Out of the debacle of the Panic of 1819 emerged the beginnings of the Jacksonian movement dedicated to laissezfaire, hard money, and the separation of money and banking from the State. During the 1820s, the new Democratic Party was established by Martin Van Buren and Andrew Jackson to take back America for the Old Republican program. The first step on the agenda was to abolish the Bank of the United States, which was up for renewal in 1836. The imperious Nicholas Biddle, head of the BUS who was continuing the chain of control over the Bank by the Philadelphia financial elite, decided to force the issue early, filing for renewal in 1831. Jackson, in a dramatic message, vetoed renewal of the Bank charter, and Congress failed to pass it over his veto.
Triumphantly reelected on the Bank issue in 1832, President Jackson disestablished the BUS as a central bank by removing Treasury deposits from the BUS in 1833, placing them in a number of state banks (soon called “pet banks”) throughout the country. At first, the total number of pet banks was seven, but the Jacksonians, eager to avoid a tight-knit oligarchy of privileged banks, increased the number to 91 by the end of 1836. In that year, as its federal charter ran out, Biddle managed to get a Pennsylvania charter for the Bank, and the new United States Bank of Pennsylvania managed to function as a regular state bank for a few years there after.
Historians long maintained that Andrew Jackson, by his reckless act of eliminating the BUS and shifting government funds to pet banks, freed the state banks from the restraints imposed upon them by a central bank. In that way, the banks allegedly were allowed to pyramid money on top of specie, precipitating anunruly inflation later succeeded by two bank panics and a disastrous inflation.
Recent historians, however, have demonstrated that the correct picture was precisely the reverse. First, under the regime of Nicholas Biddle, BUS notes and deposits had risen, from January 1823 to January 1832, from $12 million to $42.1 million, an annual increase of 27.9 percent. This sharp inflation of the base of the banking pyramid led to a large increase in the total money supply, from $81 million to $155 million, or an annual increase of 10.2 percent. Clearly, the driving force of this monetary expansion of the 1820s was the BUS, which acted as an inflationary spur rather than as a restraint on the state banks.
The fact that wholesale prices remained about the same over this period does not mean that the monetary inflation had no ill effects. As “Austrian” business cycle theory points out, any bank credit inflation creates a boom-and-bust cycle; there is no need for prices actually to rise. Prices did not rise because an increased product of goods and services offset the monetary expansion. Similar conditions precipitated the great crash of 1929. Prices need not rise for an inflationary boom, followed by a bust, to be created. All that is needed is for prices to be kept up by the artificial boom, and be higher than they would have been without the monetary expansion. Without the credit expansion, prices would have fallen during the 1820s, as they would have a century later, there by spreading the benefits of a great boom in investments and production to everyone in the country.
Recent historians have also demonstrated that most of the state banks warmly supported recharter of the Bank of the United States. With the exception of the banks in New York, Connecticut, Massachusetts, and Georgia, the state banks over whelmingly backed the BUS. But if the BUS was a restraining influence on their expansion, why did they endorse it? In short, the BUS had a poor inflationary record in the 1820s, and the state banks, recognizing its role as a spur to their own credit expansion, largely fought on its behalf in the recharter struggle of the early 1830s.
Further more, the inflationary boom of the 1830s began, not with Jackson’s removal of the deposits in 1833, but three years earlier, as an expansion fueled by the central bank. Thus, the total money supply rose from $109 million in 1830 to $155 million at the end of 1831, a spectacular expansion of 35 percent in one year. This monetary inflation was sparked by the central bank, which increased its notes and deposits from January 1830 to January 1832 by 45.2 percent.
There is no question, however, that the money supply and the price level rose spectacularly from 1833 to 1837. Total money supply rose from $150 million at the beginning of 1833 to $276 million four years later, an astonishing rise of 84 percent, or 21 percent per annum. Wholesale prices, in turn, rose from 84 in the spring of 1834 to 131 in early 1837, a rise of 52 percent in a little lessthan three years—or an annual rise of 19.8 percent.
The monetary expansion, however, was not caused by state banks going hog wild. The spark that ignited the inflation was an unusual and spectacular inflow of Mexican silver coins into the United States—brought about by the minting of debased Mexican copper coins which the Mexican government tried to keep at par value with silver. The system of fractional reserve banking, however, fundamentally was to blame for magnifying the influx of specie and pyramiding notes and deposits upon the specie base. In 1837, the boom came to an end, followed by the inevitable bust, as Mexico was forced to discontinue its copper coin issue by the outflow of silver, and the Bank of England, worried about inflationat home, tightened its own money supply and raised interest rates. The English credit contraction in late 1836 caused a bust in the American cotton export trade in London, followed by contractionist pressure on American trade and banks.
In response to this contractionist pressure—demands for specie—the banks throughout the United States (including the old BUS) promptly suspended specie payments in May 1837. The governments allowed them to do so, and continued to receive the notes in taxes. The notes began to depreciate at varying rates, and inter regional trade with in the United States was crippled.
The banks, however, could not hope to be allowed to continue on a fiat basis indefinitely, so they reluctantly began contracting their credit in order to go back eventually on specie. Finally, the New York banks were compelled by law to resume paying in specie, and other banks followed in 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. Specie continued to flow into the country, but increased public distrust in the banks and demands to redeem in specie put enough pressure on the banks to force the contraction. In response, wholesale prices fell precipitately, by over 30 percent in seven months, declining from 131 in February 1837 to 98 in September of that year. This healthy deflation brought about speedy recovery by1838. Unfortunately, public confidence in the banks returned as they resumed specie payment, so that the money supply roses lightly and prices rose by 25 percent. State governments ignited the new boom of 1838 by recklessly spending large Treasury surpluses which President Jackson had distributed pro rata to the states two years earlier. Even more money was borrowed to spend on public works and other forms of boon doggle. The states counted on Britain and other countries purchasing these new bonds, because of the cotton boom of 1838. But the boom collapsed the following year, and the states had to abandon the unsound projects of the boom. Cotton prices fell and severe deflationist pressure was put upon the banks and upon trade. More over, the BUS had invested heavily in cotton speculation, and was forced once again to suspend specie payments in the fall of 1839. This touched off a new wave of general bank suspensions in the South and West, although this time the banks of New York and New England continued to redeem in specie. Finally, the BUS, having played its role of precipitating boom and bust for the last time, was forced to close its doors for ever in 1841.
The crisis of 1839 us hered in four years of massive monetary and price deflation. Many unsound banks were finally eliminated, the number of banks declining during these years 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. Wholesale 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. The collapse of money and prices after 1839 also brought the swollen state government debts into jeopardy. State government debt had totaled a modest $26.5 million in1830. By 1835 it had reached $66.5 million, and by 1839 it hade scalated to $170 million. It was now clear that many states were in danger of default on the debt. At this point, the Whigs, taking a leaf from their Federalist forebears, called for the federal government to issue $200 million worth of bonds in order to assume all the state debt.
The American people, however, strongly opposed federal aid, including even the citizens of the states in difficulty. The British noted in wonder that the average American seemed far more concerned about the status of his personal debts than about the debts of his state. To the worried question, Suppose foreign capitalists did not lend any further to the states? the Floridian replied, “Well who cares if they don’t. We are now as a community heels over head in debt and can scarcely pay the interest.”
The implication was clear: The disappearance of foreign credit to the states would be a good thing; it would have the healthy effect of cutting off their further wasteful spending, as well as avoiding the imposition of a crippling tax burden to pay for the interest and principal. There was in this astute response an awareness by the public that they and their governments were separate and sometimes even hostile entities rather than all part of one and the same organism.
The advent of the Jacksonian Polk administration in 1845 putan end to the agitation for Federal assumption of the debt, and by 1847, four western and southern states had repudiated all or part of their debts, while six other states had defaulted from three tosix years before resuming payment.
Evidently, the 1839–43 contraction and deflation was a healthy event for the economy, since it liquidated unsound investments, debts, and banks, including the pernicious Bank of theUnited States. But didn’t the massive deflation have catastrophic effects—on production, trade, and employment—as we have generally been led to believe? Oddly enough, no. It is true that real investment fell by 23 percent during the four years of deflation, but, in contrast, real consumption increased by 21 percent and real GNP by 16 percent during this period. It seems that only the initial months of the contraction worked a hardship. And most of the deflation period was an era of economic growth.
The Jacksonians had no intention of leaving a permanent system of pet banks, and so Jackson’s chosen successor Martin VanBuren 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 solely in specie, in its own Treasury vaults or “sub treasury” branches. Van Buren managed to establish the Independent Treasury in 1840, but the Whig administration repealed it the following year. Finally, however, Democratic President Polk installed the Independent Treasury System in 1846, lasting 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. From now on, the battle over money would shift to the arena of the states.
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