Small Change and the Depression of 1837-1843 - Part Two
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Part one of this series appears here.
Part Two – George Washington and Thomas Willing invent retail banking
In his last formal message as president, George Washington explained to his fellow Americans why foreign affairs should be avoided. By seeking particular friends, Americans were guaranteed to create particular enemies.
In the 16 years that followed the publication of his farewell address, Washington’s successors would diligently ignore what he had written about the risks of foreign entanglements. John Adams, Thomas Jefferson and James Madison would each promote a plan for the country’s direct engagement in the active quarrels of the European powers. In 1812, President Madison and the Democratic-Republican majority in Congress decided that America could only increase its current prosperity by starting a foreign war. To defend the sailors of the American merchant marine from impressment by the Royal Navy, the United States would launch a land invasion of Canada. Within a year the federal budget doubled; within two years, it tripled, and the national debt doubled. By 1816, the last year of his second term, James Madison would decide that his party’s former enemy, Alexander Hamilton, had been right after all. The country really did need a central bank to be the exchange of first resort for the U. S. Treasury’s IOUs. Like the Bank of England then and then Federal Reserve , the new Bank of the United States would accept sovereign debt at par; against those assets the national bank would issue its own currency that would be the legal equivalent of coinage.
This was very much what Hamilton had wanted for his American plan, but it was not at all the national finance that George Washington gave to the country. In 1791, the members of his cabinet had presumed that America’s first national bank would be what its second became. When Washington chose Thomas Willing to be the bank’s president, neither expected him to create a banking system based on the continuous exchange of bank notes that were not legal tender. Over the next two decades, the United States would see the development of an ever-expanding number of competing and cooperating independent banks that were intermediaries for each other’s bits of printed paper denominated in dollars. Unlike the Bank of England, the Bank of the United States would not be forced to suspend the redemption of its notes for gold and silver coin; but its success and those of the state-chartered banks would come not from the accumulation of specie reserves but from the willingness of people to exchange federal and state bank notes without ever asking for coin.
In 1807, when Thomas Willing retired, the Bank of the United States had nine offices – one in every commercial metropolis in the country: Philadelphia, Boston, New York, Charleston, Baltimore, Norfolk, Savannah, Washington, D.C. and New Orleans. When the Bank of the United States began accepting subscriptions for the sale of its shares in 1792, there were four incorporated banks in the U.S. Fifteen years later there were 98.
The national bank would be the largest corporation in the country in assets, income and number of employees; taken together, the offices of the state-chartered banks would be even larger in size and financial importance. A quarter century after the surrender at Yorktown, the United States had 107 banking offices ; England, Wales, Scotland and Ireland, with three times as many people, had 70. The greatest of all surprises – both to Americans and foreigners – would be the popular reach of the American banking system. Somehow, in less than two decades, an effectively bankrupt former outpost of the British Empire had become the world’s Leviathan of personal banking. Per capita, the United States had four and a half times as many banks as Britain; and retail finance – the getting and spending of currency – had reached into the American ’s daily lives.
In 1800, the smallest denomination note of the Bank of England was for five pounds, and that “small” bill was an emergency measure adopted only because of the need to expand the Exchequer’s usable money supply during the Napoleonic wars. At the same time, state-chartered American banks were printing one- dollar bills. Based on their weight and fineness as coins, the exchange rate was five dollars to the pound. Five pounds ($25) was six weeks’ pay for a lieutenant in the Royal Navy; a dollar was a day’s wage for an experienced American merchant seaman (who was often a deserter from the Royal Navy). To handle their payrolls, ships in the British Navy would sometimes have to wait at anchor for weeks for the needed small coin to be accumulated. For American sailors, a delay of more than a day or two in receiving bank notes when their ship reached home would be reason to jump ship and sign on with a different crew. On a blustery day in May 1797, Richard Howe, the admiral of the fleet, would spend 12 hours bouncing around the anchorage at Plymouth in a captain’s gig and visit each Royal Navy ship to reassure its officers and men that the seamen’s grievances about pay were being remedied. Britain had enough coin to pay enormous subsidies to its allies; it did not have enough ordinary currency to pay its seamen.
Yet, Great Britain was an immensely wealthier country. Parliament was financing the Coalition Wars against Napoleon and keeping half a million men under arms in its Army and Navy at a time when the United States could barely afford a failed expedition against the Barbary pirates. The United States had almost no gold coins and very few silver ones; Britain held the bulk of Europe’s specie reserves. The extraordinary but speculative future profits to be gained from investing in the vast lands of interior of the American continent would be a recurring fantasy; but, to date, the only gains from trade with the New World had come from John Jacob Astor’s brokerage of beaver skins and the shipments of pine tar, tobacco, and potash. Measured by its financial resources and actual commerce, the United States was a pauper compared to Britain. The Royal Navy exercised supreme authority over ocean-going trade, and Britain’s ability to maintain without default a debt larger than the amount of its annual commerce had made London the center of international financial exchange. The Navy’s physical development – the ships, dockyards, and bases – had been paid for in credit; and Britain’s land wealth was also thoroughly mortgaged; but the ability of the Bank of England to make interest payments in specie on the outstanding debt was accepted as being beyond question, even though the domestic redemption of the Bank of England’s notes had been suspended. Even in the midst of war, bond holders were content to have the cash flows from their bond coupons become automatic deposits to their accounts at the Bank of England. (As he served as commander of the continental army, George Washington and his wife remained holders of Bank of England shares.)
With its bank notes legally guaranteed at par, a deposit with the central bank retained full parity with specie as a store of value. To assure that the Bank of England’s accounts and notes would always and everywhere be accepted at parity, Parliament had made any discounting of them illegal and given the bank the power to regulate the access to banking itself. Parliamentary advocates of the quantity theory of money would win the political argument over the question of note issue; to maintain parity for the Bank of England’s legal tender paper. the amount of bank notes in circulation must be strictly limited to the bank’s reserves of coin and bullion.
Thomas Willing understood why Britain’s imperial financial system depended on the Bank of England’s notes always trading at par. He also understood why, for the United States of America, parity between gold and paper was irrelevant. For a country whose growth depended on foreign trade and finance, the domestic currency had to be subordinate to international money. For a country that must develop its own internal markets, liquidity must be the first consideration; the United States had to develop means of exchange for its domestic commerce. For that goal, the quantity theory of money was irrelevant. Money priced credit; it did not create it. Neither did the law.
The greatest of all the failure of the Continental Congress had been its belief that it could, like Parliament and the Crown, use sovereign financial authority to its advantage. By demanding that its paper be accepted as absolute legal tender, the Continental Congress had ruined its chance of maintaining any credit with the people. Continental dollar bills became worthless, not because they were printed on paper but because Congress had made it a crime for its currency to be exchanged at anything other than its printed denomination. Thanks to France’s money, ships and soldiers, the colonies had survived the financial ruin of war and become a new nation; but independence had not solved the former colonies’ bankruptcy. A decade after the Treaty of Paris, the United States still had a chronic foreign exchange deficit, a fragile equilibrium in foreign trade, a complete lack of any savings in international money – i.e., coin, and pitifully little foreign credit. It had, in fact, only two financial assets: the Constitutional inability to issue paper currency ; and the legal freedom to discount bank notes against the Constitution’s legal tender standard.
Thanks to Washington’s leadership, the convention for the writing of the national Constitution had deprived both the president and Congress of the power of issue. The Treasury could not print money, only coin it; and the Bank of the United States would not have the monopoly prerogatives of a central bank. Its notes would be accepted at par in payments to the government; but they would hold no priority in private exchanges, nor would they have any claim to parity with coin. The charters of both the Bank of the United States and the state banks obligated them to redeem their demand notes for coin in the same way that all debtors were required to discharge their obligations in legal tender. But the charters did not restrict American banks to issuing only demand notes as bills of exchange. From his first days working as an intern for his father and grandfather in the 1750 until his death in 1821, Thomas Willing would deal in bills of exchange. In his view, bank notes, like every other credit instrument , could only be valued by the ever-changing equilibriums of bid and ask for both promised and present payments. As coin the dollar must be, like the pound, an unchangeable quantity of specie; but there was no reason why American bank notes should not be freely discounted based on the terms of each exchange.
But, if their charters obligated the first Bank of the United States and the state banks to exchange demand notes for coin, how could the American banks avoid the suspension that had been imposed by Parliament on the Bank of England? How could dollar bills remain in circulation?
David Ricardo would raise this question with his colleagues in Parliament; it amazed him that Americans could happily swap bank notes without ever worrying about whether they could be converted to coin. The explanation offered was that social pressure was so great in American communities that no one dared to present their notes for redemption because it would threaten the survival of the town’s bank. Then, how could the Bank of the United States and the state charted banks be accepting each other’s notes for deposit? That only made sense if they were imitating what the Sword Bank had done during the Mississippi bubble and were seeking to put their banking competitors out of business by “note harvesting” – by taking in and accumulating a large quantity of a rival’s notes and then presenting them all at once for redemption.
The difference was that under Willing’s rules, American banks were still free to issue notes on whatever terms they chose. To maintain parity, a note of the Bank of England had to be subject to instant redemption; but the notes of American banks could be “post” dated or created in “inferior” denominations for which there was no usable coinage. An American bank could issue notes that promised redemption and payment of accrued interest on a date six month or a year from the date of issue. In such a world harvesting could cost more than it gained. The rumor that a rival was harvesting would prompt the target bank to begin accumulating the harvester’s own notes; and, as the two competing banks attempted to corner each other’s outstanding notes, they would both find themselves leaving other banks to profit from having their notes remain in broad circulation.
The Revolutionary War had made American legislators focus on the limiting the total dollar amount of notes that a bank could issue by setting maximum ratios of notes outstanding to the contributed capital – usually no more than two-to -one; but there were no reserve limits specified and it would not be until the 1820s that legislators even began to place limits on the denominations that could be issued.
Britain’s imperial financial system depended on the Bank of England’s notes always trading at par, but American bank notes need not try to escape being seen as what they were – a form of credit paper. For credit to grow, its forms had to be freely discountable and priced by competitive exchange against a fixed monetary standard that the government did not control. By expanding the offices of the first Bank of the United States and effectively goading the states to allow people to seek charters for their own banks, Thomas Willing had created a banking system that was actively seeking to do what Britain thought it had to avoid – the discounting and free exchange of credit paper. In such an open system the volume of trade for everything people bought and sold could grow, decline and increase even higher because, no matter how hard it was to find coins, there was never an absolute shortage of the means of exchange.
Thanks to the tariff system of taxation, open discounting would also supply the country with the international money that it needed. As the largest bank in each American port city, the Bank of the United States’ offices would be the primary dealers in foreign exchange. If foreign merchants wanted to quit the American market and take home their profits and capital, they had the choice of receiving payment in gold and silver coin or leaving their funds on deposit with the bank and issue bills of exchange in London and Amsterdam against those deposits to the merchants who wanted to do business in America. (As the depository for the federal government’s tariffs, the first Bank of the United States could accept its own notes in payment of federal taxes at par.)
For most foreign merchants, it proved far more sensible to leave their profits and capital with the First Bank and avoid the risks of actual transfers of coin. By the end of his tenure as president of the Bank of the United States, Thomas Willing had become popularly known as “the Great Regulator.” That title had a quite different meaning at the turn of the 18th century than it has today. Regulators had been the rebellious libertarians with muskets in North Carolina whom many historians see as the first movers of the American Revolution in North Carolina. Willing’s “regulation” had been entirely in favor of credit equality. No one in the United States could be forced by law to accept any bank note as full and final payment; dealing in paper was entirely voluntary. No government authority – neither the legislatures of the states nor Congress – had the legal authority that the British Crown still claimed. They could not designate as money anything that was not coined.
Yet, by the end of the first decade of the 19th century, everyone in the United States was accepting denominations printed on paper by banks as payments in dollars; and the banks that issued the notes were willingly accepting their own and other bank’s paper as deposits. Americans had invented retail credit banking and discovered how much they liked it.
Stefan Jovanovich manages the portfolio for The NJT Company, Inc., a family office based in Nevada.