Banking was Contentious—Why Isn't Its History?

Dan Allosso

Banking has been a contentious issue throughout American History. The pages of our history books allow us brief glimpses of the most familiar stories, like Jefferson’s distrust of Hamilton and the Jacksonian Bank War. The popular press continues to blame banks—especially big, powerful, central ones—for many of our economic ills. It’s interesting that Rolling Stone has been at the forefront of this popular war against the central banks, featuring frequent articles by William Greider in the 1980s and Matt Taibbi in recent months. This ongoing popular distrust of banks and bankers, however, seems not to be shared by many of the economic historians we look to for leadership on these issues, and who often treat historical bankers with respect verging on reverence. As a result, the stories of American banking that find there way into mainstream history often treat the objectives and goals of bankers as economically sound and politically neutral, even when they acknowledge popular dissent.

For example, consider the early 19th-century “Suffolk System,” imposed on New England by the Suffolk Bank and six other Boston banks. It has come down to us as an attempt to insure the value of New England bank notes, at a time when any chartered bank was allowed to print its own money. Students reading about this and living in a world where we have a single, national currency, naturally assume that the Suffolk System provided an urgently needed service for the New England Economy. People who want to justify “small government” on economic terms suggest that bad (country) banknotes were driving good (city) banknotes out of the market through Gresham's Law, and that the system was proof that “private individuals acting outside the bounds of political control have proven entirely capable of providing much the same functions as a central bank, and at a far lower cost.” Even economic historians who admit that the Suffolk System was thoroughly hated by most New England banks, treat the system as a tool for providing a needed benefit to the financial market, and analyze its efficiency in providing this service.

The average discount on country banknotes in Boston by the 1820s was less than one percent, suggesting that most people did not fear to use them as currency. The Suffolk’s objective, economic historians tell us, was to insure the integrity of these various pieces of money; but also, they admit, to reduce the volume of country banknotes circulating in the city. Why might a consortium of city bankers be interested in reducing the circulation of country notes? Perhaps to give their own notes more circulation? Similarly, the Suffolk’s tactics for getting banks to “join” their system involved hoarding large quantities of the target bank’s notes and then bringing them into the bank for redemption all at once. This constituted an artificial “run” on the country banks, and at least one filed suit against the Suffolk for “malicious intent to break the bank without cause.” Historians have praised the Suffolk for forcing rural banks to hold larger reserves. But with mass redemptions comprising often more than half the victim bank’s total assets, it’s questionable whether any of the Suffolk’s associated Boston banks could have withstood similar treatment. So, what was the real objective of these raids?

The effect of the raids, historians agree, was to intimidate banks into joining the system. They were required to deposit $5,000 in the Suffolk Bank, on which they were paid no interest. You could call this a tax, but ransom might be a better word. The Suffolk thus had the use of hundreds of thousands of dollars over a period of four decades, at no cost. When the New England banks finally fought back, and got a state charter for their own clearinghouse, the Suffolk did not choose to compete with them. It went back to its regular business. Economic historians have suggested this change had something to do with the relative efficiency of the “cross-subsidization” of “payments-system networks,” and have analyzed these economic factors in detail. But perhaps in focusing so intently on the numbers, they miss the motivation. What if the goal of the system was never about providing an efficient service? What if it was about improving the competitive position of the Boston bankers by either limiting or taxing the rest of the New England banks?

It seems to me that motivation is the crucial question, in historical questions like this one. Too often, I think, historians take up the documented rationales for acts like the creation of the Suffolk System, as if they came from a disinterested, reliable source. They treat challenges in the popular press, and even in the courts, as understandable but generally misguided opposition to good economic policy. And perhaps they hesitate to dig deeper into the lives and personal archives of the people behind these changes, because that type of research is not part of the traditional “tool-box” of economic history. It’s precisely these personal archives, if they exist, that might provide answers to why people like the Boston bankers joined together to establish organization like the Suffolk System. These answers might shed an altogether different light on the actions of these institutions and the results they ultimately achieved.

Reading Primary Sources: Bank Notes

Dan Allosso

We don’t think much about our money. We may worry about how much of it we need; but we’re not concerned about what it looks like or where it came from. Rarely do we remember that this is a modern phenomenon. Until the Civil War, Americans were very aware of the origin and relative safety of their money.

The best money in early nineteenth-century America was gold, but there was a limit to how much of it you could conveniently carry. And there wasn’t enough of it to go around, especially in towns and villages far from financial centers like New York and Philadelphia. So local people exchanged promissory notes that were basically IOUs stating, for example, that Miller Jones owed Farmer Smith $50 for his wheat harvest, payable sixty days after Smith delivered the bushels of grain to the mill. If Farmer Smith needed to pay someone else sooner than sixty days, he had several options. He could write his own promissory notes (if people trusted him), endorse the Miller Jones’s note to a third party (if people trusted Miller Jones), or take Jones’s note to the bank for cash. The banker would exchange the note for cash, at a “discount” representing interest for the sixty days he would have to hold Jones’s note before he could redeem it. The “cash” the banker would give Farmer Smith could include gold coins if Smith insisted on it, but if the banker had his way it would be—and this is where it gets interesting—bank notes.

Bank notes were initially just like promissory notes, except that they were issued by the bank. They were usually written to a named recipient for a specific amount. But they were much more easy to endorse to a second party, because in most cases everyone knew and trusted the bank. Over time, banks were able not only to write a lot of these types of notes, but to begin writing general notes for smaller denominations, that were immediately payable to anyone “on sight.” Of course the details of how this developed varied from place to place, but these small denomination sight notes became “circulating currency,” or what we think of as money.

When banks gained the ability to issue their own notes, they basically began creating money. In many states, there were laws requiring the bankers to invest in a state insurance fund, or to deposit securities (government bonds or mortgages) with the state comptroller in order to issue notes, but very rarely was there a substantial specie requirement. In other words, the money these state banks printed was usually backed by something other than piles of gold in the vaults of the banks, because there were no piles of gold.

Confidence in the banker issuing a note was crucial to the note’s acceptance. This confidence was naturally greater in states that had a “safety fund” or that required securities to back note issues. Everyone knew that there was never enough gold at the bank to pay all the notes. The expectation was rather that there would be enough to conduct regular business, and pay the notes brought in for redemption on any given day, rather than all the notes outstanding. This differential between everyday redemptions and all the notes outstanding was all-important: this was how the bank literally made money.

The money-making ability of the local bank was not only profitable for the banker, but was essential to the community. Without the money printed by local banks, farmers and millers would have had a much more difficult time doing their business. Especially in remote areas, which was where most of the farm products destined for city dinner tables were grown. Most of the “real money” (that is, gold) was hoarded in the big eastern cities, or after Andrew Jackson’s 1837 Specie Circular was used to buy land at the frontier Land Offices. Very little was available in the settled farmlands that made up the middle of the country. Local banks provided the cash and credit that allowed farmers to plant, tend, and harvest their crops, at a time when 90 percent of Americans were farmers.

All this changed during the Civil War. The Lincoln administration first issued their own notes, called Greenbacks because they were printed with green ink, to help pay for the war. Between 1863 and 1865, Lincoln’s Treasury Secretary, Salmon Chase, led a campaign to centralize control of American banking by creating a system of national banks and by taxing the notes of local banks, to make them too expensive to use relative to the new national notes. Chase and his supporters claimed that local banks were unsafe, and that the extreme variety of notes floating around in the economy (it has been claimed there were over 9,000 different types in circulation in the early 1860s) provided too much opportunity for counterfeiters. While both of these arguments were valid up to a point, Chase’s solution wasn’t the only possible response. Our current system of national currency was not inevitable; by nationalizing the power to make money, Chase added a nearly immeasurable new source of revenue for the central government. This aspect of the change to national notes has gone largely unrecognized, and we now treat our national currency as a completely natural and inevitable part of our national economy--except in a few places like far western Massachusetts, where local people have taken advantage of changes and loopholes in the banking laws, to once again begin making their own money.