The Antebellum Financial System November 13, 2007

Origins of US Money and Banking: Why do we have bank? Supply credit Keep assets safe

Origins of US Money and Banking: Forms of Money Specie – precious metals such as gold and silver Paper money – banknotes supplied by banks

Origins of US Money and Banking: Origins of paper money Example: Suppose you are a shopkeeper and you want to stock a six month supply of pots and pans in your store. You give a $500 promissory note to a local banker The banker charges you a 3% interest rate for 6 months (6% per annum) and gives you $485 in banknotes

Origins of US Money and Banking: Origins of paper money You travel to the city to buy $485 worth of pots and pans from the wholesaler You return to your retail shop and sell the pots and pans over the next 6 months After the 6 months you pay $500 to the banker

Origins of US Money and Banking: Origins of paper money The wholesaler pays himself, his workers, and his suppliers with the banknotes. The banknotes circulate in the economy as money At some point the banknotes return to the original banker for redemption

Origins of US Money and Banking: Origins of paper money Why did the shopkeeper use banknotes instead of specie to buy his pots? Why did the wholesaler accept the banknotes?

Origins of US Money and Banking: Skepticism of Early Banks Do you think the bank backed up his banknotes one-for-one with specie in his bank? Bankers only held enough specie to cover the expected redemption of banknotes This fractional reserve system allows bankers to generate more profits through extending credit

Origins of US Money and Banking: Skepticism of Early Banks The perception was that bankers were greedy and were increasing the money supply and causing rapid inflation by printing too many bank notes This is not credible because most bankers self-regulated. Their business depended on their ability to convert!

Origins of US Money and Banking: Price Levels in the Antebellum Period Four periods of inflation 1790s – very few banks; probably due to high demand of American exports War of 1812 – still very few banks; war financing 1830s – large imports of silver from Mexico, i.e. increase in the monetary base 1850s – large increases in the specie stock, this time from California

The First and Second Banks of the United States First attempts at Central Banking First Bank of the United States: 1791 – 1811 Second Bank of the United States:

The First and Second Banks of the United States Functions: Receive payments to the government Kept monetary base in check

The First and Second Banks of the United States: Why did they fail? Perceived as anti-business – no cheap credit Possibly unconstitutional “privileged monopoly” Banks were distrusted in general

Institutional Innovation in Absence of Central Bank Suffolk Bank of Boston served as regional bank in New England Controlled New England money supply Required smaller out-of-town banks to keep deposits in order to keep their banknotes convertible in Boston New England never needed to suspend convertibility

Institutional Innovation in Absence of Central Bank New York – deposit insurance scheme New York Free Banking Act of 1838

Institutional Origins of Savings Banks Two purposes of banks: provide credit and provide safe place to store assets Prior to banks, where did people keep their money? Before the Industrial Revolution, was there a pressing need for banks to deposit cash wages?

Institutional Origins of Savings Banks “Philanthropic” banks for the poor and working class First bank chartered in Boston in 1816 Trustees volunteered their time to run bank and make investment decisions Poor and working class depositors earned dividends on deposits

Savings Banks: Why start a savings bank? Who benefits? Savers benefit Savings banks provided a relatively safe place to deposit wages Savers earned substantial dividends from investments

Savings Banks: Why start a savings bank? Who benefits? Do the bank trustees benefit? Philanthropic motive? Philanthropy is a poor economic reason to run a bank Personal gain? Trustees could not profit directly from investments, but… Trustees could direct investments into projects that benefit them directly or indirectly

Savings Banks: Why start a savings bank? Who benefits? Example: New York savings banks New York government restricted savings bank investments to state bonds Bonds were used to finance large infrastructure projects, i.e. Erie Canal Result: savings banks located along Erie Canal

New York Savings Banks, One Savings Bank - Multiple Savings Banks 4 4 New York City Rochester Area Albany Area

New York Savings Banks, One Savings Bank - Multiple Savings Banks - Erie Canal 4 4 New York City Rochester Area Albany Area

Savings Banks: Legacy Opened up formal financial intermediation to the working class Freed up new sources of financial capital for investments Provided investment funds for important public infrastructure projects