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Savings and Loan Industry (U.S.)

David Mason, Young Harris College

The savings and loan industry is the leading source of institutional finance for residential home mortgages in America. From the appearance of the first thrift in Philadelphia in 1831, savings and loans (S&Ls) have been primarily local lenders focused on helping people of modest means to acquire homes. This mission was severely compromised by the financial scandals that enveloped the industry in the 1980s, and although the industry was severely tarnished by these events S&Ls continue to thrive.

Origins of the Thrift Industry

The thrift industry traces its origins to the British building society movement that emerged in the late eighteenth century. American thrifts (known then as “building and loans” or “B&Ls”) shared many of the same basic goals of their foreign counterparts — to help working-class men and women save for the future and purchase homes. A person became a thrift member by subscribing to shares in the organization, which were paid for over time in regular monthly installments. When enough monthly payments had accumulated, the members were allowed to borrow funds to buy homes. Because the amount each member could borrow was equal to the face value of the subscribed shares, these loans were actually advances on the unpaid shares. The member repaid the loan by continuing to make the regular monthly share payments as well as loan interest. This interest plus any other fees minus operating expenses (which typically accounted for only one to two percent of revenues) determined the profit of the thrift, which the members received as dividends.

For the first forty years following the formation of the first thrift in 1831, B&Ls were few in number and found in only a handful of Midwestern and Eastern states. This situation changed in the late nineteenth century as urban growth (and the demand for housing) related to the Second Industrial Revolution caused the number of thrifts to explode. By 1890, cities like Philadelphia, Chicago, and New York each had over three hundred thrifts, and B&Ls could be found in every state of the union, as well as the territory of Hawaii.

Differences between Thrifts and Commercial Banks

While industrialization gave a major boost to the growth of the thrift industry, there were other reasons why these associations could thrive along side larger commercial banks in the 19th and early 20th centuries. First, thrifts were not-for-profit cooperative organizations that were typically managed by the membership. Second, thrifts in the nineteenth century were very small; the average B&L held less than $90,000 in assets and had fewer than 200 members, which reflected the fact that these were local institutions that served well-defined groups of aspiring homeowners.

Another major difference was in the assets of these two institutions. Bank mortgages were short term (three to five years) and were repaid interest only with the entire principle due at maturity. In contrast, thrift mortgages were longer term (eight to twelve years) in which the borrower repaid both the principle and interest over time. This type of loan, known as the amortizing mortgage, was commonplace by the late nineteenth century, and was especially beneficial to borrowers with limited resources. Also, while banks offered a wide array of products to individuals and businesses, thrifts often made only home mortgages primarily to working-class men and women.

There was also a significant difference in the liabilities of banks and thrifts. Banks held primarily short-term deposits (like checking accounts) that could be withdrawn on demand by accountholders. In contrast, thrift deposits (called share accounts) were longer term, and because thrift members were also the owners of the association, B&Ls often had the legal right to take up to thirty days to honor any withdrawal request, and even charge penalties for early withdrawals. Offsetting this disadvantage was the fact that because profits were distributed as direct credits to member share balances, thrifts members earned compound interest on their savings.

A final distinction between thrifts and banks was that thrift leaders believed they were part of a broader social reform effort and not a financial industry. According to thrift leaders, B&Ls not only helped people become better citizens by making it easier to buy a home, they also taught the habits of systematic savings and mutual cooperation which strengthened personal morals. This attitude of social uplift was so pervasive that the official motto of the national thrift trade association was “The American Home. Safeguard of American Liberties” and its leaders consistently referred to their businesses as being part of a “movement” as late as the 1930s.

The “Nationals” Crisis

The early popularity of B&Ls led to the creation of a new type of thrift in the 1880s called the “national” B&L. While these associations employed the basic operating procedures used by traditional B&Ls, there were several critical differences. First, the “nationals” were often for-profit businesses formed by bankers or industrialists that employed promoters to form local branches to sell shares to prospective members. The members made their share payments at their local branch, and the money was sent to the home office where it was pooled with other funds members could borrow from to buy homes. The most significant difference between the “nationals” and traditional B&Ls was that the “nationals” promised to pay savings rates up to four times greater than any other financial institution. While the “nationals” also charged unusually high fees and late payment fines as well as higher rates on loans, the promise of high returns caused the number of “nationals” to surge. When the effects of the Depression of 1893 resulted in a decline in members, the “nationals” experienced a sudden reversal of fortunes. Because a steady stream of new members was critical for a “national” to pay both the interest on savings and the hefty salaries for the organizers, the falloff in payments caused dozens of “nationals” to fail, and by the end of the nineteenth century nearly all the “nationals” were out of business.

The “nationals” crisis had several important effects on the thrift industry, the first of which was the creation of the first state regulations governing B&Ls, designed both to prevent another “nationals” crisis and to make thrift operations more uniform. Significantly, thrift leaders were often responsible for securing these new guidelines. The second major change was the formation of a national trade association to not only protect B&L interests, but also promote business growth. These changes, combined with improved economic conditions, ushered in a period of prosperity for thrifts, as seen below:

Year Number of B&Ls
Assets (000,000)
1888 3,500 $300
1900 5,356 $571
1914 6,616 $1,357

Source: Carroll D. Wright, Ninth Annual Report of the Commissioner of Labor: Building and Loan Associations (Washington, D.C.: USGPO, 1894), 214; Josephine Hedges Ewalt, A Business Reborn: The Savings and Loan Story, 1930-1960 (Chicago: American Savings and Loan Institute Publishing Co., 1962), 391. (All monetary figures in this study are in current dollars.)

The Thrift Trade Association and Business Growth

The national trade association that emerged from the “nationals” crisis became a prominent force in shaping the thrift industry. Its leaders took an active role in unifying the thrift industry and modernizing not only its operations but also its image. The trade association led efforts to create more uniform accounting, appraisal, and lending procedures. It also spearheaded the drive to have all thrifts refer to themselves as “savings and loans” not B&Ls, and to convince managers of the need to assume more professional roles as financiers.

The consumerism of the 1920s fueled strong growth for the industry, so that by 1929 thrifts provided 22 percent of all mortgages. At the same time, the average thrift held $704,000 in assets, and more than one hundred thrifts had over $10 million in assets each. Similarly, the percentage of Americans belonging to B&Ls rose steadily so that by the end of the decade 10 percent of the population belonged to a thrift, up from just 4 percent in 1914. Significantly, many of these members were upper- and middle-class men and women who joined to invest money safely and earn good returns. These changes led to broad industry growth as seen below:

Year Number of B&Ls Assets (000,000)
1914 6,616 $1,357
1924 11,844 $4,766
1930 11,777 $8,829

Source: Ewalt, A Business Reborn, 391

The Depression and Federal Regulation

The success during the “Roaring Twenties” was tempered by the financial catastrophe of the Great Depression. Thrifts, like banks, suffered from loan losses, but in comparison to their larger counterparts, thrifts tended to survive the 1930s with greater success. Because banks held demand deposits, these institutions were more susceptible to “runs” by depositors, and as a result between 1931 and 1932 almost 20 percent of all banks went out of business while just over 2 percent of all thrifts met a similar fate. While the number of thrifts did fall by the late 1930s, the industry was able to quickly recover from the turmoil of the Great Depression as seen below:

Year Number of B&Ls Assets (000,000)
1930 11,777 $8,829
1937 9,225 $5,682
1945 6,149 $8,747

Source: Savings and Loan Fact Book, 1955 (Chicago: United States Savings and Loan League, 1955), 39.

Even through fewer thrifts failed than banks, the industry still experienced significant foreclosures and problems attracting funds. As a result, some thrift leaders looked to the federal government for assistance. In 1932, the thrift trade association worked with Congress to create a federal home loan bank that would make loans to thrifts facing fund shortages. By 1934, the other two major elements of federal involvement in the thrift business, a system of federally-chartered thrifts, and a federal deposit insurance program, were in place.

The creation of federal regulation was the most significant accomplishment for the thrift industry in the 1930s. While thrift leaders initially resisted regulation, in part because they feared the loss of business independence, their attitudes changed when they saw the benefits regulation gave to commercial banks. As a result, the industry quickly assumed an active role in the design and implementation of thrift oversight. In the years that followed, relations between thrift leaders and federal regulators became so close that some critics alleged that the industry had effectively “captured” their regulatory agencies.

The Postwar “Glory Years”

By all measures, the two decades that followed the end of World War II were the most successful period in the history of the thrift industry. The return of millions of servicemen eager to take up their prewar lives led to a dramatic increase in new families, and this “baby boom” caused a surge in new (mostly suburban) home construction. By the 1940s S&Ls (the name change occurred in the late 1930s) provided the majority of the financing for this expansion. The result was strong industry expansion that lasted through the early 1960s. In addition to meeting the demand for mortgages, thrifts expanded their sources of revenue and achieved greater asset growth by entering into residential development and consumer lending areas. Finally, innovations like drive-up teller windows and the ubiquitous “time and temperature” signs helped solidify the image of S&Ls as consumer-friendly, community-oriented institutions.

By 1965, the industry bore little resemblance to the business that had existed in the 1940s. S&Ls controlled 26 percent of consumer savings and provided 46 percent of all single-family home loans (tremendous gains over the comparable figures of 7 percent and 23 percent, respectively, for 1945), and this increase in business led to a considerable increase size as seen below:

Year Number of S&Ls Assets (000,000)
1945 6,149 $8,747
1952 6,004 $22,585
1959 6,223 $63,401
1965 6,071 $129,442

Source:Savings and Loan Fact Book, 1966, (Chicago: United States Savings and Loan League, 1966)92-4.

This expansion, however, was not uniform. More than a third of all thrifts had fewer than $5 million in assets each, while the one hundred largest thrifts held an average of $340 million each; three S&Ls approached $5 billion in assets. While regional expansion in states like California, account for part of this disparity, there were other controversial actions that fueled individual thrift growth. Some thrifts attracted funds by issuing stock to the public and become publicly held corporations. Another important trend involved raising rates paid on savings to lure deposits, a practice that resulted in periodic “rate wars” between thrifts and even commercial banks. These wars became so severe that in 1966 Congress took the highly unusual move of setting limits on savings rates for both commercial banks and S&Ls. Although thrifts were given the ability to pay slightly higher rates than banks, the move signaled an end to the days of easy growth for the thrift industry.

Moving from Regulation to Deregulation

The thirteen years following the enactment of rate controls presented thrifts with a number of unprecedented challenges, chief of which was finding ways to continue to expand in an economy characterized by slow growth, high interest rates and inflation. These conditions, which came to be known as “stagflation,” wrecked havoc with thrift finances for a variety of reasons. Because regulators controlled the rates thrifts could pay on savings, when interest rates rose depositors often withdrew their funds and placed them in accounts that earned market rates, a process known as disintermediation. At the same time, rising rates and a slow growth economy made it harder for people to qualify for mortgages that in turn limited the ability to generate income.

In response to these complex economic conditions, thrift managers came up with several innovations, such as alternative mortgage instruments and interest-bearing checking accounts, as a way to retain funds and generate lending business. Such actions allowed the industry to continue to record steady asset growth and profitability during the 1970s even though the actual number of thrifts was falling, as seen below.

Year Number of S&Ls Assets (000,000)
1965 6,071 $129,442
1970 5,669 $176,183
1974 5,023 $295,545
1979 4,709 $579,307

Source: Savings and Loan Fact Book, 1980, (Chicago: United States Savings and Loan League, 1980)48-51.

Despite such growth, there were still clear signs that the industry was chafing under the constraints of regulation. This was especially true with the large S&Ls in the western United States that yearned for additional lending powers to ensure continued growth. At the same time, major changes in financial markets, including the emergence of new competitors and new technologies, fueled the need to revise federal regulations for thrifts. Despite several efforts to modernize these laws in the 1970s, few substantive changes were enacted.

The S&L Crisis of the 1980s

In 1979 the financial health of the thrift industry was again challenged by a return of high interest rates and inflation, sparked this time by a doubling of oil prices. Because the sudden nature of these changes threatened to cause hundreds of S&L failures, Congress finally acted on deregulating the thrift industry. It passed two laws (the Depository Institutions Deregulation and Monetary Control Act of 1980 and the Garn-St. Germain Act of 1982) that not only allowed thrifts to offer a wider array of savings products, but also significantly expanded their lending authority. These changes were intended to allow S&Ls to “grow” out of their problems, and as such represented the first time that the government explicitly sought to increase S&L profits as opposed to promoting housing and homeownership. Other changes in thrift oversight included authorizing the use of more lenient accounting rules to report their financial condition, and the elimination of restrictions on the minimum numbers of S&L stockholders. Such policies, combined with an overall decline in regulatory oversight (known as forbearance), would later be cited as factors in the later collapse of the thrift industry.

While thrift deregulation was intended to give S&Ls the ability to compete effectively with other financial institutions, it also contributed to the worst financial crisis since the Great Depression as seen below:

Year S&L Failures Assets (000,000) Year Total S&Ls Industry Assets (000,000)
1980-2 118 $43,101 1980 3,993 $603,777
1983-5 137 $39,136 1983 3,146 $813,770
1986-7 118 $32,248 1985 3,274 $1,109,789
1988 205 $100,705 1988 2,969 $1,368,843
1989 327 $135,245 1989 2,616 $1,186,906

Source: Statistics on failures: Norman Strunk and Fred Case, Where Deregulation Went Wrong (Chicago: United States League of Savings Institutions, 1988), 10; Lawrence White, The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation (New York: Oxford University Press, 1991), 150; Managing the Crisis: The FDIC and RTC Experience, 1980‑1994 (Washington, D.C.: Resolution Trust Corporation, 1998), 795, 798; Historical Statistics on Banking, Bank and Thrift Failures, FDIC web page accessed 31 August 2000; Total industry statistics: 1999 Fact Book: A Statistical Profile on the United States Thrift Industry. (Washington, D.C.: Office of Thrift Supervision, June 2000), 1, 4.

The level of thrift failures at the start of the 1980s was the largest since the Great Depression, and the primary reason for these insolvencies was the result of losses incurred when interest rates rose suddenly. Even after interest rates had stabilized and economic growth returned by the mid-1980s, however, thrift failures continued to grow. One reason for this latest round of failures was because of lender misconduct and fraud. The first such failure tied directly to fraud was Empire Savings of Mesquite, TX in March 1984, an insolvency that eventually cost the taxpayers nearly $300 million. Another prominent fraud-related failure was Lincoln Savings and Loan headed by Charles Keating. When Lincoln came under regulatory scrutiny in 1987, Senators Dennis DeConcini, John McCain, Alan Cranston, John Glenn, and Donald Riegle (all of whom received campaign contributions from Keating and would become known as the “Keating Five”) questioned the appropriateness of the investigation. The subsequent Lincoln failure is estimated to have cost the taxpayers over $2 billion. By the end of the decade, government officials estimated that lender misconduct cost taxpayers more than $75 billion, and the taint of fraud severely tarnished the overall image of the savings and loan industry.

Because most S&Ls were insured by the Federal Savings & Loan Insurance Corporation (FSLIC), few depositors actually lost money when thrifts failed. This was not true for thrifts covered by state deposit insurance funds, and the fragility of these state systems became apparent during the S&L crisis. In 1985, the anticipated failure of Home State Savings Bank of Cincinnati, Ohio sparked a series of deposit runs that threatened to bankrupt that state’s insurance program, and eventually prompted the governor to close all S&Ls in the state. Maryland, which also operated a state insurance program, experienced a similar panic when reports of fraud surfaced at Old Court Savings and Loan in Baltimore. In theaftermath of the failures in these two states all other state deposit insurance funds were terminated and the thrifts placed under the FSLIC. Eventually, even the FSLIC began to run out of money, and in 1987 the General Accounting Office declared the fund insolvent. Although Congress recapitalized the FSLIC when it passed the Competitive Equality Banking Act, it also authorized regulators to delay closing technically insolvent S&Ls as a way to limit insurance payoffs. The unfortunate consequence of such a policy was that allowing troubled thrifts to remain open and grow eventually increased the losses when failure did occur.

In 1989, the federal government finally created a program to resolve the S&L crisis. In August, Congress passed the Financial Institutions Reform Recovery and Enforcement Act (FIRREA), a measure that both bailed out the industry and began the process of re-regulation. FIRREA abolished the Federal Home Loan Bank Board and switched S&L regulation to the newly created Office of Thrift Supervision. It also terminated the FSLIC and moved the deposit insurance function to the FDIC. Finally, the Resolution Trust Corporation was created to dispose of the assets held by failed thrifts, while S&Ls still in business were placed under stricter oversight. Among the new regulations thrifts had to meet were higher net worth standards and a “Qualified Thrift Lender Test” that forced them to hold at least 70 percent of assets in areas related to residential real estate.

By the time the S&L crisis was over by the early 1990s, it was by most measures the most expensive financial collapse in American history. Between 1980 and 1993, 1,307 S&Ls with more than $603 billion in assets went bankrupt, at a cost to taxpayers of nearly $500 billion. It should be noted that S&Ls were not the only institutions to suffer in the 1980s, as the decade also witnessed the failure of 1,530 commercial banks controlling more than $230 billion in assets.

Explaining the S&L Crisis

One reason why so many thrifts failed in the 1980s was in the nature of how thrifts were deregulated. S&Ls historically were specialized financial institutions that used relatively long-term deposits to fund long-term mortgages. When thrifts began to lose funds to accounts that paid higher interest rates, initial deregulation focused on loosening deposit restrictions so thrifts could also offer higher rates. Unfortunately, because thrifts still lacked the authority to make variable rate mortgages many S&Ls were unable to generate higher income to offset expenses. While the Garn-St. Germain Act tried to correct this problem, the changes authorized were exceptionally broad and included virtually every type of lending power.

The S&L crisis was magnified by the fact that deregulation was accompanied by an overall reduction in regulatory oversight. As a result, unscrupulous thrift managers were able to dodge regulatory scrutiny, or use an S&L for their own personal gain. This, in turn, related to another reasons why S&Ls failed — insider fraud and mismanagement. Because most thrifts were covered by federal deposit insurance, some lenders facing insolvency embarked on a “go for broke” lending strategy that involved making high risk loans as a way to recover from their problems. The rationale behind this was that if the risky loan worked the thrift would make money, and if the loan went bad insurance would cover the losses.

One of the most common causes of insolvency, however, was that many thrift managers lacked the experience or knowledge to evaluate properly the risks associated with lending in deregulated areas. This applied to any S&L that made secured or unsecured loans that were not traditional residential mortgages, since each type of financing entailed unique risks that required specific skills and expertise on how to identify and mitigate. Such factors meant that bad loans, and in turn thrift failures, could easily result from well-intentioned decisions based on incorrect information.

The S&L Industry in the 21st Century

Although the thrift crisis of the 1980s severely tarnished the S&L image, the industry survived the period and, now under greater government regulation, is once again growing. At the start of the twenty-first century, America’s 1,103 thrift institutions control more than $863 billion in assets, and remain the second-largest repository for consumer savings. While thrift products and services are virtually indistinguishable from those offered by commercial banks (thrifts can even call themselves banks), these institutions have achieved great success by marketing themselves as community-oriented home lending specialists. This strategy is intended to appeal to consumers disillusioned with the emergence of large multi-state banking conglomerates. Despite this rebound, the thrift industry (like the commercial banking industry) continues to face competitive challenges from nontraditional banking services, innovations in financial technology, and the potential for increased regulation.


Barth, James. The Great Savings and Loan Debacle. Washington, D.C.: AEI Press, 1991.

Bodfish, Morton. editor. History of Buildings & Loan in the United States. Chicago: United States Building and Loan League, 1932.

Ewalt, Josephine Hedges. A Business Reborn: The Savings and Loan Story, 1930‑1960. Chicago: American Savings and Loan Institute Press, 1964.

Lowy, Martin. High Rollers: Inside the Savings and Loan Debacle. New York: Praeger, 1991.

Mason, David L. “From Building and Loans to Bail-Outs: A History of the American Savings and Loan Industry, 1831-1989.”Ph.D dissertation, Ohio State University, 2001.

Riegel, Robert and J. Russell Doubman. The Building‑and‑Loan Association. New York: J. Wiley & Sons, Inc., 1927.

Rom, Mark Carl. Public Spirit in the Thrift Tragedy. Pittsburgh: University of Pittsburgh Press, 1996.

Strunk, Norman and Fred Case. Where Deregulation Went Wrong: A Look at the Causes Behind Savings and Loan Failures in the 1980s. Chicago: United States League of Savings Institutions, 1988.

White, Lawrence, J. The S&L Debacle: Public Policy Lessons for Bank and Thrift Regulation. New York: Oxford University Press, 1991.

Citation: Mason, David. “Savings and Loan Industry, US”. EH.Net Encyclopedia, edited by Robert Whaples. June 10, 2003. URL

US Banking History, Civil War to World War II

Richard S. Grossman, Wesleyan University

The National Banking Era Begins, 1863

The National Banking Acts of 1863 and 1864

The National Banking era was ushered in by the passage of the National Currency (later renamed the National Banking) Acts of 1863 and 1864. The Acts marked a decisive change in the monetary system, confirmed a quarter-century-old trend in bank chartering arrangements, and also played a role in financing the Civil War.

Provision of a Uniform National Currency

As its original title suggests, one of the main objectives of the legislation was to provide a uniform national currency. Prior to the establishment of the national banking system, the national currency supply consisted of a confusing patchwork of bank notes issued under a variety of rules by banks chartered under different state laws. Notes of sound banks circulated side-by-side with notes of banks in financial trouble, as well as those of banks that had failed (not to mention forgeries). In fact, bank notes frequently traded at a discount, so that a one-dollar note of a smaller, less well-known bank (or, for that matter, of a bank at some distance) would likely have been valued at less than one dollar by someone receiving it in a transaction. The confusion was such as to lead to the publication of magazines that specialized in printing pictures, descriptions, and prices of various bank notes, along with information on whether or not the issuing bank was still in existence.

Under the legislation, newly created national banks were empowered to issue national bank notes backed by a deposit of US Treasury securities with their chartering agency, the Department of the Treasury’s Comptroller of the Currency. The legislation also placed a tax on notes issued by state banks, effectively driving them out of circulation. Bank notes were of uniform design and, in fact, were printed by the government. The amount of bank notes a national bank was allowed to issue depended upon the bank’s capital (which was also regulated by the act) and the amount of bonds it deposited with the Comptroller. The relationship between bank capital, bonds held, and note issue was changed by laws in 1874, 1882, and 1900 (Cagan 1963, James 1976, and Krooss 1969).

Federal Chartering of Banks

A second element of the Act was the introduction bank charters issued by the federal government. From the earliest days of the Republic, banking had been considered primarily the province of state governments.[1] Originally, individuals who wished to obtain banking charters had to approach the state legislature, which then decided if the applicant was of sufficient moral standing to warrant a charter and if the region in question needed an additional bank. These decisions may well have been influenced by bribes and political pressure, both by the prospective banker and by established bankers who may have hoped to block the entry of new competitors.

An important shift in state banking practice had begun with the introduction of free banking laws in the 1830s. Beginning with laws passed in Michigan (1837) and New York (1838), free banking laws changed the way banks obtained charters. Rather than apply to the state legislature and receive a decision on a case-by-case basis, individuals could obtain a charter by filling out some paperwork and depositing a prescribed amount of specified bonds with the state authorities. By 1860, over one half of the states had enacted some type of free banking law (Rockoff 1975). By regularizing and removing legislative discretion from chartering decisions, the National Banking Acts spread free banking on a national level.

Financing the Civil War

A third important element of the National Banking Acts was that they helped the Union government pay for the war. Adopted in the midst of the Civil War, the requirement for banks to deposit US bonds with the Comptroller maintained the demand for Union securities and helped finance the war effort.[2]

Development and Competition with State Banks

The National Banking system grew rapidly at first (Table 1). Much of the increase came at the expense of the state-chartered banking systems, which contracted over the same period, largely because they were no longer able to issue notes. The expansion of the new system did not lead to the extinction of the old: the growth of deposit-taking, combined with less stringent capital requirements, convinced many state bankers that they could do without either the ability to issue banknotes or a federal charter, and led to a resurgence of state banking in the 1880s and 1890s. Under the original acts, the minimum capital requirement for national banks was $50,000 for banks in towns with a population of 6000 or less, $100,000 for banks in cities with a population ranging from 6000 to 50,000, and $200,000 for banks in cities with populations exceeding 50,000. By contrast, the minimum capital requirement for a state bank was often as low as $10,000. The difference in capital requirements may have been an important difference in the resurgence of state banking: in 1877 only about one-fifth of state banks had a capital of less than $50,000; by 1899 the proportion was over three-fifths. Recognizing this competition, the Gold Standard Act of 1900 reduced the minimum capital necessary for national banks. It is questionable whether regulatory competition (both between states and between states and the federal government) kept regulators on their toes or encouraged a “race to the bottom,” that is, lower and looser standards.

Table 1: Numbers and Assets of National and State Banks, 1863-1913

Number of Banks Assets of Banks ($millions)
National Banks State Banks National Banks State Banks
1863 66 1466 16.8 1185.4
1864 467 1089 252.2 725.9
1865 1294 349 1126.5 165.8
1866 1634 297 1476.3 154.8
1867 1636 272 1494.5 151.9
1868 1640 247 1572.1 154.6
1869 1619 259 1564.1 156.0
1870 1612 325 1565.7 201.5
1871 1723 452 1703.4 259.6
1872 1853 566 1770.8 264.5
1873 1968 277 1851.2 178.9
1874 1983 368 1851.8 237.4
1875 2076 586 1913.2 395.2
1876 2091 671 1825.7 405.9
1877 2078 631 1774.3 506.9
1878 2056 510 1770.4 388.8
1879 2048 648 2019.8 427.6
1880 2076 650 2035.4 481.8
1881 2115 683 2325.8 575.5
1882 2239 704 2344.3 633.8
1883 2417 788 2364.8 724.5
1884 2625 852 2282.5 760.9
1885 2689 1015 2421.8 802.0
1886 2809 891 2474.5 807.0
1887 3014 1471 2636.2 1003.0
1888 3120 1523 2731.4 1055.0
1889 3239 1791 2937.9 1237.3
1890 3484 2250 3061.7 1374.6
1891 3652 2743 3113.4 1442.0
1892 3759 3359 3493.7 1640.0
1893 3807 3807 3213.2 1857.0
1894 3770 3810 3422.0 1782.0
1895 3715 4016 3470.5 1954.0
1896 3689 3968 3353.7 1962.0
1897 3610 4108 3563.4 1981.0
1898 3582 4211 3977.6 2298.0
1899 3583 4451 4708.8 2707.0
1900 3732 4659 4944.1 3090.0
1901 4165 5317 5675.9 3776.0
1902 4535 5814 6008.7 4292.0
1903 4939 6493 6286.9 4790.0
1904 5331 7508 6655.9 5244.0
1905 5668 8477 7327.8 6056.0
1906 6053 9604 7784.2 6636.0
1907 6429 10761 8476.5 7190.0
1908 6824 12062 8714.0 6898.0
1909 6926 12398 9471.7 7407.0
1910 7145 13257 9896.6 7911.0
1911 7277 14115 10383 8412.0
1912 7372 14791 10861.7 9005.0
1913 7473 15526 11036.9 9267.0

Source: U.S. Department of the Treasury. Annual Report of the Comptroller of the Currency (1931), pp. 3, 5. State bank columns include data on state-chartered commercial banks and loan and trust companies.

Capital Requirements and Interest Rates

The relatively high minimum capital requirement for national banks may have contributed to regional interest rate differentials in the post-Civil War era. The period from the Civil War through World War I saw a substantial decline in interregional interest rate differentials. According to Lance Davis (1965), the decline in difference between regional interest rates can be explained by the development and spread of the commercial paper market, which increased the interregional mobility of funds. Richard Sylla (1969) argues that the high minimum capital requirements established by the National Banking Acts represented barriers to entry and therefore led to local monopolies by note-issuing national banks. These local monopolies in capital-short regions led to the persistence of interest rate spreads.[3] (See also James 1976b.)

Bank Failures

Financial crises were a common occurrence in the National Banking era. O.M.W. Sprague (1910) classified the main financial crises during the era as occurring in 1873, 1884, 1890, 1893, and 1907, with those of 1873, 1893, and 1907 being regarded as full-fledged crises and those of 1884 and 1890 as less severe.

Contemporary observers complained of both the persistence and ill effects of bank failures under the new system.[4] The number and assets of failed national and non-national banks during the National Banking era is shown in Table 2. Suspensions — temporary closures of banks unable to meet demand for their liabilities — were even higher during this period.

Table 2: Bank Failures, 1865-1913

Number of Failed Banks Assets of Failed Banks ($millions)
National Banks Other Banks National Banks Other banks
1865 1 5 0.1 0.2
1866 2 5 1.8 1.2
1867 7 3 4.9 0.2
1868 3 7 0.5 0.2
1869 2 6 0.7 0.1
1870 0 1 0.0 0.0
1871 0 7 0.0 2.3
1872 6 10 5.2 2.1
1873 11 33 8.8 4.6
1874 3 40 0.6 4.1
1875 5 14 3.2 9.2
1876 9 37 2.2 7.3
1877 10 63 7.3 13.1
1878 14 70 6.9 26.0
1879 8 20 2.6 5.1
1880 3 10 1.0 1.6
1881 0 9 0.0 0.6
1882 3 19 6.0 2.8
1883 2 27 0.9 2.8
1884 11 54 7.9 12.9
1885 4 32 4.7 3.0
1886 8 13 1.6 1.3
1887 8 19 6.9 2.9
1888 8 17 6.9 2.8
1889 8 15 0.8 1.3
1890 9 30 2.0 10.7
1891 25 44 9.0 7.2
1892 17 27 15.1 2.7
1893 65 261 27.6 54.8
1894 21 71 7.4 8.0
1895 36 115 12.1 11.3
1896 27 78 12.0 10.2
1897 38 122 29.1 17.9
1898 7 53 4.6 4.5
1899 12 26 2.3 7.8
1900 6 32 11.6 7.7
1901 11 56 8.1 6.4
1902 2 43 0.5 7.3
1903 12 26 6.8 2.2
1904 20 102 7.7 24.3
1905 22 57 13.7 7.0
1906 8 37 2.2 6.6
1907 7 34 5.4 13.0
1908 24 132 30.8 177.1
1909 9 60 3.4 15.8
1910 6 28 2.6 14.5
1911 3 56 1.1 14.0
1912 8 55 5.0 7.8
1913 6 40 7.6 6.2

Source: U.S. Department of the Treasury. Annual Report of the Comptroller of the Currency (1931), pp. 6, 8.

The largest number of failures occurred in the years following the financial crisis of 1893. The number and assets of national and non-national bank failures remained high for four years following the crisis, a period which coincided with the free silver agitation of the mid-1890s, before returning to pre-1893 levels. Other crises were also accompanied by an increase in the number and assets of bank failures. The earliest peak during the national banking era accompanied the onset of the crisis of 1873. Failures subsequently fell, but rose again in the trough of the depression that followed the 1873 crisis. The panic of 1884 saw a slight increase in failures, while the financial stringency of 1890 was followed by a more substantial increase. Failures peaked again following several minor panics around the turn of the century and again at the time of the crisis of 1907.

Among the alleged causes of crises during the national banking era were that the money supply was not sufficiently elastic to allow for seasonal and other stresses on the money market and the fact that reserves were pyramided. That is, under the National Banking Acts, a portion of banks’ required reserves could be held in national banks in larger cities (“reserve city banks”). Reserve city banks could, in turn, hold a portion of their required reserves in “central reserve city banks,” national banks in New York, Chicago, and St. Louis. In practice, this led to the build-up of reserve balances in New York City. Increased demands for funds in the interior of the country during the autumn harvest season led to substantial outflows of funds from New York, which contributed to tight money market conditions and, sometimes, to panics (Miron 1986).[5]

Attempted Remedies for Banking Crises

Causes of Bank Failures

Bank failures occur when banks are unable to meet the demands of their creditors (in earlier times these were note holders; later on, they were more often depositors). Banks typically do not hold 100 percent of their liabilities in reserves, instead holding some fraction of demandable liabilities in reserves: as long as the flows of funds into and out of the bank are more or less in balance, the bank is in little danger of failing. A withdrawal of deposits that exceeds the bank’s reserves, however, can lead to the banks’ temporary suspension (inability to pay) or, if protracted, failure. The surge in withdrawals can have a variety of causes including depositor concern about the bank’s solvency (ability to pay depositors), as well as worries about other banks’ solvency that lead to a general distrust of all banks.[6]


Bankers and policy makers attempted a number of different responses to banking panics during the National Banking era. One method of dealing with panics was for the bankers of a city to pool their resources, through the local bankers’ clearinghouse and to jointly guarantee the payment of every member banks’ liabilities (see Gorton (1985a, b)).

Deposit Insurance

Another method of coping with panics was deposit insurance. Eight states (Oklahoma, Kansas, Nebraska, Texas, Mississippi, South Dakota, North Dakota, and Washington) adopted deposit insurance systems between 1908 and 1917 (six other states had adopted some form of deposit insurance in the nineteenth century: New York, Vermont, Indiana, Michigan, Ohio, and Iowa). These systems were not particularly successful, in part because they lacked diversification: because these systems operated statewide, when a panic fell full force on a state, deposit insurance system did not have adequate resources to handle each and every failure. When the agricultural depression of the 1920s hit, a number of these systems failed (Federal Deposit Insurance Corporation 1988).

Double Liability

Another measure adopted to curtail bank risk-taking, and through risk-taking, bank failures, was double liability (Grossman 2001). Under double liability, shareholders who had invested in banks that failed were liable to lose not only the money they had invested, but could be called on by a bank’s receiver to contribute an additional amount equal to the par value of the shares (hence the term “double liability,” although clearly the loss to the shareholder need not have been double if the par and market values of shares were different). Other states instituted triple liability, where the receiver could call on twice the par value of shares owned. Still others had unlimited liability, while others had single, or regular limited, liability.[7] It was argued that banks with double liability would be more risk averse, since shareholders would be liable for a greater payment if the firm went bankrupt.

By 1870, multiple (i.e., double, triple, and unlimited) liability was already the rule for state banks in eighteen states, principally in the Midwest, New England, and Middle Atlantic regions, as well as for national banks. By 1900, multiple liability was the law for state banks in thirty-two states. By this time, the main pockets of single liability were in the south and west. By 1930, only four states had single liability.

Double liability appears to have been successful (Grossman 2001), at least during less-than-turbulent times. During the 1890-1930 period, state banks in states where banks were subject to double (or triple, or unlimited) liability typically undertook less risk than their counterparts in single (limited) liability states in normal years. However, in years in which bank failures were quite high, banks in multiple liability states appeared to take more risk than their limited liability counterparts. This may have resulted from the fact that legislators in more crisis-prone states were more likely to have already adopted double liability. Whatever its advantages or disadvantages, the Great Depression spelled the end of double liability: by 1941, virtually every state had repealed double liability for state-chartered banks.

The Crisis of 1907 and Founding of the Federal Reserve

The crisis of 1907, which had been brought under control by a coalition of trust companies and other chartered banks and clearing-house members led by J.P. Morgan, led to a reconsideration of the monetary system of the United States. Congress set up the National Monetary Commission (1908-12), which undertook a massive study of the history of banking and monetary arrangements in the United States and in other economically advanced countries.[8]

The eventual result of this investigation was the Federal Reserve Act (1913), which established the Federal Reserve System as the central bank of the US. Unlike other countries that had one central bank (e.g., Bank of England, Bank of France), the Federal Reserve Act provided for a system of between eight and twelve reserve banks (twelve were eventually established under the act, although during debate over the act, some had called for as many as one reserve bank per state). This provision, like the rejection of the first two attempts at a central bank, resulted, in part, from American’s antipathy towards centralized monetary authority. The Federal Reserve was established to manage the monetary affairs of the country, to hold the reserves of banks and to regulate the money supply. At the time of its founding each of the reserve banks had a high degree of independence. As a result of the crises surrounding the Great Depression, Congress passed the Banking Act of 1935, which, among other things, centralized Federal Reserve power (including the power to engage in open market operations) in a Washington-based Board of Governors (and Federal Open Market Committee), relegating the heads of the individual reserve banks to a more consultative role in the operation of monetary policy.

The Goal of an “Elastic Currency”

The stated goals of the Federal Reserve Act were: ” . . . to furnish an elastic currency, to furnish the means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.” Furnishing an “elastic currency” was important goal of the act, since none of the components of the money supply (gold and silver certificates, national bank notes) were able to expand or contract particularly rapidly. The inelasticity of the money supply, along with the seasonal fluctuations in money demand had led to a number of the panics of the National Banking era. These panic-inducing seasonal fluctuations resulted from the large flows of money out of New York and other money centers to the interior of the country to pay for the newly harvested crops. If monetary conditions were already tight before the drain of funds to the nation’s interior, the autumnal movement of funds could — and did –precipitate panics.[9]

Growth of the Bankers’ Acceptance Market

The act also fostered the growth of the bankers’ acceptance market. Bankers’ acceptances were essentially short-dated IOUs, issued by banks on behalf of clients that were importing (or otherwise purchasing) goods. These acceptances were sent to the seller who could hold on to them until they matured, and receive the face value of the acceptance, or could discount them, that is, receive the face value minus interest charges. By allowing the Federal Reserve to rediscount commercial paper, the act facilitated the growth of this short-term money market (Warburg 1930, Broz 1997, and Federal Reserve Bank of New York 1998). In the 1920s, the various Federal Reserve banks began making large-scale purchases of US Treasury obligations, marking the beginnings of Federal Reserve open market operations.[10]

The Federal Reserve and State Banking

The establishment of the Federal Reserve did not end the competition between the state and national banking systems. While national banks were required to be members of the new Federal Reserve System, state banks could also become members of the system on equal terms. Further, the Federal Reserve Act, bolstered by the Act of June 21, 1917, ensured that state banks could become member banks without losing any competitive advantages they might hold over national banks. Depending upon the state, state banking law sometimes gave state banks advantages in the areas of branching,[11] trust operations,[12] interlocking managements, loan and investment powers,[13] safe deposit operations, and the arrangement of mergers.[14] Where state banking laws were especially liberal, banks had an incentive to give up their national bank charter and seek admission to the Federal Reserve System as a state member bank.

McFadden Act

The McFadden Act (1927) addressed some of the competitive inequalities between state and national banks. It gave national banks charters of indeterminate length, allowing them to compete with state banks for trust business. It expanded the range of permissible investments, including real estate investment and allowed investment in the stock of safe deposit companies. The Act greatly restricted the ability of member banks — whether state or nationally chartered — from opening or maintaining out-of-town branches.

The Great Depression: Panic and Reform

The Great Depression was the longest, most severe economic downturn in the history of the United States.[15] The banking panics of 1930, 1931, and 1933 were the most severe banking disruption ever to hit the United States, with more than one quarter of all banks closing. Data on the number of bank suspensions during this period is presented in Table 3.

Table 3: Bank Suspensions, 1921-33

Number of Bank Suspensions
All Banks National Banks
1921 505 52
1922 367 49
1923 646 90
1924 775 122
1925 618 118
1926 976 123
1927 669 91
1928 499 57
1929 659 64
1930 1352 161
1931 2294 409
1932 1456 276
1933 5190 1475

Source: Bremer (1935).

Note: 1933 figures include 4507 non-licensed banks (1400 non-licensed national banks). Non-licensed banks consist of banks operating on a restricted basis or not in operation, but not in liquidation or receivership.

The first banking panic erupted in October 1930. According to Friedman and Schwartz (1963, pp. 308-309), it began with failures in Missouri, Indiana, Illinois, Iowa, Arkansas, and North Carolina and quickly spread to other areas of the country. Friedman and Schwartz report that 256 banks with $180 million of deposits failed in November 1930, while 352 banks with over $370 million of deposits failed in the following month (the largest of which was the Bank of United States which failed on December 11 with over $200 million of deposits). The second banking panic began in March of 1931 and continued into the summer.[16] The third and final panic began at the end of 1932 and persisted into March of 1933. During the early months of 1933, a number of states declared banking holidays, allowing banks to close their doors and therefore freeing them from the requirement to redeem deposits. By the time President Franklin Delano Roosevelt was inaugurated on March 4, 1933, state-declared banking holidays were widespread. The following day, the president declared a national banking holiday.

Beginning on March 13, the Secretary of the Treasury began granting licenses to banks to reopen for business.

Federal Deposit Insurance

The crises led to the implementation of several major reforms in banking. Among the most important of these was the introduction of federal deposit insurance under the Banking (Glass-Steagall) Act of 1933. Originally an explicitly temporary program, the Act established the Federal Deposit Insurance Corporation (the FDIC was made permanent by the Banking Act of 1935); insurance became effective January 1, 1934. Member banks of the Federal Reserve (which included all national banks) were required to join FDIC. Within six months, 14,000 out of 15,348 commercial banks, representing 97 percent of bank deposits had subscribed to federal deposit insurance (Friedman and Schwartz, 1963, 436-437).[17] Coverage under the initial act was limited to a maximum of $2500 of deposits for each depositor. Table 4 documents the increase in the limit from the act’s inception until 1980, when it reached its current $100,000 level.

Table 4: FDIC Insurance Limit

1934 (January) $2500
1934 (July) $5000
1950 $10,000
1966 $15,000
1969 $20,000
1974 $40,000
1980 $100,000

Additional Provisions of the Glass-Steagall Act

An important goal of the New Deal reforms was to enhance the stability of the banking system. Because the involvement of commercial banks in securities underwriting was seen as having contributed to banking instability, the Glass-Steagall Act of 1933 forced the separation of commercial and investment banking.[18] Additionally, the Acts (1933 for member banks, 1935 for other insured banks) established Regulation Q, which forbade banks from paying interest on demand deposits (i.e., checking accounts) and established limits on interest rates paid to time deposits. It was argued that paying interest on demand deposits introduced unhealthy competition.

Recent Responses to New Deal Banking Laws

In a sense, contemporary debates on banking policy stem largely from the reforms of the post-Depression era. Although several of the reforms introduced in the wake of the 1931-33 crisis have survived into the twenty-first century, almost all of them have been subject to intense scrutiny in the last two decades. For example, several court decisions, along with the Financial Services Modernization Act (Gramm-Leach-Bliley) of 1999, have blurred the previously strict separation between different financial service industries (particularly, although not limited to commercial and investment banking).


The Savings and Loan crisis of the 1980s, resulting from a combination of deposit insurance-induced moral hazard and deregulation, led to the dismantling of the Depression-era Federal Savings and Loan Insurance Corporation (FSLIC) and the transfer of Savings and Loan insurance to the Federal Deposit Insurance Corporation.

Further Reading

Bernanke, Ben S. “Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression.” American Economic Review 73 (1983): 257-76.

Bordo, Michael D., Claudia Goldin, and Eugene N. White, editors. The Defining Moment: The Great Depression and the American Economy in the Twentieth Century. Chicago: University of Chicago Press, 1998.

Bremer, C. D. American Bank Failures. New York: Columbia University Press, 1935.

Broz, J. Lawrence. The International Origins of the Federal Reserve System. Ithaca: Cornell University Press, 1997.

Cagan, Phillip. “The First Fifty Years of the National Banking System: An Historical Appraisal.” In Banking and Monetary Studies, edited by Deane Carson, 15-42. Homewood: Richard D. Irwin, 1963.

Cagan, Phillip. The Determinants and Effects of Changes in the Stock of Money. New York: National Bureau of Economic Research, 1065.

Calomiris, Charles W. and Gorton, Gary. “The Origins of Banking Panics: Models, Facts, and Bank Regulation.” In Financial Markets and Financial Crises, edited by Glenn R. Hubbard, 109-73. Chicago: University of Chicago Press, 1991.

Davis, Lance. “The Investment Market, 1870-1914: The Evolution of a National Market.” Journal of Economic History 25 (1965): 355-399.

Dewald, William G. “ The National Monetary Commission: A Look Back.”

Journal of Money, Credit and Banking 4 (1972): 930-956.

Eichengreen, Barry. “Mortgage Interest Rates in the Populist Era.” American Economic Review 74 (1984): 995-1015.

Eichengreen, Barry. Golden Fetters: The Gold Standard and the Great Depression, 1919-1939, Oxford: Oxford University Press, 1992.

Federal Deposit Insurance Corporation. “A Brief History of Deposit Insurance in the United States.” Washington: FDIC, 1998.

Federal Reserve. The Federal Reserve: Purposes and Functions. Washington: Federal Reserve Board, 1994.

Federal Reserve Bank of New York. U.S. Monetary Policy and Financial Markets.

New York, 1998.

Friedman, Milton and Anna J. Schawtz. A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press, 1963.

Goodhart, C.A.E. The New York Money Market and the Finance of Trade, 1900-1913. Cambridge: Harvard University Press, 1969.

Gorton, Gary. “Bank Suspensions of Convertibility.” Journal of Monetary Economics 15 (1985a): 177-193.

Gorton, Gary. “Clearing Houses and the Origin of Central Banking in the United States.” Journal of Economic History 45 (1985b): 277-283.

Grossman, Richard S. “Deposit Insurance, Regulation, Moral Hazard in the Thrift Industry: Evidence from the 1930s.” American Economic Review 82 (1992): 800-821.

Grossman, Richard S. “The Macroeconomic Consequences of Bank Failures under the National Banking System.” Explorations in Economic History 30 (1993): 294-320.

Grossman, Richard S. “The Shoe That Didn’t Drop: Explaining Banking Stability during the Great Depression.” Journal of Economic History 54, no. 3 (1994): 654-82.

Grossman, Richard S. “Double Liability and Bank Risk-Taking.” Journal of Money, Credit, and Banking 33 (2001): 143-159.

James, John A. “The Conundrum of the Low Issue of National Bank Notes.” Journal of Political Economy 84 (1976a): 359-67.

James, John A. “The Development of the National Money Market, 1893-1911.” Journal of Economic History 36 (1976b): 878-97.

Kent, Raymond P. “Dual Banking between the Two Wars.” In Banking and Monetary Studies, edited by Deane Carson, 43-63. Homewood: Richard D. Irwin, 1963.

Kindleberger, Charles P. Manias, Panics, and Crashes: A History of Financial Crises. New York: Basic Books, 1978.

Krooss, Herman E., editor. Documentary History of Banking and Currency in the United States. New York: Chelsea House Publishers, 1969.

Minsky, Hyman P. Can ‘It” Happen Again? Essays on Instability and Finance. Armonk, NY: M.E. Sharpe, 1982.

Miron , Jeffrey A. “Financial Panics, the Seasonality of the Nominal Interest Rate, and the Founding of the Fed.” American Economic Review 76 (1986): 125-38.

Mishkin, Frederic S. “Asymmetric Information and Financial Crises: A Historical Perspective.” In Financial Markets and Financial Crises, edited by R. Glenn Hubbard, 69-108. Chicago: University of Chicago Press, 1991.

Rockoff, Hugh. The Free Banking Era: A Reexamination. New York: Arno Press, 1975.

Rockoff, Hugh. “Banking and Finance, 1789-1914.” In The Cambridge Economic History of the United States. Volume 2. The Long Nineteenth Century, edited by Stanley L Engerman and Robert E. Gallman, 643-84. New York: Cambridge University Press, 2000.

Sprague, O. M. W. History of Crises under the National Banking System. Washington, DC: Government Printing Office, 1910.

Sylla, Richard. “Federal Policy, Banking Market Structure, and Capital Mobilization in the United States, 1863-1913.” Journal of Economic History 29 (1969): 657-686.

Temin, Peter. Did Monetary Forces Cause the Great Depression? New York: Norton, 1976.

Temin, Peter. Lessons from the Great Depression. Cambridge: MIT Press, 1989.

Warburg,. Paul M. The Federal Reserve System: Its Origin and Growth: Reflections and Recollections, 2 volumes. New York: Macmillan, 1930.

White, Eugene N. The Regulation and Reform of American Banking, 1900-1929. Princeton: Princeton University Press, 1983.

White, Eugene N. “Before the Glass-Steagall Act: An Analysis of the Investment Banking Activities of National Banks.” Explorations in Economic History 23 (1986) 33-55.

White, Eugene N. “Banking and Finance in the Twentieth Century.” In The Cambridge Economic History of the United States. Volume 3. The Twentieth Century, edited by Stanley L.Engerman and Robert E. Gallman, 743-802. New York: Cambridge University Press, 2000.

Wicker, Elmus. The Banking Panics of the Great Depression. New York: Cambridge University Press, 1996.

Wicker, Elmus. Banking Panics of the Gilded Age. New York: Cambridge University Press, 2000.

[1] The two exceptions were the First and Second Banks of the United States. The First Bank, which was chartered by Congress at the urging of Alexander Hamilton, in 1791, was granted a 20-year charter, which Congress allowed to expire in 1811. The Second Bank was chartered just five years after the expiration of the first, but Andrew Jackson vetoed the charter renewal in 1832 and the bank ceased to operate with a national charter when its 20-year charter expired in 1836. The US remained without a central bank until the founding of the Federal Reserve in 1914. Even then, the Fed was not founded as one central bank, but as a collection of twelve regional reserve banks. American suspicion of concentrated financial power has not been limited to central banking: in contrast to the rest of the industrialized world, twentieth century US banking was characterized by large numbers of comparatively small, unbranched banks.

[2] The relationship between the enactment of the National Bank Acts and the Civil War was perhaps even deeper. Hugh Rockoff suggested the following to me: “There were western states where the banking system was in trouble because the note issue was based on southern bonds, and people in those states were looking to the national government to do something. There were also conservative politicians who were afraid that they wouldn’t be able to get rid of the greenback (a perfectly uniform [government issued wartime] currency) if there wasn’t a private alternative that also promised uniformity…. It has even been claimed that by setting up a national system, banks in the South were undermined — as a war measure.”

[3] Eichengreen (1984) argues that regional mortgage interest rate differentials resulted from differences in risk.

[4] There is some debate over the direction of causality between banking crises and economic downturns. According to monetarists Friedman and Schwartz (1963) and Cagan (1965), the monetary contraction associated with bank failures magnifies real economic downturns. Bernanke (1983) argues that bank failures raise the cost of credit intermediation and therefore have an effect on the real economy through non-monetary channels. An alternative view, articulated by Sprague (1910), Fisher (1933), Temin (1976), Minsky (1982), and Kindleberger (1978), maintains that bank failures and monetary contraction are primarily a consequence, rather than a cause, of sluggishness in the real economy which originates in non-monetary sources. See Grossman (1993) for a summary of this literature.

[5] See Calomiris and Gorton (1991) for an alternative view.

[6] See Mishkin (1991) on asymmetric information and financial crises.

[7] Still other states had “voluntary liability,” whereby each bank could choose single or double liability.

[8] See Dewald (1972) on the National Monetary Commission.

[9] Miron (1986) demonstrates the decline in the seasonality of interest rates following the founding of the Fed.

[10] Other Fed activities included check clearing.

[11] According to Kent (1963, pp. 48), starting in 1922 the Comptroller allowed national banks to open “offices” to receive deposits, cash checks, and receive applications for loans in head office cities of states that allowed state-chartered banks to establish branches.

[12] Prior to 1922, national bank charters had lives of only 20 years. This severely limited their ability to compete with state banks in the trust business. (Kent 1963, p. 49)

[13] National banks were subject to more severe limitations on lending than most state banks. These restrictions included a limit on the amount that could be loaned to one borrower as well as limitations on real estate lending. (Kent 1963, pp. 50-51)

[14] Although the Bank Consolidation Act of 1918 provided for the merger of two or more national banks, it made no provision for the merger of a state and national bank. Kent (1963, p. 51).

[15] References touching on banking and financial aspects of the Great Depression in the United States include Friedman and Schwartz (1963), Temin (1976, 1989), Kindleberger (1978), Bernanke (1983), Eichangreen (1992), and Bordo, Goldin, and White (1998).

[16] During this period, the failures of the Credit-Anstalt, Austria’s largest bank, and the Darmstädter und Nationalbank (Danat Bank), a large German bank, inaugurated the beginning of financial crisis in Europe. The European financial crisis led to Britain’s suspension of the gold standard in September 1931. See Grossman (1994) on the European banking crisis of 1931. The best source on the gold standard in the interwar years is Eichengreen (1992).

[17] Interestingly, federal deposit insurance was made optional for savings and loan institutions at about the same time. The majority of S&L’s did not elect to adopt deposit insurance until after 1950. See Grossman (1992).

[18] See, however, White (1986) for

Citation: Grossman, Richard. “US Banking History, Civil War to World War II”. EH.Net Encyclopedia, edited by Robert Whaples. March 16, 2008. URL

When Washington Shut down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy

Author(s):Silber, William L.
Reviewer(s):Moen, Jon

Published by EH.NET (June 2007)

William L. Silber, When Washington Shut down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy. Princeton: Princeton University Press, 2007. xi + 217 pp. $28 (cloth), ISBN: 978-0-691-12747-7.

Reviewed for EH.Net by Jon Moen, Department of Economics, University of Mississippi.

The financial crisis of 1914 occupies an ambiguous position in the lineup of American banking and financial crises. It was not one of the celebrated National Banking Era panics (1873, 1884, 1890, 1893, and 1907 by Wicker’s estimation), but it was not then a crisis of the Federal Reserve Era either. Because it wasn’t a banking panic and because it straddled the transition between these two great periods in American banking, it is often presented as a coda to the symphony of earlier panics. For example, it is mentioned only in passing in Friedman and Schwartz’ Monetary History, and I could find no mention of it in Allan Meltzer’s recent History of the Federal Reserve, Volume I. William L. Silber’s book, When Washington Shut down Wall Street, argues persuasively that this crisis helped propel the United States and the dollar to international preeminence, thus raising its status to that of the Panic of 1907.

Silber presents a detailed (and densely referenced) history of the personalities and events in the months leading up to the opening of the Federal Reserve System on November 16, 1914. He focuses in particular on the actions of the Secretary of the Treasury William McAdoo. By Silber’s account, McAdoo’s decisive action in closing the New York Stock Exchange on July 31, 1914 for four months protected the stock of gold in the U.S. and gave the young Federal Reserve System a chance to get organized. This is in contrast to the popular belief that the Governing Board of the NYSE initiated the closure of the exchange in the face of a massive sell-off in shares as a means to protect share prices. Why did McAdoo order the exchange closed? According to Silber he wasn’t concerned about a sell-off in shares driving down prices, for American bargain hunters (the “Shorts”) would snap up the shares. Rather, he was concerned that the sellers, mainly the British and the French, would then convert the dollar proceeds to gold and ship it off to Europe to finance their war efforts, effectively wiping out the U.S. gold stock. Without gold, the young Federal Reserve would have nothing to back its note issue, diminishing its credibility as a central bank. By also insisting that the U.S. remain on the gold standard while everybody else but England was going off of it, McAdoo signaled that the U.S. was determined to honor its foreign debt, preventing a massive devaluation of the dollar. Of course, if foreigners couldn’t convert stock assets to dollars in the first place, staying on the gold standard would be much easier for the U.S. Nevertheless, such bold and decisive action by McAdoo set the foundation for the shift away from the pound sterling to the dollar as the international reserve currency after World War I.

The book is written with a general audience in mind, but it is an important book for any scholar of financial and banking panics. While it contains little theoretical analysis of the crisis, it makes up for that by presenting a tremendous amount of historical detail in a compelling and fast-moving story. An example of this is his account of how gold arbitrage actually worked under the gold standard. We are all aware of the gold points and that gold flowed across the Atlantic when the dollar/sterling exchange rate reached either point. But Silber explains the actual mechanics of gold arbitrage using the example of Max May, the vice president at Guaranty Trust Company in charge of foreign exchange operations. In chapter two he clearly outlines how Max would have to locate a ship going to England, get gold coin or bullion packaged in barrels with sawdust to prevent abrasion of the gold, and get the barrels insured and safely stowed on board. He also provides a numerical demonstration of how much profit May and other arbitrageurs could make at certain exchange rates. Max reappears in chapter 5 in an extended dialogue explaining why the value of sterling was so high in August 1914; as a bonus there is also a detailed discussion of the several types of bills of exchange. Some might view these examples as a bit simplistic, but they are great stuff for a classroom discussion of the gold standard.

Several chapters are worth mentioning in particular, as they highlight Silber’s thesis that McAdoo was central in transforming the U.S. into a financial superpower. Chapter three outlines the events of the Panic of 1907 and how they led to the creation of the emergency currency authorized in the Aldrich-Vreeland Act. Silber makes it clear that the key New York bankers had the horrors of 1907 in mind as they saw gold beginning to flow out of the U.S. at the outbreak of World War I. It was the large gold inflows from Europe that eventually damped the 1907 panic; gold leaving the country was not a comforting development. This leads into chapter four, which describes how the emergency currency was almost unavailable for the Crisis of 1914. The Federal Reserve Act extended the life of the Aldrich-Vreeland currency through June 30, 1915 ? it was to have expired a year earlier. Unfortunately, most of the large banks in New York were not eligible to issue the currency, for they had not issued national bank notes at least equal to 40 percent of their capital. Here McAdoo’s decisive action saved the day when he was able to convince Congress to amend the Aldrich-Vreeland Act to suspend the 40 percent requirement, allowing the large New York banks, as well as banks in other cities, to meet the withdrawals of cash as Americans began hoarding cash in anticipation of war. The Epilogue compares McAdoo’s behavior to several modern Federal Reserve Board chairmen like Arthur Burns, Paul Volcker, and Alan Greenspan. The latter two compare favorably to McAdoo in their decisive handling of financial crises.

Was McAdoo as vital for America’s transformation as Silber would have us believe? I think he makes a reasonable case, although it is also easy to believe that the combination of the Great Depression, the abandonment of the gold standard, and World War II would have left the U.S. as the world’s financial superpower and the dollar as the reserve currency. Be that as it may, this short book contains a vast fund of information and history about an oddly neglected event in U.S. history.


Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867 to 1960. Princeton, 1963.

Allan Meltzer, A History of the Federal Reserve, Volume I: 1913-1951. Chicago, 2003.

Elmus Wicker, Banking Panics of the Gilded Age. Cambridge, 2000.

Jon Moen is an Associate Professor in the Department of Economics at the University of Mississippi. He has studied retirement in the United States in addition to his research on the Panic of 1907. He is currently working on a book with Ellis Tallman of the Atlanta Federal Reserve Bank on the Panic of 1907.

Subject(s):Military and War
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed

Author(s):Wicker, Elmus
Reviewer(s):Tallman, Ellis W.

Published by EH.NET (August 2006)

Elmus Wicker, The Great Debate on Banking Reform: Nelson Aldrich and the Origins of the Fed. Columbus, OH: Ohio State University Press, 2005. xii + 120 pp. $35 (cloth), ISBN: 0-8142-1000-7.

Reviewed for EH.NET by Ellis W. Tallman, Federal Reserve Bank of Atlanta.

Elmus Wicker has written another important book for understanding a crucial portion of the complex economic history of the United States’s banking system. The book describes the evolution of the banking reform debate that took place between 1894 and 1913 in newspapers, magazines, and political discourse, documenting the sharp turns it took along with changes in the key reform proposals from the most influential reformers. The book ends with Wicker suggesting that the creation of the Fed may have been accidental. Although the conclusion is debatable, the book will likely motivate further research on the banking reform movement and should appeal particularly to the specialist in the monetary history of the United States.

The core of the book centers on how the banking reform debate evolved from the initial asset-based currency proposals arising from the interior banks toward the central bank-like plans (mainly from the New York City banking interests) that culminated in the passage of the Federal Reserve Act. Wicker presents essential details on various banking reform proposals, the key participants, and the main tenets of the reforms and he makes it clear that the path toward the establishment of a central banking entity was circuitous.

For the context of banking reform, it helps to provide a brief synopsis of the cornerstone events spurring the debate. During the Banking Crisis of 1893, the New York City national banks left interior banks to fend for themselves by restricting convertibility of deposits into currency. Under existing banking legislation, banks outside New York City could not increase their currency supply when demand required it, but instead relied on their reserves on deposit at New York City national banks. In reform proposals, the banks outside New York City wanted to reduce their dependence on New York City national banks when emergency cash needs arose. Asset-based currency provisions would reduce that dependence. New York City bankers opposed asset-based currency proposals, instead supporting (though half-heartedly) central bank proposals. These positions held generally prior to the Panic of 1907.

In a brief book, each chapter takes on a mission and Chapter 3, entitled “The Quest for an Asset-Based Currency, 1894-1908″ argues that initial banking reform proposals aimed to repair the flaws of the National Banking System: seasonal money market stringency and banking panics. The initial reform proposals wrangled with “inelasticity of the currency,” that is, the failure of currency (note issuance from banks especially) to respond to changes in demand, most notably, the seasonal demands from the agricultural cycle. The book provides a complete analysis of proposals and reform movements, and the descriptions retain a thematic continuity to the title. The Baltimore Plan in 1894 was conceived by bankers in the Baltimore Clearing House who then presented a proposal for currency reform at the American Bankers’ Association annual convention. Wicker presents the detailed asset-based currency proposal of the Baltimore Plan, emphasizing that the plan was not uniformly supported by reformers with similar views. For example, J. Laurence Laughlin, chairman of the Department of Economics at the University of Chicago, perceived that the key constraint in a banking panic was access to credit, which was not going to be fixed by additional currency. Laughlin’s subsequent participation in the Indianapolis Monetary Commission in 1897 links together the discussion of the two reform movements, making clear that the latter reform gained from the work of the Baltimore Plan. The Indianapolis Monetary Commission had as its goal the appointment of a National Monetary Commission, much like the one commissioned in the Aldrich-Vreeland Act of 1908.

Wicker describes several other less well known reform proposals that deserve notice. Among the other banking reform proposals, the Pratt Bill of 1903 would have authorized each clearinghouse with the right to issue currency on the collateral of its general assets, thereby offering asset-based currency only through the clearinghouses rather than individual banks. This innovative element was similar to the portion of the Aldrich-Vreeland Act that allowed clearinghouses the authority to issue “emergency currency.”

The New York Chamber of Commerce Report in 1906 proposed a banking reform that promoted the establishment of a European-style central bank. Arising from New York City business leaders, the proposal provides a key contrast to the proposals from outside New York City. Frank Vanderlip, an executive at National City Bank in New York City, participated in the effort, although he apparently was unconvinced by the final draft of the proposal. It was a notable outlier among the reform proposals prior to the Panic of 1907.

The book leaves two key questions relatively unanswered. First, Wicker asks how it was that the Midwestern, interior banking forces that initiated the serious effort toward reform lost the leadership of the banking reform movement to Wall Street bankers. Without that leadership, the interior banking interests had limited influence on the shape and content to the banking reform legislation. I think that the book understates the effect that the Panic of 1907 had on the banking reform debate. Wicker describes the Columbia University Lectures, a set of prepared lectures held in New York City on banking and financial market reform presented by a list of distinguished bankers, scholars, and public servants. The motivation for the lecture series arose from the aftermath of the Panic of 1907, which had affected New York City banks and financial markets most intensely. As a result, New York City banking interests had a heightened interest in the banking reform debate. The influence of the Wall Street bankers on the reform proposals in 1908 and afterward changed the contents of the banking reform debate. Separately, Wicker argues that bank reform shifted toward the creation of a central bank and lost its focus on panic prevention. This loss of focus in the banking reform movement on its initial motivation is not fully developed in the book, and offers some opportunities for additional inquiries.

The second question that the book raises but then does not fully answer refers to the change in the perspective on banking reform of the central political character of the book, Nelson Aldrich, Senator from Rhode Island and Chairman of the Senate Banking Committee. The text describes how Aldrich left the United States to visit European central banks; at the time of his departure, Aldrich believed in the efficacy of currency reform, perhaps some form of asset-based currency legislation. Upon his return, though, Aldrich was an advocate of establishing a central bank in the United States. The discussion leaves the reader asking “why did he change his mind?” It is left for further research to uncover whether there was an event or particular observation that led Aldrich to change his mind. The address by Aldrich in the National Monetary Commission (Volume XX) emphasizes the absence of large-scale credit disruptions in Europe over the period in which the United States faced several serious crises, but there is no revelation of what caused his notable change of view.

The description of the infamous Jekyll Island cabal and its role in the conception and creation of the Aldrich Bill offers perhaps the most accessible content for the general interest reader. Wicker describes the key personalities, their views, and their role in the creative process. The participants of Jekyll Island meeting were Nelson Aldrich, Henry P. Davison (a partner of J.P. Morgan and Co.), A. Piatt Andrew (a Harvard economics professor on leave as Assistant Treasury Secretary), Frank Vanderlip (second in command to James Stillman at National City Bank), and Paul Warburg (an investment banker from Kuhn-Loeb). Wicker emphasizes the absence of Benjamin Strong from the list of participants, and provides ample source material to underline that fact. Otherwise, the discussion of the Aldrich Bill is concise and accurate to set up a comparison with the Owen-Glass Bill that was eventually passed as legislation for the creation of the Federal Reserve System.

The discussion of the Glass Bill examines an overlooked antecedent in the Muhleman Plan. Apparently, it is one of three proposals that H. Parker Willis, assistant to Carter Glass and often referred to as a central figure in the drafting of the Glass Bill, summarized for the Glass subcommittee. Wicker also describes Victor Morawetz’s plan for regional reserve banks, in which the each district has considerable autonomy, a notable difference from the Aldrich Bill. Regional district autonomy was adapted to the Glass Bill.

The book spends substantial text highlighting the differences and similarities of the Aldrich and Glass-Owen Bills. The differences were huge, despite the obvious benefit that the Owen-Glass Bill received from the Aldrich Bill as blueprint. The Aldrich Bill left the National Reserve Association as an entity run by bankers with some political oversight, whereas the Owen-Glass Bill reversed the roles. In terms of currency, the Aldrich Bill maintained currency as bank issue, whereas the Owen-Glass Bill made currency an obligation of the U.S. Treasury. With respect to the regional structure and districts, the Aldrich Bill was somewhat more centralized than the Owen-Glass Bill. The autonomy of the district banks in the Owen-Glass Bill contrasted with the Aldrich Bill proposal, and in retrospect, such autonomy likely hindered coordination within the Federal Reserve System during the Great Depression. The similarities of the two bills provide backdrop for another central theme of the book.

The subtitle of the book is Nelson Aldrich and the Origins of the Fed and the author makes no secret of his intention to acknowledge the debt owed to Nelson Aldrich for the successful passage of the Federal Reserve Act. The point is well-argued, well-worth making, and it is simple. Nelson Aldrich participated in the investigation of other central banks, he was crucial in guiding the momentum for banking reform toward the establishment of a central bank, and he coordinated the writing of the Aldrich Bill, which was an important blueprint for the Owen-Glass Bill. Aldrich was able to push the debate far enough to allow discussion of an institution that could be referred to as a central bank. For seven preceding decades in the United States, there was innate aversion to any proposal for a central bank. The contribution of Aldrich to the success of the Owen-Glass Bill, both in its content and in its passage, seems unmistakable.

The contribution of this book is more than a summary of central points on bank reform proposals and their shortcomings. Instead, it offers a comprehensive yet concise analysis of the great American debate on banking reform. The book should become required reading for those interested in U.S. monetary and financial history, as a synopsis of the banking reform proposals as well as the development and passage of the Federal Reserve Act.

Ellis W. Tallman is Vice President in the Macro Policy Group of the Research Department at the Federal Reserve Bank of Atlanta. His research interests in economic history focus on financial crises and specifically on the Panic of 1907 in the United States. He and his frequent co-author Jon Moen are completing a manuscript of a book examining the economic arguments that supported the movement to establish a central bank in the United States in the early twentieth century.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Making of Global Finance, 1880-1913

Author(s):Flandreau, Marc
Zumer, Frederic
Reviewer(s):Rockoff, Hugh

Published by EH.NET (February 2005)

Marc Flandreau and Frederic Zumer, The Making of Global Finance, 1880-1913. Paris: OECD, 2004. 144 pp. $30 (paperback), ISBN: 92-64-01534-5.

Reviewed for EH.NET by Hugh Rockoff, Department of Economics, Rutgers University.

The authors of this careful and vigorously argued monograph enter the debate over the role of the gold standard in the international economic system at the end of the nineteenth century. One issue is whether or not a country’s adherence to the gold standard mattered to international financial markets. One school of thought holds that it mattered a great deal, that financial markets approved of countries that joined the gold standard. The literature that supports this view includes Michael Bordo and Hugh Rockoff (1996), Nathan Sussman and Yishay Yafeh (2000), and Maurice Obtsfeld and Alan M. Taylor (2003). Flandreau and Zumer, however, are firmly on the other side. As far as they can see, international capital markets were supremely indifferent to whether or not a country adhered to gold.

(There is, I have to confess, a certain satisfaction in knowing that I have at least helped stirred things up. A famous economic historian once told me, however, that it wasn’t enough to have papers and books attacking you — you hadn’t really arrived in economic history until an entire conference was held to refute your ideas!)

The methodology that Flandreau and Zumer use is straightforward and in some ways is simply a further development of what has gone before. They run a regression in which the dependent variable is the difference between the yield for a particular country’s bond and the yield on U.K. bonds. The independent variables include a dummy variable for adherence to the gold standard and other variables that they classify as structural variables, reputational variables, and political variables. The structural variables include debt burden (defined as government interest payments relative to government revenues), exports relative to population, bank reserves relative to banknotes, exports relative to population, government deficits relative to government revenue, and exchange rate volatility. The reputational variables include whether or not a country has defaulted on its bonds and a memory variable to allow for the slow recovery of its reputation. The political variables include the enfranchised share of the population and political crises.

The great strength of the monograph is the care that Flandreau and Zumer have put into measuring their variables and running alternative specifications of the regression to test the robustness of their results. The sample consists of annual data for seventeen countries from 1880 to 1913. The countries were chosen mainly, it seems, because Flandreau and Zumer found data for them in the archives of the Credit Lyonnais that they could use to double check their variables and to be sure that they were looking at things in the way that a major participant in the market looked at things. For this reason some countries that you might want to include, such as the United States, Canada, and Australia, are omitted. Nevertheless, there is something to be said for having authors work with data they are sure about. Their data is reported in appendices, and available at

The main finding is that the coefficient on the gold standard dummy turns out to be small and insignificant in most of the regressions and the coefficient on the debt burden variable turns out to be large and significant. Flandreau and Zumer conclude that adherence to the gold standard did not matter, but that the debt burden did. The dragon has been slayed. One can’t help but be impressed with the effort and care that has gone into the monograph. Still, I have some reservations about the test that I have grouped under five headings. Some of these reservations might be regarded more as ideas for future research than as direct criticisms of what Flandreau and Zumer have done.

1. Left-hand and right-hand variables The variable that Flandreau and Zumer tout as the scourge of the gold standard dummy is the debt burden: interest payments divided by revenue. This is the real determinant of interest rates, they claim, because this is what the Credit Lyonnais looked at, and because it just makes sense as an indicator of the likelihood of bankruptcy. Just as a bank lending to a homebuyer would want to know the debt burden of the potential buyer relative to his or her ability to pay, bankers at the turn of the century wanted to look at the debt burden of the governments to which they lent relative to the ability of the governments to pay. One problem with using this variable in a linear regression, however, is that the variable on the left hand side, the yield for a particular country less the U.K. yield, is closely related by construction to the variable on the right hand side, interest payments divided by revenues. Consider the following example. You have two countries identical in every way except A borrows at a high rate of interest and B at a low rate of interest. If they both borrow the same amount, interest payments will be higher for A than for B — interest rate and debt burden will be positively correlated. Or consider what happens if the rate on a government’s bond falls, and the government refinances some of its debt at the lower rate. Again, the dependent variable and independent variable move together by construction.

2. Upstream and downstream variables A second, perhaps more important, problem is that the regression strategy combines what I like to call upstream and downstream variables. An extreme example will make the distinction I have in mind clearer. Suppose someone claims that prohibiting construction near a lake increases the amount of fish caught in a lake. A regression of fish caught per acre of water on a dummy variable for whether or not construction was permitted near a lake might show that prohibiting construction increases the catch. Add the stock of fish per acre in each lake to the regression and the significance of the prohibition of construction might disappear. The number of fish in the lake determines how many will be caught. One could then jump to the conclusion that prohibiting construction near lakes has no effect. Presumably, with enough data one could tease out the effects of limiting construction and other variables that might affect the amount of fish in the lake. In practice, however, this might be difficult if there are a small number of lakes in the sample.

The same problem, arises, I believe, in the current context. One example is the inclusion of both exchange rate volatility and the gold standard dummy in the same equation. Exchange rate stability (which turns out to have a large and significant coefficient in many of the regressions) is downstream from the gold standard. We might substitute it for the gold standard dummy, but to include both exchange rate volatility and the gold standard dummy obscures the effect of the choice of exchange rate regime.

The debt burden variable is also, to some extent, a downstream variable. The point of attaching one’s currency to gold was not to fool investors, while going about one’s old spendthrift ways. The point was to achieve long-run discipline. A country could not run continual deficits and inflate them away and remain permanently on the gold standard. Defending the currency was the principle that allowed central banks and governments to follow more conservative policies than they otherwise would. Ultimately, of course, the goal was to have modest deficits and a debt well within the capacity of the country to service. Putting all of these variables into the right hand side of the regression tends to obscure the effect of adhering to gold on the achievement of these long-term goals.

3. The gold standard dummies While the authors have put a great deal of energy into perfecting the other variables in the equation, they have put no energy into improving the gold standard variables. Indeed, it seems at points as if they can hardly be bothered to look at such nonsense. It is clear to me, however, that the current gold-standard variables are rather primitive because they fail to reflect the credibility of the commitment to the gold standard. True, credibility is not easily measured, but it is none-the-less crucial. The United States is a good example. Flandreau and Zumer, as I noted, exclude the United States. But it is the case I know best, and it makes the point. The dollar was convertible into gold, except during financial crises, from the time that convertibility was established after the Civil War until the Great Depression. One could represent this by simply assigning a dummy variable of one (on the gold standard) in every year in the period that Flandreau and Zumer examine. Yet the credibility of the U.S. commitment to the gold standard varied. When the Free Silver movement was at its height in the 1890s the fear that the United States would leave the gold standard was real. Milton Friedman and Anna Schwartz, looking at short-term interest rates, conclude that the resolution of the fear that the United States would leave gold explains a sharp drop in the level of the short-term U.S.-U.K. differential between 1874 and 1896. According to Friedman and Schwartz (1982, 515) peaks in the differential in 1893 and 1896 are consistent with this interpretation.

“The peak in 1893 is connected to the banking panic in that year. The initial banking difficulties reinforced fears, endemic before 1896 because of silver politics, that the United States would go off gold and the dollar would depreciate. … The peak in 1896 is connected with the capital flight of that year accelerated by Bryan’s nomination, which greatly strengthened fears that the United States would leave gold. In both cases, fear of devaluation meant that owners of United Kingdom capital were reluctant to participate in the United States short-term market except at a substantial premium. The election of McKinley changed the situation drastically. It made United States’ retention of the gold standard secure for the time being, and the subsequent flood of gold from South Africa, Alaska, and Colorado removed all doubts.”

Charles Calomiris (1992), similarly, thought that the threat of free silver affected the capital market, although he argued that the markets simply feared a temporary suspension of convertibility and post-suspension devaluation, rather than a permanent abandonment of gold. The point, however, is that even in the case of the United States which in the end remained solidly committed to gold, credibility varied, and that a dummy variable that simply looks at whether convertibility was maintained during a particular year is insufficient to capture the credibility of the commitment.

4. The changing credibility of the gold standard The credibility of the gold standard itself changed over the period 1880 to 1913. The correlation between the gold standard dummies and the defaults shows why. In 1880, the first year in the sample, 10 of the 17 countries in the sample were adhering to the gold standard. Up to 1913 only one, Portugal, would default. One country, Spain, was off gold and in default in 1880. The remaining six countries in the sample were off gold in 1880, but paying their debts. Three of the six would later default. Being on or off gold in 1880, in other words, turned out to be a good predictor of which countries would pay their debts. I suppose that participants in international financial markets might have ignored this information on the grounds that it was irrelevant. The ratio of interest payments to government revenues was equally good as a predictor of default. Nevertheless, adhering to gold was a device for achieving long-term stability. Perhaps recognition of the connection between being off gold and defaulting is why countries made an effort to stay on or get on gold. Of the 10 countries on the gold standard in 1880 only one was off in 1913. Of the seven countries off the gold standard in 1880, six were on by 1913 including all those that defaulted. In short, of the 17 countries in the sample, 15 had made the decision by 1913 to adhere to the gold standard. Given this scenario, it is possible that the credibility of the gold standard itself, as a means of achieving and as a symbol of financial rectitude was increasing over the period 1880 to 1913. The regression strategy as far as I can see simply assumes that being on gold in 1880 meant the same thing to participants as being on gold in 1913.

5. Policy variables and non-policy variables One reason why (some) economists and economic historians focus on adherence to the gold standard is because this was a policy variable, a choice actually being made by many countries at the turn of the century. Again, this was clearly true in the United States. Free silver (bimetallism at a ratio of 16 units of silver to one of gold) was a genuine alternative to the gold standard. It was promoted by one of the two major political parties, and might have been adopted by the United States. Fiscal policies, perhaps to a lesser degree, fall in the same category. It is important to see what might have been driving these debates, and what effects the choices made had on the U.S. economy.

There are other potential fundamentals that might have been more important than adherence to the gold standard in shaping the flow of capital, but were not policy variables. It may have been extremely important to British lenders that the population of a country be predominantly white, Anglo-Saxon, and Protestant. Being a colony of Britain may have been important as well. And having a high level of education may have impressed potential investors. Of course, if these factors were important they must be given their due in order to see what impact policy choices actually had. But the focus on policy variables, even when their potential contribution is marginal, is important if history is to provide lessons for today.

To be sure, what is or is not a policy variable is to some extent a matter of costs and benefits. Educational levels, colonial status, even religion can be, and in some cases have been deliberately changed. And it is always possible to look at a more fundamental analysis in which what look to be policy choices are really predetermined outcomes. There are variables, in other words, that explain why a country “chose” to adhere or not adhere to gold. When the election of 1896 began it seemed as if Bryan might win, and so Americans debated his policies at length. It seems as if Americans could make a choice. Yet it may also be true that there exists some model of the political process that takes into account various political fundamentals (the ethnic mix of the population, the rate of growth of the economy, and so on) that would show us why Bryan was destined to lose. Hillel is right: “all is foreseen, and freewill is given.”

The lack of clear distinctions between policy and non-policy variables affects the usefulness of the concluding section of the book. Flandreau and Zumer feel that the choice of exchange rate regime didn’t matter. This is useful advice — don’t waste your time worrying about gold or bimetallism. Perhaps today the advice would be don’t worry about fixed or flexible exchange rates. The debate over free silver in the United States and many other countries was, evidently, a lot of sound and fury signifying nothing. But what should people have worried about? Here Flandreau and Zumer make a number of assertions, but few of them qualify as practical advice. They note that “The adoption of ‘good’ [their quotation marks] domestic policies expedited the globalization of capital much more decisively than did the removal of legal barriers to financial exchange.” They also note that “debt burden was the one key factor that determined market access.” And they note that “Political crises such as wars or domestic unrest were detrimental to a country’s credit.” And that “?the reduction of public debts was achieved not through fiscal balance but via [their emphasis] economic growth,” which leads them to conclude that this “shows the importance of development policies in fostering international financial integration …” But what are we to make of all this? Surely every politician and government official knew that debt burdens and political crises were bad and that economic growth was good. The question was not where they wanted to go, but what policies would help them get there.

If I were starting to work on the “Good Housekeeping” paper again I would certainly write it differently. I would certainly want to take into account the important work by Flandreau and Zumer based on the archives of the Credit Lyonnais to better describe the channels through which adherence to gold mattered. But I am not persuaded that the gold standard was a matter of no concern, and that all of the debate over it at the end of the nineteenth century was a waste of time. I am persuaded, however, that Flandreau and Zumer are fine scholars, and have written an important book that future research in this area will need to take into account.


Michael Bordo and Hugh Rockoff, “The Gold Standard as a Good Housekeeping Seal of Approval.” Journal of Economic History 56 (June 1996): 389-428.

Charles Calomiris, “Greenback Resumption and Silver Risk: The Economics and Politics of Monetary Regime Change in the United States, 1862-1900.” NBER Working Paper, w4166, September 1992.

Milton Friedman and Anna J. Schwartz, Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867-1975. Chicago: University of Chicago Press, 1982.

Maurice Obstfeld and Alan M. Taylor, “Sovereign Risk, Credibility and the Gold Standard: 1870-1913 versus 1925-31.” Economic Journal (April 2003): 241-75.

Nathan Sussman and Yishay Yafeh. “Institutions, Reforms, and Country Risk: Lessons from Japanese Government Debt in the Meiji Era.” Journal of Economic History 60 (June 2000): 442-67.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: Pre WWII

A History of the Federal Reserve, Vol. I: 1913-51

Author(s):Meltzer, Allan H.
Reviewer(s):Wood, John H.

Published by EH.NET (June 2003)

Allan H. Meltzer, A History of the Federal Reserve, Vol. I: 1913-51. Chicago: University of Chicago Press, 2003. xiii + 800 pp. $75 (hardcover), ISBN: 0-226-51999-6.

Reviewed for EH.NET by John H. Wood, Department of Economics, Wake Forest University.

Allan Meltzer has given us a thorough history of the Federal Reserve’s monetary policy from its founding in December 1913 to the Treasury-Federal Reserve Accord in the spring of 1951. Several excellent descriptive and critical studies of various parts of this period of the Fed are available, led by a considerable portion of Friedman and Schwartz’s Monetary History. But Meltzer advances our understanding of the Fed in two respects that that I explore in this review: First, he considers all the significant episodes of monetary policy, usually in more detail than can be found elsewhere. This book must be the starting point for future studies of Federal Reserve monetary policy, not only for the period covered by the book, but also for the succeeding fifty years because the Fed’s organization and most of its beliefs and procedures were developed in the earlier period. The second main contribution is an extension of the first. Meltzer makes unequalled use of the unpublished minutes, correspondence, and other internal papers of the Federal Reserve Board and the Federal Reserve Bank of New York. He takes us further behind the scenes of policymaking.

This review seeks to locate the book in the literature on the Fed, a task made easier by Meltzer’s recognition of previous work and the absence of radically new interpretations. He supports the positions that have been associated with monetarist criticisms by Friedman and Schwartz and his work with Karl Brunner since the 1960s, especially the Fed’s lack of understanding of its role in the economy and its obsession with financial markets, commercial bank free reserves in particular. His support is in the form of information about the ideas, institutions, and personalities behind actions and inactions that are well known. We are told that the inflation and deflation of 1919-21, the Great Depression of 1929-33, the recession of 1937-38, and the post-World War II inflation would have been avoided or greatly moderated if the Fed had make money grow at a constant rate, as Friedman proposed (1959, 92) or as adjusted for velocity and inflation as Meltzer proposed (1984). Whether or not we accept these conclusions, Meltzer enables us to increase our understanding of the Fed’s intentions, or rather the intentions of different parts of an institution that was at war with itself.

The new material may be the book’s most important contribution to research because it adds to the information available for the study of the policy preferences of different interests in the Federal Reserve and their effects on decisions. Internal conflicts often involved battles for control between the Board in Washington and the regional Reserve Banks. The Federal Reserve Act of 1913 was vague about control. The powers of the Fed — particularly discounting and open-market operations — were vested in the Banks under the Board’s supervision. The extent of this supervision — broad or, as the Banks complained, amounting to the micro-management of a central bank from Washington — was the main source of these conflicts, which spilled over into policy decisions. It is also possible that policy differences between the Board and the Banks, especially New York, were partly due to the knowledge and interests arising from their political and economic environments. Given the importance attached to these differences, I would like to have seen more attention paid to their possible reasons beyond institutional grasps for power. It is no surprise to find the Board more sympathetic to (or under the thumb of) the Treasury during the latter’s pressures for continued bond supports after the two world wars. Less expected, perhaps, was the Board’s greater skepticism of market forces. Its preference for controls over interest rates helped to rationalize its support for Treasury low-interest programs. But the Board also differed from New York in believing that controls could control stock speculation in 1928-29 without impinging on “legitimate” credit. Havrilesky (288-331) found that the Banks’ greater reliance on interest rates continued in the second half of the century. Might those, like the New York Fed, who are immersed in the financial markets repose more trust in their operation, specifically in the efficacy of interest rates as rationing devices, compared with credit controls? On the other hand, this tack may not be appealing to monetarists who already find the Fed too sensitive to markets and interest rates. Meltzer finds that a good deal of the Board’s criticism of the New York Bank after the Crash was motivated more by concern for control than different perceptions of economic relations (289).

Meltzer confirms the charge that the Fed neglected to develop a model, or guide, to policy. This neglect can be interpreted with more sympathy than Meltzer and other critics have shown, although they recognize the Fed’s difficulties, because important conditions assumed by the Fed’s creators quickly disintegrated with war and its aftermath. They were adrift without a destination, compass, or anchor. The great inflow of gold caused by European inflations and other disorders divorced the Fed’s actions from the historic central bank concern for its reserve. The Fed’s timid support of credit during the Great Depression may have been partly due to a desire to preserve the gold standard (Eichengreen; Meltzer is doubtful, 405), but its interest in price stability between 1921 and 1929 prevented it from taking full advantage of its more-than-ample reserves.

We must also realize that prevalent economic models did not imply the countercyclical policy to which economists were converted a decade later. An influential theory that implied “liquidation” in depression stemmed from the belief that deflations are reactions to inflations that had been driven by speculations in inventories and fixed assets. These should be allowed to return to normal levels. Deflations must be allowed to run their course (Hayek; Treasury Secretary Mellon, discussed by Meltzer, 400). Attempts to force money into paths “where it was not wanted” merely sow the seeds of future inflation. We can see where this policy was conducive to long-run price stability under the gold standard — price indexes in 1933 still exceeded those of 1914. Even if Meltzer, like Friedman and Schwartz, is right that the Fed should have tried for constant money growth or at least a stable price level, the application of such a policy would have required remarkably prescient theoretical sophistication by a group of committees of mainly conventional businessmen unused to abstractions.

Irving Fisher was a notable exception in his resistance to conventional sound money. But his “compensated dollar” plan for stabilizing the price level by adjusting the price of gold (182) was ridiculed as “a rubber dollar” (Hoover, 119) and dismissed by the New York Fed’s Benjamin Strong as the work of “extreme quantity theorists” (Chandler, 203).

Meltzer’s criticisms of the Fed, like Friedman and Schwartz’s, are meant to be lessons for policy. In its theoretical and policy implications, the book is mainstream monetarism, deserving of the usual plaudits and criticisms: money and output are correlated, so that money must be important, but no convincing evidence of the direction of causation is offered.

Prospective buyers should note that the book is not about Federal Reserve activities that are not directly part of monetary policy. Check clearing and other parts of the payments system, on which most Fed employees work, are ignored, and the structure and regulation of banking receive little attention. The last omission is more the Fed’s than Meltzer’s. The Fed recognized the weakness of the banking system as evidenced by the high failure rate of banks during the 1920s, but it did not work towards an improvement — unlike President Hoover (121-25), who tried unsuccessfully for a system of larger and stronger banks. When Board Chairman Marriner Eccles (266-69) sought measures similar to Hoover’s in 1936, he was rebuffed by President Roosevelt. The Fed’s lack of attention to the banking structure is striking in light of England’s experience, where the encouragement of amalgamations after the Panic of 1825, which was attributed to the fragility of small banks, contributed to the decline in the frequency and severity of panics as the nineteenth century progressed (none after 1866). On the other hand, the Fed might have followed Congress in taking the banking structure as given because the protection of local banks had been a political condition of the Federal Reserve Act.

Returning to the Fed’s model, or lack thereof, Meltzer agrees with his predecessors that monetary policy was an irregular mix of the gold standard rules of the game, the real bills doctrine, and a concern for price stability that seemed important only when inflation threatened. The place of the real bills doctrine in Fed thinking is unclear. The Federal Reserve Act has been interpreted as a legal implementation of the doctrine by its limitation of private discounting to real bills of exchange, that is, short-term lending secured by inventories. This had always been regarded as sound practice for commercial banks, and the Fed favored it in aggregate because lending for productive purposes was more conducive to economic activity and price stability than “speculative” lending on securities. But favoring real bills is not the real bills “doctrine,” as Meltzer would have it. The doctrine’s fallacies had often been shown, particularly the indeterminacy of the price level when credit is linked to expected prices (Thornton, 244-59), and monetary policy (as opposed to rhetoric, for example, Senator Glass; Meltzer, 400) did not suggest that the Fed believed it. If it had, there would have been no role for interest rates. In the closest it came to expressions of policy guides, in the Board’s 1923 Annual Review and statements by Benjamin Strong (Chandler, 188-246), the Fed indicated less fear of inflation from real bills than other lending. But it depended on interest rates to rein in excessive borrowing, whatever the purposes. Whether credit was “excessive” tended to depend on what was happening to the price level, although this connection was cloudy in Fed statements at least partly because it did not wish to be held responsible for price stability. The reasons for the Fed’s opposition to an official goal of price stability probably included its constraints on the pursuit of other goals, such as the alleviation of financial stress, and the fact that its proponents in Congress (especially James Strong of Kansas) were most interested in restoring agricultural prices to previous heights.

Touching on Meltzer’s relations to other controversies: He continues to differ from Friedman and Schwartz (692) in his argument (with Brunner, 1968, and agreed by Wicker, 1969, and Wheelock, 1991) that the Fed’s actions during the Great Depression would have been approximately the same if Benjamin Strong (who died in 1928) had continued at the helm of the New York Bank. Meltzer believes that Strong’s “attachment” to commercial bank borrowing from the Fed and free reserves as policy guides continued after 1928, and were responsible for its failure to increase credit between 1929 and 1933 and its doubling of reserve-requirements ratios in 1936-37. This position dates at least from the 1960s, when he and Brunner assisted Congressman Patman’s investigation of the Fed that initiated the work leading to the book under review.

It was a common belief in government and Congress that “international cooperation,” specifically the creation of inflation in the interests of European currencies (Hoover, 1952, 6-14), interfered with domestic goals. Meltzer agrees with Hardy (228-32) and Friedman and Schwartz that the accusation is unsupported. Quoting the latter: “foreign considerations were seldom important in determining the policies followed but were cited as additional justification for policies adopted primarily on domestic grounds when foreign and domestic considerations happened to coincide” (279).

I do not think that Meltzer’s treatment of bank failures during the Great Depression adequately reflects Wicker’s (1996) investigations that seriously undermine Friedman and Schwartz’s interpretations and suggest that the name “runs” is inappropriate. The three banking crises of 1930-31 identified by Friedman and Schwartz (and accepted by Meltzer, 323, 731) involved mostly small banks that were insolvent. Farm and real estate prices had fallen drastically, and banks failed because their customers failed. The frequency of failures in the “crisis periods” was only slightly greater than in the period as a whole, and were geographically concentrated. None became national in scope or exerted pressure on, not to say panic in, the New York money market. The first consisted largely of the collapse of the Caldwell investment banking firm of Nashville, Tennessee, which controlled the largest chain of banks in the South and was heavily invested in real estate. There is no evidence of contagion. The “crisis” of mid-1931 was concentrated in northern Ohio and the Chicago suburbs, where small banks had multiplied with the real estate boom. The crisis of September-October 1931was wider, but concentrated in Chicago, Pittsburgh, and Philadelphia.

This brings us to Meltzer’s (and Friedman and Schwartz’s) criticism of the Fed’s failure to apply Bagehot’s proposal that the central bank act as lender of last resort. That is, as holder of the nation’s reserve it should stand ready to supply the cash demanded in times of panic. Meltzer contends that “Most of the bank failures of 1929 to 1932, and the final collapse in the winter of 1933, could have been avoided” (729) if the Fed had applied Bagehot’s rule. However, as he (283-91) and Friedman and Schwartz (335-39) recognize elsewhere, the New York Fed actively assisted the financial markets during and after the Crash, and withdrew when there was no evidence of panic in New York, that is, “once borrowing and upward pressure on interest rates” declined (Meltzer, 288). I find Meltzer convincing when he suggests that this “was consistent with the Riefler-Burgess [free reserves] framework,” as opposed to Friedman and Schwartz’s argument that New York eventually yielded to the Board’s opposition to its open-market purchases. “The dispute was mainly about procedure, not about substance,” Meltzer (289) argues. “They [the Board] disliked New York’s decision to act alone.” It appears to this reviewer that the Fed’s actions as described by Meltzer and Friedman and Schwartz, generally conformed with Bagehot’s advice to relieve illiquidity in the money market in times of panic. He had not recommended the rescue of insolvent banks in the hinterlands that did not threaten the money market. This includes at least the beginnings of the nationwide closures of 1933 that were precipitated by the Michigan governor’s decision to close the banks in his state to protect them from the possibility of a run when the failure of Ford’s bank in Detroit (which was also heavily invested in real estate) was announced.

I end with comments that are more differences of emphasis than of substance: The Fed’s irrelevance in planning postwar financial arrangements is interesting, although Meltzer may exaggerate its significance. He wrote: “In the 1930s, the Treasury replaced the Federal Reserve as the principal negotiator on international financial arrangements” (737). In fact, governments have always, directly and firmly, controlled monetary arrangements. Their seizures of the details of monetary policy in the U.S. and U.K. in the early 1930s were remarkable, but the U.S. government’s control of changes in the monetary system as exemplified by the devaluation of 1933, Bretton Woods in 1944, and the Nixon suspension of 1971 had also been the practice of Parliament, which decided (with more or less advice from the Bank of England) suspensions, resumptions, legal tender, and other trade and financial arrangements. The irrelevance of the Fed in the negotiation of post-World War II financial agreements was shared by the Bank of England. Their places in the row behind finance ministers during negotiations continued an age-old practice. It is interesting in light of the high visibility of central banks in the operation of monetary systems that the structures of those systems belong to governments. Without defending the Fed, which ought to have behaved better within the framework that it was given, the real failure to respond to the catastrophe should be laid at the feet of the government. Herbert Hoover was more active than he is often given credit for, but he departed from tradition in leaning on the “weak reed” that was the Federal Reserve (1952, 212; Meltzer, 413).

Meltzer suggests that the Great Depression was not considered a failure of monetary policy at the time (727). He refers to the Federal Reserve and economists, and I agree. But this was not true of the public or of substantial parts of Congress (which he acknowledges on p. 427). Carter Glass was a powerful defender of the Fed in the Senate, but the House passed the Goldsborough Bill directing the Federal Reserve “to take all available steps to raise the present deflated wholesale commodity level of prices as speedily as possible to the level existing before the present deflation” by a vote of 289-60 in 1932, before it was watered down into a meaningless resolution in the Senate. The 72nd Congress (1931-33) introduced more than fifty bills to increase the money supply, which came closer to passage as the depression worsened (Krooss, 2662). It would be difficult to imagine a more damaging commentary on Woodrow Wilson’s idealistic expert (read “remote”) institution than Chicago Congressman A.J. Sabath’s question to Chairman Eugene Meyer in 1931: “Does the board maintain that there is no emergency existing at this time” (letter entered into the Congressional Record, Jan. 19) — or a similar lack of sensitivity of legislators in a democracy. The monetary authority supplanted by the Fed — the Treasury with an attentive Congress — might have done no better. But the sharp actions in 1865 (when Congress reversed its decision to retire the greenbacks after voters complained) and 1890 and 1893 (when it increased and then reduced the monetization of silver during recession and then gold flight) suggest that it would not have stayed on the sidelines if it had not been inhibited by (and waiting for) its expert creation. This is not (necessarily) a plea for free banking, but at least for monetary authorities that are closer to the effects of their actions.

I would have liked to see Meltzer subject the Fed’s existence to a little scrutiny, and to consider what kinds of institutions might have better responded to events or (this is surely an oversight) been more likely to adopt his preferred policy model. My guess is that he, Friedman and Schwartz, and most of the rest of the economics profession share Woodrow Wilson’s desire for experts: The Fed should be independent but use the right model.


Karl Brunner and Allan H. Meltzer. The Federal Reserve’s Attachment to the Free Reserve Concept. For Subcommittee on Domestic Finance, The Federal Reserve after Fifty Years. House Committee on Banking and Currency. Washington, 1965.

Karl Brunner and Allan H. Meltzer. “What Did We Learn from the Monetary Experience of the United States in the Great Depression?” Canadian Journal of Economics, May 1968.

W. Randolph Burgess. The Reserve Banks and the Money Market. New York, 1927.

Lester V. Chandler. Benjamin Strong, Central Banker. Washington, 1958.

Marriner Eccles. Beckoning Frontiers. New York, 1951.

Barry Eichengreen. Golden Fetters: The Gold Standard and the Great Depression, 1919-39. New York, 1992.

Milton Friedman. A Program for Monetary Stability. New York, 1959.

Milton Friedman and Anna J. Schwartz. A Monetary History of the United States, 1867-1960. Princeton, 1963.

Charles O. Hardy. Credit Policies of the Federal Reserve System. Washington, 1932.

Thomas Havrilesky. The Pressures on American Monetary Policy. Boston, 1993.

Freidrich A. Hayek. Prices and Production. London, 1931.

Herbert Hoover. Memoirs: The Great Contraction, 1929-41. New York, 1952.

Herman E. Krooss, editor. Documentary History of Banking and Currency in the United States. New York, 1969.

Allan H. Meltzer. “Overview,” in Federal Reserve Bank of Kansas City, Price Stability and Public Policy, 1984.

Winfield W. Riefler. Money Rates and Money Markets in the United States. New York, 1930.

Henry Thornton. An Inquiry into the Nature and Effects of the Paper Credit of Great Britain. London, 1802.

David C. Wheelock. The Strategy and Consistency of Federal Reserve Monetary Policy, 1924-33. Cambridge, 1991.

Elmus Wicker. “Brunner and Meltzer on Federal Reserve Monetary Policy during the Great Depression,” Canadian Journal of Economics, May 1969.

Elmus Wicker. Banking Panics of the Great Depression. Cambridge, 1996.

John Wood’s main research interest is a history of the ideas and behavior of British and American central bankers since 1694. Recent articles include “Bagehot’s Lender of Last Resort: A Hollow Hallowed Tradition,” Independent Review (Winter 2003), and “The Determination of Commercial Bank Reserve Requirements” (with Cara Lown), Review of Financial Economics (December 2002).

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

The Great Wave: Price Revolutions and the Rhythm of History

Author(s):Fischer, David Hackett
Reviewer(s):Munro, John H.

Published by EH.NET (February 1999)

David Hackett Fischer, The Great Wave: Price Revolutions and the Rhythm of

History. Oxford and New York: Oxford University Press, 1996. xvi + 536.

$35 (hardcover), ISBN: 019505377X. $16.95 (paperback), ISBN: 019512121X.

Reviewed for EH.NET by John H. Munro, Department of Economics, University of


Let me begin on a positive note. This is indeed a most impressive work: a

vigorous, sweeping, grandiose, and contentious, though highly entertaining,

portrayal of European and North American economic history, from the High Middle

Ages to the present, viewed through the lens of “long-wave” secular price-

trends. Indeed its chief value may well lie in the controversies that it is

bound to provoke, particularly from economists, to inspire new avenues of

research in economic history

, especially in price history. The author contends that, over the past eight

centuries, the European economy has experienced four major “price-

revolutions,” whose inflationary forces ultimately became economically and

socially destructive, with adverse consequences that provoked various complex

reactions whose “resolutions” in turn led to more harmonious, prosperous, and

“equitable” economic and social conditions during intervening eras of “price

equilibria”. These four price-revolutions are rather too neatly set out as the

following: (1) the later- medieval, from c.1180-c.1350; (2) the far better

known 16th-Century Price-Revolution, atypically dated from c.1470 to c.1650,

(3) the inflation of the Industrial Revolution era, from c.1730 to 1815; and

(4) the 20th century price-revolution, conveniently dated from 1896 to 1996

(when he published the book).

Though I am probably more sympathetic

to the historical concept of

“long-waves” than the majority of economists, I do agree with many opponents of

this concept that such long-waves are exceptionally difficult to define and

explain in any mathematically convincing models, which are certainly not

supplied here. For reasons to be explored in the course of this review, I

cannot accept his depictions, analysis

, and explanations for any of them. This will not surprise Prof. Fischer, who

is evidently not an admirer of the economics profession. He is particularly

hostile to those of us deemed to be “monetarists,” evidently used as a

pejorative term. After rejecting not only the “monetarist” but also the


neo-Classical, agrarian, environmental, and historicist” models, for their

perceived deficiencies in explaining inflations, and after condemning

economists and historians alike for imposing rigid models in attempting to

unravel the mysteries of European and North American economic history,

Fischer himself imposes an exceptionally rigid and untenable model for all four

of his so-called price-revolutions, containing in fact selected Malthusian and

monetarist elements from these supposedly rejected models.

In essence, the Fischer model contends that all of his four long-wave

inflations manifested the following six-part consecutive chain of causal and

consequential factors, inducing new causes, etc., into the next part of the

chain. First, each inflationary long-wave began with a prosperity created from

the preceding era of price-equilibrium, one promoting a population growth that

inevitably led to an expansion in aggregate demand that in turn outstripped

aggregate supply, thus — according to his model

– causing virtually ALL prices to rise. Evidently his model presupposes that

all sectors of the economy, in all historical periods under examination, came

to suffer from Malthusian-Ricardian diminishing

returns and rising marginal costs, etc. Second, in each and every such era,

after some indefinite lapse of time, and after the general population had

become convinced that rising prices constituted a persistent and genuine trend,

the “people” demanded and

received from their governments an increase in the money supply to

“accommodate” the price rises. As Fischer specifically comments on p. 83: “in

every price-revolution, one finds evidence of frantic efforts to expand the

money supply, after people have discovered that prices are rising in a secular

way.” Third, and invariably, in his view, that subsequent and continuous growth

in the money supply served only to fuel and thus aggravate the already existing

inflation. He never explains, however, for any of

the four long-waves, why those increases in money stocks were always in excess

of the amount required “to accommodate inflation”. Fourth, with such

money-stock increases, the now accelerating inflation ultimately produced a

steadily worsening impoverishment of the masses, aggravated malnutrition,

generally deteriorating biological conditions, and a breakdown of family

structures and the social order, with increasing incidences of crime and social

violence: i.e., with a rise in consumer prices that outstripped generally

sticky wages in each and every era, and with a general transfer of wealth from

the poorer to richer strata of society. Fifth, ultimately all these negative

forces produced economic and social crises that finally brought the

inflationary forces to a halt,

producing a fall in population and thus (by his model) in prices, declines that

subsequently led to a new era of “price-equilibrium,” along with concomitant

re-transfers of wealth and income from the richer to the poorer strata of


(where such wealth presumably belonged). Sixth, after some period of economic

prosperity and social harmony, this vicious cycle would recommence, i.e., when

these favorable conditions succeeded in promoting a new round of incessant

population growth, which inevitably sparked those same inflationary forces to

produce yet another era of price-revolution, continuing until it too had run

its course.

While many economic historians, using more structured Malthusian-Ricardian type

models, have also provided a similarly bleak portrayal of

demographically-related upswings and downswings of the European economy,

most have argued that this bleak cycle was broken with the economic forces of

the modern Industrial Revolution era. Fischer evidently does not. Are we the

reforecondemned, according to his view, to suffer these never-ending bleak

cycles– economic history according to the Myth of Sisyphus, as it were?

Perhaps not, if government leaders were to listen to the various nostrums set

forth in the final chapter,

political recommendations on which I do not feel qualified to comment.

Having engaged in considerable research, over the past 35 years, on European

monetary, price, and wage histories from the 13th to 19th centuries, I am,

however, rather more qualified

to comment on Fischer’s four supposed long-waves. Out of respect for the

author’s prodigious labors in producing this magnum opus, one that is bound to

have a major impact on the historical profession, especially in covering such a

vast temporal and spatial range, I feel duty-bound to provide detailed

criticisms of his analyses of these secular price trends, with as much

statistical evidence as I can readily muster. Problematic in each is defining

their time span,

i.e., the onset and termination of inflations. If many medievalists may concur

that his first long- wave did begin in the 1180s, few would now agree that it

ended as late as the Black Death of 1348-50. On the contrary,

the preceding quarter-century (1324-49) was one of very severe deflation,

certainly in both Tuscany (Herlihy 1966) and England. In the latter, the

Phelps Brown and Hopkins “basket of consumables” price index (1451-75 =

100) fell 47%: from 165 in 1323 (having been as high as 216 in 1316, with the

Great Famine) to just 88 in 1346. Conversely, while most early-modern

historians would agree that the 16th-Century Price Revolution generally ended

in the 1650s (certainly in England), few if any would date its commencement so

early as the 1470s. To be sure, in both the Low Countries and England, a

combination of coinage debasements, civil wars, bad harvests, and other

supply-shocks did produce a short-term rise in prices from the later 1470s to

the early 1490s; but thereafter their basket-of-consumables price-indices

resumed their deflationary downward trend for another three decades (Munro

1981, 1983). In both of these regions and in Spain as well (Hamilton 1934), the

sustained rise in the general price level, lasting over a century, did not

commence until c.1520.

For Fischer’s third inflationary long-wave, of the Industrial Revolution era,

his periodization is much less contentious, though one might mark its

commencement in the late 1740s rather than the early 1730s.

The last and most recent wave is, however, by far more the most controversial

in its character. Certainly a long upswing in world prices did begin in 1896,

and lasted until the 1920s; but can we really pretend that this so neatly

defined century of 1896 to 1996 truly encompasses any form of long wave when we

consider the behavior of prices from the 1920s?

Are we to pretend that the horrendous deflation of the ensuing Great Depression

era was just a temporary if unusual aberration that deviated from this

particular century long (saeclum) secular tend? Fischer, in fact,


rarely ever discusses deflation, ignoring those of the 14th century and most

of the rest. Instead, he views the three periods intervening between his price-

revolutions as much more harmonious eras of price-equilibria: i.e. 1350-1470;

1650 – 1730; 1820 –

1896; and he suggests that we are now entering a fourth such era. In my own

investigations of price and monetary history from the 12th century, prices rise

and fall,

with varying degrees of amplitude; but they rarely if ever remain stable,

“in equilibrium”.

Certainly “equilibrium” is not a word that I would apply to the first of these

eras, from 1350 to 1470: not with the previously noted, very stark deflation of

c.1325 – 48, followed by an equally drastic inflation that ensued from the

Black Death over

the next three decades, well documented for England, Flanders (Munro 1983,

1984), France, Tuscany (Herlihy 1966),

and Aragon-Navarre (Hamilton 1936). Thus, in England, the mean quinquennial PB

& H index rose 64%: from 88 in 1340-44 to 145 in 1370-74, fal ling sharply

thereafter, by 29%, to 103 in 1405-09; after subsequent oscillations, it fell

even further to a final nadir of 87 in 1475-79 (when,

according to Fischer, the next price-revolution was now under way). For

Flanders, a similarly constructed price index of quinquennial means

(1450-74 = 100: Munro 1984), commencing only in 1350, thereafter rose 170%:

from 59 in 1350-4 to 126 in 1380-84, reflecting an inflation aggravated by

coinage debasements that England had not experienced, indeed none at all since

1351. Thereafter, the Flemish price index plunged 32%, reaching a temporary

nadir of 88 in 1400-04; but after a series of often severe price oscillations,

aggravated by warfare and more coin debasements, it rose to a peak of 138 in

1435-9; subsequent ly it fell another 31%, reaching its 15th century nadir of

95 in 1465-9 (before rising and then falling again, as noted earlier).

Implicit in these observations is the quite pertinent criticism that Fischer

has failed to use, or use properly, these and many other price

indices–especially the well-constructed Vander Wee index (1975), for the

Antwerp region, from 1400 to 1700, so important in his study; and the Rousseaux

and Gayer-Rostow-Schwarz indices for the 19th century (Mitchell &

Deane 1962). On the other hand, he has relied far too much on the dangerously

faulty d’Avenel price index (1894-1926) for medieval and early-modern France.

Space limitations, and presumably the reader’s patience, prevent me from

engaging in similar analyses of price trends

over the ensuing centuries, to indicate further disagreements with Fischer’s

analyses, except to note one more quarter-century of deflation during a

supposed era of price equilibrium: that of the so-called Great Depression era

of 1873 to 1896, at least within England, when the PB&H price index fell from

1437 to 947, a decline of 34% that was unmatched, for quarter-century periods

in English economic history, since the two stark deflations of the second and

fourth quarters of the 14th century. (The Rousseaux index fell from 42.5% from

127 in 1873 to 73 in 1893).

My criticisms of Fischer’s temporal depictions of both inflationary long-waves

and intervening eras of supposed price equilibria are central to my objections

to his anti-monetarist explanations for them, or rather to his

misrepresentation of the monetarist case, a viewpoint he admittedly shares with

a great number of other historians, especially those who have found

Malthusian-Ricardian type models to be more seductively plausible explanations


inflation. Certainly, too many of my students, in reading the economic history

literature on Europe before the Industrial Revolution era, share that beguiling

view, turning a deaf ear to the following arguments: namely, that (1) a growth

in population cannot by itself,

without complementary monetary factors, cause a rise in all prices, though

certainly it often did lead to a rise in the relative prices of grain,

timber, and other natural-resource based commodities subject to diminishing

return and supply

inelasticities; and thus (2) that these simplistic demographic models involve

a fatal confusion between a change in the relative prices of individual

commodities and a rise in the overall price-level. Some clever students have

challenged that admonition,


with graphs that seek to demonstrate, with intersecting sets of aggregate

demand and supply curves, that a rise in population is sufficient to explain

inflation. My response is the following. First, all of the historical prices

with which Fischer and my students are dealing

(1180-1750) are in terms of silver-based moneys-of-account, in the traditional

pounds, shillings, and pence, tied to the region’s currently circulating silver

penny, or similar such coin, while prices expressed in terms of the gold-based

Florentine florin behaved quite differently over the long periods of time

covered in this study. Indeed we should expect such a difference in price

behavior with a change in the bimetallic ratio from about 10:1 in 1400 to about

16:1 in 1650,

which obviously reflects the fall in the relative value or purchasing power of

silver — an issue virtually ignored in Fischer’s book. Second, the shift, in

this student graph, from the conjunction of the Aggregate Demand and Supply


from P1.Q1

and P2.Q2, requires a compensatory monetary expansion in order to achieve the

transaction values indicated for the two price levels: from 17,220,000 pounds

and 122,960,000 pounds, which increase in the volume of payments had to come

from either increased

money stocks and/or flows. Even if changes in demographic and other real

variables, shared responsibility for inflation by inducing changes in those

monetary variables, we are not permitted to ignore those variables in

explaining historical inflations.

Admittedly, from the 12th to the 18th centuries, to the modern Industrial

Revolution era, correlations between demographic and price movements are often

apparent. But why do so few historians consider the alternative proposition

that much more profound, deeper economic forces might have induced a complex

combination of general economic growth, monetary expansion, and a rise in

population, together (so that such apparent statistical relationships would

have adverse Durbin-Watson statistics to indicate significant serial

correlation)? Furthermore, if population growth is the inevitable root cause of

inflation, and population decline the purported cause of deflation, how do such

models explain why the drastic depopulations of the 14th-century Black Death


followed by three decades of severe inflation in most of western Europe?

Conversely, why did late 19th-century England experience the above-noted

deflation while its population grew from 23.41 million in 1873 (PB&H at 1437)

to 30.80 million in 1896 (PB&H

at 947)?

Nor is Fischer correct in asserting that, in each and every one of his four

price-revolutions, an increase in money supplies followed rather than preceded

or accompanied the rises in the price-level. For an individual country or

region, however

, one might argue that a rise in its own price level, as a consequence of a

transmitted rise in world or at least continental prices would have quickly —

and not after the long-time lags projected in Fischer’s analysis — produced an

increase in money supplies to satisfy the economic requirements for that rise

in national/regional prices. Fischer, however, fails to offer any theoretical

analysis of this phenomenon, and makes no reference to any of the well-known

publications on the Monetary Approach to the Balance of Payments [by Frenkel

and Johnson (1976), McCloskey and Zecher (1976), Dick and Floyd (1985, 1992);

Flynn (1978) and D. Fisher (1989), for the Price Revolution era itself]. In


and with some necessary repetition, this thesis contends:

(1) that a rise in world price levels, initially arising from increases in

world monetary stocks, is transmitted to most countries through the mechanisms

of international commerce (in commodities, services, labor) and finance

(capital flows); and (2) that monetized metallic (coin) stocks and other

elements constituting M1 will be endogenously distributed among all countries

and/or regions in order to accommodate the consequent rise in the domestic

price levels, (3) without involving those international bullion flows that the

famous Hume “price- specie flow” mechanism postulates to be the consequences of

inflation-induced changes in national trade balances.

In any event, the historical evidence clearly demonstrates that, for each of

Fischer’s European-based price-revolutions, an increase in European monetary

stocks and flows always preceded the inflations. For the first,

the price-revolution of the “long-13th century” (c.1180-c.1325), Ian Blanchard

(1996) has recently demonstrated that within England its elf,

specifically in Cumberland-Northumberland, a very major silver mining boom had

commenced much earlier, c.1135-7, peaking in the 1170s, with annual silver

outputs that were “ten times more than had been produced in the whole of

Europe” for any year in

the past seven centuries. By the 1170s,

and thus still before evident signs of general inflation or a marked

demographic upswing, an even greater silver mining boom had begun in the Harz

Mountains region of Saxony, which continued to pour out vast quantities of

silver until the early 14th century. For this same

“Commercial Revolution” era, we must also consider the accompanying financial

revolution, also evident by the 1180s, in Genoa and Lombardy; and though one

may debate the impact that their deposit-

and-transfer banking and foreign-exchange banking had upon aggregate European

money supplies,

these institutional innovations undoubtedly did at least increase the volume of

monetary flows, and near the beginning, not the middle, of this first



For the far better known 16th-Century Price Revolution, Fischer seems to pose a

much greater threat to traditional monetary explanations, especially in so

quixotically dating its commencement in the 1470s, rather than in the 1520s.

Certainly Fischer and many other critics are on solid grounds in challenging

what had been, from the time of Jean Bodin (1566-78) to Earl Hamilton

(1928-35), the traditional monetary explanation for the origins of the Price

Revolution: namely, the influx of Spanish

American treasure. But not until after European inflation was well underway,

not until the mid-1530s, were any significant amounts of gold or silver being


(via Seville); and no truly large imports of silver are recorded before the

early 1560s (a

mean of 83,374 kg in 1561-55: TePaske 1983), when the mercury amalgamation

process was just beginning to effect a revolution in Spanish-American mining.

Those undisputed facts, however, in no way undermine the so-called

“monetarist” case; for Fischer, and far too many other economic historians,

have ignored the multitude of other monetary forces in play since the 1460s.

The first and least important factor was the Portuguese export of gold from

West Africa (Sao Jorge) beginning as a trickle in the 1460s;

rising to 170 kg per annum by 1480, and peaking at 680 kg p.a. in the late

1490s (Wilks 1993). Far more important was the Central European silver mining

boom, which began in the 1460s, at the very nadir of the West European

deflation, which had thus raised the purchasing power of silver and so

increased the profit incentive to seek out new silver sources: as a

technological revolution in both mechanical and chemical engineering.

According to John Nef (1941, 1952), when this German-based mining boom reached

its peak in the mid 1530s, it had augmented Europe’s silver outputs more than

five-fold, with an annual production that ranged from a minimum of 84,200 kg

fine silver to a maximum of 91,200 kg — and thus well in excess of any amounts

pouring into Seville before the mid-1560s. My own statistical compilations,

limited to just the major mines, indicate a rise in quinquennial mean

fine-silver outputs from 12,356 kg in 1470-74 to 55,025 kg in 1534-39 (Munro

1991). In England, 25-year mean mint outputs rose

from 18,932 kg silver in 1400-24 to 33,655 kg in 1475-99 to 59,090 kg in

1500-24; and then to 305,288 kg in 1550-74 (i.e., after Henry VIII’s

“Great Debasement”); in the southern Low Countries, those means go from 54,444

kg in 1450-74 to 280,958 kg in 15 50-74 (Challis 1992; Munro 1983,


In my view, however, equally important and probably even more important was the

financial revolution that had begun in or by the 1520s with legal sanctions for

and then legislation on full negotiability, and the contemporary establishment

of effective secondary markets (especially the Antwerp Bourse) in fully

negotiable bills and rentes, i.e., heritable government annuities; and the

latter owed their universal and growing popularity, compared with other forms

of public debt, to papal bulls (1425,

1455) that had exonerated them from any taint of usury. To give just one

example of a veritable explosion in this form of public credit (which thus

reduced the relative demand for gold and silver coins), an issue that Fischer

almost completely ignores: the annual volume of transactions in Spanish

heritable juros rose from 5 million ducats (of 375 maravedis) in 1515 to 83

million ducats in the 1590s (Vander Wee 1977). Thus we need not call upon

Spanish-American bullion imp orts to explain the monetary origins of the

European Price Revolution, though their importance in aggravating and

accelerating the extent of inflation from the 1550s need hardly be questioned,

especially, as Frank Spooner (1972) has so aptly demonstrated,

even anticipated arrivals of Spanish treasure fleets would induce German and

Genoese bankers to expand credit issues by some multiples of the perceived

bullion values. Fischer, by the way, comments (p. 82) that: “the largest

proportionate increases in Spanish prices occurred during the first half of

the sixteenth century — not the second half, when American treasure had its

greatest impact.” This is simply untrue: from 1500-49, the Spanish composite

price index rose 78.5%; from 1550-99, it rose by another 92.1% (Hamilton


Changes in money stocks or other monetary variables do not, however,

provide the complete explanation for the actual extent of inflation in this or

in any other era. Even if every inflationary price trend that I have

investigate d, from the 12th to 20th centuries, has been preceded or

accompanied by some form of monetary expansion, in none was the degree of

inflation directly proportional to the observed rate of monetary expansion,

with the possible exception of the post World War I hyperinflations.

Consider this proposition in terms of the oft-maligned, conceptually limited,

but still heuristically useful monetary equation MV = Py [in which real y = Y/P

= C + I + G+ (X-M)]; or, better, in terms of the Cambridge “real cash

balances” approach: M = kPy [in which k = the proportion of real NNI (Py) that

the public chooses to hold in real cash balances, reflecting the constituent

elements of Keynesian liquidity preference]. Some Keynesian economists would

contend that an increase in M, or in the rate of growth of money stocks, would

be accompanied by some

offsetting rise in y (i.e. real NNI), whether exogenously created or

endogenously induced by related forces of monetary expansion, and also by some

decline in the income velocity of money, with a reduced need to economize on

the use of money. Since mathematically V = 1/k, they would similarly posit

that an expansion in M,

or its rate of growth, would have led, ceteris paribus — without any change in

liquidity preference, to a fall

in (nominal) interest rates, and thus, by the consequent reduction in the

opportunity costs of holding cash balances, to the necessarily corresponding

rise in k (i.e., an increase in the demand for real cash balances; see Keynes

1936, pp. 306-07). Sometimes, but only very rarely, have changes in these two

latter variables y and V (1/k) fully offset an increase in M; and thus such

increases in money stocks have also resulted, in most historical instances, in

some non-proportional degree of inflation: a rising P, as measured by some

suitable price index, such as the Phelps Brown and Hopkins

basket-of-consumables. [Other economists,

it must be noted, would contend that, in any event, the traditional Keynesian

model is really not applicable to such long-term

phenomena as Fischer’s price-revolutions.

Keynes himself, in considering “how changes in the quantity of money affect

prices… in the long run,” said, in the General Theory (1936, p. 306):

“This is a question for historical generalisation rather than for

pure theory.”]

For the 16th-century Price Revolution, therefore, the interesting question now

becomes: not why did it occur so early (i.e., before significant influxes of

Spanish American bullion); but rather why so late — so many decades after the

onset of the Central European silver-copper mining boom?

Since that boom had commenced in the 1460s, precisely when late-medieval

Europe’s population was at its nadir, perhaps 50% below the 1300 peak, and just

after the Hundred Years’ War had ended, and just

after the complex network of overland continental trade routes between Italy

and NW Europe had been successfully restored, one might contend that in such an

economy with so much “slack” in under-utilized resources, especially land, and

with elastic supplies for so many commodities, both the monetary expansion and

economic recovery of the later 15th century , preceding any dramatic

demographic recovery, permitted an increase in y proportional to the growth of

M, without the onset of diminishing returns an d without significant inflation,

before the 1520s By that decade, however, the monetary expansion had become

all the more powerful: with the peak of the Central European silver-mining

boom and with the rapid increase in the use of negotiable, transferable

credit instruments; and, furthermore, with the Ottoman conquest of the Mamluk

Sultanate (1517), which evidently diverted some considerable amounts of

Venetian silver exports from the Levant to the Antwerp market.

The role of the income-velocity of money

is far more problematic. According to Keynesian expectations, velocity should

have fallen with such increases in money stocks. Yet three eminent economic

historians — Harry Miskimin

(1975), Jack Goldstone (1984), and Peter Lindert (1985) — have sought

to explain England’s16th-century Price Revolution by a very contrary thesis:

of increased money flows (or reductions in k) that were induced by demographic

and structural economic changes, involving interalia(according to their

various models) disproportionate changes in urbanization, greater

commercialization of the rural sectors, far more complex commercial and

financial networks, changes in dependency ratios, etc. The specific

circumstances so portrayed, however, apart from the demographic, are largely

peculiar to 16th- century England and thus do not so convincingly explain the

very similar patterns of inflation in the 16th-century Low Countries, which had

undergone most of these structural economic changes far earlier. Certainly

these velocity model s cannot logically be applied to Fischer’s three other

inflationary long-waves. Indeed, in an article implicitly validating Keynesian

views, Nicholas Mayhew (1995) has contended that the income-velocity of money

has always fallen with an expansion in money stocks, from the medieval to

modern eras, with this one anomalous exception of the 16th-century Price

Revolution. Perhaps, for this one era,

we have misspecified V (or k) by misspecifiying M: i.e., by not properly

including increased issues of negotiable credit; or perhaps institutional

changes in credit (as Goldstone and Miskimin both suggest) did have as dramatic

an effect on V as on M. Furthermore, an equally radical change in the coined

money supply (certainly in England), from one that had been principally gold

to one which, precisely from the 1520s, became largely and then almost entirely

silver, may provide the solution to the velocity paradox: in that the

transactions velocity attached to small value silver coins, of 1d., is

obviously far higher

velocity than that for gold coins valued at 80d and 120d. Except for a brief

reference to Mayhew’s article in the lengthy bibliography, Fischer virtually

ignores such velocity issues

(and thus changes in the demand for real cash balances) throughout his

eight-century survey of secular price trends.

Finally, Fischer’s thesis that population growth was responsible for this the

most famous Price Revolution (and all other inflationary long waves) is hardly

credible, especially if he insists on dating its inception the 1470s. For most

economic historians (Vander Wee 1963; Blanchard 1970;

Hatcher 1977, 1986; Campbell 1981; Harvey 1993) contend that, in NW Europe,

late-medieval demographic decline continued into the early 16th-century;

and that England’s population in 1520 was no more than 2.25 million,

compared to estimates ranging from a minimum of 4.0 to a maximum of 6.0 or even

7.0 million around 1300, the upper bounds being favored by most historians. How

– even if the demographic model were to be theoretically acceptable — could

a modest population growth from such a very low level in the 1520s, reaching

perhaps 2.83 million in 1541, and peaking at 5.39 million in 1656, have been

the fundamental cause of persistent, European wide-inflation, already underway

in the 1520s?

According to Fischer, the ensuing, intervening price-equilibrium

(c.1650-c.1730) involved no discernible monetary contraction, and similarly,

his next inflationary long-wave (c.1730-1815) began well before any monetary

expansion became — in his view — manifestly evident. The monetary and price

data, suggest otherwise, however, incomplete though they may be. Thus, the data

complied by Bakewell, Cross, TePaske, and many others on silver mining at

Potosi (Peru) and Zacatecas (Mexico) indicate that their combined outputs fell

from a mean of 178,692 kg in 1636-40 to one of 101,534 kg in 1661-5, rising to

a mean of 156,497 kg in 1681-5

[partially corresponding to guesstimates of European bullion imports, which

Morineau (1985) extracted fr om Dutch gazettes]; but then sharply falling once

more, and even further, to a more meager mean of 95,842 kg in 1696-1700. During

this same era, the Viceroyalty of Peru’s domestically-

retained share of silver-based public revenues rose from 54% to 96%

(T ePaske 1981); the combined silver exports of the Dutch and English East

India Companies to Asia (Chaudhuri 1968; Gaastra 1983) increased from a

decennial mean of 17,293 kg in 1660-69 to 73,687 kg in 1700-09, while English

mint outputs in terms of fine sil ver (Challis 1992) fell from a mean of 19,400

kg in 1660-64 (but 23,781 kg in 1675-79) to one of just 430.4 kg in 1690-94,

i.e., preceding the Great Recoinage of 1696-98. From the early 18th century,

however, European silver exports to Asia were well more

than offset by a dramatic rise in Spanish-American, and especially Mexican

silver production: for the latter (with evidence from new or previously

unrecorded mines: assembled by Bakewell 1975, 1984; Garner 1980,

1987; Coatsworth 1986, and others), aggregate production more than doubled

from a mean of 129,878 kg in 1700-04 to one of 305,861 kg in 1745-49.

Possibly even more important, especially with England’s currency shift from a

silver to a gold standard, was a veritable explosion in aggregate

Latin-American gold production: from a decennial mean of just 863.90 kg in


zooming to 16,917.4 kg in 1741-50 (TePaske 1998). Within Europe itself, as

Blanchard (1989) has demonstrated, Russian silver mining outputs, ultimately

responsible for perhaps 7%

of Europe’s total stocks,

rose from virtually nothing in the late 1720s to peak at 33,000 kg per annum in

the late 1770s, falling to 18,000 kg in the early 1790s then rising to 21,000

kg per year in the later 1790s.

Finally, even though changes in annual mint outputs are not valid indicators

of changes in coined money supplies, let alone of changes in M1,

the fifty-year means of aggregate values of English mint outputs (silver and

gold: Challis 1992) do provide interesting signals of longer-term monetary

changes: a fall from an annual mean of 348,829 pounds in 1596-1645 to one of

275,403 pounds in 1646-95, followed by a rise, with more than a full recovery,

to an annual mean of 369,644 pounds in 1700-49 (thus excluding the Great

Recoinage of 1696-98). Meanwhile, if the earlier Price Revolution had indeed

peaked in 1645-49, with the quinquennial mean PB&H index at 680, falling to a

nadir of 579 in 1690-94, the fluctuations in the first half of the 18th-century

do not demonstrate any clear inflationary trend, with the mean PB&H index

(briefly peaking at 635 in 1725-9) stalled at virtually the same former level,

581, in 1745-49. Thereafter, of course,

for the second half of the 18th century, the trend is very strongly and

incessantly upward, with almost a

doubling in PB&H index, to 1093 in 1795-9.

Whatever one may wish to deduce from all these diverse data sets, we are

certainly not permitted to conclude, as does Fischer, that inflation preceded

monetary expansion, and did so consistently. Such a view becomes all the more

untenable when the radical changes in English and banking and credit

institutions, following the establishment of the Bank of England in 1694-97,

are taken into account: the consequent introduction and rapid expansion in

legal-tender paper bank note issues (with prior informal issues by London’s

Goldsmith banks), and more especially fully negotiable,

transferable, and discountable Exchequer bills, government annuities,

inland bills and promissory notes, whose veritable explosion in circulation

from the 1760s, with the proliferation of English country-banks, hardly

requires any further elaboration, even if these issues are given short shrift

in Fischer’s book. In view of such complex changes in Britain’s financial and

monetary structures,

subsequent data on coinage outputs have even more limited utility in

estimating money stocks. But we may note that aggregate mined outputs of

Mexican silver more than doubled, from a quinquennial mean of 305,861 kg in

1745-49 to 619,495 kg in 1795-99, while those of Peru more than tripled, from

34,318 kg in 1735-39 (no data for the 1740s) to 126,354 kg in 1795-99 (Garner

1980, 1987; Bakewell 1975, 1984; J.

Fisher, 1975).

Having earlier considered the so-called and misconstrued

“price-equilibrium” of 182 0-1896, let us now finally examine the inception of

the fourth and final long-wave commencing in 1896. Fischer again contends that

population growth was the “prime mover,” despite the fact that Britain’s own

intrinsic growth rate had been falling from its

1821 peak [from 1.75 to 1.31 in 1865, the last year given in Wrigley-Davies-

Oppen-Schofield (1997)]. For evidence he cites an assertion in Colin McEvedy

and Richard Jones, Atlas of World Population History (1978) to the effect that

world population, having increased by 35% from 1850 to 1900,

increased a further 53% by 1950. Are we therefore to believe that such growth

was itself responsible for a 45.2% rise in, for this era, the better structured

Rousseaux price-index [base 100 = (1865cp +1885cp)/2]: from 73 in 1896 to 106

[while the PB&H index rose from 947 in 1896 to 1021 in 1913]?

As for the role of monetary factors in the commencement of this fourth long

wave, Fischer observes (p. 184) that “the rate of growth in gold production

throughout the world was roughly the same before and after 1896.” This

undocumented assertion, about an international economy whose commerce and

finance was now based upon the gold standard, is not quite accurate.

According to assiduously calculated estimates in Eichengreen

and McLean

(1994), decennial mean world gold outputs, having fallen from 185,900 kg in

1850-9 to 135,000 kg in 1880-9 (largely accompanying the aforementioned 44%

fall in the Rousseaux composite index from 128 in 1872 to 72 in 1895),

thereafter soared to

a mean of 255,600 kg in 1890-9 — their graph of annualized data shows that

the bulk of this increased output occurred after 1896 — virtually doubling to

an annual mean of 513,900 kg in 1900-14.

World War I, of course, effectively ended the international gold-standard era,

since the Gold- Exchange Standard of 1925-6 was rather different from the older

system; and the post-war era ushered in a radically new monetary world of fiat

paper currencies, whose initial horrendous manifestation came in the hyper

inflations of Weimar Germany, Russia, and most Central European countries, in

the early 1920s. For this post-war economy, Fischer does admit that monetary

factors often had some considerable importance in influencing price trends; but

his analyses, even of the post-war radical, paper-fuelled hyperinflations, are

not likely to satisfy most economists, either for the inter-war or Post World

War II eras, up to the present day.

This review, long as it is, cannot possibly do full justice to an eight-century

study of this scope and magnitude. So far I have neglected to consider his

often fascinating analyses of the social consequences of inflation over these

many centuries, except for brief allusions in the introduction, where I

indicated his deeply hostile views to persistent inflation for its inevitably

insidious consequences: the impoverishment of the masses, growing malnutrition,

the spread of killer-diseases, increased crime and violence in general, and a

breakdown of the social order, etc.

While some of

the evidence for the latter seems plausible, I do have some concluding quarrels

with his use of real wage indices. Much of our available nominal money-wage

evidence comes from institutional sources on daily wages, which, by their very

nature, tend to be fixed over long periods of time [as Adam Smith noted in the

Wealth of Nations (Cannan ed.

1937, p. 74), “sometimes for half a century together”). Therefore, for such

wage series, real wages rose and fell with the consumer price index, as

measured by, for example, our Phelps Brown and Hopkins basket-of-consumables

index. Its chief problem (as opposed to the better constructed Vander Wee

index for Brabant) is that its components, for long periods, constitute fixed

percentages of the total composite index,

irrespective of changes in relative prices for, say, grains; and they thus do

not reflect the consumers’ ability to make cost-saving substitutions.

Secondly, they are necessarily based on daily wage rates, without any

indication of total annual money incomes; thirdly, the great majority of

money-wage earners in pre-modern Europe earned not day rates but piece-work

wages, for which evidence is extremely scant.

But more important, before the 18th century (or even later), a majority of the

European population did not live by money wages; and most wage-earners had

supplementary forms of income, especially agricultural, that helped insulate

them to some degree from sharp rises in food prices. If rising food prices hurt

many wage-earners, they also benefited ma ny peasants,

especially those with customary tenures and fixed rentals who could thereby

capture some of the economic rent accruing on their lands with such price

increases. It may be simplistic to note that there are always gainers and

losers with both inflation and deflation — but even more simplistic to focus

only on the latter in times of inflation, and especially simplistic to focus on

a real wage index based on the PB&H index. And if deflation is so beneficial

for the masses, why, during the deflationary period in later 17th and early

18th century England, do we find, along with a rise in this real-wage index, a

rise in the death rate from 23.68/1000 in 1626 to 32.14/1000 in 1681,

thereafter falling slightly but rising again to an ultimate peak of

37.00/1000 in 1725 (admittedly an era of anomalous disease-related

mortalities), when the PB&H real-wage index stood at 60 —

some 24% higher than the RWI of 36 for 1626? One of the many imponderables yet

to be considered, though one might ponder that sometimes high real wages

reflect labor shortages from dire conditions, rather than general prosperity

and more equitable wealth and income distributions, as Fischer suggests.

Finally, Fischer’s argument that inflationary price-revolutions were always

especially harmful to the lower classes by leading to rising interest rates is

sometimes but not universally true, even if rational creditors should have

raised rates to protect themselves from inflation. Thus, for the Antwerp money

market in the 16th century,

the meticulous evidence compiled by Vander Wee (1964, 1977) shows that

nominal interest rates fell over this entire period [from 20% in 1515 to 9% in

1549 to 5% in 1561; and on the riskier short term loans to the Habsburg

government, from a mean of 19.5

% in 1506-10 to one of 12.3% in 1541-45 to 9.63% in 1561-55]. In the next

price-revolution, during the later 18th century, nominal interest rates did

rise during periods of costly warfare, i.e., with an increasing risk premium;

but real interest rates actually fell because of the increasing tempo of

inflation (Turner 1984), more so than did real wages for most industrial



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provided in the original publication.

Frank Spooner, The International Economy and Monetary Movements in France,

1493-1725 (Cambridge, Mass., 1972)

John TePaske, “New World Silver, Castile, and the Philippines, 1590-1800 A.D.,”

in John F. Richards, ed., Precious Metals in the Medieval and Early Modern

Worlds (Durham, N.C.

, 1983), pp. 424-446.

John TePaske, “New World Gold Production in Hemispheric and Global Perspective,

1492 – 1810,” in Clara Nunez, ed., Monetary History in Global Perspective, 1500

- 1808, Papers presented to Session B-6 of the Twelfth International Eco nomic

History Congress (Seville, 1998), pp. 21-32.

Michael Turner, Enclosures in Britain, 1750 – 1830, Studies in Economic History

Series (London, 1984).

Herman Vander Wee, Growth of the Antwerp Market and the European Economy,

14th to 16th Centuries,

3 Vols. (The Hague, 1963). Vol. I: Statistics; Vol.

II: Interpretation, 374-427; and Vol. III: Graphs.

Herman Vander Wee, “Monetary, Credit, and Banking Systems,” in E.E. Rich and

Charles Wilson, eds., The Cambridge Economic History of Europe, Vol. V:

T he Economic Organization of Early Modern Europe(Cambridge, 1977), chapter V,

pp. 290-393.

Herman Vander Wee, “Prijzen en lonen als ontwikkelingsvariabelen: Een

vergelijkend onderzoek tussen Engeland en de Zuidelijke Nederlanden,

1400-1700,” in Album aan geboden aan Charles Verlinden ter gelegenheid van zijn

dertig jaar professoraat (Gent, 1975), pp. 413-47; reissued in English

translation (without the tables) as “Prices and Wages as Development Variables:

A Comparison Between England and the Southern Net herlands,

1400-1700,” Acta Historiae Neerlandicae, 10 (1978), 58-78.

Ivor Wilks, “Wangara, Akan, and the Portuguese in the Fifteenth and Sixteenth

Centuries,” in Ivor Wilks, ed., Forests of Gold: Essays on the Akan and the

Kingdom of Asante (Athens, Ohio

, 1993), pp. 1-39.

E.A. Wrigley, R.S. Davies, J.E. Oeppen, and R.S. Schofield, English Population

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Cambridge University Press, 1997).

Subject(s):Macroeconomics and Fluctuations
Geographic Area(s):General, International, or Comparative
Time Period(s):General or Comparative