# THE SECOND BANK OF THE UNITED STATES - The Mystery of Banking

The United States emerged from the War of 1812 in a chaotic monetary state, its monetary system at a fateful cross roads. The banks, checked only by the varying rates of depreciation of their notes, multiplied and expanded wildly, freed from the obligation of redeeming their notes and deposits in specie. Clearly, the nation could not continue indefinitely with discordant sets of individual banks issuing fiat money. It was apparent that there were only two ways out of this pressing problem. One was the hard money path, advocated by the Old Republicans, and, for their own purposes, the Federa lists. The federal and state governments would then have sternly compelled the recklessly inflating banks to redeem promptly in specie and, when most of the banks outside of New England failed to do so, force them to liquidate. In that way, the mass of depreciated and inflated notes would have been liquidated quickly, and specie would have poured back out of hoards and into the country to supply a circulating medium. America’s inflationary experience would have been ended, perhaps forever.

Instead, the centrist Democrat-Republican establishment in 1816 turned to the second way: the old Federalist path of a new inflationary central bank, the Second Bank of the United States. Modeled closely after the First Bank, the Second Bank, a private corporation with 1/5 of its stock owned by the federal government, was to create a uniform national paper currency, purchase a large part of the public debt, and receive deposits of Treasury funds. The BUS notes and deposits were to be redeemable in specie, and they were given quasi-legal tender status by the federal government’s receiving them in payment of taxes.

That the purpose of establishing the BUS was to support rather than restrain the state banks in their inflationary course is shown by the shameful deal that the BUS made with the state banks as soon as it opened its doors in January 1817. While it was enacting the BUS charter in April 1816, Congress passed a resolution of Daniel Webster, at that time a Federalist champion of hard money, requiring that after February 20, 1817, the U.S.would accept in payments for taxes only specie, Treasury notes, BUS notes, or state bank notes redeemable in specie on demand. In short, no irredeemable state bank notes would be accepted after that date. Instead of using this opportunity to compel the banks to redeem, however, the BUS, meeting with representatives from the leading urban banks outside Boston, agreed to issue $6 million worth of credit in New York, Philadelphia, Baltimore, andVirginia before insisting on specie payments on debts due from the state banks. In return for that massive inflation, the state banks graciously consented to resume specie payments. More over, the BUS and the state banks agreed to mutually support each other in any emergency, which, of course, meant in practice that the far stronger BUS was committed to the propping up of the weaker state banks. Several of the Congressional opponents delivered trenchant critiques of the establishment of the BUS. Senator William H.Wells, Federalist from Delaware, noted in some surprise that: This bill came out of the hands of the Administration ostensibly for the purpose of correcting the diseased state of our paper currency, by restraining and curtailing the over issue of banking paper; and yet it came prepared to inflict upon us the same evil; being itself nothing more than simply a paper-making machine. . . . The disease, it is said, under which the people labor, is the banking fever of the States; and this is to be cured by giving them the banking fever of the United States. In the House of Representatives, Artemas Ward, Jr., Federalist from Massachusetts, pointed out that the remedy for the evil of inflated and depreciated paper was simple: “refusing to receive the notes of those banks, which do not pay specie, in dues to the Government.” This would naturally be done, Ward pointed out,but for an alliance, which he considered “disgraceful to the country and unjust to individuals,” between the Secretary of the Treasury and the banks, without which the evil never would have existed. The leader in the battle against the Bank, Daniel Webster, Federalist of New Hampshire, pointed out that “there was no remedy for the state of depreciation of the paper currency, but the resumption of specie payments,” which the government should force the banks to undertake. But the most eloquent attack on the new BUS was that of the fiery Old Republican from Virginia, John Randolph of Roanoke. After pointing out that only specie can soundly function as money, Randolph prophetically warned that a central bank would be an engine of irresistible power in the hands of any administration; that it would be in politics and finance what the celebrated proposition of Archimedes was in physics—a place, the fulcrum from which, at the will of the Executive, the whole nation could be huffed to destruction, or managedin any way, at his will and discretion. The Bank, Randolph charged, would serve “as a crutch,” and, as far as he understood it, it was a broken one: “it would tend, instead of remedying the evil, to aggravate it.”“We do not move forth rightly against the insolvent banks,”Randolph warned, because of fear and greed: Every man you meet in this House or out of it, with somer are exceptions, which only served to prove the rule, was either a stock holder, president, cashier, clerk or door keeper, runner, engraver, paper-maker, or mechanic in some otherway to a bank . . . However great the evil of their conduct might be . . . whowas to bell the cat—who was to take the bull by the horns?. . . There were very few, he said, who dared to speak truth to this mammoth; the banks were so linked together with the business of the world, that there were very few men exempt from their influence. The true secret is, said he, the banks are creditors as well as debtors and so their debtors fear to tackle the banks. Randolph went on to pinpoint the fraudulent nature of fractional reserve banking: . . . [i]t was as much swindling to issue notes with intent not to pay, as it was burglary to break open a house. If they were unable to pay, the banks were bankrupts . . . The BUS was driven through Congress by the Madison administration and particularly by Secretary of the Treasury Alexander J. Dallas, whose appointment had been pushed for that purpose. Dallas, a wealthy Philadelphia lawyer, was a close friend, counsel, and financial associate of Philadelphia merchant and banker, Stephen Girard, reputedly one of the two wealthiest men in the country. Girard had been the largest single stock holder of the First BUS, and during the War of 1812, he became a very heavy investor in the war debt of the federal government. As a prospective large stock holder of the BUS and as a way of creatinga buyer for his public debt, Girard began to urge a new Central Bank. Dallas’s appointment as Secretary of Treasury in 1814 was successfully engineered by Girard and his close friend, wealthy New York merchant and fur trader, John Jacob Astor, also a heavy investor in the war debt. As a result of the deal between the BUS and the state banks, the resumption of specie payments by the latter after 1817 was more nominal than real, there by setting the stage for continued inflation, and for renewed wide spread suspensions of specie payment during the 1819–21 panic and depression. A mark of this failure of redemption was that varying discounts on bank notes against specie continued from 1817 on. The problem was aggravated by the fact that the BUS lacked the courage to insist on payment of notes from the state banks. As a result, the BUS piled up large balances against the state banks, reaching over$2.4 million during 1817 and 1818. As the major historian of the BUS writes: “So many influential people were interested in the [state banks] as stock holders that it was not advisable to give offense by demanding payment in specie, and borrowers were anxious to keep the banks in the humor to lend.”

From its inception, the Second BUS launched a massive inflation of money and credit. Lax about insisting on the required payments of its capital in specie, the Bank failed to raise the $7 million legally required to be subscribed in specie. During 1817 and1818, its specie never rose above$2.5 million and at the peak of its initial expansion, BUS specie was $21.8 million. Thus, in ascant year and a half of operation, the BUS added a net of$19.2 million to the money supply.

Outright fraud abounded at the BUS, especially at the Philadelphia and Baltimore branches, which made 3/5 of all BUSloans.9 Furthe rmore, the BUS attempt to provide a uniform national currency foundered on the fact that the western and southern branches could inflate credit and bank notes, and that the inflated notes would then come into the more conservative branches in New York and Boston, which would be obligated to redeem the inflated notes at par. In this way, the conservative branches were stripped of specie while the western branches continued to inflate unchecked.

The expansionary operations of the BUS impelled an inflationary expansion of state banks on top of the enlargement of the central bank. The number of incorporated state banks rose from 232 in 1816 to 338 in 1818, with Kentucky alone chartering 40 new banks in the 1817–18 legislative session. The estimated total money supply in the nation rose from $67.3 million in 1816 to$94.7 million in 1818, a rise of 40.7 percent in two years. Most of this increase was supplied by the BUS.10 This enormous expansion of money and credit impelled a full-scale inflationary boom through out the country.

Starting in July 1818, the government and the BUS began to see what dire straits they were in; the enormous inflation of money and credit, aggravated by the massive fraud, had put the BUS in danger of going under and illegally failing to maintains pecie payments. Over the next year, the BUS began a series of enormous contractions, forced curtailment of loans, contractions of credit in the south and west, refusal to provide uniform national currency by redeeming its shaky branch notes at par, and at last, seriously enforcing the requirement that its debtor banks redeem in specie. These heroic actions, along with the ouster of President William Jones, managed to save the BUS, but the contraction of money and credit swiftly brought to the United States its first wide spread economic and financial depression. The first nation wide “boom-bust” cycle had arrived in the United States, ignited by rapid and massive inflation and quickly succeeded by contraction of money and credit. Banks failed, and private banks curtailed their credits and liabilities and suspended specie payments in most parts of the country.

Contraction of money and credit by the BUS was almost incredible, notes and deposits falling from $21.8 million in June1818 to$11.5 only a year later. The money supply contributed by the BUS was there by contracted by no less than 47.2 percent inone year. The number of incorporated banks at first remained the same, and then fell rapidly from 1819 to 1822, dropping from 341 in mid-1819 to 267 three years later. Total notes and depositsof state banks fell from an estimated $72 million in mid-1818 to$ 62.7 million a year later, a drop of 14 percent in one year. If we add in the fact that the U.S. Treasury contracted total treasury notes from $8.81 million to zero during this period, we get a total money supply of$103.5 million in 1818, and $74.2 million in1819, a contraction in one year of 28.3 percent. The result of the contraction was a rash of defaults, bankruptcies of business and manufacturers, and a liquidation of unsound investments during the boom. Prices in general plummeted: the index of export staples fell from 158 in November 1818 to 77 in June 1819, an annualized drop of 87.9 percent in seven months. In the famous charge of the Jacksonian hard money economist and historian William M. Gouge, by its precipitate and dramatic contraction “the Bank was saved, and the people were ruined.” The Bank of the United States was supposed to bring the blessings of a uniform paper currency to the United States. Yet from the time of the chaotic 1814–17 experience, the notes of the state banks had circulated at varying rates of depreciation, depending on how long the public believed they could keep redeeming their obligations in specie. During the panic of 1819, obstacles and intimidation were often the lot of those who attempted to press the banks to fulfill their contractual obligations to pay in specie. Thus, Maryland and Pennsylvania engaged in almost bizarre inconsistency. Maryland, on February 15, 1819, enacted a law “to compel . . . banks to pay specie for their notes, or forfeit their charters.” Yet, two days after this seemingly tough action, it passed another law relieving banks of any obligation to redeem notes held by professional money brokers, the major force ensuring such redemption. The latter act was supposed “to relieve the people of this state . . . from the evil arising from the demands made on the banks of this state for gold and silver by brokers.” Pennsylvania followed suit a month later. In this way, these states could claim to be enforcing contract and property rights while trying to prevent the most effective means of such enforcement. Banks south of Virginia largely went off specie payment during the Panic of 1819, and in Georgia at least general suspension continued almost continuously down to the 1830s. One customer complained during 1819 that in order to collect in specie from the largely state-owned Bank of Darien in Georgia, he was forced to swear before a justice of the peace, five bank directors, and the bank cashier, that each and every note he presented to the bank was his own and that he was not a “money broker” or an agent for anyone else. Further more, he was forced to pay a fee of$1.3 6on each note in order to obtain the specie to which he was entitled.

In North Carolina, further more, banks were not penalized by the legislature for suspending specie payments to brokers, though they were for suspending payments to other depositors. Thus encouraged, the three leading banks of North Carolina met in June 1819 and agreed not to pay specie to brokers or their agents. Their notes, however, immediately fell to a 15 percent discount outside the state. In the course of this partial default, of course, the banks continued to require their own debtors to pay them at par in specie. Many states permitted banks to suspend specie payments during the Panic of 1819, and four Western states—Tennessee, Kentucky, Missouri, and Illinois—established state-owned banks totry to combat the depression by issuing large amounts of inconvertible paper money. In all states trying to prop up bank paper, a quasi-legal tender status was conferred on it by agreeing to receive the notes in taxes or debts due to the state. All the inconvertible paper schemes led to massive depreciation and disappearance of specie, succeeded by rapid liquidation of the new state owned banks.