The War of 1812 and its Aftermath
War has generally had grave and fateful consequences for the American monetary and financial system.
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.
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.
The constitutional prohibition against state paper money and the implicit rebuff to all fiat paper were certainly influenced by the Revolutionary War experience.
The war of 1812 to 1815 had momentous consequences for the monetary system.
An enormous expansion in the number of banks and in bank notes and deposits was spurred by the dictates of war finance.
New England banks were more conservative than in other regions, and the region was strongly opposed to the war with England,
so little public debt was purchased in New England.
Yet imported goods, textile manufacturers, and munitions had to be purchased in that region by the federal government.
The government therefore encouraged the formation of new and recklessly inflationary banks in
the mid-Atlantic, southern and western states, which printed huge quantities of new notes
to purchase government bonds.
The federal government thereupon used these notes to purchase manufactured goods in New
England.
Thus, from 1811 to 1815, the number of banks in the country increased from 117 to 212.
In addition, there had sprung up 35 private unincorporated banks, which were illegal in
most states but were allowed to function under war conditions.
Specie in the 30 reporting banks, 26% of the total number of banks of 1811, amounted to
$2.57 million in 1811.
This figure had risen to $5.4 million in the 98 reporting banks in 1815, or 40% of the
total.
Notes and deposits, on the other hand, were $10.95 million in 1811 and had increased to
$31.6 million in 1815 among the reporting banks.
If we make the heroic assumption that we can estimate the money supply for the country
by multiplying by the proportion of unreported banks and we then add in the Bank of the United
States totals for 1811, Specie in all banks would total $14.9 million in 1811 and $13.5
If we factor in the Bank of the United States then, the bank pyramid ratio was 3.7 to 1
and the reserve ratio 0.27 in 1811, while the pyramid ratio 4 years later was 5.85 to
1 and the reserve ratio 0.17.
But the aggregates scarcely tell the whole story since, as we have seen, the expansion
took place solely outside of New England, while New England banks continued on their
relatively sound basis and did not inflate their credit.
The record expansion of the number of banks was in Pennsylvania, which incorporated no
No less than 41 new banks in the month of March 1814, contrasting to only 4 banks which
had existed in that state, all in Philadelphia, until that date.
It is instructive to compare the pyramid ratios of banks in various reporting states in 1815
to only 1.96 to 1 in Massachusetts, 2.7 to 1 in New Hampshire, and 2.42 to 1 in Rhode
This monetary situation meant that the United States government was paying for New England
manufactured goods with a mass of inflated bank paper outside the region.
Soon, as the New England banks called upon the other banks to redeem their notes in specie,
The mass of inflating banks faced imminent insolvency.
It was at this point that a fateful decision was made by the U.S. government and concurred
in by the governments of the states outside New England.
As the banks all faced failure, the governments, in August 1814, permitted all of them to suspend
specie payments, that is, to stop all redemption of notes and deposits in gold or silver, and
yet to continue in operation.
In short, in one of the most flagrant violations of property rights in American history, the
banks were permitted to waive their contractual obligations to pay in specie while they themselves
could expand their loans and operations and force their own debtors to repay their loans
as usual.
Indeed, the number of banks and bank credit expanded rapidly during 1815 as a result of
this governmental carte blanche.
It was precisely during 1815 when virtually all the private banks sprang up, the number
The number of banks increasing in one year from 208 to 246.
Reporting banks increased their pyramid ratios from 3.17 to 1 in 1814 to 5.85 to 1 the following
year.
A drop of reserve ratios from 0.32 to 0.17.
Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary
The very impetus during the War of 1812 came during the year 1815 after specie payments
had been suspended throughout the country by government action.
Historians dedicated to the notion that central banks restrained state or private bank inflation
have placed the blame for the multiplicity of banks and bank credit inflation during
the War of 1812 on the absence of a central bank.
But as we have seen, both the number of banks and bank credit grew apace during the period
of the first bank of the United States, pyramiding on top of the latter's expansion, and would
continue to do so under the second bank, and, for that matter, the Federal Reserve system
in later years.
In the federal government, not the state banks themselves is largely to blame for encouraging
new inflated banks to monetize the war debt.
Then, in particular, it allowed them to suspend specie payment in August 1814 and to continue
Another neglected responsibility of the U.S. government for the wartime inflation was its
massive issue of Treasury notes to help finance the war effort.
While this Treasury paper was interest-bearing and was redeemable in specie in one year,
The cumulative amount outstanding functioned as money, as it was used in transactions among
the public and was also employed as reserves or quote, high-powered money by the expanding
banks.
The fact that the government received the treasury notes for all debts and taxes gave
the notes a quasi-legal tender status.
Most of the treasury notes were issued in 1814 and 1815, when their outstanding total
reached $10.65 million and $15.46 million respectively.
Not only did the treasury notes fuel the bank inflation, but their quasi-legal tender status
brought Gresham's Law into operation and specie flowed out of the banks and public circulation
outside of New England and into New England and out of the country.
The expansion of bank money and treasury notes during the war drove up prices in the United
States.
Wholesale price increases from 1811 to 1815 averaged 35%, with different cities experiencing
Expansion and Demands for Redemption in Specie, State and Federal Governments looked the other
way and permitted general suspension of specie payments while bank operations continued to
flourish.
It thus became clear to the banks that in a general crisis they would not be required
to meet the ordinary obligations of contract law or of respect for property rights, so
their inflationary expansion was permanently encouragedivid this massive failure of government
to fulfill its obligation to enforce contracts and defend the rights of property.
Suspensions of species payments informally or officially permeated the economy outside
of New England during the Panic of 1819, occurred everywhere outside of New England in 1837
and in all states south and west of New Jersey in 1839.
A general suspension of species payments occurred throughout the country once again in the Panic
of 1857.
It is important to realize then, in evaluating the American banking system before the Civil
War, that even in the later years, when there was no central bank, the system was not quote
free in any proper economic sense.
Free banking can only refer to a system in which banks are treated as any other business
and that therefore failure to obey contractual obligations, in this case prompt redemption
of notes and deposits in specie, must incur immediate insolvency and liquidation.
Burdened by the tradition of allowing general suspensions that arose in the United States
in 1814, the pre-Civil War banking system, despite strong elements of competition when
not saddled with a central bank, must rather be termed in the phrase of one economist as
quote, decentralization without freedom.
From the 1814 to 1817 experience on, the notes of state banks circulated at varying rates
of depreciation, depending on public expectations of how long they would be able to keep redeeming
In that era of poor communications and high transportation costs, the tendency for a banknote
was to depreciate in proportion to its distance from the home office.
One effective, if time-consuming, method of enforcing redemption on nominally-specie-paying
Banking, was the emergence of a class of professional, quote, money brokers.
These brokers would buy up a mass of depreciated notes of nominally specie-paying banks and
then travel to the home office of the bank to demand redemption in specie.
Merchants, money brokers, bankers and the general public were aided in evaluating the
various state bank notes by the development of monthly journals known as quote, bank note
detectors.
These detectors were published by money brokers and periodically evaluated the market rate
of Various Banknotes in Relation to Specie.
Quote, Wildcat banks were so named because in that age of poor transportation, banks hoping
to inflate and not worry about redemption attempted to locate in a wildcat country where
money brokers would find it difficult to travel.
It should be noted that if it were not for periodic suspension, there would have been
no room for Wildcat banks or for varying degrees of lack of confidence in the genuineness of
Specie redemption at any given time.
It can be imagined that the advent of the money broker was not precisely welcomed in
the town of an errant bank, and it was easy for the townspeople to blame the resulting
collapse of bank credit on the sinister stranger rather than on the friendly neighborhood banker.
During the Panic of 1819, when banks collapsed after an inflationary boom lasting until 1817,
obstacles and intimidation were often the lot of those who attempted to press the banks
to fulfill their contractual obligation to pay in specie.
Thus, Maryland and Pennsylvania during the Panic of 1819 engaged in almost bizarre inconsistency
in this area.
Maryland on February 15, 1819 enacted a law, quote, 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 money brokers, quote, the major force ensuring the people
Pennsylvania followed suit a month later.
In this way, these states could claim to maintain the virtue of enforcing contract and property
rights while moving to prevent the most effective method of ensuring such enforcement.
During the 1814-1817 general suspension, noteholders who sued for specie payments seldom gained
satisfaction in the courts.
Thus, Isaac Bronson, a prominent Connecticut banker in a specie-paying region, sued various
New York banks for payment of notes in specie.
He failed to get satisfaction, and for his pains, received only abuse in the New York
press as an agent of quote, misery and ruin.
The banks south of Virginia largely went off specie payment during the panic of 1819, and
in Georgia, at least general suspension continued almost continuously to the 1830s.
One customer complained during 1819 that in order to collect in specie from the largely
state-owned Bank of Darien, Georgia, he was forced to swear before a justice of the piece
in the bank 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.
He was forced to swear to the oath in the presence of at least five bank directors and
the bank's cashier, and he was forced to pay a fee of $1.36 on each note in order to
acquire specie on demand.
Two years later, when a note holder demanded $30,000 in specie at the Planters Bank of
Georgia, he was told he would be paid in pennies only, while another customer was forced to
accept pennies handed out to him at a rate of $60 a day.
During the panic, North Carolina and Maryland in particular moved against the money brokers
in a vain attempt to prop up the depreciated notes of their state's banks.
In North Carolina, banks were not penalized by the legislature for suspending specie payments
Backed by government, the three leading banks of the state met and agreed in June 1819 not
to pay specie to brokers or their agents.
Their notes immediately fell to a 15% discount outside the state.
However, the banks continued to require, ignoring the inconsistency that their own debtors pay
them at par in specie.
Maryland, during the same year, moved to require a license of $500 per year for money brokers
in addition to an enormous $20,000 bond to establish the business.
Maryland tried to bolster the defense of banks and the attack on brokers by passing a compulsory
par law in 1819 prohibiting the exchange of specie from Maryland banknotes at less than
par.
The law was readily evaded, however, with the penalty merely adding to the discount
as compensation for the added risk.
Specie furthermore was driven out of the state by the operation of Gresham's law.
In Kentucky, Tennessee and Missouri, stay laws were passed requiring creditors to accept
depreciated and inconvertible bank paper in payment of debts, else suffer a stay of execution
of the debt.
In this way, quasi-legal tender status was conferred on the paper.
Many states permitted banks to suspend specie payment and four western states, Tennessee,
Kentucky, Missouri and Illinois, established state-owned banks to try to overcome the
The Depression by issuing large issues of inconvertible paper money.
In all states trying to prop up inconvertible bank paper, a quasi-legal status was also
conferred on the paper by agreeing to receive the notes in taxes or debts due to the state.
The result of all the inconvertible paper schemes was rapid and massive depreciation.
Disappearance of specie succeeded by speedy liquidation of the new state-owned banks.
An amusing footnote on the problem of banks being protected against their contractual
obligations to pay in specie occurred in the course of correspondence between one of the
earliest economists of America, the young Philadelphia State Senator, Condi Rigaud,
and the eminent English economist, David Ricardo.
Ricardo had evidently been bewildered by Rigaud's statement that banks technically required
to pay in specie often were not called upon to do so.
On April 18, 1821, Rigaud replied, explaining the power of banks in the United States,
Quote, You state in your letter that you find it
difficult to comprehend why persons who had a right to demand coin from the banks in payment
of their notes so long for boar to exercise it.
This no doubt appears paradoxical to one who resides in a country where an act of parliament
was necessary to protect the bank, but the difficulty is easily solved.
The whole of our population are either stockholders of banks or in debt to them.
It is not the interest of the first to press the banks, and the rest are afraid.
This is the whole secret.
An independent man, who is neither a stockholder or debtor, who would have ventured to compel
Tell the Banks to Do Justice would have been persecuted as an enemy of society.