I have always been afraid of banks Andrew Jackson
Few greater enormities are chargeable to politicians than the destruction of the bank of the United States R Caterall
The motivation behind this paper is to analyse from the perspective of a historian of economic thought and policy the rationale and implications of the destruction of the Second bank of the United States. The account is valuable as an account of the way in which economic thought, political ideology and vested interests can combine to shape policy. The debate also raised issues which are relevant to our modern economic system. The case for state supervision over the banking system is considered by almost all economists as to be so self-evident. But this has not always been the case and the debate over the banks future is a pointed reminder of this fact. Some of the arguments furnished against the bank may challenge some of the complacently held axioms of modern thought.
Other issues of this period relevant today include the benefits or otherwise of inter-regional monetary union. (Frass (1974) has shown how the BUS acted to standardise local regional exchange rates and nominal price levels and the effect which this had on peripheral areas.) Likewise the conflict laid bare some differing, and still widely held, preconceptions regarding both the optimal and the legitimate magnitude of government intervention. This account may not offer exact policy prescriptions for modern economists, since the economy, society and prevailing values have changed so much, but they can offer fresh perspectives to modern thinkers.
The 1820s and 1830s in the United States were a time of extremely rapid, but also volatile economic growth. New natural resources were being exploited as the frontier expanded and the new techniques of the industrial revolution were being introduced. The old money supply of gold and silver specie was stretched and found inadequate for the liquidity needs of the growing economy. (Temin indicates that in 1830 the total value of the gold and silver specie in circulation in the economy amounted to only l/30th to l/50th the value of GNP.) The emergence of a number of banks operating fractional reserve note-issuing systems was the result. The notes were underwritten by varying proportions of specie and although not legal tender were widely accepted in payment for debts, although usually discounted below their par value.
The quality of bank notes varied. Fraud was commonplace by unscrupulous bankers who could persuade or bribe the local state legislature to grant them the charter necessary to commence a banking business. For instance Pessen notes that in 1828 the 17 banks chartered in Mississippi circulated notes with a face value of $6 million from a specie base of $303,000. It was in such an environment that the Bank of the United States operated. One of its functions was to discipline and support state banks. As the federal governments fiscal agent it received bank notes in payment for taxes. The BUS would then present these to the issuing state bank in order to redeem them for the gold necessary to pay the taxes it had collected to the federal treasury. In this way state banks were forced to keep a higher stock of specie on reserve than would otherwise be necessary. Conversely the U.S. could also act as a lender of last resort to banks in trouble by not presenting these notes for redemption but rather allowing these banks to run into debt to it.
The political environment of that period was marked by the ascendancy of an ideology termed Jacksonism. Focused around Andrew Jackson, elected president in 1828, this ideology was an uncomfortable, perhaps inconsistent, mixture of agrarianism, nationalism, populism and libertarianism. However the one element which unified this group was a deep hostility to a privileged east-coast based aristocracy. The Philadelphia-based bank of the United States with its obviously patrician president, Nicholas Biddle, could hardly prove to be popular with this new regime.
The Jackson administrations assault on the bank began in 1830. In 1832 Jackson used his presidential veto to thwart the Banks supporters attempt to use Congress to enact a new charter for the Bank. Jackson then used his second presidential election victory later that year as a mandate to order the withdrawal of all federal funds from the bank in 1833. When the Banks original charter expired in 1836 it succeeded in being re-chartered, albeit now only on as a much reduced state bank under the auspices of the Penneslvyania state legislature as the United States bank of Penneslvyania. In 1841 it went bankrupt as a result of speculative dabbling in the cotton market. I shall now consider the motives which inspired the attack on this institution.
Both Pessen and Hammond add an additional group to this coalition; the state banks, who disliked being constrained by the BUSs policy of redeeming their bank notes. This enforced a much higher reserve ratio and hence restricted their lending activities. Hammond also adds to this element the class of nouveau riche entrepreneurs and speculators, a class to which, he maintained, Jackson and many of his associates belonged, and which also disliked the restriction of credit. However, I would argue that the importance of this proposed group in effecting the banks destruction has been over-emphasised by pro-BUS writers such as Hammond and Caterall.
Firstly, the actual existence of such a coalition is questionable. Pessen gives evidence that the New York financial community were divided over the question of the wisdom of the attack on the Bank. Also he shows that at least some of the state banks grudgingly acknowledged one banks role in disciplining the banking system and its activities as a lender of last resort. The homogeneity of Hammonds speculative entrepreneurial class is one for which he offers merely anecdotal evidence and no quantitative evidence. Secondly, to concentrate upon vested interests is to ignore the other influences on political action. Ideologies and economic logic also play a role. Hammond, the primary exponent of the self-interest theory, fails to explain satisfactorily why the measure was extremely popular. Only a tiny proportion of the population would have gained directly and immediately from the destruction of the institution. We must examine the political philosophy and economic logic behind the opposition of the bank. These arguments had much public support which was vital to Jacksons destruction of the bank.
One branch of the school consisted of states rights advocates, who strongly opposed the substantial power wielded by the federally-chartered bank. Many considered the chartering of the bank an unconstitutional extension of the power of the federal congress. Their position was summarised by Jackson who described the bank as a threat to democratic institutions by the federal authorities. With the destruction of the bank, the power of intervention in the banking and monetary system was left in the hands of individual states until the civil war.
Another stream within the anti-bank framework were the libertarian thinkers. They postulated the illegitimacy (on moral grounds) of any government intervention in the economy or in society beyond a bare minimum. This period was the golden age of Laissez Faire. This group was related to and associated with the Free Banking school which challenged on economic grounds the necessity of government intervention in the monetary system.
This was not the case in 1832. We have Schumpeters (1954) comment that in the first part of the 19th century most economists believed in the merit of a privately provided and competitively supplied currency. Glasner shows how Smith differed from Hume in advocating state non-intervention in the supply of money. Smith argued that a convertible paper money could not be issued to excess by privately owned banks in a competitive banking environment. Today we see money as a natural public good owing to the externalities caused by variations in its quantity. So the free bankers views were consistent with economic logic of the day.
This groups most prominent exponent was Andrew Jackson himself. In his farewell speech he refers to the paper money system and its natural associates monopoly and exclusive privilege. The value of paper, he states, is liable to great and sudden fluctuations and cannot be relied upon to keep the medium of exchange uniform in amount. Jacksons views on this topic may be due to an incident early in his career when he was almost bankrupted after accepting bank notes which turned out to be worthless in return for a debt.
In contrast to the free-banking school this group could be termed conservative, wishing to destroy the system of fractional reserve paper money by removing the kingpin of the banking system which produced it; the Bank of the United States. Even within this group there was a severe division between those advocating gold specie, those advocating a silver specie, and those advocating a bi-metallic medium of exchange.
Advocates for the bank did emphasise its moderating role in regulating, informally, the fractional reserve system and hence its publicly-interested central-bank type nature. Such arguments were almost certain to fall on barren ground. Only two major institutions were available for comparison. The first one was John Laws bank from early 18th century France, and the chaotic and inflationary experience of this scheme was hardly one to inspire confidence. The other example was the Bank of England which was at the time subject to scathing attacks during the bullionist controversy, (Hammond (1947) and Glastner (1989)).
Secondly, those who attack the bank on the grounds that it was a predatory monopolist within the banking system have had their arguments somewhat refuted by the evidence garnered by Highfield, OHara and Wood, who carried out a systematic econometric survey with regards to the banks decision variables during its existence and found no evidence that its dealings with its competitor banks or with its markets were marked by any of the predatory practices associated with monopolists. However perhaps the anti-bank forces could argue that it was the banks potential as a monopolist rather than its actual behaviour which justified the withdrawal of its charter. The methodology of such evidence and the quality of the data upon which they are based may also be attacked but such studies must be considered none the less.
There are two different interpretations of these events. The first one, expounded by Hammond and Caterall, blames Jacksons actions in destroying the bank for the inflationary boom and resultant recession over the period 1834 to 1837. In their view, dismantling the BUS took a restraint off the fractional reserve system and led, post-1834, to an increase in the money supply which caused the boom. Of course, this was checked in 1837 by a downturn, a downturn made worse by the fact that at this stage the banking system, due to its low reserve ratio, was now very unstable and experienced significant levels of bank collapse. On the face of it the hypothesis has some factual support. Over the period 1833 to 1837 the amount of bank notes in circulation rose from a value of $10.2 million to $149.2 million.
However data from Temin and Engerman show that the banks aggregated reserve ratio did not fall over 1834-1837. It had remained steady from the mid-1820s. Thus, the BUSs demise had not caused the money supply to rise by allowing reserve ratios to fall.
An alternative hypothesis was advanced by Temin. He argued that monetary expansion did not come from a falling reserve ratio but rather from an inflow of silver into the United States in the 1830s. He backs his argument up by showing how this inflow in the 1830s would have resulted from increased silver production in Mexico, from an increase in British investment in America and from the fall in US imports of opium from China, which stopped the outflow of silver. So it is possible to dismiss the relationship between the Banks demise and the panic of 1837 as a coincidence.
Frass study does not extend beyond 1834 but we can assume that the removal of the bank led to the cessation of these harmful activities. However, we must note that a trade off would have had to be made. A higher level of financial instability may have been the price paid for freer availability of capital and cheaper land in these peripheral regions.
Similarly, after 1837 the reserve ratio of the banking system was much higher than it had been during the period of the BUSs existence. This reflected public mistrust of banks in the wake of the panic of 1837 when many banks failed. This lack of confidence in the paper money system, could have been ameliorated by a central-bank type institution. Hence one result of the demise of this bank may in fact have been a higher reserve ratio, less availability of credit and a lower money supply during the 1840s and 1850s. The evolution of the American banking system was also probably affected. The BUS was one of the first and last banks chartered by the federal authorities for commercial banking activities nation-wide. Had it survived it is unlikely that Americas retail banking market today would have been so localised and fragmented in a way which is extremely uncharacteristic of other large industrialised economics. After the banks destruction, banking returned to being a decentralised business in which institutions were chartered by the individual states.
The banks defeat also had profound implications for the role of the state in America in managing monetary policy. Large scale Federal intervention in the supply of money did not take place again until the American Civil War. However Jacksons victory had imbued US political culture with dislike of centralised institutions with large influence over the banking system. The United States did not develop a central banking agency until 1913. This institution was highly decentralised consisting of twelve autonomous components one in each of Americas largest cities. One result of this de-centralisation may have been the incoherent response of the monetary authorities to the 1929 crash and the resultant run on the banking system, possibly one cause of the 1930s great depression. Hence one interpretation might see the destruction of the bank of the United States as leading to the worlds most severe economic recession a century later.
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