A History of Money and Banking in the United States: The Colonial Era to World War II
Page 9
A bank credit inflation the magnitude of that of the 1830s is bound to run into shoals that cause the banks to stop the expansion and begin to contract. As the banks expand, and prices rise, specie is bound to flow out of the country and into the hands of the domestic public, and the pressure on the banks to redeem in specie will intensify, forcing cessation of the boom and even monetary contraction. In a sense, the immediate precipitating cause is of minor importance. Even so, the Jackson administration has been unfairly blamed for precipitating the panic of 1837 by issuing the Specie Circular in 1836.
In 1836 the Jackson administration decided to stop the enormous speculation in Western public lands that had been fueled during the past two years by the inflation of bank credit. Hence, Jackson decreed that public land payments would have to be made in specie. This had the healthy effect of stopping public land speculation, but recent studies have shown that the Specie Circular had very little impact in putting pressure on the banks to pay specie.78 From the point of view of the Jacksonian program, however, it was as important as moving toward putting the U.S. government finances on a purely specie basis.
Another measure advancing the Jacksonian program was also taken in 1836. Jackson, embarrassed at the government having amassed a huge budget surplus during his eight years in office, ordered the Treasury to distribute the surplus proportionately to the states. The distribution was made in notes presumably payable in specie. But again, Temin has shown that the distribution had little impact on movements of specie between banks and therefore in exerting contractionist pressure upon them.79
What, then, was the precipitating factor in triggering the panic of 1837? Temin plausibly argues that the Bank of England, worried about inflation in Britain, and the consequent outflow of gold, tightened the money supply and raised interest rates in the latter half of 1836. As a result, credit contraction severely restricted the American cotton export trade in London, exports declined, cotton prices fell, capital flowed into England, and contractionist pressure was put upon American trade and the American banks. Banks throughout the United States—including the Bank of the United States—promptly suspended specie payments in May 1837, their notes depreciated at varying rates, and interregional trade within the country was crippled.
While banks were able to evade specie payments and continue operations, they were still obliged to contract credit in order to go back on specie eventually, since they could not hope to be creating fiat money indefinitely and be allowed to remain in business. Finally, the New York banks were compelled by law to resume paying their contractual obligations, and the other banks followed in the fall of 1838. During the year 1837, the money supply fell from $276 million to $232 million, a large drop of 15.6 percent in one year. Total specie in the country continued to increase in 1837, up to $88 million, but growing public distrust of the banks (reflected in an increase in the proportion of money held as specie from 13 percent to 23 percent) put enough pressure upon the banks to force the contraction. The banks’ reserve ratio rose from 0.16 to 0.20. In response to the monetary contraction, wholesale prices fell precipitately, by over 30 percent in seven months, declining from 131 in February 1837 to 98 in September of that year.
In 1838 the economy revived. Britain resumed easy credit that year, cotton prices rose, and a short-lived boomlet began. Public confidence in the banks unwisely returned as they resumed specie payment, and as a result, the money supply rose slightly during the year, and prices rose by 25 percent, increasing from 98 in September 1837 to 125 in February 1839.
Leading the boom of 1838 were state governments, who, finding themselves with the unexpected windfall of a distributed surplus from the federal government, proceeded to spend the money wildly and borrow even more extravagantly on public works and other uneconomic forms of “investment.” But the state governments engaged in rashly optimistic plans that their public works would be financed heavily from Britain and other countries, and the cotton boom on which these hopes depended collapsed again in 1839. The states had to abandon their projects en masse. Cotton prices declined, and severe contractionist pressure was put on trade. Furthermore, the Philadelphia-based Bank of the United States had invested heavily in cotton speculation, and the falling price of cotton forced the Bank of the United States, once again, to suspend payments in October 1839. This touched off a wave of general bank suspensions in the south and west, but this time the banks of New York and New England continued to redeem their obligations in specie. Finally, the Bank of the United States, having for the last time played a leading role in generating a recession and monetary crisis, was forced to close its doors two years later.
With the crisis of 1839 there ensued four years of massive monetary and price deflation. Unsound banks were finally eliminated; unsound investments generated in the boom were liquidated. The number of banks during these four years fell by 23 percent. The money supply fell from $240 million at the beginning of 1839 to $158 million in 1843, a seemingly cataclysmic drop of 34 percent, or 8.5 percent per annum. Prices fell even further, from 125 in February 1839 to 67 in March 1843, a tremendous drop of 42 percent, or 10.5 percent per year.
During the boom, as we have indicated, state governments went heavily into debt, issuing bonds to pay for wasteful public works. In 1820, the total indebtedness of American states was a modest $12.8 million; by 1830, it rose to $26.5 million. But then it started to escalate, reaching $66.5 million in 1835 and skyrocketing to $170 million by 1839. The collapse of money, credit banking, and prices after 1839 brought these state debts into jeopardy. At this point, the Whigs, taking a leaf from their forebears, the Federalists, agitated for the federal government to bail out the states and assume their debts.80 After the crisis of 1839 arrived, some of the southern and western states were clearly in danger of default, their plight made worse by the fact that the bulk of the debt was held by British and Dutch capitalists and that specie would have to be sent abroad to meet the heavy interest payments. The Whigs pressed further for federal assumption of the debt, with the federal government to issue $200 million worth of bonds in payment. Furthermore, British bankers put severe pressure on the United States to assume the state debts if it expected to float further loans abroad.
The American people, however, spurned federal aid, including even the citizens of the states in difficulty, and the advent of the Polk administration ended any prospects for federal assumption. The British noted in wonder that the average American was far more concerned about his personal debts to other individuals and banks than about the debts of his state. In fact, the people were quite willing to have the states repudiate their debts outright. Demonstrating an astute perception of the reckless course the states had taken, the typical American response to the problem, “Suppose foreign capitalists did not lend any more to the states?” was the sharp retort was, “Well who cares if they don’t? We are now as a community heels over head in debt and can scarcely pay the interest.”81 The implication was that the disappearance of foreign credit to the states would have the healthy effect of cutting off their wasteful spending—as well as avoiding the imposition of a crippling tax burden to pay for the interest and principal. There was in this response an awareness by the public that they and their government were separate and sometimes even hostile entities rather than one and the same organism.82
By 1847, four western and southern states (Mississippi, Arkansas, Michigan, and Florida) had repudiated all or part of their debts. Six other states (Maryland, Illinois, Indiana, Louisiana, Arkansas, and Pennsylvania) had defaulted from three to six years before resuming payment.
It is evident, then, that the 1839–1843 contraction was healthful for the economy in liquidating unsound investments, debts, and banks, including the pernicious Bank of the United States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment, as we have been led to believe? In a fascinating analysis and comparison with the deflation of 1929–1933 a century later, Professor Temin shows that the pe
rcentage of deflation over the comparable four years (1839–1843 and 1929–1933) was almost the same.83 Yet the effects on real production of the two deflations were very different. Whereas in 1929–1933, real gross investment fell catastrophically by 91 percent, real consumption by 19 percent, and real GNP by 30 percent; in 1839–1843, investment fell by 23 percent, but real consumption increased by 21 percent and real GNP by 16 percent. The interesting problem is to account for the enormous fall in production and consumption in the 1930s, as contrasted to the rise in production and consumption in the 1840s. It seems that only the initial months of the contraction worked a hardship on the American public and that most of the earlier deflation was a period of economic growth. Temin properly suggests that the reason can be found in the downward flexibility of prices in the nineteenth century, so that massive monetary contraction would lower prices but not particularly cripple the world of real production or standards of living. In contrast, in the 1930s government placed massive roadblocks on the downward fall of prices and wage rates and hence brought about severe and continuing depression of production and living standards.
The Jacksonians had no intention of leaving a permanent system of pet banks, and so after the retirement of Jackson, his successor, Martin Van Buren, fought to establish the Independent Treasury System, in which the federal government conferred no special privilege or inflationary prop on any bank; instead of a central bank or pet banks, the government was to keep its funds purely in specie, in its own Treasury vaults—or its “subtreasury” branches—and simply take in and spend funds from there. Van Buren finally managed to establish the Independent Treasury System, which would last until the Civil War. At long last, the Jacksonians had achieved their dream of severing the federal government totally from the banking system and placing its finances on a purely hard-money, specie basis.
THE JACKSONIANS AND THE COINAGE LEGISLATION OF 1834
We have seen that the Coinage Act of 1792 established a bimetallic system in which the dollar was defined as equaling both 371.25 grains of pure silver and 24.75 grains of pure gold—a fixed weight ratio of 15 grains of silver to 1 grain of gold. But bimetallism foundered on Gresham’s Law. After 1805, the world market value of silver fell to approximately 15.75-to-1, so that the U.S. fixed mint ratio greatly undervalued gold and overvalued silver. As a result gold flowed out of the country and silver flowed in, so that after 1810 only silver coin, largely overvalued Spanish-American fractional silver coin, circulated within the United States. The rest of the currency was inflated bank paper in various stages of depreciation.
The Jacksonians, as we have seen, were determined to eliminate inflationary paper money and substitute a hard money consisting of specie—or, at the most—of paper 100-percent-backed by gold or silver. On the federal level, this meant abolishing the Bank of the United States and establishing the independent Treasury. The rest of the fight would have to be conducted during the 1840s and later, at the state level where the banks were chartered. But one thing the federal government could do was readjust the specie coinage. In particular, the Jacksonians were anxious to eliminate small-denomination bank notes ($20 and under) and substitute gold and silver coins for them. They reasoned that the average American largely used these coins, and they were the ones bilked by inflated paper money. For a standard to be really gold and silver, it was vital that gold or silver coins circulate and be used as a medium of exchange by the average American.
To accomplish this goal, the Jacksonians set about to establish a comprehensive program. As one vital step, one of the Coinage Acts of 1834 readjusted the old mint ratio of 15-to-1 that had undervalued gold and driven it out of circulation. The Coinage Act devalued the definition of the gold dollar from the original 24.75 grains to 23.2 grains, a debasement of gold by 6.26 percent. The silver dollar was left at the old weight of 371.25 grains, so that the mint ratio between silver and gold was now fixed at a ratio of 16-to-1, replacing the old 15-to-1. It was unfortunate that the Jacksonians did not appreciate silver (to 396 grains) instead of debasing gold, for this set a precedent for debasement that was to plague America in 1933 and after.84
The new ratio of 16-to-1, however, now undervalued silver and overvalued gold, since the world market ratio had been approximately 15.79-to-1 in the years before 1834. Until recently, historians have assumed that the Jacksonians deliberately tried to bring in gold and expel silver and establish a monometallic gold standard by the back door. Recent study has shown, however, that the Jacksonians only wanted to give gold inflow a little push through a slight undervaluation and that they anticipated a full coin circulation of both gold and silver.85 In 1833, for example, the world market ratio was as high as 15.93-to-1. Indeed, it turns out that for two decades the Jacksonians were right, and that the slight 1-percent premium of silver over gold was not enough to drive the former coins out of circulation.86 Both silver and gold were imported from then on, and silver and gold coins both circulated successfully side by side until the early 1850s. Lightweight Spanish fractional silver remained overvalued even at the mint ratio, so it flourished in circulation, replacing depreciated small notes. Even American silver dollars were now retained in circulation since they were “shielded” and kept circulating by the presence of new, heavyweight Mexican silver dollars, which were exported instead.87
In order to stimulate the circulation of both gold and silver coins instead of paper notes, the Jacksonians also passed two companion coinage acts in 1834. The Jacksonians were not monetary nationalists; specie was specie, and they saw no reason that foreign gold or silver coins should not circulate with the same full privileges as American-minted coins. Hence, the Jacksonians, in two separate measures, legalized the circulation of all foreign silver and gold coins, and they flourished in circulation until the 1850s.88, 89
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 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 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