The Antebellum Financial System

1. The Antebellum Financial System November 13, 2007

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

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

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

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

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

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

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

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

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

13. The First and Second Banks of the United States • First attempts at Central Banking • First Bank of the United States: 1791 – 1811 • Second Bank of the United States: 1816 - 1836

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

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

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

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

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

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

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

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

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

25. Rochester Area Albany Area New York City 4 New York Savings Banks, 1819 - 1834 • One Savings Bank • Multiple Savings Banks 4

26. 4 New York Savings Banks, 1819 - 1834 • One Savings Bank • Multiple Savings Banks • Erie Canal 4 Rochester Area Albany Area New York City

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