The Signing of the Treaty of Ghent, Christmas Eve, 1814
by Charles Amédée Forestier.
This is the sixth installment of the book club discussion of Rothbard's Money and Banking in the United States. So far we have covered the book through First Bank of the United States section in part 1:
![History of Money in the United States [HOMIUS] - 1.5](https://substackcdn.com/image/fetch/$s_!Vr5L!,w_140,h_140,c_fill,f_webp,q_auto:good,fl_progressive:steep,g_auto/https%3A%2F%2Fsubstack-post-media.s3.amazonaws.com%2Fpublic%2Fimages%2F9848fae8-cef5-4c58-a404-2da21106e06e_720x450.jpeg)
As usual, will quote directly the passages I found especially interesting, including my takes here and there. The emphasis is always mine, unless stated otherwise.
THE WAR OF 1812 AND ITS AFTERMATH
War has generally had grave and fateful consequences for the American monetary and financial system.
"It was a dark and stormy night". Sorry, could not resist.
The War of 1812–15 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 ... was strongly opposed to the war with England, so little public debt was purchased in New England. Yet imported goods, textile manufactures, 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.
... 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 percent of the total number of banks of 1811, amounted to $2.57 million in 1811; this figure had risen to $5.40 million in the 98 reporting banks in 1815, or 40 percent 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.
Rothbard makes a back-of-the-envelope calculation and estimates that "the bank pyramid ratio was 3.70-to-1 and the reserve ratio 0.27 in 1811; while the pyramid ratio four years later [in 1815] 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.
Thus most of the expansion happened outside of New England.
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 Island, as contrasted to 19.2-to-1 in Pennsylvania, 18.46-to-1 in South Carolina, and 18.73-to-1 in Virginia.
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.
Reminds one of the 2008 bail-out, doesn't it? The more things change the more they stay the same. Or maybe things never really changed.
Rothbard comes to the conclusion that it's that decision that led to the major inflationary expansion during the war of 1812. In addition, the U.S. government issued a massive amount of Treasure notes. Those were accepted by the government for all debts and taxes, making them de-facto currency and further fueling inflation. Not only that, 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.
Suspension of specie payments by banks during the 1812 war set a precedent for other such suspensions, at least in parts of the country: during the panic of 1819, in 1837, and 1839. And throughout the whole country 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 “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 “Decentralization without Freedom.”
In that era of poor communications and high transportation costs, the tendency for a bank note 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 banks was the emergence of a class of professional “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.
“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 “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.
The chapter continues with describing various abuses by governments and banks to prevent redemption in specie.
During the 1814–1817 general suspension, noteholders who sued for specie payment 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 “misery and ruin.”
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 peace 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 noteholder 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 the rate of $60 a day.
The chapter is concluded with a quote from the letter by Condy Raguet - a young Philadelphia state Senator and one of the earliest American economists - and famous English economist David Ricardo:
"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 forebore to exercise it. This no doubt appears paradoxical to one who resides in a country where an act of parliament was necessary to protect a 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 was neither a stockholder or debtor, who would have ventured to compel the banks to do justice, would have been persecuted as an enemy of society".