Photo: Wikimedia Commons
The U.S. has been able to sit back and watch as Europe struggles to hold its currency union together.Americans can safely assume there is no danger Illinois, as bad as its finances are, will drop out and issue its own currency in “Lincolns.”
It wasn’t always so.
For a quarter of a century, America’s states and territories, and the institutions within them, began circulating their own currency, as the agrarian mistrust of centralized banking eventually climaxed in the destruction of the Second Bank of the United States in 1832.
This period is well known among collectors and numismatists.
But for others — even within the banking industry itself — this period remains mostly unknown.
We wanted to shed some light on this colourful but important moment in the country’s growth.
The story begins in 1832. President Jackson, an agrarian and hard currency advocate, is reelected and vetoes the rechartering of the Second Bank of the United States.
Next, Congress passes legislation that the government's funds would be held by local banks instead of a centralized reserve.
This worked fine initially, but soon inflation begins to climb as the banks extend their circulation.
Rep. Caleb Smith, in 1846, observed the effect this had: 'an odious discrimination as made against that portion of the people who desired to purchase the public lands, which could be justified upon no principle of justice or policy.'
This cartoon from Harper's Weekly captures the national sentiment that resulted.
Husband: 'I have no money, and cannot get any work.'
Wife: 'My dear, cannot you contrive to get some food for the children? I don't care for myself.'
The children: 'I'm so hungry,' 'I say Father, can't you get some 'Specie Claws?' and 'Father can't I have a piece of bread?'
Landlords, one of whom is carrying a warrant of 'Distraint for Rent': 'I say Sam, I wonder where we are to get our Costs.'
Banks respond by suspending specie payments — you could no longer redeem your cash for gold and silver.
The panic and subsequent credit crunch cause states to reexamine their entire approach to banking regulation.
Until 1837, states had exclusive right to charter banks. But this had given the impression of favoritism, and often produced in fact monopolies.
'I shall tread in the footsteps of my illustrious predecessor,' a Harper's Weekly cartoon depicts President Martin Van Buren, Jackson's successor and for many the culprit for the crisis, as saying.
That year, the state of Michigan – less than a few months old — enacts the country's first free banking act. New York follows suit a year later.
A bank could now be chartered under the terms of a general law of incorporation rather than having to pass through state legislation. It was an explicit repeal of Hamiltonian banking, which dictated that the power to print currency should lie with the federal government. The 'free banking era' has begun, and for the next 25 years, the number of banks chartered in the U.S. explode.
There was one catch: now that the government, every business could now issue its own currency. Given our modern banking system, this would seem like chaos.
And in many cases, it was. There are some amazingly colourful accounts from the era of enterprising crooks who exploited the new laws. Here's one incident that speaks to the wild cat banking climate in Michigan...
How The Bills Were Circulated
'The Bank of Sandstone, in Jackson county, had an extended circulation. A man, whose name is withheld for the sake of his family and descendants, who are not to blame for his disreputable transactions, went to the Bank of Sandstone and effected a heavy loan. The security was of the same valuable character as that assigned to the trustees of the city of Brest, probably being on city lots of some imaginary city. With the wild cat money raised in this loan he went through the State buying everything which he could convert. Horses, cattle, sheep, swine, produce of all kinds, farms and everything could be turned into money he bought at hte seller's price, paying for it in bills of hte Bank of Sandstone. As very few persons knew where Barry, which was the seat of hte Bank of Sandstone, was, or any good reason why the bills of its bank were not as good as those of any other, it may reasonably be supposed that he had very little trouble in disposing of them. Thus the bills of hte Bank of Sandstone got into wide circulation, but the holders might as well have had so much brown wrapping-paper instead.
A Polite Officer
'A gentleman in this city, in the way of business, became the unhappy possessor of $1,200 or $1,500 in bills on the Bank of Brest, and it occurred to him that he would go down to the bank and get them redeemed. Accordingly he made a journey to Brest and brought up at the door of the bank, where he was received by the President in the politest manner possible. That officer invited him in and showed him every attention, cordially pressed him to dine with him and opened several bottles of wine, and set before him dishes to tempt an epicure. He conversed volubly on every subject, except finance, and rather monopolized the conversation to himself. At length the Detroit man forced an opportunity to make known his errand to Brest. The affable officer lost none of his politeness, but regretted with great suavity the inability of the bank to redeem the bills just then. Some specie was daily expected, and it was unfortunate that he had not called a few days sooner, before there had been such a run on the bank. But it would be all right in a few days. The holder of hte bills took his departure in hte midst of a shower of apologies. He is the holder of some of the bills yet.
The more crooked free bankers would purchase state bonds with notes they themselves had printed, then disappear to avoid having to redeem the coupon.
'They had to be hunted for in the woods, among the retreats of wild cats. Their cash reserves were sometimes kegs of nails and broken glass with a layer of coin on top. Specie exhibited to the examiners at one bank was whisked through the trees to be exhibited at another the next day...
'Gold and silver flew about the country with the celerity of magic; its sound was heard in the depths of the forest; yet, like the wind, one knew not whence it came or whither it was going.'
According to one source, with a year of the law's passage in Detroit (Michigan's original capital), more than 40 banks are set up. Within 2 years, more than 40 are in receivership.
Some states also try to take advantage of the new environment by chartering government banks. This is met with uneven results.
The State Bank of Indiana became a respectable institution. But the State Bank of Illinois 'became entangled in public improvement schemes and an effort to help the city of Alton outstrip St. Louis as a commercial centre and river port. It went bankrupt in 1842.'
An entire publishing industry springs up around Bank Note Reporters that would print what various known notes were worth.
Researchers at the Minneapolis Fed have come up with charts showing the various discounts in New York for bank notes when one or both institutions were suspending gold and silver redemptions. Here's the chart for Cincinnati.
The researchers also calculated average discount versus distance from the country's financial centre.
For many agrarian southern and western states, free banking only exacerbates their misgivings about banking in general. As a result, many passed statutes that banned banking outright. They had varying degrees of success.
Iowa tried to ban banking, and not even have a state bank. The move backfired. 'Investigators were struck by the volume of bank notes circulating in a state where banking was forbidden, counted in Iowa City alone -- then the state's capital -- the notes of more than 300 banks.'
Many of which were issued by companies in neighbouring territories like Nebraska, which itself had forbidden notes but charted 8 institutions for the purpose of circulating them in Iowa, where 'agencies' were maintained.
But most bankers and historians now say that for all its faults, the system function relatively smoothly.
According to Alan Greenspan: 'While free banking was not actually as free as commonly perceived, it also was not nearly as unstable. The perception of the free banking era as an era of 'wildcat' banking marked by financial instability and, in particular, by widespread significant losses to noteholders also turns out to be exaggerated. Recent scholarship has demonstrated that free bank failures were not as common and resulting losses to noteholders were not as severe as earlier historians had claimed.'
Source: Federal Reserve
The free banking era ended — and our modern banking era began — rather naturally, with the exigencies of the Civil War.
The Union needed a uniform way of paying for munitions, and the power of currency was restored to the federal government. Their 'greenbacks' would become the most widely circulated currency in the country, and free bank era notes were slowly phased out.
The era was more exuberance from a youthful nation. A member of The Pioneer Society Of Michigan, writing in 1884, probably sums up the era best...
Looking Over The Field
now it is hard to understand how men of ordinary wisdom and prudence were led into this wild scheme of universal banking. But they suffered intensely for it. Individual and State credit were ruined. Michigan, which had just then been admitted into the Union, and was rapidly filling up with a stirring New England population, received a check to her immigration and to her commercial prosperity form which she did not recover for many years.
'But the lesson was not lost. Upon the ruins of that utterly prostrated credit she build ed so wisely that now no State enjoys greater prosperity or has a more enviable reputation for financial soundness.'