WEBVTT NOTE 9. The War of 1812 and Its Aftermath 1 00:00:00.000 --> 00:00:03.000 The War of 1812 and its Aftermath 2 00:00:03.000 --> 00:00:10.000 War has generally had grave and fateful consequences for the American monetary and financial system. 3 00:00:10.000 --> 00:00:22.000 We have seen that the Revolutionary War occasioned a mass of depreciated fiat paper, worthless continentals, a huge public debt, and the beginnings of central banking in the Bank of North America. 4 00:00:22.000 --> 00:00:42.000 The Hamiltonian financial system, and even the Constitution itself, was in large part shaped by the Federalist desire to fund the federal and state public debt via federal taxation, and a major reason for the establishment of the First Bank of the United States was to contribute to the funding of the newly assumed federal debt. 5 00:00:42.000 --> 00:00:51.000 The constitutional prohibition against state paper money and the implicit rebuff to all fiat paper were certainly influenced by the Revolutionary War experience. 6 00:00:51.000 --> 00:00:57.000 The war of 1812 to 1815 had momentous consequences for the monetary system. 7 00:00:57.000 --> 00:01:04.000 An enormous expansion in the number of banks and in bank notes and deposits was spurred by the dictates of war finance. 8 00:01:04.000 --> 00:01:10.000 New England banks were more conservative than in other regions, and the region was strongly opposed to the war with England, 9 00:01:10.000 --> 00:01:13.000 so little public debt was purchased in New England. 10 00:01:13.000 --> 00:01:19.000 Yet imported goods, textile manufacturers, and munitions had to be purchased in that region by the federal government. 11 00:01:19.000 --> 00:01:24.520 The government therefore encouraged the formation of new and recklessly inflationary banks in 12 00:01:24.520 --> 00:01:29.720 the mid-Atlantic, southern and western states, which printed huge quantities of new notes 13 00:01:29.720 --> 00:01:31.920 to purchase government bonds. 14 00:01:31.920 --> 00:01:36.080 The federal government thereupon used these notes to purchase manufactured goods in New 15 00:01:36.080 --> 00:01:37.080 England. 16 00:01:37.080 --> 00:01:45.700 Thus, from 1811 to 1815, the number of banks in the country increased from 117 to 212. 17 00:01:45.700 --> 00:01:50.460 In addition, there had sprung up 35 private unincorporated banks, which were illegal in 18 00:01:50.460 --> 00:01:54.380 most states but were allowed to function under war conditions. 19 00:01:54.380 --> 00:02:00.980 Specie in the 30 reporting banks, 26% of the total number of banks of 1811, amounted to 20 00:02:00.980 --> 00:02:04.420 $2.57 million in 1811. 21 00:02:04.420 --> 00:02:11.300 This figure had risen to $5.4 million in the 98 reporting banks in 1815, or 40% of the 22 00:02:11.300 --> 00:02:12.300 total. 23 00:02:12.300 --> 00:02:18.900 Notes and deposits, on the other hand, were $10.95 million in 1811 and had increased to 24 00:02:18.900 --> 00:02:24.460 $31.6 million in 1815 among the reporting banks. 25 00:02:24.460 --> 00:02:28.340 If we make the heroic assumption that we can estimate the money supply for the country 26 00:02:28.340 --> 00:02:33.340 by multiplying by the proportion of unreported banks and we then add in the Bank of the United 27 00:02:33.340 --> 00:02:41.700 States totals for 1811, Specie in all banks would total $14.9 million in 1811 and $13.5 28 00:02:41.700 --> 00:03:09.180 If we factor in the Bank of the United States then, the bank pyramid ratio was 3.7 to 1 29 00:03:09.180 --> 00:03:17.380 and the reserve ratio 0.27 in 1811, while the pyramid ratio 4 years later was 5.85 to 30 00:03:17.380 --> 00:03:21.940 1 and the reserve ratio 0.17. 31 00:03:21.940 --> 00:03:26.640 But the aggregates scarcely tell the whole story since, as we have seen, the expansion 32 00:03:26.640 --> 00:03:30.900 took place solely outside of New England, while New England banks continued on their 33 00:03:30.900 --> 00:03:34.700 relatively sound basis and did not inflate their credit. 34 00:03:34.700 --> 00:03:38.620 The record expansion of the number of banks was in Pennsylvania, which incorporated no 35 00:03:38.620 --> 00:03:44.800 No less than 41 new banks in the month of March 1814, contrasting to only 4 banks which 36 00:03:44.800 --> 00:03:49.700 had existed in that state, all in Philadelphia, until that date. 37 00:03:49.700 --> 00:03:55.500 It is instructive to compare the pyramid ratios of banks in various reporting states in 1815 38 00:03:55.500 --> 00:04:02.580 to only 1.96 to 1 in Massachusetts, 2.7 to 1 in New Hampshire, and 2.42 to 1 in Rhode 39 00:04:02.580 --> 00:04:18.780 This monetary situation meant that the United States government was paying for New England 40 00:04:18.780 --> 00:04:23.620 manufactured goods with a mass of inflated bank paper outside the region. 41 00:04:23.620 --> 00:04:28.780 Soon, as the New England banks called upon the other banks to redeem their notes in specie, 42 00:04:28.780 --> 00:04:32.860 The mass of inflating banks faced imminent insolvency. 43 00:04:32.860 --> 00:04:37.100 It was at this point that a fateful decision was made by the U.S. government and concurred 44 00:04:37.100 --> 00:04:40.900 in by the governments of the states outside New England. 45 00:04:40.900 --> 00:04:47.060 As the banks all faced failure, the governments, in August 1814, permitted all of them to suspend 46 00:04:47.060 --> 00:04:53.420 specie payments, that is, to stop all redemption of notes and deposits in gold or silver, and 47 00:04:53.420 --> 00:04:55.900 yet to continue in operation. 48 00:04:55.900 --> 00:05:01.140 In short, in one of the most flagrant violations of property rights in American history, the 49 00:05:01.140 --> 00:05:05.780 banks were permitted to waive their contractual obligations to pay in specie while they themselves 50 00:05:05.780 --> 00:05:10.460 could expand their loans and operations and force their own debtors to repay their loans 51 00:05:10.460 --> 00:05:11.860 as usual. 52 00:05:11.860 --> 00:05:17.620 Indeed, the number of banks and bank credit expanded rapidly during 1815 as a result of 53 00:05:17.620 --> 00:05:20.340 this governmental carte blanche. 54 00:05:20.340 --> 00:05:25.380 It was precisely during 1815 when virtually all the private banks sprang up, the number 55 00:05:25.380 --> 00:05:30.460 The number of banks increasing in one year from 208 to 246. 56 00:05:30.460 --> 00:05:38.260 Reporting banks increased their pyramid ratios from 3.17 to 1 in 1814 to 5.85 to 1 the following 57 00:05:38.260 --> 00:05:39.260 year. 58 00:05:39.260 --> 00:05:43.860 A drop of reserve ratios from 0.32 to 0.17. 59 00:05:43.860 --> 00:05:49.860 Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary 60 00:05:49.860 --> 00:05:55.300 The very impetus during the War of 1812 came during the year 1815 after specie payments 61 00:05:55.300 --> 00:05:59.540 had been suspended throughout the country by government action. 62 00:05:59.540 --> 00:06:03.920 Historians dedicated to the notion that central banks restrained state or private bank inflation 63 00:06:03.920 --> 00:06:07.880 have placed the blame for the multiplicity of banks and bank credit inflation during 64 00:06:07.880 --> 00:06:11.580 the War of 1812 on the absence of a central bank. 65 00:06:11.580 --> 00:06:16.080 But as we have seen, both the number of banks and bank credit grew apace during the period 66 00:06:16.080 --> 00:06:20.940 of the first bank of the United States, pyramiding on top of the latter's expansion, and would 67 00:06:20.940 --> 00:06:25.560 continue to do so under the second bank, and, for that matter, the Federal Reserve system 68 00:06:25.560 --> 00:06:26.560 in later years. 69 00:06:26.560 --> 00:06:31.420 In the federal government, not the state banks themselves is largely to blame for encouraging 70 00:06:31.420 --> 00:06:34.640 new inflated banks to monetize the war debt. 71 00:06:34.640 --> 00:06:40.920 Then, in particular, it allowed them to suspend specie payment in August 1814 and to continue 72 00:06:40.920 --> 00:06:59.360 Another neglected responsibility of the U.S. government for the wartime inflation was its 73 00:06:59.360 --> 00:07:03.640 massive issue of Treasury notes to help finance the war effort. 74 00:07:03.640 --> 00:07:08.120 While this Treasury paper was interest-bearing and was redeemable in specie in one year, 75 00:07:08.120 --> 00:07:12.760 The cumulative amount outstanding functioned as money, as it was used in transactions among 76 00:07:12.760 --> 00:07:17.800 the public and was also employed as reserves or quote, high-powered money by the expanding 77 00:07:17.800 --> 00:07:18.800 banks. 78 00:07:18.800 --> 00:07:22.440 The fact that the government received the treasury notes for all debts and taxes gave 79 00:07:22.440 --> 00:07:25.640 the notes a quasi-legal tender status. 80 00:07:25.640 --> 00:07:30.420 Most of the treasury notes were issued in 1814 and 1815, when their outstanding total 81 00:07:30.420 --> 00:07:36.880 reached $10.65 million and $15.46 million respectively. 82 00:07:36.880 --> 00:07:41.200 Not only did the treasury notes fuel the bank inflation, but their quasi-legal tender status 83 00:07:41.200 --> 00:07:46.840 brought Gresham's Law into operation and specie flowed out of the banks and public circulation 84 00:07:46.840 --> 00:07:51.720 outside of New England and into New England and out of the country. 85 00:07:51.720 --> 00:07:55.560 The expansion of bank money and treasury notes during the war drove up prices in the United 86 00:07:55.560 --> 00:07:57.040 States. 87 00:07:57.040 --> 00:08:03.080 Wholesale price increases from 1811 to 1815 averaged 35%, with different cities experiencing 88 00:08:33.080 --> 00:08:37.820 Expansion and Demands for Redemption in Specie, State and Federal Governments looked the other 89 00:08:37.820 --> 00:08:42.640 way and permitted general suspension of specie payments while bank operations continued to 90 00:08:42.640 --> 00:08:44.120 flourish. 91 00:08:44.120 --> 00:08:48.120 It thus became clear to the banks that in a general crisis they would not be required 92 00:08:48.120 --> 00:08:53.040 to meet the ordinary obligations of contract law or of respect for property rights, so 93 00:08:53.040 --> 00:08:57.380 their inflationary expansion was permanently encouragedivid this massive failure of government 94 00:08:57.380 --> 00:09:03.220 to fulfill its obligation to enforce contracts and defend the rights of property. 95 00:09:03.220 --> 00:09:07.180 Suspensions of species payments informally or officially permeated the economy outside 96 00:09:07.180 --> 00:09:13.480 of New England during the Panic of 1819, occurred everywhere outside of New England in 1837 97 00:09:13.480 --> 00:09:17.780 and in all states south and west of New Jersey in 1839. 98 00:09:17.780 --> 00:09:21.840 A general suspension of species payments occurred throughout the country once again in the Panic 99 00:09:21.840 --> 00:09:24.000 of 1857. 100 00:09:24.000 --> 00:09:27.900 It is important to realize then, in evaluating the American banking system before the Civil 101 00:09:27.900 --> 00:09:32.840 War, that even in the later years, when there was no central bank, the system was not quote 102 00:09:32.840 --> 00:09:36.040 free in any proper economic sense. 103 00:09:36.040 --> 00:09:40.680 Free banking can only refer to a system in which banks are treated as any other business 104 00:09:40.680 --> 00:09:45.700 and that therefore failure to obey contractual obligations, in this case prompt redemption 105 00:09:45.700 --> 00:09:51.760 of notes and deposits in specie, must incur immediate insolvency and liquidation. 106 00:09:51.760 --> 00:09:55.700 Burdened by the tradition of allowing general suspensions that arose in the United States 107 00:09:55.700 --> 00:10:01.460 in 1814, the pre-Civil War banking system, despite strong elements of competition when 108 00:10:01.460 --> 00:10:06.140 not saddled with a central bank, must rather be termed in the phrase of one economist as 109 00:10:06.140 --> 00:10:10.320 quote, decentralization without freedom. 110 00:10:10.320 --> 00:10:16.420 From the 1814 to 1817 experience on, the notes of state banks circulated at varying rates 111 00:10:16.420 --> 00:10:21.380 of depreciation, depending on public expectations of how long they would be able to keep redeeming 112 00:10:21.380 --> 00:10:37.700 In that era of poor communications and high transportation costs, the tendency for a banknote 113 00:10:37.700 --> 00:10:41.940 was to depreciate in proportion to its distance from the home office. 114 00:10:41.940 --> 00:10:46.740 One effective, if time-consuming, method of enforcing redemption on nominally-specie-paying 115 00:10:46.740 --> 00:10:52.100 Banking, was the emergence of a class of professional, quote, money brokers. 116 00:10:52.100 --> 00:10:57.060 These brokers would buy up a mass of depreciated notes of nominally specie-paying banks and 117 00:10:57.060 --> 00:11:00.940 then travel to the home office of the bank to demand redemption in specie. 118 00:11:00.940 --> 00:11:05.420 Merchants, money brokers, bankers and the general public were aided in evaluating the 119 00:11:05.420 --> 00:11:09.740 various state bank notes by the development of monthly journals known as quote, bank note 120 00:11:09.740 --> 00:11:11.340 detectors. 121 00:11:11.340 --> 00:11:15.460 These detectors were published by money brokers and periodically evaluated the market rate 122 00:11:15.460 --> 00:11:18.380 of Various Banknotes in Relation to Specie. 123 00:11:18.380 --> 00:11:24.020 Quote, Wildcat banks were so named because in that age of poor transportation, banks hoping 124 00:11:24.020 --> 00:11:28.660 to inflate and not worry about redemption attempted to locate in a wildcat country where 125 00:11:28.660 --> 00:11:31.900 money brokers would find it difficult to travel. 126 00:11:31.900 --> 00:11:35.240 It should be noted that if it were not for periodic suspension, there would have been 127 00:11:35.240 --> 00:11:40.060 no room for Wildcat banks or for varying degrees of lack of confidence in the genuineness of 128 00:11:40.060 --> 00:11:43.080 Specie redemption at any given time. 129 00:11:43.080 --> 00:11:46.800 It can be imagined that the advent of the money broker was not precisely welcomed in 130 00:11:46.800 --> 00:11:50.660 the town of an errant bank, and it was easy for the townspeople to blame the resulting 131 00:11:50.660 --> 00:11:55.920 collapse of bank credit on the sinister stranger rather than on the friendly neighborhood banker. 132 00:11:55.920 --> 00:12:02.040 During the Panic of 1819, when banks collapsed after an inflationary boom lasting until 1817, 133 00:12:02.040 --> 00:12:06.200 obstacles and intimidation were often the lot of those who attempted to press the banks 134 00:12:06.200 --> 00:12:10.080 to fulfill their contractual obligation to pay in specie. 135 00:12:10.080 --> 00:12:16.680 Thus, Maryland and Pennsylvania during the Panic of 1819 engaged in almost bizarre inconsistency 136 00:12:16.680 --> 00:12:18.440 in this area. 137 00:12:18.440 --> 00:12:25.000 Maryland on February 15, 1819 enacted a law, quote, to compel banks to pay specie for their 138 00:12:25.000 --> 00:12:27.480 notes or forfeit their charters. 139 00:12:27.480 --> 00:12:32.040 Yet two days after this seemingly tough action, it passed another law relieving banks of any 140 00:12:32.040 --> 00:12:37.320 obligation to redeem notes held by money brokers, quote, the major force ensuring the people 141 00:12:37.320 --> 00:12:47.360 Pennsylvania followed suit a month later. 142 00:12:47.360 --> 00:12:52.020 In this way, these states could claim to maintain the virtue of enforcing contract and property 143 00:12:52.020 --> 00:12:57.360 rights while moving to prevent the most effective method of ensuring such enforcement. 144 00:12:57.360 --> 00:13:03.660 During the 1814-1817 general suspension, noteholders who sued for specie payments seldom gained 145 00:13:03.660 --> 00:13:05.560 satisfaction in the courts. 146 00:13:05.560 --> 00:13:11.040 Thus, Isaac Bronson, a prominent Connecticut banker in a specie-paying region, sued various 147 00:13:11.040 --> 00:13:14.040 New York banks for payment of notes in specie. 148 00:13:14.040 --> 00:13:17.960 He failed to get satisfaction, and for his pains, received only abuse in the New York 149 00:13:17.960 --> 00:13:21.800 press as an agent of quote, misery and ruin. 150 00:13:21.800 --> 00:13:26.760 The banks south of Virginia largely went off specie payment during the panic of 1819, and 151 00:13:26.760 --> 00:13:32.400 in Georgia, at least general suspension continued almost continuously to the 1830s. 152 00:13:32.400 --> 00:13:36.600 One customer complained during 1819 that in order to collect in specie from the largely 153 00:13:36.600 --> 00:13:41.240 state-owned Bank of Darien, Georgia, he was forced to swear before a justice of the piece 154 00:13:41.240 --> 00:13:45.500 in the bank that each and every note he presented to the bank was his own and that he was not 155 00:13:45.500 --> 00:13:48.160 a money broker or an agent for anyone else. 156 00:13:48.160 --> 00:13:51.920 He was forced to swear to the oath in the presence of at least five bank directors and 157 00:13:51.920 --> 00:13:57.540 the bank's cashier, and he was forced to pay a fee of $1.36 on each note in order to 158 00:13:57.540 --> 00:14:00.200 acquire specie on demand. 159 00:14:00.200 --> 00:14:04.520 Two years later, when a note holder demanded $30,000 in specie at the Planters Bank of 160 00:14:04.520 --> 00:14:09.820 Georgia, he was told he would be paid in pennies only, while another customer was forced to 161 00:14:09.820 --> 00:14:14.220 accept pennies handed out to him at a rate of $60 a day. 162 00:14:14.220 --> 00:14:18.720 During the panic, North Carolina and Maryland in particular moved against the money brokers 163 00:14:18.720 --> 00:14:23.000 in a vain attempt to prop up the depreciated notes of their state's banks. 164 00:14:23.000 --> 00:14:27.360 In North Carolina, banks were not penalized by the legislature for suspending specie payments 165 00:14:27.360 --> 00:14:36.240 Backed by government, the three leading banks of the state met and agreed in June 1819 not 166 00:14:36.240 --> 00:14:39.520 to pay specie to brokers or their agents. 167 00:14:39.520 --> 00:14:43.640 Their notes immediately fell to a 15% discount outside the state. 168 00:14:43.640 --> 00:14:48.960 However, the banks continued to require, ignoring the inconsistency that their own debtors pay 169 00:14:48.960 --> 00:14:51.320 them at par in specie. 170 00:14:51.320 --> 00:14:56.640 Maryland, during the same year, moved to require a license of $500 per year for money brokers 171 00:14:56.640 --> 00:15:02.120 in addition to an enormous $20,000 bond to establish the business. 172 00:15:02.120 --> 00:15:06.240 Maryland tried to bolster the defense of banks and the attack on brokers by passing a compulsory 173 00:15:06.240 --> 00:15:11.360 par law in 1819 prohibiting the exchange of specie from Maryland banknotes at less than 174 00:15:11.360 --> 00:15:12.360 par. 175 00:15:12.360 --> 00:15:16.100 The law was readily evaded, however, with the penalty merely adding to the discount 176 00:15:16.100 --> 00:15:18.920 as compensation for the added risk. 177 00:15:18.920 --> 00:15:23.320 Specie furthermore was driven out of the state by the operation of Gresham's law. 178 00:15:23.320 --> 00:15:28.440 In Kentucky, Tennessee and Missouri, stay laws were passed requiring creditors to accept 179 00:15:28.440 --> 00:15:34.000 depreciated and inconvertible bank paper in payment of debts, else suffer a stay of execution 180 00:15:34.000 --> 00:15:35.000 of the debt. 181 00:15:35.000 --> 00:15:39.240 In this way, quasi-legal tender status was conferred on the paper. 182 00:15:39.240 --> 00:15:44.280 Many states permitted banks to suspend specie payment and four western states, Tennessee, 183 00:15:44.280 --> 00:15:49.000 Kentucky, Missouri and Illinois, established state-owned banks to try to overcome the 184 00:15:49.000 --> 00:15:53.380 The Depression by issuing large issues of inconvertible paper money. 185 00:15:53.380 --> 00:15:58.260 In all states trying to prop up inconvertible bank paper, a quasi-legal status was also 186 00:15:58.260 --> 00:16:03.820 conferred on the paper by agreeing to receive the notes in taxes or debts due to the state. 187 00:16:03.820 --> 00:16:08.640 The result of all the inconvertible paper schemes was rapid and massive depreciation. 188 00:16:08.640 --> 00:16:14.620 Disappearance of specie succeeded by speedy liquidation of the new state-owned banks. 189 00:16:14.620 --> 00:16:18.940 An amusing footnote on the problem of banks being protected against their contractual 190 00:16:18.940 --> 00:16:23.460 obligations to pay in specie occurred in the course of correspondence between one of the 191 00:16:23.460 --> 00:16:28.780 earliest economists of America, the young Philadelphia State Senator, Condi Rigaud, 192 00:16:28.780 --> 00:16:31.880 and the eminent English economist, David Ricardo. 193 00:16:31.880 --> 00:16:36.180 Ricardo had evidently been bewildered by Rigaud's statement that banks technically required 194 00:16:36.180 --> 00:16:39.740 to pay in specie often were not called upon to do so. 195 00:16:39.740 --> 00:16:46.180 On April 18, 1821, Rigaud replied, explaining the power of banks in the United States, 196 00:16:46.180 --> 00:16:49.140 Quote, You state in your letter that you find it 197 00:16:49.140 --> 00:16:53.980 difficult to comprehend why persons who had a right to demand coin from the banks in payment 198 00:16:53.980 --> 00:16:57.820 of their notes so long for boar to exercise it. 199 00:16:57.820 --> 00:17:01.980 This no doubt appears paradoxical to one who resides in a country where an act of parliament 200 00:17:01.980 --> 00:17:06.540 was necessary to protect the bank, but the difficulty is easily solved. 201 00:17:06.540 --> 00:17:10.860 The whole of our population are either stockholders of banks or in debt to them. 202 00:17:10.860 --> 00:17:15.720 It is not the interest of the first to press the banks, and the rest are afraid. 203 00:17:15.720 --> 00:17:17.440 This is the whole secret. 204 00:17:17.440 --> 00:17:22.180 An independent man, who is neither a stockholder or debtor, who would have ventured to compel 205 00:17:22.180 --> 00:17:27.220 Tell the Banks to Do Justice would have been persecuted as an enemy of society.