A History of Money and Banking in the United States: The Colonial Era to World War II (16 page)

A third plank in the Jacksonian coinage platform was to establish branch U.S. mints so as to coin the gold found in newly discovered mines in Georgia and North Carolina. The Jackson administration finally succeeded in getting Congress to do so in 1835 when it set up branch mints to coin gold in North Carolina and Georgia, and silver and gold at New Orleans.90

Finally, on the federal level, the Jacksonians sought to levy a tax on small bank notes and to prevent the federal government from keeping its deposits in state banks, issuing small notes, or accepting small bank notes in taxes. They were not successful, but the independent Treasury eliminated public deposit in state banks and the Specie Circular, as we have seen, stopped the receipt of bank notes for public land sales. From 1840 on, the hard-money battle would be waged at the state level.

In the early 1850s, Gresham’s Law finally caught up with the bimetallist idyll that the Jacksonians had forged in the 1830s, replacing the earlier de facto silver monometallism. The sudden 88As Jackson’s Secretary of the Treasury Levi Woodbury explained the purpose of this broad legalization of foreign coins: “to provide a full supply and variety of coins, instead of bills below five and ten dollars,” for this would be “particularly conducive to the security of the poor and middling classes, who, as they own but little in, and profit but little by, banks, should be subjected to as small risk as practicable by their bills.” Quoted in Martin, “Metallism,” p. 242.

89In 1837 another coinage act made a very slight adjustment in the mint ratios. In order to raise the alloy composition of gold coins to have them similar to silver, the definition of the gold dollar was raised slightly from 23.2 grains to 23.22 grains. With the weight of the silver dollar remaining the same, the silver-gold ratio was now very slightly lowered from 16.002-to-1 to 15.998-to-1. Further slight adjustments in valuations of foreign coins in the Coinage Act of 1843 resulted in the undervaluation of many foreign coins and their gradual disappearance. The major ones—Spanish fractional silver—continued, however, to circulate widely.

Ibid., p. 436.

90Ibid., p. 240.

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discovery of extensive gold mines in California, Russia, and Australia greatly increased gold production, reaching a peak in the early 1850s. From the 1720s through the 1830s, annual world gold production averaged $12.8 million, never straying very far from that norm. Then, world gold production increased to an annual average of $38.2 million in the 1840s, and spurted upward to a peak of $155 million in 1853. World gold production then fell steadily from that peak to an annual average of $139.9

million in the 1850s and to $114.7 million from 1876 to 1890. It was not to surpass this peak until the 1890s.91

The consequence of the burst in gold production was, of course, a fall in the price of gold relative to silver in the world market. The silver-gold ratio declined from 15.97 in January 1849 to an average of 15.70 in 1850 to 15.46 in 1851 and to an average of 15.32-to-1 in the eight years from 1853 to 1860.92 As a result, the market premium of American silver dollars over gold quickly rose above the 1-percent margin, which was the estimated cost of shipping silver coins abroad. That premium, which had hovered around 1 percent since the mid-1830s, suddenly rose to 4.5 percent at the beginning of 1851, and after falling back to about 2 percent at the turn of 1852, bounced back up and remained at the 4- to 5-percent level.

The result was a rapid disappearance of silver from the country, the heaviest and therefore most undervalued coins vanishing first. Spanish-milled dollars, which contained 1 percent to 5 percent more silver than American dollars, commanded a premium of 7 percent and went first. Then went the full-weight American silver dollars and after that, American fractional silver coins, which were commanding a 4-percent premium by the fall of 1852. The last coins left were the worn Spanish and Mexican fractions, which were depreciated by 10

91On gold production, see Laughlin,
History of Bimetallism,
pp. 283–86; and David A. Martin, “1853: The End of Bimetallism in the United States,”
Journal of Economic History
33 (December 1973): 830.

92The silver-gold ratio began to slide sharply in October and November 1850. Laughlin,
History of Bimetallism,
pp. 194, 291.

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to 15 percent. By the beginning of 1851, however, even these worn foreign silver fractions had gone to a 1-percent premium and were beginning to go.

It was clear that America was undergoing a severe small-coin crisis. Gold coins were flowing into the country, but they were too valuable to be technically usable for small-denomination coins. The Democratic Pierce administration saw with horror millions of dollars of unauthorized private small notes flood into circulation in early 1853 for the first time since the 1830s.

The Jacksonians were in grave danger of losing the fight for hard-money coinage, at least for the smaller and medium denominations. Something had to be done quickly.93

The ultimate breakdown of bimetallism had never been clearer. If bimetallism is not in the long run viable, this leaves two free-market, hard-money alternatives: (a) silver monometallism with the dollar defined as a weight of silver only, and gold circulating freely by weight at freely fluctuating market rates; or (b) gold monometallism with the dollar defined only as a weight of gold, with silver circulating by weight. Each of these is an example of what has been called “parallel standards” or

“free metallism,” in which two or more metal coins are allowed to fluctuate freely within the same area and exchange at free-market prices. As we have seen, colonial America was an example of such parallel standards, since foreign gold and silver coins circulated freely and at fluctuating market prices.94

93Martin, “Metallism,” p. 240.

94For an account of how parallel standards worked in Europe from the medieval period through the eighteenth century, see Luigi Einaudi, “The Theory of Imaginary Money from Charlemagne to the French Revolution,” in
Enterprise and Secular Change,
F. Lane and J. Riemersma, eds. (Homewood, Ill.: Irwin, 1953), pp. 229–61. Robert Lopez contrasts the ways in which Florence and Genoa each returned to gold coinage in the mid-thirteenth century, after a gap of half a millennium: Florence, like most medieval states, made bimetallism and trimetallism a base of its monetary policy . . . it committed
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The United States could have taken this opportunity of monetary crisis to go on either version of a parallel standard.95

Apparently, however, few thought of doing so. Another viable though inferior solution to the problem of bimetallism was to establish a monometallic system, either de facto or de jure
,
with the other metal circulating in the form of lightweight, and therefore overvalued, or “token” coinage. Silver monometallism was immediately unfeasible since it was rapidly flowing out of the country, and because gold, being far more valuable than silver, the government to the Sysiphean labor of readjusting the relations between different coins as the ratio between the different metals changes, or as one or another coin was debased. . . . Genoa on the contrary,
in conformity with the
principle of restricting state intervention as much as possible
did not try to enforce a fixed relation between coins of different metals. . . . Basically, the gold coinage of Genoa was not meant to integrate the silver and bullion coinages but to form an independent system. (Robert Sabatino Lopez, “Back to Gold, 1252,”
Economic History Review
[April 1956]: 224; emphasis added)

See also James Rolph Edwards, ”Monopoly and Competition in Money,”
Journal of Libertarian Studies
4 (Winter 1980): 116. For an analysis of parallel standards, see Ludwig von Mises,
The Theory of Money and Credit,
3rd ed. (Indianapolis: Liberty Classics, 1980), pp. 87, 89–91, 205–07.

95Given parallel standards, the ultimate, admittedly remote solution would be to eliminate the term “dollar” altogether, and simply have both gold and silver coins circulate by regular units of weight: “grain,”

“ounce,” or “gram.” If that were done, all problems of bimetallism, debasement, Gresham’s Law, etc., would at last disappear. While such a pure free-market solution seems remote today, the late nineteenth century saw a series of important international monetary conferences trying to move toward a universal gold or silver gram, with each national currency beginning as a simple multiple of each other, and eventually only units of weight being used. Before the conferences foundered on the gold-silver problem, such a result was not as remote or utopian as we might now believe. See the fascinating account of these conferences in Henry B. Russell,
International Monetary Conferences
(New York: Harper and Bros., 1898).

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could not technically function easily as a lightweight subsidiary coin. The only feasible solution, then, within a monometallic framework, was to make gold the basic standard and let highly overvalued, essentially token, silver coins function as subsidiary small coinage. Certainly if a parallel standard was not to be adopted, the latter solution would be far better than allowing depreciated paper notes to function as small currency.

Under pressure of the crisis, Congress decided, in February 1853, to keep the de jure bimetallic standard but to adopt a de facto gold monometallic standard, with fractional silver coins circulating as a deliberately overvalued subsidiary coinage, legal tender up to a maximum of only $5. The fractional silver coins were debased by 6.91 percent. With silver commanding about a 4-percent market premium over gold, this meant that fractional silver was debased 3 percent below gold. At that depreciated rate, fractional silver was not overvalued in relation to gold, and remained in circulation. By April, the new subsidiary quarter-dollars proved to be popular and by early 1854

the problem of the shortage of small coins in America was over.

In rejecting proposals either to go over completely to de jure gold monometallism or to keep the existing bimetallic system, Congress was choosing a gold standard temporarily, but keeping its options open. The fact that it continued the old full-bodied silver dollar, the “dollar of our fathers,” demonstrates that an eventual return to de facto bimetallism was by no means being ruled out—albeit Gresham’s Law could not then maintain the American silver dollar in circulation.96

In 1857, an important part of the Jacksonian coinage program was repealed, as Congress, in an exercise of monetary nationalism, eliminated all legal tender power of foreign coins.97

96For an excellent portrayal of the congressional choice in 1853, see Martin, “1853,” pp. 825–44.

97Only Spanish-American fractional silver coins were to remain legal tender, and they were to be received quickly at government offices and
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A History of Money and Banking in the United States:
The Colonial Era to World War II

DECENTRALIZED BANKING FROM THE 1830S

TO THE CIVIL WAR

After the central bank was eliminated in the 1830s, the battle for hard money largely shifted to the state governmental arena.

During the 1830s, the major thrust was to prohibit the issue of small notes, which was accomplished for notes under five dollars in 10 states by 1832, and subsequently, five others restricted or prohibited such notes.98

The Democratic Party became ardently hard-money in the various states after the shock of the financial crisis of 1837 and 1839. The Democratic drive was toward the outlawry of all fractional reserve bank paper. Battles were fought also, in the late 1840s, at constitutional conventions of many states, particularly in the west. In some western states, the Jacksonians won temporary success, but soon the Whigs would return and repeal the bank prohibition. The Whigs, trying to find some way to overcome the general revulsion against banks after the crisis of the late 1830s, adopted the concept of “free” banking, which had been enacted by New York and Michigan in the late 1830s. From New York, the idea spread outward to the rest of the country and triumphed in 15 states by the early 1850s. On the eve of the Civil War, 18 out of the 33 states in the Union had adopted

“free” banking laws.99

It must be realized that “free” banking, as it came to be known in the United States before the Civil War, was unrelated to the philosophic concept of free banking analyzed by economists. As we have seen earlier, genuine free banking is a system where entry into banking is totally free; the banks are neither subsidized nor regulated, and at the first sign of failure to immediately reminted into American coins. Hepburn,
History of Currency
, pp. 66–67.

98See Martin, “Metallism,” pp. 242–43.

99Hugh Rockoff,
The Free Banking Era: A Re-Examination
(New York: Arno Press, 1975), pp. 3–4.

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redeem in specie payments, a bank is forced to declare insolvency and close its doors.

“Free” banking before the Civil War, on the other hand, was very different.100 As we have pointed out, the government allowed periodic general suspensions of specie payments whenever the banks overexpanded and got into trouble—the latest episode was in the panic of 1857. It is true that bank incorporation was now more liberal since any bank that met the legal regulations could become incorporated automatically without lobbying for special legislative charters, as had been the case before. But the banks were now subject to a myriad of regulations, including edicts by state banking commissioners and high minimum capital requirements that greatly restricted entry into the banking business. But the most pernicious aspect of “free” banking was that the expansion of bank notes and deposits was directly tied to the amount of state government securities that the bank had invested in and posted as bond with the state. In effect, then, state government bonds became the reserve base upon which banks were allowed to pyramid a multiple expansion of bank notes and deposits. Not only did this system provide explicitly or implicitly for fractional reserve banking, but the pyramid was tied rigidly to the amount of government bonds purchased by the banks. This provision deliberately tied banks and bank credit expansion to the public debt; it meant that the more public debt the banks purchased, the more they could create and lend out new money. Banks, in short, were encouraged to monetize the public debt, state governments were thereby encouraged to go into debt, and hence, government and bank inflation were intimately linked.