A Short History of Paper Money and Banking

CHAPTER XXI. Additional Particulars of the History of Banking from 1824 to 1829.

The professors of natural science are able to give satisfactory accounts of the general causes of heat and cold in different latitudes, and of snow and rain in different seasons, but it is in most instances beyond their power to state in what degree each of the general causes known to be in operation, has contributed to the state of the weather at a particular time and particular place. Banking is like the weather. It is affected by a variety of causes, which present themselves in different combinations. Many of these causes are of such a nature that their operation, if separately considered, would be inappreciable, though when united they produce a very sensible effect. Others are so strongly marked in their consequences, that their operation can at times be calculated with all the accuracy which is necessary for illustrating general principles.

Among these latter causes must be ranked the conflicts of the Banks with one another, and their dealings with Government. These are sufficient to produce great commercial embarrassments, even when there is no very great demand for specie for exportation. We have seen that the war between the allied Banks of Boston and the country Banks, produced a great scarcity of money in New England, in May 1825, or at the very time when speculation was most active in the Middle and Southern States. The President of the United States’ Bank speaks of the “reaction, as it is called,” taking place in Philadelphia, “in October.” But the newspapers make mention of the pressure in July, and it is well known that it is not till sometime after great pressures begin, that mention is made of them in the public journals. Taking into consideration the facts that the pressure was felt here some four or five months before the crisis in England, that exchanges were in favor of this country, and that during this time the English country Banks were, according to Lord Liverpool, increasing their issues, we are inclined to think that some other cause besides the foreign demand for specie must have contributed to the reaction of 1825—at least so far as it affected the United States’ Bank, and through it the other Banks and the community. We have a cause adequate to the effect, in the loans of ten million dollars made by the Bank to the Government in 1824 and 1825. The amount may not be large, abstractedly considered, but a paper money Bank which has been doing business for several years, can seldom, unless it has a surplus stock of specie, make loans for a long period, without being afterwards forced to resort to such measures as operate with great hardship on its regular customers. “The constant tendency of Banks,” as Mr. Biddle has correctly observed, “is to lend too much—to put too many notes in circulation.” And the Bank of the United States, after having lent as much as it could to private traders, strained its credit and resources to lend to Government, and thereby put more notes in circulation than the state of trade required.

The peculiar force with which the pressure of 1825 operated on the United States’ Bank, strengthens this reasoning. It receives additional corroboration in the fact that the reaction was over in the United States much sooner than in England: and also in the fact that the exports of gold and silver in the year 1825, exceeded the imports in only the small sum of 2,600,000 dollars, the imports for the year being $6,150,785, and the exports $8,787,055.

It must, indeed, be admitted that a very small export of specie sometimes produces very great confusion. Mr. Carey, in a work published in 1810, says—“The merchants engaged in the trade to the East Indies, made application last spring to the Bank of the United States for dollars to remit there, and offered a premium of one per cent. The directors took the matter under consideration, and with liberality resolved to furnish the necessary sums without premium What was the exact amount I cannot state, but I have reason to believe it exceeded half a million of dollars. They were applauded for their liberality. But, however extraordinary it may appear, the effect of the operation was absolutely to impel some of the other Banks to curtail their discounts considerably.”

If our currency was metallic, the exportation of ten or twenty millions of gold and silver, would have no more effect on the general train of commercial operations than the exportation of so many dollars’ worth of iron and copper, for the exportation of specie would never commence till the domestic demand was fully satisfied. But, now, the fitting out of a single East India ship, may derange the trade of a city: and diminishing the ordinary stock of specie in the amount of only two or three millions, may derange the trade of the country.

This may appear strange at first view, but Mr. Biddle, in his Address to the Stockholders of the United States’ Bank, in September 1831, gives us very satisfactory reasons why a cause, apparently so very trifling, should produce so very great an effect. “It is the peculiarity of our moneyed system, that in many parts of the country the precious metals are excluded from the minor channels of circulation by a small paper currency, in consequence of which the greater portion of these metals is accumulated in great masses in the Atlantic cities, liable to be immediately demanded on notes previously issued in the confidence of the continuance of the same state of things which caused the abundant issue of them; at the first turn in the tide of foreign exchange—when the supply of foreign exchange is unequal to the daily demand, the vaults of the Banks may be exhausted before any precaution can prevent it. These very precautions too, consisting as they do almost exclusively of curtailment of their loans, made suddenly—mostly without concert, and always under the influence of anxiety if not of alarm, may fall with oppressive weight on the community, by the pressure in which alone can be produced the necessary reaction. This reaction, moreover, is necessarily slow, since our distance from Europe makes it less easy to restore the equilibrium than between adjoining countries in the same hemisphere.”

It certainly was not by any increase of its loans to merchants that the Bank of the United States was brought into difficulty in 1825, for these loans, including in the calculation common discounts and bills of exchange, actually sustained a reduction of upwards of 300,000 dollars, between the 1st of January, 1824, and the 31st of July, 1825. By its bans of ten millions to Government, the Bank appears to have added to its circulation, between the dates just mentioned, only 3,277,885. But this, it seems, was two millions six hundred thousand more paper than the country could bear, for in this amount the exports of specie exceeded the imports in 1825.

It is well worthy of observation, that the total import of foreign merchandise in 1825, was, according to the customhouse returns, $96,340,075, and the total export of domestic and foreign produce, was $99,535,388. If allowance be made for freight of the exports, and profits on them in foreign markets, it will be seen that the “balance of trade” was decidedly in favor of the country. So that, altogether, we have in the events of the year, an example that, in time of profound peace, and when the balance of trade is in favor of the country, and when the exports of specie exceed the imports in the sum of only two or three millions, a whole community may, by the operations of paper money Banking, be brought to the very verge of insolvency.

The evils produced by Banks’ making loans to Government are occasional. These produced by Banks’ trading on Government deposits, are perpetual. These deposits vary in the amount of millions in the course of a few months. A Bank may know that the Government will, in the course of a short period, require its funds to pay off a portion of the public debt, or for some other purpose, but as the constant tendency of Banks is to lend too much and put too many notes in circulation, a Bank having possession of such funds seldom fails to make discounts on them as freely as on its own capital, trusting that when the Government shall demand its own, means may be found of meeting the demand through a credit in Europe, or some other financial operation. The most common mode is that of reducing commercial discounts. In the voluminous documents appended to the report made by a Committee of Congress in April 1832, continual reference is made to changes in the operations of the United States’ Bank, rendered necessary by Government’s reclaiming its deposits for the purpose of paying off the public debt.

If the State Banks should be made the depositories of the public funds, the evil would be increased instead of being diminished. Paper money Banks cannot be employed in any way as fiscal machines, without embarrassing the operations either of Government or of the community, and sometimes of both. If we had a metallic currency, and if our fiscal concerns were managed without the agency of Banks, the paying off of ten or twenty millions of public debt in the course of a year, would have the same effect as the paying off of ten or twenty millions of private debt—would produce benefit instead of injury. But as matters have been managed through the agency of the Banks, the paying off of the public debt has indirectly contributed to the irregularities of the money market since the year 1825.

The pressure of 1828 operated with more force on the local Banks than on the Bank of the United States. It was, as we have reason to believe, with great difficulty that some of the principal Banks of Philadelphia placed themselves in a situation of repose. As the imports of specie had in the previous year exceeded the exports, the imports having been $8,151,130, and the exports $7,971,307, while the total value of exports was $82,324,827, and of imports only $79,484,068, we cannot resist the conclusion that the difficulties of 1828 were, as well as those of 1825, owing, in a great measure, to domestic causes. The pressure in that year appears to have been independent of any movements in Europe. Money was very plenty in England. The interest on commercial securities in London in August, was only two per cent. The Bank of France had it in contemplation in November, to reduce the rate of discount to three per cent. In December, there was, indeed, a pressure in both France and England, but our difficulties commenced in the early part of the year. The foreign demand for specie could not have been great, as the exports of gold and silver in the whole year amounted to $7,550,339, and were nearly balanced by the imports, which amounted to $7,489,741.

To account for the difficulties in the year 1828, it is necessary to take into consideration a fact which was mentioned by Mr. Biddle in the verbal expose he gave to the stockholders of the United States’ Bank, at their meeting in August. He then stated that the circulation of the Bank had been increased between August 1822 and August 1828, from 5,400,000 dollars, to upwards of 13,000,000, and that this had been effected, without adding any thing to the aggregate amount of currency, but simply by displacing an equal amount of the notes of the local Banks. Admitting this to be the fact, we have a satisfactory reason for the pressure felt by the other Banks of Philadelphia, while the United States’ Bank was in a situation of great strength and repose. It was in the previous year, or 1827, that the United States’ Bank commenced the issue of branch drafts for the sums of five and ten dollars, by which it obtained a decided advantage over the State Banks. It was thereby able, in December 1827, to put a stop to the circulation of the notes of the Cape Fear Bank of North Carolina; and to this operation of displacing the notes of the local Banks by the small branch drafts of the United States’ Bank, may be attributed great part of the difficulties of the year 1828. It must be evident to every person, that new and unexpected demands on the local Banks by the United States’ Bank, must have the same effect on them as new and unexpected demands on them for specie to send abroad. The United States’ Bank may expand in the same proportion as the local Banks contract; but it has a different class of customers, and thus while money is made plenty with one portion of the community, it may be made scarce with another. The pressure of 1828 did not seem to affect the dealers in public stocks. Its weight fell principally on the merchants, and other productive members of society.

The difficulties of the year 1829, appear to have been owing in part to the operation of displacing local Bank notes by the branch drafts of the United States’ Bank, in part to local causes of different kinds in different parts of the country, and in part to the state of commercial affairs in Europe. The operations of the United States’ Bank are so limited in New England, that the people of that quarter of the country must attribute the principal evils they suffer to the doings of their local Banks. The people of the other States must attribute their sufferings to the combined operations of the local Banks and the Bank of the United States, bearing in mind the fact, that the United States’ Bank has a share in producing these evils, only in proportion to the amount of its capital, the number of its branches, the control it has of the funds of Government, and the changes it makes from time to time, in its mode of operation.