in seizing the proper moment to expand and contract it—taking care, in working with such explosive materials, whenever there is doubt, to incline to the side of safety.

“These simple elements explain the present situation of the country. Its disorder is over-trading, brought on by over-banking. The remedy is to bank less, and to trade less.

“During the last year, money was very abundant—that is, the demand for coin being small in proportion, the Banks distributed freely their discounts and notes. This plenty concurred with other causes, especially the expectation of a new tariff, to induce an increased importation of foreign goods, and, at the same time, furnish great facility for procuring them on credit. For instance, in the difficulty of procuring profitable investments, there were found capitalists who exported the coin of the country, and sold their bills for it on credit—thus obtaining a small profit on the shipment, and a greater on the discount of the notes taken for their bills. This fraction of a per centage on the shipment of coin, seems to be a trifling gain for the great inconvenience to which it often subjects the community; but the profit, though small, is lawful, and no odium should attach to the agents, for the operation is often a wholesome corrective of excessive issues of paper. The effect was, that by the month of February, the exportations of specie to France and England had become unusually large, amounting, probably, in the preceding twelve months, to between four and five million dollars; and great importations were constantly arriving, and which, when sold, would require remittances to Europe. Hitherto, at this season, the demand for exchange had been supplied by the bills drawn on the produce of the South, when shipped to Europe; but this year the crop, and with it the bills produced by it, has come tardily into the market, so that the demands of exchange for the proceeds of the arriving shipments were directed immediately to the exhausted vaults of the Banks. Such an effect was to be averted without loss of time. The directors of the Bank of the United States, as was their natural duty, were the first to perceive the danger, and the Bank was immediately placed in a situation of great strength and repose. The State Banks followed its example. They began by restraining their loans within their income, and gradually and quietly decreasing the amount of them, and more especially directing their retrenchments on those whose operations were particularly connected with the exportations they desired to prevent. The course of business has been this: A merchant borrows from the Banks and sends abroad $100,000 in coin, or he buys bills from one who has shipped the coin. With these he imports a cargo of goods—obtaining a long credit for the duties—sends them to auction, where they are sold, and the auctioneer’s notes given for them. These notes are discounted by the Banks, and the merchant is then put in possession of another $100,000, which he again ships, and thus he proceeds in an endless circle, as long as the Banks, by discounting his notes, enable him to send the coin, and tempt him to do so, by keeping up prices here by their excessive issues. The Banks, therefore, begin by diminishing or withdrawing these artificial facilities, leaving the persons directly concerned in this trade to act as they please with their own funds, but not with the funds of the Banks. The immediate consequence is, that the auctioneers can no longer advance the money for entire cargoes—that they no longer sell for credit, but for cash—that the price of goods falls—that instead of being sold in large masses, they are sold slowly and in small parcels, so that the importer is not able to remit the proceeds in large amounts. This diminishes the demand for bills and for specie to send abroad. In the meantime, the importer, finding the prices of his goods fall, imports no more; and the shipper of coin, finding less demand for exchange, and that he can make more of his money by using it at home than by exporting it, abstains from sending it abroad. Time is thus gained till the arrival of the Southern exchange, which will supply the demand without the aid of the coin, and then every thing resumes its accustomed course.

“This is the point to which the present measures of the Banks are tending. The purpose must be accomplished, in a longer or shorter time, with a greater or less degree of pressure, but the effect must and will be produced.”

This account, mutatis mutandis, will serve for a history of Banking in almost any year. “Such is the circle a mixed currency is always describing.” The only difference is, that the circle is sometimes wider and sometimes narrower.

“The constant tendency of Banks is to lend too much, and to put too many notes in circulation.” Sometimes it is a demand for specie to establish a new institution at New Orleans, that compels them to diminish their issues; sometimes it is a demand for specie for the use of the British army in Canada, sometimes the crop of cotton comes in tardily—sometimes it is something else: but a year seldom passes without some cause of this kind occurring, and it is impossible in the nature of things that such causes should not occur.

It would seem from Mr. Biddle’s statements in another part of this essay, that, though every thing appeared very smooth on the surface in 1827, great danger lurked beneath. Speaking of the State Banks, he says, “what interest has the community in propping up many of these institutions? Let any sedate man look at the returns made this winter of the state of the Banks in various parts of the United States, and then answer whether they need further exemptions from the necessity of accommodating their business to their means.     *     *     *     *     *     * In the present and immediate example, no man can fail to perceive that, but for the warning restriction imposed by the Bank of the United States and the leading State Banks, the events of the last six weeks would have brought many of them to the verge of insolvency, whence they could only escape by some sudden shock to the community.”

In 1825, the immediate danger was to the Banks, and through them to the community. In 1826, the United States’ Bank and the leading State Banks placed themselves “in a situation of great strength and repose,” but the sufferings of the community were not the less severe on that account. It was, in fact, by producing sufferings in the community, that the Banks placed themselves in that situation from which they regarded what was going on around them with so much complacency. The people implored them for relief, but the President of the United States’ Bank replied, “It is in the order of nature, that if men or nations live extravagantly, they must suffer till they repair their losses by prudence, and that neither men nor Banks should impose on the community by promises to pay what they cannot pay. The laws of trade have their own remedy for such disorders, as infallible as the law of animal life, which enables the human system to relieve itself from its own excesses. Both must have their course. But the Bank of the United States is invoked to assume that which, whoever attempts, deserves the ruin he will suffer. It is requested to erect itself into a special providence to modify the laws of nature, and to declare that the ordinary fate of the heedless and improvident shall not be applied to the United States. Our countrymen are to be indulged without restraint in the utmost extravagance of the luxuries of Europe, on credit from the Banks; and when the day of payment arrives, the debtor shall not be called upon for payment—the Banks shall not be incommoded to pay their own notes, for the moment any inconvenience is felt, the Bank of the United States will certainly interpose and pay the debt. But if the Bank of the United States blends any sense with its tenderness, it will-do nothing of all this.”

This reply, though not very consoling, would have been unanswerable, if it had not been that “the disorder of the country was over-trading, brought on by over-banking.”

The Banks continued to diminish mercantile facilities, in the month of May. In September there was another pressure on the community; and in December a great scarcity of money was felt in Boston.

The President of the United States’ Bank, in a letter to the Secretary of the Treasury, dated July 18th, 1829, says the office at Portsmouth, “last year was nearly prostrated in the general ruin which spread over that country. Out of 460,000 dollars of loans, 148,000 dollars was thrown under protest: still further protests were expected, and the actual loss sustained there will not be less than 112,000.”

In March 1829, there was a pressure in Philadelphia: and in the following months great apprehensions were entertained in New York for the safety of the country Banks in that and the neighboring States. A writer in the United States Telegraph endeavored to show that the Banks of that city were also in a perilous condition. The difficulties appear to have been greatest in that city about the beginning of June. In the middle of the month, it was announced that the money market was becoming easy. Many New York merchants were, however, compelled to make compromises with their creditors; and many mechanics were deprived of employment.

The greatest distress in this year, appears to have been in Rhode Island. The Providence Literary Subaltern, as quoted by the Philadelphia Gazette, on the 26th of June, says—“The embarrassments which have been realized in this immediate neighborhood for the last ten days, have had no parallel in the history of the Republic. Men of reputed capital, who have withstood the shock of former changes and times; men who for the last forty years have stood firm, erect and undismayed before the tempest of the times that have assailed them, are now tottering on the verge of bankruptcy and ruin. Their fall bears excessively heavy on the poor and laboring classes, who, by the way, are in reality the principal sufferers. Deprived of employment, destitute and friendless, they are thrown upon the world, and know not how to obtain a livelihood. Within the last ten days, within the circle of the ten adjacent miles, upwards of twenty-five hundred people have been suddenly and unexpectedly thrown out of employment, and the distress that such an event has produced, can be far better imagined than described.”