Small Change and the Depression of 1837-1843 - Part One

During and after the Revolution, the Continental Congress and the state legislators and governors literally papered the country with bills of exchange. They issued notes that they labelled money, promised to redeem them in coin and then printed more paper money instead. After half a decade of peace, the paper Continental dollar was priced at the silver and gold price of its commodity value as raw paper. Coins of any denomination were even scarcer than they had been during the war because both the French and English armies had taken their chests of gold and silver and gone home. The states had also borrowed money and even assumed part of the debts of the Continental Congress. Many argued that the states, which had tax revenue, should take over the entire public debt of the country. Others pointed out that 80% to 90% of state tax revenue went to paying interest on their own and the Continental Congress debt they had assumed.

By 1787, the news that priced money had become so uniformly bad that state legislatures were even willing to spend some of the few coins they had to send people to Philadelphia for a convention. The hope was that this meeting of Congress could define, once and for all, what the law’s final word was about money. As war veterans, many of the delegates had their own particular money questions to resolve; they held the various written promises to pay that had been given to the soldiers of the Revolutionary army. Like everyone else in the country, the delegates wanted to have Congress give a price to government IOUs using something other than their weight in paper. The delegates to the Constitutional Convention found it easy to define the monetary standard; in a single morning, they decided that lawful tender in the United States was what it was worldwide – gold and silver coins. They also came to an agreement that the new Congress should become responsible for all the public debts from the Revolution. Accepting that obligation would gain the national government the respect that it needed. It would also justify giving Congress the sole sovereign authority over lawful tender.

There was one final question that the Convention did not answer: What would the country have for a national banking system – a central bank of issue or a bank of discount and deposit? Under Alexander Hamilton’s plan, the national bank would issue legal tender notes to purchase Treasury bonds; by paying the bond interest in specie, the bank would guarantee that Treasury bonds could always be sold at par. A sinking fund would be established to pay off the debt; but the fund’s actual purpose would be to allow the bank to carry out market operations that the Constitution prohibited the Treasury from conducting. Thomas Willing, whom President Washington appointed as president of the Bank of the United States, had a very different idea for the national bank’s purpose. It was to establish a competitive system of deposit banking to be regulated by the relative discounts people themselves accepted as borrowers and lenders.

In spring of 1792, Congress voted to adopt An Act to Incorporate the Subscribers to the Bank of the United States. A $25 subscription payment would give the purchaser the right to buy one of the 25,000 shares being offered. There would be four calls for capital contributions: January 1, 1792, July 1, 1792, January 1, 1793, and July 1, 1793. Each contribution would be $100 in either silver or gold coin, priced using the Spanish milled dollar and 15-1 ratio for valuation, and $300 of Treasury bonds, with the 6% coupon bond valued at par and the 3% coupon bonds valued at half par value. Once shares were issued, after the first capital contribution, they would pay $9 in dividends every six months – i.e. 6%.

Within six months of the bank’s subscription book being opened on July 1, 1792, the United States of America had its first financial market panic. The public cause was the failure of William Duer and Alexander Macomb. During the Revolution, Duer had been a member of the Board of War and during the Revolution and been a military contractor. His Scioto Land Company had become well-known as a developer of the Northwest Territory; it promised to be a developer and builder, not just a land speculator. His political connections were impeccably bipartisan. The Federalist Secretary of the Treasury could rely on him as an expert in international finance. As he left France to return to New York to become secretary of state, Democrat-Republican Thomas Jefferson was happy to see Joel Barlow, his publicist, stay on in Paris as head salesman for Duer’s Scioto Land Company. Barlow would work with Duer’s French partners to sell tracts of “established” Scioto farmland to French investors eager to leave revolutionary Paris and head for the safety of what would become Marietta, Ohio. Alexander Macomb had made his fortune acquiring and selling property in North Carolina. After coming to Manhattan, he had become the most visibly rich man in New York. His brand new mansion off Broadway had been opened in 1790 to serve as George Washington’s executive mansion. Washington would stay there from February to August 1790.

Speculators had been excited by Duer and Macomb’s leveraged combination of Treasury bonds and Bank of the United States subscription rights. Their derivative investments had punished people who bet against them. Alexander Hamilton had thought it necessary to come to the rescue of the Bank of New York in August with $150,000. The bank, which Hamilton had incorporated in 1784, found itself in some difficulty over collateral. In the full year of 1791, the Treasury would commit a total of $343,000 to “help stabilize the market”; but it would not be enough. In December, the news reached Philadelphia and New York and Boston that the first French settlers had arrived in Scioto. Duer’s and Barlow’s promises had proved to be a total scam. “Development” had been a single, one-room wood cabin with a sign painted on the side; and the company’s land was, in fact, owned by the Ohio Company.

On January 18, 1792, Alexander Hamilton wrote to Thomas Willing: “There are various arrangements necessary to be made between the Government and the Bank of the United States, which will better be treated in a personal conference than by writing. I request therefore that such proceeding as may appear proper to the Direction, for that purpose, may be adopted.” On March 9, Duer and Macomb would declare outright default on their obligations and be sentenced to debtors’ prison. To “save the market,” Alexander Hamilton would summon the board of the sinking fund and persuade them to authorize further quantitative easing; the Treasury would issue another $243 million in notes and pledge to purchase an additional $500 million in bonds from the Bank of New York if its holdings of federal bonds proved to be “excess collateral.” By May 1792 the panic was over.

Academic studies now offer Hamilton’s actions as a precedent for the effectiveness that central banks can show in rescuing markets from a crisis. Thomas Willing and the Bank of the United States are criticized for not having come to the aid of the Treasury. Willing would certainly understand the criticism, but his likely answer would be that the country needed a very different banking system – one like Scotland’s, not England’s. The United States needed to be full of banks of deposit and discount. The Bank of the United States’ duty was to accept for deposit coin, other’s bank notes and bills of exchange and offer discounts. A bank of deposit and discount could fully respect the Constitutional coin money standard without its notes needing to be lawful tender. Exchanges could be “real” without the use of coin using only the discounts that the market gives to bank notes and other credit paper using the denominations set by the Coinage Act.

Left to themselves, people chose whatever means of payment best suited their purpose – wampum, bills of exchange or barrels of flour. For savings, precious metal had a preference because bullion could be held indefinitely in storage without any waste of its value. Wherever there was sovereign authority, as in England and America, people would need to have official money, whether coin or paper, because that was the only way they could pay their taxes. Honest coin from a government or private mint produced bullion in set pieces that had already been weighed and measured. Even when official coin had been adulterated and did not hold its promised amount of precious metal, its denominations had the sovereign approval; they might even be fobbed off on the unwary at par or used to pay taxes to a corrupt or stupid revenue agent.

The very flaw of a fractionally reserved central bank was that its structure always compelled it to act first to reassure the rich. Whenever financial panics occurred in Europe, the tiny number of people who owned sterling silver dinnerware would think about melting down their plate so they could take the precious metal and run. As they did that, they would also demand all the gold and silver coin from the banks and, before them, the goldsmiths. To “save the market,” as Hamilton had tried to do, the government would order banks to suspend redemptions of coin and restrict further issues of bank notes. The actions would save the reserve; but they would do so at the price of the general welfare. A central bank acting as lender of last resort did not bind the wealthy to the government, as Hamilton promised; it bound the government to the wealthy.

Economic slumps occurred when there were wars, bad harvests or collapses in the profit margins of important trades. In each case, people lost parts of their income, and their smaller earnings caused a reduction in trade. The central bank’s ability to change its discounts could not end a war or salvage a harvest or even restore a collapsed profit margin. The only trade in which interest payments alone determined profit margins was finance; there was not even any evidence that lowering discount rates to merchant banks and other financial intermediaries produced lower consumer interest rates. On the contrary, in a slump banks and other lenders would do everything possible to use lower borrowing costs to increase their spreads. They would do this by not reducing the rates they charged to their borrowers. By constricting the supply of credit paper, especially the amounts in small denominations, the government would squeeze the popular economy.

For the depositors and creditors of the bank, including the Treasury of the United States, the first duty was to guarantee that they always had access to their own money, in good times and bad. For the holders of the debt of the United States of America, the first duty was that all interest be paid in coin, as promised. People needed the certainty that their deposits were fungible, that the notes paid out by banks for account withdrawals would be commonly accepted in daily commerce. To achieve that, banks of deposit had to accept the discipline of the relatively small exchanges that people made part of their lives and merchants made part of their businesses.

Between them, George Washington and Thomas Willing would decide every question of political economy for the early republic. They did so largely contrary to both Federalist and Democratic-Republican opinion. Washington would reject both John Adams’ and Thomas Jefferson’s eagerness for foreign engagements. Those always led to war. Willing completely thwarted Hamilton’s efforts to establish a central bank of issue and declined to have the Bank of the United States act as the lender of last resort in a securities market panic. Between them they created the seemingly paradoxical system of a mushrooming state-chartered banking system left ungoverned by a national bank of deposit that cheerfully accepted the burdens of getting and holding sufficient coin to allow the United States to run a permanent trade deficit while its government paid its bills and the interest on its debt in the form of legal tender that the Constitution required.

The American economy would be founded on hundreds and eventually thousands of incorporated small change jars.

Stefan Jovanovich manages the portfolio for The NJT Company, Inc., a family office based in Nevada.

Read more articles by Stefan Jovanovich