Victoria

Kirk Critchlow
ECON 1740
Ch. 12 Money and Banking in the Developing Economy

The American Monetary Unit

 Since international trade used the dollar and its subdivisions more than any other coins, it
became customary to do business in terms of dollars.
 The dollar was adopted as the unit of account and a decimal system was adopted instead
of the arithmetic old English system of pounds and shillings.
 Thomas Jefferson argued the easiest ratio of multiplication and division was by tens, so
that is why the decimal system was adopted.
 Both silver and gold were used as the currency’s value. (Gold served higher
denomination coins while silver served smaller denominations)
 The Spanish dollars varied in their content of pure silver. The number of grains of silver
in the new U.S. dollar would be the average of the Spanish coins circulating.

The Bimetallic Standard

 An issue with the bimetallic standard is the relative values of gold and silver fluctuate.
 Greshaw’s Law: money overvalued at the mint tends to drive out of circulation money
undervalued at the mint, providing that the two monies circulate at fixed ratios.
o For example: college professors worry students will take an easy class to get an
easy A because that easy A counts the same towards their grade point average as
an A from a hard course. This law applies in this case because the difference
between the way students and colleges value courses is equivalent to coins when
there is a difference between the way the market and the mint values of metal in
the coins.
 The discovery of gold in California in 1848 pushed the trend towards a pure gold
circulation fast.
 One major benefit of bimetallic standard is the cheaper metal can replace the dear metal,
which helps maintain the stock of money and the price level.

Bank Notes as Paper Money

 By 1800, there were 88 banks, 2 were private, state chartered banks that issued their own
paper money redeemable in gold or silver
 Bank notes were similar to bank deposits. When a bank made loans to customers they
gave their proceeds in the form of their own note (which was circulated as cash) or as a
deposit in which customers could write checks.
  Before the Civil War, banks issued more notes than credits to people.
 Banks no longer issue notes and the Federal Reserve makes paper money.
 Typically, only notes issued by nearby banks would be accepted.
 People from distant cities would have to exchange their “foreign” money to the local
cities money and they would be charged a fee.

The First Bank of the United States

 Robert Morris established and organized the first American bank in 1781 with Congress’s
approval;
o This helped finance the war and provide financial organization at this time
 Alexander Hamilton, the first secretary of the treasury, wrote the Report on a National
Bank in which he argued there needed to be a National Bank that issued notes that would
replace the gold in silver in circulation, which could then be exported in exchange for real
goods and services.
 President Washington signed a bill on February 14, 1791, that created the first bank of
the US that was chartered for 20 years.

Second Bank of the United States

 The Second Bank of the US was passed in 1816 after difficulties in financing the War of
1812 and inflation.
 Nicholas Biddle was the president of this bank.
 This bank was the last resort lender of state banks.
 Biddle was able to make this bank the largest American dealer in foreign exchange and
was able to protect the country from a specie drain.
 Andrew Jackson was opposed to banks because: they were” unconstitutional”, there were
too many foreign ownerships of its shares, and domestic ownership was too heavily
concentrated in the East.

Economic Fluctuations and the Second Bank

 There is an argument that the absence of the second bank caused irresponsible
banking, which led to increases in money supply and price level, which led to the
Great Depression.
o As prices rose, people fled to the banks to exchange their paper money into
species and the banks didn’t have enough. If the second bank was there, they
could have had a last resort lender, and then the Great Depression happened.
 Owners interested in making a quick profit formed new banks known as “wildcat
banks.”
 The Specie Circular in 1836 required most federal land sales be done in species.
Experiments in state banking controls

The variety of banking systems that the states established during the antebellum era is simply
astonishing. Some prohibited banking, some established state banks, some permitted “free
banking,” and the list could easily be extended. For this reason, economic historians have been
drawn to this era to learn what sorts of banking systems work well and which do not.

The Suffolk System and the Safety Fund

 In 1824, six Boston banks joined with the Suffolk Bank of Boston to create a system for
presenting country banks with their notes in volume, thus forcing them to hold higher
reserves of specie.
 The country agreed to keep deposits in the Suffolk Bank, resulting in the first
arrangement of a clearing house for currencies of remote banks.
 A countless source of funds, helped make the Suffolk Bank one of the most profitable in
the country.
 Other Boston banks shared in this profit through their owner ship of Suffolk stock.
 By 1825, country notes passed through the Suffolk system at par. Consequently, New
England was blessed with a uniform currency.
 The Suffolk Bank continued as the agency for clearing New England notes until 1858,
when some Boston Banks and country banks that resented the dictatorial policies of the
Suffolk Bank organized a rival instiution.
 In 1827 New York invoked state regulatory power, to increase protection for deposits and
note holders.
 The state passed a law holding bank stockholders responsible for debts.

Free Banking

 New York assembly passed the first law in 1838.

 The beginning of the agitation for the New York system and final passage of the act.
 To protect note holders and sometimes boost the states credit, the free banking laws
require the banks to deposit bonds, these are usually federal bonds or those issued by the
state where the bank was located.
 The free banking systems of New York and Ohio were probably the models for the
national banking system adopted during the civil war.

The Forstall System

  In 1842 Louisiana set up a system called the Forstall system, that became a model of
sound and conservative banking.
 Louisiana law required banks to keep a specie reserve equal to one-third of their
combined note and deposit liabilities.

The Economic Consequences of the Gold Rush

 In 1848, gold was discovered in California.

 Gold was the basis of much of world’s monetary system.
 The stock of money in the United States rose from 100 in 1849 to a peak of 182 in 1856 a
rate of increase of about 8.5 percent per year.
 By 1855, farm prices had risen 58 percent compared to 17 percent for chemical and drug
prices.