A Brief Monetary History Of The United States: Part II

Today we bring you Part II of “A Brief Monetary History of the United States” from the Ron Paul Monetary Policy Anthology. The full series can be found at the following links:

  • Part I – Colonial Money and the Coinage Act of 1792
  • Part II – The Banks of the United States, McCulloch v. Maryland, and Private Coinage
  • Part III – Government Begins to Monopolize Currency
  • Part IV – The Legal Tender Cases and the “Crime of ’73”
  • Part V – The Rise of the Fed
  • Part VI – The Great Depression, Gold Confiscation, and the Gold Exchange Standard
  • Part VII – The Dollar Reigns Supreme: From Bretton Woods to Stagflation
  • Part VIII – The 1980s to the Great Recession and on to the Future
  • First and Second Banks of the United States

    First Bank of the United States Building

    First Bank of the United States Building

    The First Bank of the United States was established in 1791 as a national central bank. One of the justifications behind the establishment of the Bank was to combat the supposed scarcity of money and to facilitate commerce through the expansion of credit. The national bank proposal ignored the true cause of specie scarcity, which was the legal overvaluation of one form of money over another. Whenever money was given legal tender status and a fixed legal value, Gresham’s Law took hold and gold or silver vanished from circulation. What proponents of central banking really wanted was an enlarged and eased issuance of credit, especially to the federal government, believing that easy credit was the path to economic prosperity.

    The establishment of the Bank of the United States was hotly debated. The Jeffersonians argued that because there was no explicit authority for the federal government to create a bank, the establishment of a bank was therefore unconstitutional. The Hamiltonians argued that establishing a bank was an implied power necessary to the functioning of government and therefore justifiable under the Constitution’s Necessary and Proper Clause. President Washington sided with the Hamiltonians and signed into law the First Bank of the United States. This was one example of a number of laws passed in the early years of the Republic which tested the restrictions placed upon the federal government by the Constitution.

    While the notes of the Bank of the United States were not legal tender, any of its notes payable in gold and silver coin were to be “receivable in all payments to the United States.” This meant that the notes the Bank issued would be treated as good as gold in, for example, payment of taxes or customs duties. Government acceptance of this new currency aided its circulation, and the Bank promptly issued millions of dollars worth of new notes. The Bank’s note issuance fueled a wave of speculation, a series of bubbles, and drastic increases in prices.

    The Bank’s charter was only for twenty years and was due to expire on March 4, 1811. A vigorous debate on the charter’s renewal occupied Congress. In the end, a bill to renew the Bank’s charter failed by a single vote in both the House and Senate, and the Bank’s charter expired. Its stock and buildings were purchased by Stephen Girard, who named his newly acquired bank after himself. That bank funded much of the federal government’s bond issues during the War of 1812, and survived until its acquisition by Mellon Bank in 1983.

    The War of 1812 roiled the country’s monetary system, particularly in the aftermath of specie suspension which was initiated in late 1814. Specie suspension meant that banknotes, which were issued by banks and usually contained a promise to pay the bearer of the note on demand in gold or silver, were no longer required to be redeemed for gold or silver. Freed from the requirement to back their notes with hard money, banks were able to dramatically increase the dollar amount of notes issued. Not surprisingly, this monetary inflation led to continued speculation and price increases.

    Proponents of central banking managed in 1816 to pass a law establishing a new Bank of the United States, ostensibly to combat the monetary mischief overtaking the country. Among the provisions of the new law was a ban on this Second Bank of the United States being able to suspend specie redemption; were it to do so, it would be required to compensate noteholders not only with principal, but with interest accruing at the rate of 12 percent per year. This safeguard tacitly acknowledged the role that suspension of specie redemption had played in the monetary turmoil. Within a year of its chartering, however, the Second Bank of the United States struck a deal with state banks, offering them millions of dollars in credit in exchange for the state banks resuming specie redemption, and promising mutual assistance in the event of crisis. In practice, though, mutual assistance meant that the stronger, government-privileged Bank of the United States would stand ready to bail out the weaker state banks, and not vice versa.

    Second Bank of the United States Building

    Second Bank of the United States Building

    Ultimately the Second Bank of the United States followed the same course as the First Bank. It pyramided large amounts of notes on top of a small supply of specie, and its laxity in demanding specie payments from state banks allowed the state banks to pyramid note issue on top of their specie holdings. Because it was forbidden from suspending specie payments on its own notes, the Bank was eventually forced to demand specie from its debtors, brought specie in from abroad, and sharply contracted credit: policies which helped lead to the Panic of 1819. Continuing its monetary inflation into the early 1830s, the Second Bank created another artificial credit boom that eventually burst, causing the Panic of 1837.

    During the credit boom, the Bank still faced opposition, predominantly from President Andrew Jackson, who viewed the bank as unconstitutional and corrupt. The Second Bank’s charter was good until 1836, but supporters of the Bank decided to push for renewal early, in 1832 – to head off Jackson’s opposition to renewal by making it an election year issue. The Bank’s president, Nicholas Biddle, successfully lobbied for a recharter bill, which passed both Houses of Congress. Despite political opposition, President Jackson vetoed the bill. Rather than hurting him in the election, his anti-Bank platform aided his election to a second term. Without enough votes in Congress to override the veto, the Bank’s federal charter was allowed to lapse and it received a new charter as a Pennsylvania state bank under Biddle’s leadership, eventually going under altogether in 1841.

    McCulloch v. Maryland

    Chief Justice John Marshall, Author of the Decision in McCulloch v. Maryland. Portrait by Henry Inman (1832).

    Chief Justice John Marshall, Author of the Decision in McCulloch v. Maryland. Portrait by Henry Inman (1832).

    Even though The Second Bank of the United States lasted only twenty years, it played a major role in one of the most important Supreme Court Cases ever decided, McCulloch v. Maryland (1819). The state of Maryland attempted to tax the Baltimore branch of the Second Bank of the United States, as it was a bank operating in Maryland that had not been chartered by the Maryland legislature. The Bank’s Baltimore branch director refused to pay the tax, and the ensuing court case made it all the way to the Supreme Court, which decided in favor of the Bank.

    The major principle ratified by this decision was that of “implied powers.” In the Court’s opinion, because incidental or implied powers were not expressly prohibited by the Constitution, the federal government was permitted to exercise whatever powers it deemed necessary to carry out its Constitutional functions. This broad interpretation of implied powers and of the Constitution’s Necessary and Proper Clause set a dangerous precedent for future Court decisions, particularly in the development of American banking and monetary policy. In the eyes of the Court, McCulloch validated the constitutionality of federal government intervention into the banking sector as well as the creation of a federal government-established central bank.

    Coinage Acts of 1834, 1837, and 1853

    Due to the fact that the market exchange rate between silver and gold rose from 15:1 towards 16:1 after the passage of the Coinage Act of 1792, legally undervalued gold coinage failed to circulate in the United States. In 1834, Congress passed the Coinage Act of 1834, which retained the dollar as 371.25 grains of silver, but devalued the $10 gold eagle coin from 247.5 to 232 grains of gold. This was later amended by the Coinage Act of 1837 to 232.2 grains of gold, or 23.22 grains of gold per dollar, which was to remain the gold weight of the dollar until 1934.

    1837 $5 gold piece. Image: PCGS CoinFacts

    1837 $5 gold piece. Image: PCGS CoinFacts

    The immediate result of this legislation establishing a 16.002:1 ratio (slightly higher than the prevailing world market rate) was that gold coinage began to flow into the United States once again. Fortunately, silver was not so undervalued against the world market rate that it flowed out, and so, both domestic and foreign gold and silver coins once again circulated side by side in the United States.

    Discovery of gold in California and the subsequent California Gold Rush of 1849 led to a decrease in the world market value of gold relative to silver, with the silver/gold ratio moving back down towards 15:1. With the government’s bimetallic ratio at 16:1, coins (this time silver) began to leave the country since it was now profitable to export and melt them. Silver coinage being the more practical medium of exchange for everyday purchases, economic transactions became more and more difficult. In response, Congress passed the Coinage Act of 1853, which debased the half dollar from 206.25 grains of 90% silver to 192 grains of 90% silver, with quarters and dimes being debased in the same manner. Additionally, silver half dollars, quarters, and dimes were to be legal tender only to a maximum of five dollars, the first time such restrictions had been placed on silver coinage.

    The Gold Rush and Private Coinage

    1853 California 1/4 dollar gold coin. Image: PCGS CoinFacts

    1853 California 1/4 dollar gold coin. Image: PCGS CoinFacts

    In California, coins of any type were scarce. Not only were silver coins hard to come by, but gold coins as well. San Francisco had a U.S. Assay Office, which could qualitatively assess precious metals, but was not allowed to mint coins since it was not a branch of the U.S. Mint. In the absence of an official branch of the Mint, private mints began producing gold coins, often of original design, in denominations ranging from 25 cents to 50 dollars. These coins circulated as needed until the U.S. Mint established its San Francisco branch and began minting operations.

    Christopher Bechtler $1 gold coin. Image: PCGS CoinFacts

    Christopher Bechtler $1 gold coin. Image: PCGS CoinFacts

    Private coinage was nothing new in the history of the United States, as areas underserved by the U.S. Mint’s operations often saw private mints spring up to mint newly mined metal into currency that was badly needed to maintain economic activity. One prominent example was that of Christopher Bechtler in North Carolina, who minted gold coins for years before the U.S. government opened its mints in Charlotte, North Carolina and Dahlonega, Georgia. As long as the market trusted that the coins contained the amount of gold claimed by the minter, the coins circulated at face value. While they were never as widely circulated throughout the country as U.S. or foreign coins, privately-minted coins served a useful and crucial function in those areas facing a shortage of federal or foreign coinage.

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