Howard Bodenhorn, Lafayette College

The first legitimate commercial bank in the United States was the Bank of North America founded in 1781. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the bank, which loaned to the cash-strapped Revolutionary government as well as private citizens, mostly Philadelphia merchants. The possibilities of commercial banking had been widely recognized by many colonists, but British law forbade the establishment of commercial, limited-liability banks in the colonies. Given that many of the colonists’ grievances against Parliament centered on economic and monetary issues, it is not surprising that one of the earliest acts of the Continental Congress was the establishment of a bank.

The introduction of banking to the U.S. was viewed as an important first step in forming an independent nation because banks supplied a medium of exchange (banknotes¹ and deposits) in an economy perpetually strangled by shortages of specie money and credit, because they animated industry, and because they fostered wealth creation and promoted well-being. In the last case, contemporaries typically viewed banks as an integral part of a wider system of government-sponsored commercial infrastructure. Like schools, bridges, road, canals, river clearing and harbor improvements, the benefits of banks were expected to accrue to everyone even if dividends accrued only to shareholders.

Financial Sector Growth

By 1800 each major U.S. port city had at least one commercial bank serving the local mercantile community. As city banks proved themselves, banking spread into smaller cities and towns and expanded their clientele. Although most banks specialized in mercantile lending, others served artisans and farmers. In 1820 there were 327 commercial banks and several mutual savings banks that promoted thrift among the poor. Thus, at the onset of the antebellum period (defined here as the period between 1820 and 1860), urban residents were familiar with the intermediary function of banks and used bank-supplied currencies (deposits and banknotes) for most transactions. Table 1 reports the number of banks and the value of loans outstanding at year end between 1820 and 1860. During the era, the number of banks increased from 327 to 1,562 and total loans increased from just over $55.1 million to $691.9 million. Bank-supplied credit in the U.S. economy increased at a remarkable annual average rate of 6.3 percent. Growth in the financial sector, then outpaced growth in aggregate economic activity. Nominal gross domestic product increased an average annual rate of about 4.3 percent over the same interval. This essay discusses how regional regulatory structures evolved as the banking sector grew and radiated out from northeastern cities to the hinterlands.

Table 1

Number of Banks and Total Loans, 1820-1860

Sources: Fenstermaker (1965); U.S. Comptroller of the Currency (1931).

Adaptability

As important as early American banks were in the process of capital accumulation, perhaps their most notable feature was their adaptability. Kuznets (1958) argues that one measure of the financial sector’s value is how and to what extent it evolves with changing economic conditions. Put in place to perform certain functions under one set of economic circumstances, how did it alter its behavior and service the needs of borrowers as circumstances changed. One benefit of the federalist U.S. political system was that states were given the freedom to establish systems reflecting local needs and preferences. While the political structure deserves credit in promoting regional adaptations, North (1994) credits the adaptability of America’s formal rules and informal constraints that rewarded adventurism in the economic, as well as the noneconomic, sphere. Differences in geography, climate, crop mix, manufacturing activity, population density and a host of other variables were reflected in different state banking systems. Rhode Island’s banks bore little resemblance to those in far away Louisiana or Missouri, or even those in neighboring Connecticut. Each state’s banks took a different form, but their purpose was the same; namely, to provide the state’s citizens with monetary and intermediary services and to promote the general economic welfare. This section provides a sketch of regional differences. A more detailed discussion can be found in Bodenhorn (2002).

State Banking in New England

New England’s banks most resemble the common conception of the antebellum bank. They were relatively small, unit banks; their stock was closely held; they granted loans to local farmers, merchants and artisans with whom the bank’s managers had more than a passing familiarity; and the state took little direct interest in their daily operations.

Of the banking systems put in place in the antebellum era, New England’s is typically viewed as the most stable and conservative. Friedman and Schwartz (1986) attribute their stability to an Old World concern with business reputations, familial ties, and personal legacies. New England was long settled, its society well established, and its business community mature and respected throughout the Atlantic trading network. Wealthy businessmen and bankers with strong ties to the community — like the Browns of Providence or the Bowdoins of Boston — emphasized stability not just because doing so benefited and reflected well on them, but because they realized that bad banking was bad for everyone’s business.

Besides their reputation for soundness, the two defining characteristics of New England’s early banks were their insider nature and their small size. The typical New England bank was small compared to banks in other regions. Table 2 shows that in 1820 the average Massachusetts country bank was about the same size as a Pennsylvania country bank, but both were only about half the size of a Virginia bank. A Rhode Island bank was about one-third the size of a Massachusetts or Pennsylvania bank and a mere one-sixth as large as Virginia’s banks. By 1850 the average Massachusetts bank declined relatively, operating on about two-thirds the paid-in capital of a Pennsylvania country bank. Rhode Island’s banks also shrank relative to Pennsylvania’s and were tiny compared to the large branch banks in the South and West.

Table 2

Average Bank Size by Capital and Lending in 1820 and 1850 Selected States and Cities

(in $ thousands)

Notes: ¹ Virginia figures for 1822. ² Figures represent branch averages.

Source: Bodenhorn (2002).

Explanations for New England Banks’ Relatively Small Size

Several explanations have been offered for the relatively small size of New England’s banks. Contemporaries attributed it to the New England states’ propensity to tax bank capital, which was thought to work to the detriment of large banks. They argued that large banks circulated fewer banknotes per dollar of capital. The result was a progressive tax that fell disproportionately on large banks. Data compiled from Massachusetts’s bank reports suggest that large banks were not disadvantaged by the capital tax. It was a fact, as contemporaries believed, that large banks paid higher taxes per dollar of circulating banknotes, but a potentially better benchmark is the tax to loan ratio because large banks made more use of deposits than small banks. The tax to loan ratio was remarkably constant across both bank size and time, averaging just 0.6 percent between 1834 and 1855. Moreover, there is evidence of constant to modestly increasing returns to scale in New England banking. Large banks were generally at least as profitable as small banks in all years between 1834 and 1860, and slightly more so in many.

Lamoreaux (1993) offers a different explanation for the modest size of the region’s banks. New England’s banks, she argues, were not impersonal financial intermediaries. Rather, they acted as the financial arms of extended kinship trading networks. Throughout the antebellum era banks catered to insiders: directors, officers, shareholders, or business partners and kin of directors, officers, shareholders and business partners. Such preferences toward insiders represented the perpetuation of the eighteenth-century custom of pooling capital to finance family enterprises. In the nineteenth century the practice continued under corporate auspices. The corporate form, in fact, facilitated raising capital in greater amounts than the family unit could raise on its own. But because the banks kept their loans within a relatively small circle of business connections, it was not until the late nineteenth century that bank size increased.²

Once the kinship orientation of the region’s banks was established it perpetuated itself. When outsiders could not obtain loans from existing insider organizations, they formed their own insider bank. In doing so the promoters assured themselves of a steady supply of credit and created engines of economic mobility for kinship networks formerly closed off from many sources of credit. State legislatures accommodated the practice through their liberal chartering policies. By 1860, Rhode Island had 91 banks, Maine had 68, New Hampshire 51, Vermont 44, Connecticut 74 and Massachusetts 178.

The Suffolk System

One of the most commented on characteristic of New England’s banking system was its unique regional banknote redemption and clearing mechanism. Established by the Suffolk Bank of Boston in the early 1820s, the system became known as the Suffolk System. With so many banks in New England, each issuing it own form of currency, it was sometimes difficult for merchants, farmers, artisans, and even other bankers, to discriminate between real and bogus banknotes, or to discriminate between good and bad bankers. Moreover, the rural-urban terms of trade pulled most banknotes toward the region’s port cities. Because country merchants and farmers were typically indebted to city merchants, country banknotes tended to flow toward the cities, Boston more so than any other. By the second decade of the nineteenth century, country banknotes became a constant irritant for city bankers. City bankers believed that country issues displaced Boston banknotes in local transactions. More irritating though was the constant demand by the city banks’ customers to accept country banknotes on deposit, which placed the burden of interbank clearing on the city banks.³

In 1803 the city banks embarked on a first attempt to deal with country banknotes. They joined together, bought up a large quantity of country banknotes, and returned them to the country banks for redemption into specie. This effort to reduce country banknote circulation encountered so many obstacles that it was quickly abandoned. Several other schemes were hatched in the next two decades, but none proved any more successful than the 1803 plan.

The Suffolk Bank was chartered in 1818 and within a year embarked on a novel scheme to deal with the influx of country banknotes. The Suffolk sponsored a consortium of Boston bank in which each member appointed the Suffolk as its lone agent in the collection and redemption of country banknotes. In addition, each city bank contributed to a fund used to purchase and redeem country banknotes. When the Suffolk collected a large quantity of a country bank’s notes, it presented them for immediate redemption with an ultimatum: Join in a regular and organized redemption system or be subject to further unannounced redemption calls.⁴ Country banks objected to the Suffolk’s proposal, because it required them to keep noninterest-earning assets on deposit with the Suffolk in amounts equal to their average weekly redemptions at the city banks. Most country banks initially refused to join the redemption network, but after the Suffolk made good on a few redemption threats, the system achieved near universal membership.

Early interpretations of the Suffolk system, like those of Redlich (1949) and Hammond (1957), portray the Suffolk as a proto-central bank, which acted as a restraining influence that exercised some control over the region’s banking system and money supply. Recent studies are less quick to pronounce the Suffolk a successful experiment in early central banking. Mullineaux (1987) argues that the Suffolk’s redemption system was actually self-defeating. Instead of making country banknotes less desirable in Boston, the fact that they became readily redeemable there made them perfect substitutes for banknotes issued by Boston’s prestigious banks. This policy made country banknotes more desirable, which made it more, not less, difficult for Boston’s banks to keep their own notes in circulation.

Fenstermaker and Filer (1986) also contest the long-held view that the Suffolk exercised control over the region’s money supply (banknotes and deposits). Indeed, the Suffolk’s system was self-defeating in this regard as well. By increasing confidence in the value of a randomly encountered banknote, people were willing to hold increases in banknotes issues. In an interesting twist on the traditional interpretation, a possible outcome of the Suffolk system is that New England may have grown increasingly financial backward as a direct result of the region’s unique clearing system. Because banknotes were viewed as relatively safe and easily redeemed, the next big financial innovation — deposit banking — in New England lagged far behind other regions. With such wide acceptance of banknotes, there was no reason for banks to encourage the use of deposits and little reason for consumers to switch over.

Summary: New England Banks

New England’s banking system can be summarized as follows: Small unit banks predominated; many banks catered to small groups of capitalists bound by personal and familial ties; banking was becoming increasingly interconnected with other lines of business, such as insurance, shipping and manufacturing; the state took little direct interest in the daily operations of the banks and its supervisory role amounted to little more than a demand that every bank submit an unaudited balance sheet at year’s end; and that the Suffolk developed an interbank clearing system that facilitated the use of banknotes throughout the region, but had little effective control over the region’s money supply.

Banking in the Middle Atlantic Region

Pennsylvania

After 1810 or so, many bank charters were granted in New England, but not because of the presumption that the bank would promote the commonweal. Charters were granted for the personal gain of the promoter and the shareholders and in proportion to the personal, political and economic influence of the bank’s founders. No New England state took a significant financial stake in its banks. In both respects, New England differed markedly from states in other regions. From the beginning of state-chartered commercial banking in Pennsylvania, the state took a direct interest in the operations and profits of its banks. The Bank of North America was the obvious case: chartered to provide support to the colonial belligerents and the fledgling nation. Because the bank was popularly perceived to be dominated by Philadelphia’s Federalist merchants, who rarely loaned to outsiders, support for the bank waned.⁵ After a pitched political battle in which the Bank of North America’s charter was revoked and reinstated, the legislature chartered the Bank of Pennsylvania in 1793. As its name implies, this bank became the financial arm of the state. Pennsylvania subscribed $1 million of the bank’s capital, giving it the right to appoint six of thirteen directors and a $500,000 line of credit. The bank benefited by becoming the state’s fiscal agent, which guaranteed a constant inflow of deposits from regular treasury operations as well as western land sales.

By 1803 the demand for loans outstripped the existing banks’ supply and a plan for a new bank, the Philadelphia Bank, was hatched and its promoters petitioned the legislature for a charter. The existing banks lobbied against the charter, and nearly sank the new bank’s chances until it established a precedent that lasted throughout the antebellum era. Its promoters bribed the legislature with a payment of $135,000 in return for the charter, handed over one-sixth of its shares, and opened a line of credit for the state.

Between 1803 and 1814, the only other bank chartered in Pennsylvania was the Farmers and Mechanics Bank of Philadelphia, which established a second substantive precedent that persisted throughout the era. Existing banks followed a strict real-bills lending policy, restricting lending to merchants at very short terms of 30 to 90 days.⁶ Their adherence to a real-bills philosophy left a growing community of artisans, manufacturers and farmers on the outside looking in. The Farmers and Mechanics Bank was chartered to serve excluded groups. At least seven of its thirteen directors had to be farmers, artisans or manufacturers and the bank was required to lend the equivalent of 10 percent of its capital to farmers on mortgage for at least one year. In later years, banks were established to provide services to even more narrowly defined groups. Within a decade or two, most substantial port cities had banks with names like Merchants Bank, Planters Bank, Farmers Bank, and Mechanics Bank. By 1860 it was common to find banks with names like Leather Manufacturers Bank, Grocers Bank, Drovers Bank, and Importers Bank. Indeed, the Emigrant Savings Bank in New York City served Irish immigrants almost exclusively. In the other instances, it is not known how much of a bank’s lending was directed toward the occupational group included in its name. The adoption of such names may have been marketing ploys as much as mission statements. Only further research will reveal the answer.

New York

State-chartered banking in New York arrived less auspiciously than it had in Philadelphia or Boston. The Bank of New York opened in 1784, but operated without a charter and in open violation of state law until 1791 when the legislature finally sanctioned it. The city’s second bank obtained its charter surreptitiously. Alexander Hamilton was one of the driving forces behind the Bank of New York, and his long-time nemesis, Aaron Burr, was determined to establish a competing bank. Unable to get a charter from a Federalist legislature, Burr and his colleagues petitioned to incorporate a company to supply fresh water to the inhabitants of Manhattan Island. Burr tucked a clause into the charter of the Manhattan Company (the predecessor to today’s Chase Manhattan Bank) granting the water company the right to employ any excess capital in financial transactions. Once chartered, the company’s directors announced that $500,000 of its capital would be invested in banking.⁷ Thereafter, banking grew more quickly in New York than in Philadelphia, so that by 1812 New York had seven banks compared to the three operating in Philadelphia.

Deposit Insurance

Despite its inauspicious banking beginnings, New York introduced two innovations that influenced American banking down to the present. The Safety Fund system, introduced in 1829, was the nation’s first experiment in bank liability insurance (similar to that provided by the Federal Deposit Insurance Corporation today). The 1829 act authorized the appointment of bank regulators charged with regular inspections of member banks. An equally novel aspect was that it established an insurance fund insuring holders of banknotes and deposits against loss from bank failure. Ultimately, the insurance fund was insufficient to protect all bank creditors from loss during the panic of 1837 when eleven failures in rapid succession all but bankrupted the insurance fund, which delayed noteholder and depositor recoveries for months, even years. Even though the Safety Fund failed to provide its promised protections, it was an important episode in the subsequent evolution of American banking. Several Midwestern states instituted deposit insurance in the early twentieth century, and the federal government adopted it after the banking panics in the 1930s resulted in the failure of thousands of banks in which millions of depositors lost money.

“Free Banking”

Although the Safety Fund was nearly bankrupted in the late 1830s, it continued to insure a number of banks up to the mid 1860s when it was finally closed. No new banks joined the Safety Fund system after 1838 with the introduction of free banking — New York’s second significant banking innovation. Free banking represented a compromise between those most concerned with the underlying safety and stability of the currency and those most concerned with competition and freeing the country’s entrepreneurs from unduly harsh and anticompetitive restraints. Under free banking, a prospective banker could start a bank anywhere he saw fit, provided he met a few regulatory requirements. Each free bank’s capital was invested in state or federal bonds that were turned over to the state’s treasurer. If a bank failed to redeem even a single note into specie, the treasurer initiated bankruptcy proceedings and banknote holders were reimbursed from the sale of the bonds.

Actually Michigan preempted New York’s claim to be the first free-banking state, but Michigan’s 1837 law was modeled closely after a bill then under debate in New York’s legislature. Ultimately, New York’s influence was profound in this as well, because free banking became one of the century’s most widely copied financial innovations. By 1860 eighteen states adopted free banking laws closely resembling New York’s law. Three other states introduced watered-down variants. Eventually, the post-Civil War system of national banking adopted many of the substantive provisions of New York’s 1838 act.

Both the Safety Fund system and free banking were attempts to protect society from losses resulting from bank failures and to entice people to hold financial assets. Banks and bank-supplied currency were novel developments in the hinterlands in the early nineteenth century and many rural inhabitants were skeptical about the value of small pieces of paper. They were more familiar with gold and silver. Getting them to exchange one for the other was a slow process, and one that relied heavily on trust. But trust was built slowly and destroyed quickly. The failure of a single bank could, in a week, destroy the confidence in a system built up over a decade. New York’s experiments were designed to mitigate, if not eliminate, the negative consequences of bank failures. New York’s Safety Fund, then, differed in the details but not in intent, from New England’s Suffolk system. Bankers and legislators in each region grappled with the difficult issue of protecting a fragile but vital sector of the economy. Each region responded to the problem differently. The South and West settled on yet another solution.

Banking in the South and West

One distinguishing characteristic of southern and western banks was their extensive branch networks. Pennsylvania provided for branch banking in the early nineteenth century and two banks jointly opened about ten branches. In both instances, however, the branches became a net liability. The Philadelphia Bank opened four branches in 1809 and by 1811 was forced to pass on its semi-annual dividends because losses at the branches offset profits at the Philadelphia office. At bottom, branch losses resulted from a combination of ineffective central office oversight and unrealistic expectations about the scale and scope of hinterland lending. Philadelphia’s bank directors instructed branch managers to invest in high-grade commercial paper or real bills. Rural banks found a limited number of such lending opportunities and quickly turned to mortgage-based lending. Many of these loans fell into arrears and were ultimately written when land sales faltered.

Branch Banking

Unlike Pennsylvania, where branch banking failed, branch banks throughout the South and West thrived. The Bank of Virginia, founded in 1804, was the first state-chartered branch bank and up to the Civil War branch banks served the state’s financial needs. Several small, independent banks were chartered in the 1850s, but they never threatened the dominance of Virginia’s “Big Six” banks. Virginia’s branch banks, unlike Pennsylvania’s, were profitable. In 1821, for example, the net return to capital at the Farmers Bank of Virginia’s home office in Richmond was 5.4 percent. Returns at its branches ranged from a low of 3 percent at Norfolk (which was consistently the low-profit branch) to 9 percent in Winchester. In 1835, the last year the bank reported separate branch statistics, net returns to capital at the Farmers Bank’s branches ranged from 2.9 and 11.7 percent, with an average of 7.9 percent.

The low profits at the Norfolk branch represent a net subsidy from the state’s banking sector to the political system, which was not immune to the same kind of infrastructure boosterism that erupted in New York, Pennsylvania, Maryland and elsewhere. In the immediate post-Revolutionary era, the value of exports shipped from Virginia’s ports (Norfolk and Alexandria) slightly exceeded the value shipped from Baltimore. In the 1790s the numbers turned sharply in Baltimore’s favor and Virginia entered the internal-improvements craze and the battle for western shipments. Banks represented the first phase of the state’s internal improvements plan in that many believed that Baltimore’s new-found advantage resulted from easier credit supplied by the city’s banks. If Norfolk, with one of the best natural harbors on the North American Atlantic coast, was to compete with other port cities, it needed banks and the state required three of the state’s Big Six branch banks to operate branches there. Despite its natural advantages, Norfolk never became an important entrepot and it probably had more bank capital than it required. This pattern was repeated elsewhere. Other states required their branch banks to serve markets such as Memphis, Louisville, Natchez and Mobile that might, with the proper infrastructure grow into important ports.

State Involvement and Intervention in Banking

The second distinguishing characteristic of southern and western banking was sweeping state involvement and intervention. Virginia, for example, interjected the state into the banking system by taking significant stakes in its first chartered banks (providing an implicit subsidy) and by requiring them, once they established themselves, to subsidize the state’s continuing internal improvements programs of the 1820s and 1830s. Indiana followed such a strategy. So, too, did Kentucky, Louisiana, Mississippi, Illinois, Kentucky, Tennessee and Georgia in different degrees. South Carolina followed a wholly different strategy. On one hand, it chartered several banks in which it took no financial interest. On the other, it chartered the Bank of the State of South Carolina, a bank wholly owned by the state and designed to lend to planters and farmers who complained constantly that the state’s existing banks served only the urban mercantile community. The state-owned bank eventually divided its lending between merchants, farmers and artisans and dominated South Carolina’s financial sector.

The 1820s and 1830s witnessed a deluge of new banks in the South and West, with a corresponding increase in state involvement. No state matched Louisiana’s breadth of involvement in the 1830s when it chartered three distinct types of banks: commercial banks that served merchants and manufacturers; improvement banks that financed various internal improvements projects; and property banks that extended long-term mortgage credit to planters and other property holders. Louisiana’s improvement banks included the New Orleans Canal and Banking Company that built a canal connecting Lake Ponchartrain to the Mississippi River. The Exchange and Banking Company and the New Orleans Improvement and Banking Company were required to build and operate hotels. The New Orleans Gas Light and Banking Company constructed and operated gas streetlights in New Orleans and five other cities. Finally, the Carrollton Railroad and Banking Company and the Atchafalaya Railroad and Banking Company were rail construction companies whose bank subsidiaries subsidized railroad construction.

“Commonwealth Ideal” and Inflationary Banking

Louisiana’s 1830s banking exuberance reflected what some historians label the “commonwealth ideal” of banking; that is, the promotion of the general welfare through the promotion of banks. Legislatures in the South and West, however, never demonstrated a greater commitment to the commonwealth ideal than during the tough times of the early 1820s. With the collapse of the post-war land boom in 1819, a political coalition of debt-strapped landowners lobbied legislatures throughout the region for relief and its focus was banking. Relief advocates lobbied for inflationary banking that would reduce the real burden of debts taken on during prior flush times.

Several western states responded to these calls and chartered state-subsidized and state-managed banks designed to reinflate their embattled economies. Chartered in 1821, the Bank of the Commonwealth of Kentucky loaned on mortgages at longer than customary periods and all Kentucky landowners were eligible for $1,000 loans. The loans allowed landowners to discharge their existing debts without being forced to liquidate their property at ruinously low prices. Although the bank’s notes were not redeemable into specie, they were given currency in two ways. First, they were accepted at the state treasury in tax payments. Second, the state passed a law that forced creditors to accept the notes in payment of existing debts or agree to delay collection for two years.

The commonwealth ideal was not unique to Kentucky. During the depression of the 1820s, Tennessee chartered the State Bank of Tennessee, Illinois chartered the State Bank of Illinois and Louisiana chartered the Louisiana State Bank. Although they took slightly different forms, they all had the same intent; namely, to relieve distressed and embarrassed farmers, planters and land owners. What all these banks shared in common was the notion that the state should promote the general welfare and economic growth. In this instance, and again during the depression of the 1840s, state-owned banks were organized to minimize the transfer of property when economic conditions demanded wholesale liquidation. Such liquidation would have been inefficient and imposed unnecessary hardship on a large fraction of the population. To the extent that hastily chartered relief banks forestalled inefficient liquidation, they served their purpose. Although most of these banks eventually became insolvent, requiring taxpayer bailouts, we cannot label them unsuccessful. They reinflated economies and allowed for an orderly disposal of property. Determining if the net benefits were positive or negative requires more research, but for the moment we are forced to accept the possibility that the region’s state-owned banks of the 1820s and 1840s advanced the commonweal.

Conclusion: Banks and Economic Growth

Despite notable differences in the specific form and structure of each region’s banking system, they were all aimed squarely at a common goal; namely, realizing that region’s economic potential. Banks helped achieve the goal in two ways. First, banks monetized economies, which reduced the costs of transacting and helped smooth consumption and production across time. It was no longer necessary for every farm family to inventory their entire harvest. They could sell most of it, and expend the proceeds on consumption goods as the need arose until the next harvest brought a new cash infusion. Crop and livestock inventories are prone to substantial losses and an increased use of money reduced them significantly. Second, banks provided credit, which unleashed entrepreneurial spirits and talents. A complete appreciation of early American banking recognizes the banks’ contribution to antebellum America’s economic growth.

Bibliographic Essay

Because of the large number of sources used to construct the essay, the essay was more readable and less cluttered by including a brief bibliographic essay. A full bibliography is included at the end.

Good general histories of antebellum banking include Dewey (1910), Fenstermaker (1965), Gouge (1833), Hammond (1957), Knox (1903), Redlich (1949), and Trescott (1963). If only one book is read on antebellum banking, Hammond’s (1957) Pulitzer-Prize winning book remains the best choice.

The literature on New England banking is not particularly large, and the more important historical interpretations of state-wide systems include Chadbourne (1936), Hasse (1946, 1957), Simonton (1971), Spencer (1949), and Stokes (1902). Gras (1937) does an excellent job of placing the history of a single bank within the larger regional and national context. In a recent book and a number of articles Lamoreaux (1994 and sources therein) provides a compelling and eminently readable reinterpretation of the region’s banking structure. Nathan Appleton (1831, 1856) provides a contemporary observer’s interpretation, while Walker (1857) provides an entertaining if perverse and satirical history of a fictional New England bank. Martin (1969) provides details of bank share prices and dividend payments from the establishment of the first banks in Boston through the end of the nineteenth century. Less technical studies of the Suffolk system include Lake (1947), Trivoli (1979) and Whitney (1878); more technical interpretations include Calomiris and Kahn (1996), Mullineaux (1987), and Rolnick, Smith and Weber (1998).

The literature on Middle Atlantic banking is huge, but the better state-level histories include Bryan (1899), Daniels (1976), and Holdsworth (1928). The better studies of individual banks include Adams (1978), Lewis (1882), Nevins (1934), and Wainwright (1953). Chaddock (1910) provides a general history of the Safety Fund system. Golembe (1960) places it in the context of modern deposit insurance, while Bodenhorn (1996) and Calomiris (1989) provide modern analyses. A recent revival of interest in free banking has brought about a veritable explosion in the number of studies on the subject, but the better introductory ones remain Rockoff (1974, 1985), Rolnick and Weber (1982, 1983), and Dwyer (1996).

The literature on southern and western banking is large and of highly variable quality, but I have found the following to be the most readable and useful general sources: Caldwell (1935), Duke (1895), Esary (1912), Golembe (1978), Huntington (1915), Green (1972), Lesesne (1970), Royalty (1979), Schweikart (1987) and Starnes (1931).

References and Further Reading

Adams, Donald R., Jr. Finance and Enterprise in Early America: A Study of Stephen Girard’s Bank, 1812-1831. Philadelphia: University of Pennsylvania Press, 1978.

Alter, George, Claudia Goldin and Elyce Rotella. “The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth-Century.” Journal of Economic History 54, no. 4 (December 1994): 735-67.

Appleton, Nathan. A Defence of Country Banks: Being a Reply to a Pamphlet Entitled ‘An Examination of the Banking System of Massachusetts, in Reference to the Renewal of the Bank Charters.’ Boston: Stimpson & Clapp, 1831.

Appleton, Nathan. Bank Bills or Paper Currency and the Banking System of Massachusetts with Remarks on Present High Prices. Boston: Little, Brown and Company, 1856.

Berry, Thomas Senior. Revised Annual Estimates of American Gross National Product: Preliminary Estimates of Four Major Components of Demand, 1789-1889. Richmond: University of Richmond Bostwick Paper No. 3, 1978.

Bodenhorn, Howard. “Zombie Banks and the Demise of New York’s Safety Fund.” Eastern Economic Journal 22, no. 1 (1996): 21-34.

Bodenhorn, Howard. “Private Banking in Antebellum Virginia: Thomas Branch & Sons of Petersburg.” Business History Review 71, no. 4 (1997): 513-42.

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge and New York: Cambridge University Press, 2000.

Bodenhorn, Howard. State Banking in Early America: A New Economic History. New York: Oxford University Press, 2002.

Bryan, Alfred C. A History of State Banking in Maryland. Baltimore: Johns Hopkins University Press, 1899.

Caldwell, Stephen A. A Banking History of Louisiana. Baton Rouge: Louisiana State University Press, 1935.

Calomiris, Charles W. “Deposit Insurance: Lessons from the Record.” Federal Reserve Bank of Chicago Economic Perspectives 13 (1989): 10-30.

Calomiris, Charles W., and Charles Kahn. “The Efficiency of Self-Regulated Payments Systems: Learnings from the Suffolk System.” Journal of Money, Credit, and Banking 28, no. 4 (1996): 766-97.

Chadbourne, Walter W. A History of Banking in Maine, 1799-1930. Orono: University of Maine Press, 1936.

Chaddock, Robert E. The Safety Fund Banking System in New York, 1829-1866. Washington, D.C.: Government Printing Office, 1910.

Daniels, Belden L. Pennsylvania: Birthplace of Banking in America. Harrisburg: Pennsylvania Bankers Association, 1976.

Davis, Lance, and Robert E. Gallman. “Capital Formation in the United States during the Nineteenth Century.” In Cambridge Economic History of Europe (Vol. 7, Part 2), edited by Peter Mathias and M.M. Postan, 1-69. Cambridge: Cambridge University Press, 1978.

Davis, Lance, and Robert E. Gallman. “Savings, Investment, and Economic Growth: The United States in the Nineteenth Century.” In Capitalism in Context: Essays on Economic Development and Cultural Change in Honor of R.M. Hartwell, edited by John A. James and Mark Thomas, 202-29. Chicago: University of Chicago Press, 1994.

Dewey, Davis R. State Banking before the Civil War. Washington, D.C.: Government Printing Office, 1910.

Duke, Basil W. History of the Bank of Kentucky, 1792-1895. Louisville: J.P. Morton, 1895.

Dwyer, Gerald P., Jr. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (1996): 1-20.

Engerman, Stanley L., and Robert E. Gallman. “U.S. Economic Growth, 1783-1860.” Research in Economic History 8 (1983): 1-46.

Esary, Logan. State Banking in Indiana, 1814-1873. Indiana University Studies No. 15. Bloomington: Indiana University Press, 1912.

Fenstermaker, J. Van. The Development of American Commercial Banking, 1782-1837. Kent, Ohio: Kent State University, 1965.

Fenstermaker, J. Van, and John E. Filer. “Impact of the First and Second Banks of the United States and the Suffolk System on New England Bank Money, 1791-1837.” Journal of Money, Credit, and Banking 18, no. 1 (1986): 28-40.

Friedman, Milton, and Anna J. Schwartz. “Has the Government Any Role in Money?” Journal of Monetary Economics 17, no. 1 (1986): 37-62.

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¹ Banknotes were small demonination IOUs printed by banks and circulated as currency. Modern U.S. money are simply banknotes issued by the Federal Reserve Bank, which has a monopoly privilege in the issue of legal tender currency. In antebellum American, when a bank made a loan, the borrower was typically handed banknotes with a face value equal to the dollar value of the loan. The borrower then spent these banknotes in purchasing goods and services, putting them into circulation. Contemporary law held that banks were required to redeem banknotes into gold and silver legal tender on demand. Banks found it profitable to issue notes because they typically held about 30 percent of the total value of banknotes in circulation as reserves. Thus, banks were able to leverage $30 in gold and silver into $100 in loans that returned about 7 percent interest on average.

² Paul Lockard (2000) challenges Lamoreaux’s interpretation. In a study of 4 banks in the Connecticut River valley, Lockard finds that insiders did not dominate these banks’ resources. As provocative as Lockard’s findings are, he draws conclusions from a small and unrepresentative sample. Two of his four sample banks were savings banks, which were designed as quasi-charitable organizations designed to encourage savings by the working classes and provide small loans. Thus, Lockard’s sample is effectively reduced to two banks. At these two banks, he identifies about 10 percent of loans as insider loans, but readily admits that he cannot always distinguish between insiders and outsiders. For a recent study of how early Americans used savings banks, see Alter, Goldin and Rotella (1994). The literature on savings banks is so large that it cannot be be given its due here.

³ Interbank clearing involves the settling of balances between banks. Modern banks cash checks drawn on other banks and credit the funds to the depositor. The Federal Reserve system provides clearing services between banks. The accepting bank sends the checks to the Federal Reserve, who credits the sending bank’s accounts and sends the checks back to the bank on which they were drawn for reimbursement. In the antebellum era, interbank clearing involved sending banknotes back to issuing banks. Because New England had so many small and scattered banks, the costs of returning banknotes to their issuers were large and sometimes avoided by recirculating notes of distant banks rather than returning them. Regular clearings and redemptions served an important purpose, however, because they kept banks in touch with the current market conditions. A massive redemption of notes was indicative of a declining demand for money and credit. Because the bank’s reserves were drawn down with the redemptions, it was forced to reduce its volume of loans in accord with changing demand conditions.

⁴ The law held that banknotes were redeemable on demand into gold or silver coin or bullion. If a bank refused to redeem even a single $1 banknote, the banknote holder could have the bank closed and liquidated to recover his or her claim against it.

⁵ Rappaport (1996) found that the bank’s loans were about equally divided between insiders (shareholders and shareholders’ family and business associates) and outsiders, but nonshareholders received loans about 30 percent smaller than shareholders. The issue remains about whether this bank was an “insider” bank, and depends largely on one’s definition. Any modern bank which made half of its loans to shareholders and their families would be viewed as an “insider” bank. It is less clear where the line can be usefully drawn for antebellum banks.

⁶ Real-bills lending followed from a nineteenth-century banking philosophy, which held that bank lending should be used to finance the warehousing or wholesaling of already-produced goods. Loans made on these bases were thought to be self-liquidating in that the loan was made against readily sold collateral actually in the hands of a merchant. Under the real-bills doctrine, the banks’ proper functions were to bridge the gap between production and retail sale of goods. A strict adherence to real-bills tenets excluded loans on property (mortgages), loans on goods in process (trade credit), or loans to start-up firms (venture capital). Thus, real-bills lending prescribed a limited role for banks and bank credit. Few banks were strict adherents to the doctrine, but many followed it in large part.

⁷ Robert E. Wright (1998) offers a different interpretation, but notes that Burr pushed the bill through at the end of a busy legislative session so that many legislators voted on the bill without having read it thoroughly or at all.

Citation: Bodenhorn, Howard. “Antebellum Banking in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/antebellum-banking-in-the-united-states/

Benjamin J. Cohen, University of California at Santa Barbara

Monetary tradition has long assumed that, in principle, each sovereign state issues and manages its own exclusive currency. In practice, however, there have always been exceptions — countries that elected to join together in a monetary union of some kind. Not all monetary unions have stood the test of time; in fact, many past initiatives have long since passed into history. Yet interest in monetary union persists, stimulated in particular by the example of the European Union’s Economic and Monetary Union (EMU), which has replaced a diversity of national monies with one joint currency called the euro. Today, the possibility of monetary union is actively discussed in many parts of the world.

A monetary union may be defined as a group of two or more states sharing a common currency or equivalent. Although some sources extend the definition to include the monetary regimes of national federations such as the United States or of imperial agglomerations such as the old Austro-Hungarian Empire, the conventional practice is to limit the term to agreements among units that are recognized as fully sovereign states under international law. The antithesis of a monetary union, of course, is a national currency with an independent central bank and a floating exchange rate.

In the strictest sense of the term, monetary union means complete abandonment of separate national currencies and full centralization of monetary authority in a single joint institution. In reality, considerable leeway exists for variations of design along two key dimensions. These dimensions are institutional provisions for (1) the issuing of currency and (2) the management of decisions. Currencies may continue to be issued by individual governments, tied together in an exchange-rate union. Alternatively, currencies may be replaced not by a joint currency but rather by the money of a larger partner — an arrangement generically labeled dollarization after the United States dollar, the money that is most widely used for this purpose. Similarly, monetary authority may continue to be exercised in some degree by individual governments or, alternatively, may be delegated not to a joint institution but rather to a single partner such as the United States.

In political terms, monetary unions divide into two categories, depending on whether national monetary sovereignty is shared or surrendered. Unions based on a joint currency or an exchange-rate union in effect pool monetary authority to some degree. They are a form of partnership or alliance of nominal equals. Unions created by dollarization are more hierarchical, a subordinate follower-leader type of regime.

The greatest attraction of a monetary union is that it reduces transactions costs as compared with a collection of separate national currencies. With a single money or equivalent, there is no need to incur the expense of currency conversion or hedging against exchange risk in transactions among the partners. But there are also two major economic disadvantages for governments to consider.

First, individual partners lose control of both the money supply and exchange rate as policy instruments to cope with domestic or external disturbances. Against a monetary union’s efficiency gains at the microeconomic level, governments must compare the cost of sacrificing autonomy of monetary policy at the macroeconomic level.

Second, individual partners lose the capacity derived from an exclusive national currency to augment public spending at will via money creation — a privilege known as seigniorage. Technically defined as the excess of the nominal value of a currency over its cost of production, seigniorage can be understood as an alternative source of revenue for the state beyond what can be raised by taxes or by borrowing from financial markets. Sacrifice of the seigniorage privilege must also be compared against a monetary union’s efficiency gains.

The seriousness of these two losses will depend on the type of monetary union adopted. In an alliance-type union, where authority is not surrendered but pooled, monetary control is delegated to the union’s joint institution, to be shared and in some manner collectively managed by all the countries involved. Hence each partner’s loss is simultaneously also each other’s gain. Though individual states may no longer have much latitude to act unilaterally, each government retains a voice in decision-making for the group as a whole. Losses will be greater with dollarization, which by definition transfers all monetary authority to the dominant power. Some measure of seigniorage may be retained by subordinate partners, but only with the consent of the leader.

The idea of monetary union among sovereign states was widely promoted in the nineteenth century, mainly in Europe, despite the fact that most national currencies were already tied together closely by the fixed exchange rates of the classical gold standard. Further efficiency gains could be realized, proponents argued, while little would be lost at a time when activist monetary policy was still unknown.

“Universal Currency” Fails, 1867

Most ambitious was a projected “universal currency” to be based on equivalent gold coins issued by the three biggest financial powers of the day: Britain, France, and the United States. As it happened, the gold content of French coins at the time was such that a 25-franc piece — not then in existence but easily mintable — would if brought into existence have contained 112.008 grains of gold, very close to both the English sovereign (containing 113.001 grains) and American half-eagle, equal to five dollars (containing 116.1 grains). Why not, then, seek some sort of standardization of coinage among the three countries to achieve the equivalent of one single money? That was the proposal of a major monetary conference sponsored by the French Government to coincide with an international exposition in Paris in 1867. Delegates from some 20 countries, with the critical exception of Britain’s representatives, enthusiastically supported creation of a universal currency based on a 25-franc piece and called for appropriate reductions in the gold content of the sovereign and half-eagle. In the end, however, no action was taken by either London or Washington, and for lack of sustained political support the idea ultimately faded away.

Latin Monetary Union

Two years before the 1867 conference, however, the French Government did succeed in gaining agreement for a more limited initiative — the Latin Monetary Union (LMU). Joining Belgium, Italy, and Switzerland together with France, the LMU was intended to standardize the existing gold and silver coinages of all four countries. Greece subsequently adhered to the terms of the LMU in 1868, though not becoming a formal member until 1876. In practical terms, a monetary partnership among these countries had already begun to coalesce even earlier as a result of independent decisions by Belgium, Greece, Italy, and Switzerland to model their currency systems on that of France. Each state chose to adopt a basic unit equal in value to the French franc — actually called a franc in Belgium and Switzerland — with equivalent subsidiary units defined according to the French-inspired decimal system. Starting in the 1850s, however, serious Gresham’s Law type problems developed as a result of differences in the weight and fineness of silver coins circulating in each country. The LMU established uniform standards for national coinages and, by making each member’s money legal tender throughout the Union, effectively created a wider area for the circulation of a harmonized supply of specie coins. In substance a formal exchange-rate union was created, with the authority for management of participating currencies remaining with each separate government.

As a group, members were distinguished from other countries by the reciprocal obligation of their central banks to accept one another’s coins at par and without limit. Soon after its founding, however, beginning in the late 1860s, the LMU was subjected to considerable strain owing to a global glut of silver production. The resulting depreciation of silver eventually led to a suspension of silver coinage by all the partners, effectively transforming the LMU from a bimetallic standard into what came to be called a “limping gold standard.” Even so, the arrangement managed to hold together until the generalized breakdown of global monetary relations during World War I. The LMU was not formally dissolved until 1927, following Switzerland’s decision to withdraw during the previous year.

Scandinavian Monetary Union

A similar arrangement also emerged in northern Europe — the Scandinavian Monetary Union (SMU), formed in 1873 by Sweden and Denmark and joined two years later by Norway. The Scandanavian Monetary Union too was an exchange-rate union designed to standardize existing coinages, although unlike the LMU the SMU was based from the start on a monometallic gold standard. The Union established the krone (crown) as a uniform unit of account, with national currencies permitted full circulation as legal tender in all three countries. As in the LMU, members of the SMU were distinguished from outsiders by the reciprocal obligation to accept one another’s currencies at par and without limit; also as in the LMU, mutual acceptability was initially limited to gold and silver coins only. In 1885, however, the three members went further, agreeing to accept one another’s bank notes and drafts as well, thus facilitating free intercirculation of all paper currency and resulting eventually in the total disappearance of exchange-rate quotations among the three moneys. By the turn of the century the SMU had come to function, in effect, as a single unit for all payments purposes, until relations were disrupted by the suspension of convertibility and floating of individual currencies at the start of World War I. Despite subsequent efforts during and after the war to restore at least some elements of the Union, particularly following the members’ return to the gold standard in the mid-1920s, the agreement was finally abandoned following the global financial crisis of 1931.

German Monetary Union

Repeated efforts to standardize coinages were made as well by various German states prior to Germany’s political union, but with rather less success. Early accords, following the start of the Zollverein (the German region’s customs union) in 1834, ostensibly established a German Monetary Union — technically, like the LMU and SMU, also an exchange-rate union — but in fact divided the area into two quite distinct currency alliances: one encompassing most northern states, using the thaler as its basic monetary unit; and a second including states in the south, based on the florin (also known as the guilder or gulden). Free intercirculation of coins was guaranteed in both groups but not at par: the exchange rate between the two units of account was fixed at one thaler for 1.75 florins (formally, 14: 24.5) rather than one-for-one. Moreover, states remained free to mint non-standardized coins in addition to their basic units, and many important German states (e.g., Bremen, Hamburg, and Schleswig-Holstein) chose to stay outside the agreement altogether. Nor were matters helped much by the short-lived Vienna Coinage Treaty signed with Austria in 1857, which added yet a third currency, Austria’s own florin, to the mix with a value slightly higher than that of the south German unit. The Austro-German Monetary Union was dissolved less than a decade later, following Austria’s defeat in the 1866 Austro-Prussian War. A full merger of all the currencies of the German states did not finally arrive until after consolidation of modern Germany, under Prussian leadership, in 1871.

The only truly successful monetary union in Europe prior to EMU came in 1922 with the birth of the Belgium-Luxembourg Economic Union (BLEU), which remained in force for more than seven decades until blended into EMU in 1999. Following severance of its traditional ties with the German Zollverein after World War I, Luxembourg elected to link itself commercially and financially with Belgium, agreeing to a comprehensive economic union including a merger of their separate money systems. Reflecting the partners’ considerable disparity of size (Belgium’s population is roughly thirty times Luxembourg’s), Belgian francs under BLEU formed the largest part of the money stock of Luxembourg as well as Belgium, and alone enjoyed full status as legal tender in both countries. Only Belgium, moreover, had a full-scale central bank. The Luxembourg franc was issued by a more modest institution, the Luxembourg Monetary Institute, was limited in supply, and served as legal tender just within Luxembourg itself. Despite the existence of formal joint decision-making bodies, Luxembourg in effect existed largely as an appendage of the Belgian monetary system until both nations joined their EU partners in creating the euro.

Monetary Disintegration

Europe in the twentieth century has also seen the disintegration of several monetary unions, usually as a by-product of political dissent or dissolution. A celebrated instance occurred after World War I when the Austro-Hungarian Empire was dismembered by the Treaty of Versailles. Almost immediately, in an abrupt and quite chaotic manner, new currencies were introduced by each successor state — including Czechoslovakia, Hungary, Yugoslavia, and ultimately even shrunken Austria itself — to replace the old imperial Austrian crown. Comparable examples have also been provided more recently, after the end of the Cold War, following fragmentation along ethnic lines of both the Czechoslovak and Yugoslav federations. Most spectacular was the collapse of the former ruble zone following the break-up of the seven-decade-old Soviet Union in late 1991. Out of the rubble of the ruble no fewer than a dozen new currencies emerged to take their place on the world stage.

Outside Europe, the idea of monetary union was promoted mainly in the context of colonial or other dependency relationships, including both alliance-type and dollarization arrangements. Though most imperial regimes were quickly abandoned in favor of newly created national currencies once decolonization began after World War II, a few have survived in modified form to the present day.

British Colonies

Alliance-type arrangements emerged in the colonial domains of both Britain and France, the two biggest imperial powers of the nineteenth century. First to act were the British, who after some experimentation succeeded in creating a series of common currency zones, each closely tied to the pound sterling through the mechanism of a currency board. With a currency board, exchange rates were firmly pegged to the pound and full sterling backing was required for any new issue of the colonial money. Joint currencies were created first in West Africa (1912) and East Africa (1919) and later for British possessions in Southeast Asia (1938) and the Caribbean (1950). In southern Africa, an equivalent zone was established during the 1920s based on the South African pound (later the rand), which became the sole legal tender in three of Britain’s nearby possessions, Bechuanaland (later Botswana), British Basutoland (later Lesotho), and Swaziland, as well as in South West Africa (later Namibia), a former German colony administered by South Africa under a League of Nations mandate. Of Britain’s various arrangements, only two still exist in some form.

East Caribbean

One is in the Caribbean, where Britain’s monetary legacy has proved remarkably durable. The British Caribbean Currency Board evolved first into the Eastern Caribbean Currency Authority in 1965 and then the Eastern Caribbean Central Bank in 1983, issuing one currency, the Eastern Caribbean dollar, to serve as legal tender for all participants. Included in the Eastern Caribbean Currency Union (ECCU) are the six independent microstates of Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines, plus two islands that are still British dependencies, Anguilla and Montserrat. Embedded in a broadening network of other related agreements among the same governments (the Eastern Caribbean Common Market, the Organization of Eastern Caribbean States), the ECCU has functioned without serious difficulty since its formal establishment in 1965.

Southern Africa

The other is in southern Africa, where previous links have been progressively formalized, first in 1974 as the Rand Monetary Area, later in 1986 under the label Common Monetary Area (CMA), though, significantly, without the participation of diamond-rich Botswana, which has preferred to rely on its own national money. The CMA started as a monetary union tightly based on the rand, a local form of dollarization reflecting South Africa’s economic dominance of the region. But with the passage of time the degree of hierarchy has diminished considerably, as the three remaining junior partners have asserted their growing sense of national identity. Especially since the 1970s, the arrangement has been transformed into a looser exchange-rate union as each of South Africa’s partners introduced its own distinct national currency. One of them, Swaziland, has even gone so far as to withdraw the rand’s legal-tender status within its own borders. Moreover, though all three continue to peg their moneys to the rand at par, they are no longer bound by currency board-like provisions on money creation and may now in principle vary their exchange rates at will.

Africa’s CFA Franc Zone

In the French Empire monetary union did not arrive until 1945, when the newly restored government in Paris decided to consolidate the diverse currencies of its many African dependencies into one money, le franc des Colonies Françaises d’Afrique (CFA francs). Subsequently, in the early 1960s, as independence came to France’s African domains, the old colonial franc was replaced by two new regional currencies, each cleverly named to preserve the CFA franc appellation: for the eight present members of the West African Monetary Union, le franc de la Communauté Financière de l’Afrique, issued by the Central Bank of West African States; and for the six members of the Central African Monetary Area, le franc de la Coopération Financière Africaine, issued by the Bank of Central African States. Together the two groups comprise the Communauté Financière Africaine (African Financial Community). Though each of the two currencies is legal tender only within its own region, the two are equivalently defined and have always been jointly managed under the aegis of the French Ministry of Finance as integral parts of a single monetary union, popularly known as the CFA Franc Zone.

Elsewhere imperial powers preferred some version of a dollarization-type regime, promoting use of their own currencies in colonial possessions to reinforce dependency relationships — though few of these hierarchical arrangements survived the arrival of decolonization. The only major exceptions are to be found among smaller countries with special ties to the United States. Most prominently, these include Panama and Liberia, two states that owe their very existence to U.S. initiatives. Immediately after gaining its independence in 1903 with help from Washington, Panama adopted America’s greenback as its national currency in lieu of a money of its own. In similar fashion during World War II, Liberia — a nation founded by former American slaves — made the dollar its sole legal tender, replacing the British West African colonial coinage that had previously dominated the local money supply. Other long-time dollarizers include the Marshall Islands, Micronesia, and Palau, Pacific Ocean microstates that were all once administered by the United States under United Nations trusteeships. Most recently, the dollar replaced failed local currencies in Ecuador in 2000 and in El Salvador in 2001 and was adopted by East Timor when that state gained its independence in 2002.

Europe’s Monetary Union

The most dramatic episode in the history of monetary unions is of course EMU, in many ways a unique undertaking — a group of fully independent states, all partners in the European Union, that have voluntarily agreed to replace existing national currencies with one newly created money, the euro. The euro was first introduced in 1999 in electronic form (a “virtual” currency), with notes and coins following in 2002. Moreover, even while retaining political sovereignty, member governments have formally delegated all monetary sovereignty to a single joint authority, the European Central Bank. These are not former overseas dependencies like the members of ECCU or the CFA Franc Zone, inheriting arrangements that had originated in colonial times; nor are they small fragile economies like Ecuador or El Salvador, surrendering monetary sovereignty to an already proven and popular currency like the dollar. Rather, these are established states of long standing and include some of the biggest national economies in the world, engaged in a gigantic experiment of unprecedented proportions. Not surprisingly, therefore, EMU has stimulated growing interest in monetary union in many parts of the world. Despite the failure of many past initiatives, the future could see yet more joint currency ventures among sovereign states.

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Howard Bodenhorn, Lafayette College

The first legitimate commercial bank in the United States was the Bank of North America founded in 1781. Encouraged by Alexander Hamilton, Robert Morris persuaded the Continental Congress to charter the bank, which loaned to the cash-strapped Revolutionary government as well as private citizens, mostly Philadelphia merchants. The possibilities of commercial banking had been widely recognized by many colonists, but British law forbade the establishment of commercial, limited-liability banks in the colonies. Given that many of the colonists’ grievances against Parliament centered on economic and monetary issues, it is not surprising that one of the earliest acts of the Continental Congress was the establishment of a bank.

The introduction of banking to the U.S. was viewed as an important first step in forming an independent nation because banks supplied a medium of exchange (banknotes¹ and deposits) in an economy perpetually strangled by shortages of specie money and credit, because they animated industry, and because they fostered wealth creation and promoted well-being. In the last case, contemporaries typically viewed banks as an integral part of a wider system of government-sponsored commercial infrastructure. Like schools, bridges, road, canals, river clearing and harbor improvements, the benefits of banks were expected to accrue to everyone even if dividends accrued only to shareholders.

Financial Sector Growth

By 1800 each major U.S. port city had at least one commercial bank serving the local mercantile community. As city banks proved themselves, banking spread into smaller cities and towns and expanded their clientele. Although most banks specialized in mercantile lending, others served artisans and farmers. In 1820 there were 327 commercial banks and several mutual savings banks that promoted thrift among the poor. Thus, at the onset of the antebellum period (defined here as the period between 1820 and 1860), urban residents were familiar with the intermediary function of banks and used bank-supplied currencies (deposits and banknotes) for most transactions. Table 1 reports the number of banks and the value of loans outstanding at year end between 1820 and 1860. During the era, the number of banks increased from 327 to 1,562 and total loans increased from just over $55.1 million to $691.9 million. Bank-supplied credit in the U.S. economy increased at a remarkable annual average rate of 6.3 percent. Growth in the financial sector, then outpaced growth in aggregate economic activity. Nominal gross domestic product increased an average annual rate of about 4.3 percent over the same interval. This essay discusses how regional regulatory structures evolved as the banking sector grew and radiated out from northeastern cities to the hinterlands.

Table 1
Number of Banks and Total Loans, 1820-1860

Sources: Fenstermaker (1965); U.S. Comptroller of the Currency (1931).

Adaptability

As important as early American banks were in the process of capital accumulation, perhaps their most notable feature was their adaptability. Kuznets (1958) argues that one measure of the financial sector’s value is how and to what extent it evolves with changing economic conditions. Put in place to perform certain functions under one set of economic circumstances, how did it alter its behavior and service the needs of borrowers as circumstances changed. One benefit of the federalist U.S. political system was that states were given the freedom to establish systems reflecting local needs and preferences. While the political structure deserves credit in promoting regional adaptations, North (1994) credits the adaptability of America’s formal rules and informal constraints that rewarded adventurism in the economic, as well as the noneconomic, sphere. Differences in geography, climate, crop mix, manufacturing activity, population density and a host of other variables were reflected in different state banking systems. Rhode Island’s banks bore little resemblance to those in far away Louisiana or Missouri, or even those in neighboring Connecticut. Each state’s banks took a different form, but their purpose was the same; namely, to provide the state’s citizens with monetary and intermediary services and to promote the general economic welfare. This section provides a sketch of regional differences. A more detailed discussion can be found in Bodenhorn (2002).

State Banking in New England

New England’s banks most resemble the common conception of the antebellum bank. They were relatively small, unit banks; their stock was closely held; they granted loans to local farmers, merchants and artisans with whom the bank’s managers had more than a passing familiarity; and the state took little direct interest in their daily operations.

Of the banking systems put in place in the antebellum era, New England’s is typically viewed as the most stable and conservative. Friedman and Schwartz (1986) attribute their stability to an Old World concern with business reputations, familial ties, and personal legacies. New England was long settled, its society well established, and its business community mature and respected throughout the Atlantic trading network. Wealthy businessmen and bankers with strong ties to the community — like the Browns of Providence or the Bowdoins of Boston — emphasized stability not just because doing so benefited and reflected well on them, but because they realized that bad banking was bad for everyone’s business.

Besides their reputation for soundness, the two defining characteristics of New England’s early banks were their insider nature and their small size. The typical New England bank was small compared to banks in other regions. Table 2 shows that in 1820 the average Massachusetts country bank was about the same size as a Pennsylvania country bank, but both were only about half the size of a Virginia bank. A Rhode Island bank was about one-third the size of a Massachusetts or Pennsylvania bank and a mere one-sixth as large as Virginia’s banks. By 1850 the average Massachusetts bank declined relatively, operating on about two-thirds the paid-in capital of a Pennsylvania country bank. Rhode Island’s banks also shrank relative to Pennsylvania’s and were tiny compared to the large branch banks in the South and West.

Table 2
Average Bank Size by Capital and Lending in 1820 and 1850 Selected States and Cities
(in $ thousands)

Notes: ¹ Virginia figures for 1822. ² Figures represent branch averages.

Source: Bodenhorn (2002).

Explanations for New England Banks’ Relatively Small Size

Several explanations have been offered for the relatively small size of New England’s banks. Contemporaries attributed it to the New England states’ propensity to tax bank capital, which was thought to work to the detriment of large banks. They argued that large banks circulated fewer banknotes per dollar of capital. The result was a progressive tax that fell disproportionately on large banks. Data compiled from Massachusetts’s bank reports suggest that large banks were not disadvantaged by the capital tax. It was a fact, as contemporaries believed, that large banks paid higher taxes per dollar of circulating banknotes, but a potentially better benchmark is the tax to loan ratio because large banks made more use of deposits than small banks. The tax to loan ratio was remarkably constant across both bank size and time, averaging just 0.6 percent between 1834 and 1855. Moreover, there is evidence of constant to modestly increasing returns to scale in New England banking. Large banks were generally at least as profitable as small banks in all years between 1834 and 1860, and slightly more so in many.

Lamoreaux (1993) offers a different explanation for the modest size of the region’s banks. New England’s banks, she argues, were not impersonal financial intermediaries. Rather, they acted as the financial arms of extended kinship trading networks. Throughout the antebellum era banks catered to insiders: directors, officers, shareholders, or business partners and kin of directors, officers, shareholders and business partners. Such preferences toward insiders represented the perpetuation of the eighteenth-century custom of pooling capital to finance family enterprises. In the nineteenth century the practice continued under corporate auspices. The corporate form, in fact, facilitated raising capital in greater amounts than the family unit could raise on its own. But because the banks kept their loans within a relatively small circle of business connections, it was not until the late nineteenth century that bank size increased.²

Once the kinship orientation of the region’s banks was established it perpetuated itself. When outsiders could not obtain loans from existing insider organizations, they formed their own insider bank. In doing so the promoters assured themselves of a steady supply of credit and created engines of economic mobility for kinship networks formerly closed off from many sources of credit. State legislatures accommodated the practice through their liberal chartering policies. By 1860, Rhode Island had 91 banks, Maine had 68, New Hampshire 51, Vermont 44, Connecticut 74 and Massachusetts 178.

The Suffolk System

One of the most commented on characteristic of New England’s banking system was its unique regional banknote redemption and clearing mechanism. Established by the Suffolk Bank of Boston in the early 1820s, the system became known as the Suffolk System. With so many banks in New England, each issuing it own form of currency, it was sometimes difficult for merchants, farmers, artisans, and even other bankers, to discriminate between real and bogus banknotes, or to discriminate between good and bad bankers. Moreover, the rural-urban terms of trade pulled most banknotes toward the region’s port cities. Because country merchants and farmers were typically indebted to city merchants, country banknotes tended to flow toward the cities, Boston more so than any other. By the second decade of the nineteenth century, country banknotes became a constant irritant for city bankers. City bankers believed that country issues displaced Boston banknotes in local transactions. More irritating though was the constant demand by the city banks’ customers to accept country banknotes on deposit, which placed the burden of interbank clearing on the city banks.³

In 1803 the city banks embarked on a first attempt to deal with country banknotes. They joined together, bought up a large quantity of country banknotes, and returned them to the country banks for redemption into specie. This effort to reduce country banknote circulation encountered so many obstacles that it was quickly abandoned. Several other schemes were hatched in the next two decades, but none proved any more successful than the 1803 plan.

The Suffolk Bank was chartered in 1818 and within a year embarked on a novel scheme to deal with the influx of country banknotes. The Suffolk sponsored a consortium of Boston bank in which each member appointed the Suffolk as its lone agent in the collection and redemption of country banknotes. In addition, each city bank contributed to a fund used to purchase and redeem country banknotes. When the Suffolk collected a large quantity of a country bank’s notes, it presented them for immediate redemption with an ultimatum: Join in a regular and organized redemption system or be subject to further unannounced redemption calls.⁴ Country banks objected to the Suffolk’s proposal, because it required them to keep noninterest-earning assets on deposit with the Suffolk in amounts equal to their average weekly redemptions at the city banks. Most country banks initially refused to join the redemption network, but after the Suffolk made good on a few redemption threats, the system achieved near universal membership.

Early interpretations of the Suffolk system, like those of Redlich (1949) and Hammond (1957), portray the Suffolk as a proto-central bank, which acted as a restraining influence that exercised some control over the region’s banking system and money supply. Recent studies are less quick to pronounce the Suffolk a successful experiment in early central banking. Mullineaux (1987) argues that the Suffolk’s redemption system was actually self-defeating. Instead of making country banknotes less desirable in Boston, the fact that they became readily redeemable there made them perfect substitutes for banknotes issued by Boston’s prestigious banks. This policy made country banknotes more desirable, which made it more, not less, difficult for Boston’s banks to keep their own notes in circulation.

Fenstermaker and Filer (1986) also contest the long-held view that the Suffolk exercised control over the region’s money supply (banknotes and deposits). Indeed, the Suffolk’s system was self-defeating in this regard as well. By increasing confidence in the value of a randomly encountered banknote, people were willing to hold increases in banknotes issues. In an interesting twist on the traditional interpretation, a possible outcome of the Suffolk system is that New England may have grown increasingly financial backward as a direct result of the region’s unique clearing system. Because banknotes were viewed as relatively safe and easily redeemed, the next big financial innovation — deposit banking — in New England lagged far behind other regions. With such wide acceptance of banknotes, there was no reason for banks to encourage the use of deposits and little reason for consumers to switch over.

Summary: New England Banks

New England’s banking system can be summarized as follows: Small unit banks predominated; many banks catered to small groups of capitalists bound by personal and familial ties; banking was becoming increasingly interconnected with other lines of business, such as insurance, shipping and manufacturing; the state took little direct interest in the daily operations of the banks and its supervisory role amounted to little more than a demand that every bank submit an unaudited balance sheet at year’s end; and that the Suffolk developed an interbank clearing system that facilitated the use of banknotes throughout the region, but had little effective control over the region’s money supply.

Banking in the Middle Atlantic Region

Pennsylvania

After 1810 or so, many bank charters were granted in New England, but not because of the presumption that the bank would promote the commonweal. Charters were granted for the personal gain of the promoter and the shareholders and in proportion to the personal, political and economic influence of the bank’s founders. No New England state took a significant financial stake in its banks. In both respects, New England differed markedly from states in other regions. From the beginning of state-chartered commercial banking in Pennsylvania, the state took a direct interest in the operations and profits of its banks. The Bank of North America was the obvious case: chartered to provide support to the colonial belligerents and the fledgling nation. Because the bank was popularly perceived to be dominated by Philadelphia’s Federalist merchants, who rarely loaned to outsiders, support for the bank waned.⁵ After a pitched political battle in which the Bank of North America’s charter was revoked and reinstated, the legislature chartered the Bank of Pennsylvania in 1793. As its name implies, this bank became the financial arm of the state. Pennsylvania subscribed $1 million of the bank’s capital, giving it the right to appoint six of thirteen directors and a $500,000 line of credit. The bank benefited by becoming the state’s fiscal agent, which guaranteed a constant inflow of deposits from regular treasury operations as well as western land sales.

By 1803 the demand for loans outstripped the existing banks’ supply and a plan for a new bank, the Philadelphia Bank, was hatched and its promoters petitioned the legislature for a charter. The existing banks lobbied against the charter, and nearly sank the new bank’s chances until it established a precedent that lasted throughout the antebellum era. Its promoters bribed the legislature with a payment of $135,000 in return for the charter, handed over one-sixth of its shares, and opened a line of credit for the state.

Between 1803 and 1814, the only other bank chartered in Pennsylvania was the Farmers and Mechanics Bank of Philadelphia, which established a second substantive precedent that persisted throughout the era. Existing banks followed a strict real-bills lending policy, restricting lending to merchants at very short terms of 30 to 90 days.⁶ Their adherence to a real-bills philosophy left a growing community of artisans, manufacturers and farmers on the outside looking in. The Farmers and Mechanics Bank was chartered to serve excluded groups. At least seven of its thirteen directors had to be farmers, artisans or manufacturers and the bank was required to lend the equivalent of 10 percent of its capital to farmers on mortgage for at least one year. In later years, banks were established to provide services to even more narrowly defined groups. Within a decade or two, most substantial port cities had banks with names like Merchants Bank, Planters Bank, Farmers Bank, and Mechanics Bank. By 1860 it was common to find banks with names like Leather Manufacturers Bank, Grocers Bank, Drovers Bank, and Importers Bank. Indeed, the Emigrant Savings Bank in New York City served Irish immigrants almost exclusively. In the other instances, it is not known how much of a bank’s lending was directed toward the occupational group included in its name. The adoption of such names may have been marketing ploys as much as mission statements. Only further research will reveal the answer.

New York

State-chartered banking in New York arrived less auspiciously than it had in Philadelphia or Boston. The Bank of New York opened in 1784, but operated without a charter and in open violation of state law until 1791 when the legislature finally sanctioned it. The city’s second bank obtained its charter surreptitiously. Alexander Hamilton was one of the driving forces behind the Bank of New York, and his long-time nemesis, Aaron Burr, was determined to establish a competing bank. Unable to get a charter from a Federalist legislature, Burr and his colleagues petitioned to incorporate a company to supply fresh water to the inhabitants of Manhattan Island. Burr tucked a clause into the charter of the Manhattan Company (the predecessor to today’s Chase Manhattan Bank) granting the water company the right to employ any excess capital in financial transactions. Once chartered, the company’s directors announced that $500,000 of its capital would be invested in banking.⁷ Thereafter, banking grew more quickly in New York than in Philadelphia, so that by 1812 New York had seven banks compared to the three operating in Philadelphia.

Deposit Insurance

Despite its inauspicious banking beginnings, New York introduced two innovations that influenced American banking down to the present. The Safety Fund system, introduced in 1829, was the nation’s first experiment in bank liability insurance (similar to that provided by the Federal Deposit Insurance Corporation today). The 1829 act authorized the appointment of bank regulators charged with regular inspections of member banks. An equally novel aspect was that it established an insurance fund insuring holders of banknotes and deposits against loss from bank failure. Ultimately, the insurance fund was insufficient to protect all bank creditors from loss during the panic of 1837 when eleven failures in rapid succession all but bankrupted the insurance fund, which delayed noteholder and depositor recoveries for months, even years. Even though the Safety Fund failed to provide its promised protections, it was an important episode in the subsequent evolution of American banking. Several Midwestern states instituted deposit insurance in the early twentieth century, and the federal government adopted it after the banking panics in the 1930s resulted in the failure of thousands of banks in which millions of depositors lost money.

“Free Banking”

Although the Safety Fund was nearly bankrupted in the late 1830s, it continued to insure a number of banks up to the mid 1860s when it was finally closed. No new banks joined the Safety Fund system after 1838 with the introduction of free banking — New York’s second significant banking innovation. Free banking represented a compromise between those most concerned with the underlying safety and stability of the currency and those most concerned with competition and freeing the country’s entrepreneurs from unduly harsh and anticompetitive restraints. Under free banking, a prospective banker could start a bank anywhere he saw fit, provided he met a few regulatory requirements. Each free bank’s capital was invested in state or federal bonds that were turned over to the state’s treasurer. If a bank failed to redeem even a single note into specie, the treasurer initiated bankruptcy proceedings and banknote holders were reimbursed from the sale of the bonds.

Actually Michigan preempted New York’s claim to be the first free-banking state, but Michigan’s 1837 law was modeled closely after a bill then under debate in New York’s legislature. Ultimately, New York’s influence was profound in this as well, because free banking became one of the century’s most widely copied financial innovations. By 1860 eighteen states adopted free banking laws closely resembling New York’s law. Three other states introduced watered-down variants. Eventually, the post-Civil War system of national banking adopted many of the substantive provisions of New York’s 1838 act.

Both the Safety Fund system and free banking were attempts to protect society from losses resulting from bank failures and to entice people to hold financial assets. Banks and bank-supplied currency were novel developments in the hinterlands in the early nineteenth century and many rural inhabitants were skeptical about the value of small pieces of paper. They were more familiar with gold and silver. Getting them to exchange one for the other was a slow process, and one that relied heavily on trust. But trust was built slowly and destroyed quickly. The failure of a single bank could, in a week, destroy the confidence in a system built up over a decade. New York’s experiments were designed to mitigate, if not eliminate, the negative consequences of bank failures. New York’s Safety Fund, then, differed in the details but not in intent, from New England’s Suffolk system. Bankers and legislators in each region grappled with the difficult issue of protecting a fragile but vital sector of the economy. Each region responded to the problem differently. The South and West settled on yet another solution.

Banking in the South and West

One distinguishing characteristic of southern and western banks was their extensive branch networks. Pennsylvania provided for branch banking in the early nineteenth century and two banks jointly opened about ten branches. In both instances, however, the branches became a net liability. The Philadelphia Bank opened four branches in 1809 and by 1811 was forced to pass on its semi-annual dividends because losses at the branches offset profits at the Philadelphia office. At bottom, branch losses resulted from a combination of ineffective central office oversight and unrealistic expectations about the scale and scope of hinterland lending. Philadelphia’s bank directors instructed branch managers to invest in high-grade commercial paper or real bills. Rural banks found a limited number of such lending opportunities and quickly turned to mortgage-based lending. Many of these loans fell into arrears and were ultimately written when land sales faltered.

Branch Banking

Unlike Pennsylvania, where branch banking failed, branch banks throughout the South and West thrived. The Bank of Virginia, founded in 1804, was the first state-chartered branch bank and up to the Civil War branch banks served the state’s financial needs. Several small, independent banks were chartered in the 1850s, but they never threatened the dominance of Virginia’s “Big Six” banks. Virginia’s branch banks, unlike Pennsylvania’s, were profitable. In 1821, for example, the net return to capital at the Farmers Bank of Virginia’s home office in Richmond was 5.4 percent. Returns at its branches ranged from a low of 3 percent at Norfolk (which was consistently the low-profit branch) to 9 percent in Winchester. In 1835, the last year the bank reported separate branch statistics, net returns to capital at the Farmers Bank’s branches ranged from 2.9 and 11.7 percent, with an average of 7.9 percent.

The low profits at the Norfolk branch represent a net subsidy from the state’s banking sector to the political system, which was not immune to the same kind of infrastructure boosterism that erupted in New York, Pennsylvania, Maryland and elsewhere. In the immediate post-Revolutionary era, the value of exports shipped from Virginia’s ports (Norfolk and Alexandria) slightly exceeded the value shipped from Baltimore. In the 1790s the numbers turned sharply in Baltimore’s favor and Virginia entered the internal-improvements craze and the battle for western shipments. Banks represented the first phase of the state’s internal improvements plan in that many believed that Baltimore’s new-found advantage resulted from easier credit supplied by the city’s banks. If Norfolk, with one of the best natural harbors on the North American Atlantic coast, was to compete with other port cities, it needed banks and the state required three of the state’s Big Six branch banks to operate branches there. Despite its natural advantages, Norfolk never became an important entrepot and it probably had more bank capital than it required. This pattern was repeated elsewhere. Other states required their branch banks to serve markets such as Memphis, Louisville, Natchez and Mobile that might, with the proper infrastructure grow into important ports.

State Involvement and Intervention in Banking

The second distinguishing characteristic of southern and western banking was sweeping state involvement and intervention. Virginia, for example, interjected the state into the banking system by taking significant stakes in its first chartered banks (providing an implicit subsidy) and by requiring them, once they established themselves, to subsidize the state’s continuing internal improvements programs of the 1820s and 1830s. Indiana followed such a strategy. So, too, did Kentucky, Louisiana, Mississippi, Illinois, Kentucky, Tennessee and Georgia in different degrees. South Carolina followed a wholly different strategy. On one hand, it chartered several banks in which it took no financial interest. On the other, it chartered the Bank of the State of South Carolina, a bank wholly owned by the state and designed to lend to planters and farmers who complained constantly that the state’s existing banks served only the urban mercantile community. The state-owned bank eventually divided its lending between merchants, farmers and artisans and dominated South Carolina’s financial sector.

The 1820s and 1830s witnessed a deluge of new banks in the South and West, with a corresponding increase in state involvement. No state matched Louisiana’s breadth of involvement in the 1830s when it chartered three distinct types of banks: commercial banks that served merchants and manufacturers; improvement banks that financed various internal improvements projects; and property banks that extended long-term mortgage credit to planters and other property holders. Louisiana’s improvement banks included the New Orleans Canal and Banking Company that built a canal connecting Lake Ponchartrain to the Mississippi River. The Exchange and Banking Company and the New Orleans Improvement and Banking Company were required to build and operate hotels. The New Orleans Gas Light and Banking Company constructed and operated gas streetlights in New Orleans and five other cities. Finally, the Carrollton Railroad and Banking Company and the Atchafalaya Railroad and Banking Company were rail construction companies whose bank subsidiaries subsidized railroad construction.

“Commonwealth Ideal” and Inflationary Banking

Louisiana’s 1830s banking exuberance reflected what some historians label the “commonwealth ideal” of banking; that is, the promotion of the general welfare through the promotion of banks. Legislatures in the South and West, however, never demonstrated a greater commitment to the commonwealth ideal than during the tough times of the early 1820s. With the collapse of the post-war land boom in 1819, a political coalition of debt-strapped landowners lobbied legislatures throughout the region for relief and its focus was banking. Relief advocates lobbied for inflationary banking that would reduce the real burden of debts taken on during prior flush times.

Several western states responded to these calls and chartered state-subsidized and state-managed banks designed to reinflate their embattled economies. Chartered in 1821, the Bank of the Commonwealth of Kentucky loaned on mortgages at longer than customary periods and all Kentucky landowners were eligible for $1,000 loans. The loans allowed landowners to discharge their existing debts without being forced to liquidate their property at ruinously low prices. Although the bank’s notes were not redeemable into specie, they were given currency in two ways. First, they were accepted at the state treasury in tax payments. Second, the state passed a law that forced creditors to accept the notes in payment of existing debts or agree to delay collection for two years.

The commonwealth ideal was not unique to Kentucky. During the depression of the 1820s, Tennessee chartered the State Bank of Tennessee, Illinois chartered the State Bank of Illinois and Louisiana chartered the Louisiana State Bank. Although they took slightly different forms, they all had the same intent; namely, to relieve distressed and embarrassed farmers, planters and land owners. What all these banks shared in common was the notion that the state should promote the general welfare and economic growth. In this instance, and again during the depression of the 1840s, state-owned banks were organized to minimize the transfer of property when economic conditions demanded wholesale liquidation. Such liquidation would have been inefficient and imposed unnecessary hardship on a large fraction of the population. To the extent that hastily chartered relief banks forestalled inefficient liquidation, they served their purpose. Although most of these banks eventually became insolvent, requiring taxpayer bailouts, we cannot label them unsuccessful. They reinflated economies and allowed for an orderly disposal of property. Determining if the net benefits were positive or negative requires more research, but for the moment we are forced to accept the possibility that the region’s state-owned banks of the 1820s and 1840s advanced the commonweal.

Conclusion: Banks and Economic Growth

Despite notable differences in the specific form and structure of each region’s banking system, they were all aimed squarely at a common goal; namely, realizing that region’s economic potential. Banks helped achieve the goal in two ways. First, banks monetized economies, which reduced the costs of transacting and helped smooth consumption and production across time. It was no longer necessary for every farm family to inventory their entire harvest. They could sell most of it, and expend the proceeds on consumption goods as the need arose until the next harvest brought a new cash infusion. Crop and livestock inventories are prone to substantial losses and an increased use of money reduced them significantly. Second, banks provided credit, which unleashed entrepreneurial spirits and talents. A complete appreciation of early American banking recognizes the banks’ contribution to antebellum America’s economic growth.

Bibliographic Essay

Because of the large number of sources used to construct the essay, the essay was more readable and less cluttered by including a brief bibliographic essay. A full bibliography is included at the end.

Good general histories of antebellum banking include Dewey (1910), Fenstermaker (1965), Gouge (1833), Hammond (1957), Knox (1903), Redlich (1949), and Trescott (1963). If only one book is read on antebellum banking, Hammond’s (1957) Pulitzer-Prize winning book remains the best choice.

The literature on New England banking is not particularly large, and the more important historical interpretations of state-wide systems include Chadbourne (1936), Hasse (1946, 1957), Simonton (1971), Spencer (1949), and Stokes (1902). Gras (1937) does an excellent job of placing the history of a single bank within the larger regional and national context. In a recent book and a number of articles Lamoreaux (1994 and sources therein) provides a compelling and eminently readable reinterpretation of the region’s banking structure. Nathan Appleton (1831, 1856) provides a contemporary observer’s interpretation, while Walker (1857) provides an entertaining if perverse and satirical history of a fictional New England bank. Martin (1969) provides details of bank share prices and dividend payments from the establishment of the first banks in Boston through the end of the nineteenth century. Less technical studies of the Suffolk system include Lake (1947), Trivoli (1979) and Whitney (1878); more technical interpretations include Calomiris and Kahn (1996), Mullineaux (1987), and Rolnick, Smith and Weber (1998).

The literature on Middle Atlantic banking is huge, but the better state-level histories include Bryan (1899), Daniels (1976), and Holdsworth (1928). The better studies of individual banks include Adams (1978), Lewis (1882), Nevins (1934), and Wainwright (1953). Chaddock (1910) provides a general history of the Safety Fund system. Golembe (1960) places it in the context of modern deposit insurance, while Bodenhorn (1996) and Calomiris (1989) provide modern analyses. A recent revival of interest in free banking has brought about a veritable explosion in the number of studies on the subject, but the better introductory ones remain Rockoff (1974, 1985), Rolnick and Weber (1982, 1983), and Dwyer (1996).

The literature on southern and western banking is large and of highly variable quality, but I have found the following to be the most readable and useful general sources: Caldwell (1935), Duke (1895), Esary (1912), Golembe (1978), Huntington (1915), Green (1972), Lesesne (1970), Royalty (1979), Schweikart (1987) and Starnes (1931).

References and Further Reading

Adams, Donald R., Jr. Finance and Enterprise in Early America: A Study of Stephen Girard’s Bank, 1812-1831. Philadelphia: University of Pennsylvania Press, 1978.

Alter, George, Claudia Goldin and Elyce Rotella. “The Savings of Ordinary Americans: The Philadelphia Saving Fund Society in the Mid-Nineteenth-Century.” Journal of Economic History 54, no. 4 (December 1994): 735-67.

Appleton, Nathan. A Defence of Country Banks: Being a Reply to a Pamphlet Entitled ‘An Examination of the Banking System of Massachusetts, in Reference to the Renewal of the Bank Charters.’ Boston: Stimpson & Clapp, 1831.

Appleton, Nathan. Bank Bills or Paper Currency and the Banking System of Massachusetts with Remarks on Present High Prices. Boston: Little, Brown and Company, 1856.

Berry, Thomas Senior. Revised Annual Estimates of American Gross National Product: Preliminary Estimates of Four Major Components of Demand, 1789-1889. Richmond: University of Richmond Bostwick Paper No. 3, 1978.

Bodenhorn, Howard. “Zombie Banks and the Demise of New York’s Safety Fund.” Eastern Economic Journal 22, no. 1 (1996): 21-34.

Bodenhorn, Howard. “Private Banking in Antebellum Virginia: Thomas Branch & Sons of Petersburg.” Business History Review 71, no. 4 (1997): 513-42.

Bodenhorn, Howard. A History of Banking in Antebellum America: Financial Markets and Economic Development in an Era of Nation-Building. Cambridge and New York: Cambridge University Press, 2000.

Bodenhorn, Howard. State Banking in Early America: A New Economic History. New York: Oxford University Press, 2002.

Bryan, Alfred C. A History of State Banking in Maryland. Baltimore: Johns Hopkins University Press, 1899.

Caldwell, Stephen A. A Banking History of Louisiana. Baton Rouge: Louisiana State University Press, 1935.

Calomiris, Charles W. “Deposit Insurance: Lessons from the Record.” Federal Reserve Bank of Chicago Economic Perspectives 13 (1989): 10-30.

Calomiris, Charles W., and Charles Kahn. “The Efficiency of Self-Regulated Payments Systems: Learnings from the Suffolk System.” Journal of Money, Credit, and Banking 28, no. 4 (1996): 766-97.

Chadbourne, Walter W. A History of Banking in Maine, 1799-1930. Orono: University of Maine Press, 1936.

Chaddock, Robert E. The Safety Fund Banking System in New York, 1829-1866. Washington, D.C.: Government Printing Office, 1910.

Daniels, Belden L. Pennsylvania: Birthplace of Banking in America. Harrisburg: Pennsylvania Bankers Association, 1976.

Davis, Lance, and Robert E. Gallman. “Capital Formation in the United States during the Nineteenth Century.” In Cambridge Economic History of Europe (Vol. 7, Part 2), edited by Peter Mathias and M.M. Postan, 1-69. Cambridge: Cambridge University Press, 1978.

Davis, Lance, and Robert E. Gallman. “Savings, Investment, and Economic Growth: The United States in the Nineteenth Century.” In Capitalism in Context: Essays on Economic Development and Cultural Change in Honor of R.M. Hartwell, edited by John A. James and Mark Thomas, 202-29. Chicago: University of Chicago Press, 1994.

Dewey, Davis R. State Banking before the Civil War. Washington, D.C.: Government Printing Office, 1910.

Duke, Basil W. History of the Bank of Kentucky, 1792-1895. Louisville: J.P. Morton, 1895.

Dwyer, Gerald P., Jr. “Wildcat Banking, Banking Panics, and Free Banking in the United States.” Federal Reserve Bank of Atlanta Economic Review 81, no. 3 (1996): 1-20.

Engerman, Stanley L., and Robert E. Gallman. “U.S. Economic Growth, 1783-1860.” Research in Economic History 8 (1983): 1-46.

Esary, Logan. State Banking in Indiana, 1814-1873. Indiana University Studies No. 15. Bloomington: Indiana University Press, 1912.

Fenstermaker, J. Van. The Development of American Commercial Banking, 1782-1837. Kent, Ohio: Kent State University, 1965.

Fenstermaker, J. Van, and John E. Filer. “Impact of the First and Second Banks of the United States and the Suffolk System on New England Bank Money, 1791-1837.” Journal of Money, Credit, and Banking 18, no. 1 (1986): 28-40.

Friedman, Milton, and Anna J. Schwartz. “Has the Government Any Role in Money?” Journal of Monetary Economics 17, no. 1 (1986): 37-62.

Gallman, Robert E. “American Economic Growth before the Civil War: The Testimony of the Capital Stock Estimates.” In American Economic Growth and Standards of Living before the Civil War, edited by Robert E. Gallman and John Joseph Wallis, 79-115. Chicago: University of Chicago Press, 1992.

Goldsmith, Raymond. Financial Structure and Development. New Haven: Yale University Press, 1969.

Golembe, Carter H. “The Deposit Insurance Legislation of 1933: An Examination of its Antecedents and Purposes.” Political Science Quarterly 76, no. 2 (1960): 181-200.

Golembe, Carter H. State Banks and the Economic Development of the West. New York: Arno Press, 1978.

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¹ Banknotes were small demonination IOUs printed by banks and circulated as currency. Modern U.S. money are simply banknotes issued by the Federal Reserve Bank, which has a monopoly privilege in the issue of legal tender currency. In antebellum American, when a bank made a loan, the borrower was typically handed banknotes with a face value equal to the dollar value of the loan. The borrower then spent these banknotes in purchasing goods and services, putting them into circulation. Contemporary law held that banks were required to redeem banknotes into gold and silver legal tender on demand. Banks found it profitable to issue notes because they typically held about 30 percent of the total value of banknotes in circulation as reserves. Thus, banks were able to leverage $30 in gold and silver into $100 in loans that returned about 7 percent interest on average.

² Paul Lockard (2000) challenges Lamoreaux’s interpretation. In a study of 4 banks in the Connecticut River valley, Lockard finds that insiders did not dominate these banks’ resources. As provocative as Lockard’s findings are, he draws conclusions from a small and unrepresentative sample. Two of his four sample banks were savings banks, which were designed as quasi-charitable organizations designed to encourage savings by the working classes and provide small loans. Thus, Lockard’s sample is effectively reduced to two banks. At these two banks, he identifies about 10 percent of loans as insider loans, but readily admits that he cannot always distinguish between insiders and outsiders. For a recent study of how early Americans used savings banks, see Alter, Goldin and Rotella (1994). The literature on savings banks is so large that it cannot be be given its due here.

³ Interbank clearing involves the settling of balances between banks. Modern banks cash checks drawn on other banks and credit the funds to the depositor. The Federal Reserve system provides clearing services between banks. The accepting bank sends the checks to the Federal Reserve, who credits the sending bank’s accounts and sends the checks back to the bank on which they were drawn for reimbursement. In the antebellum era, interbank clearing involved sending banknotes back to issuing banks. Because New England had so many small and scattered banks, the costs of returning banknotes to their issuers were large and sometimes avoided by recirculating notes of distant banks rather than returning them. Regular clearings and redemptions served an important purpose, however, because they kept banks in touch with the current market conditions. A massive redemption of notes was indicative of a declining demand for money and credit. Because the bank’s reserves were drawn down with the redemptions, it was forced to reduce its volume of loans in accord with changing demand conditions.

⁴ The law held that banknotes were redeemable on demand into gold or silver coin or bullion. If a bank refused to redeem even a single $1 banknote, the banknote holder could have the bank closed and liquidated to recover his or her claim against it.

⁵ Rappaport (1996) found that the bank’s loans were about equally divided between insiders (shareholders and shareholders’ family and business associates) and outsiders, but nonshareholders received loans about 30 percent smaller than shareholders. The issue remains about whether this bank was an “insider” bank, and depends largely on one’s definition. Any modern bank which made half of its loans to shareholders and their families would be viewed as an “insider” bank. It is less clear where the line can be usefully drawn for antebellum banks.

⁶ Real-bills lending followed from a nineteenth-century banking philosophy, which held that bank lending should be used to finance the warehousing or wholesaling of already-produced goods. Loans made on these bases were thought to be self-liquidating in that the loan was made against readily sold collateral actually in the hands of a merchant. Under the real-bills doctrine, the banks’ proper functions were to bridge the gap between production and retail sale of goods. A strict adherence to real-bills tenets excluded loans on property (mortgages), loans on goods in process (trade credit), or loans to start-up firms (venture capital). Thus, real-bills lending prescribed a limited role for banks and bank credit. Few banks were strict adherents to the doctrine, but many followed it in large part.

⁷ Robert E. Wright (1998) offers a different interpretation, but notes that Burr pushed the bill through at the end of a busy legislative session so that many legislators voted on the bill without having read it thoroughly

Citation: Bodenhorn, Howard. “Antebellum Banking in the United States”. EH.Net Encyclopedia, edited by Robert Whaples. March 26, 2008. URL http://eh.net/encyclopedia/antebellum-banking-in-the-united-states/