The Destruction of the Second Bank of the United States (2024)

Gareth Davis
Senior Sophister

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I have always been afraid of banks Andrew Jackson

Few greater enormities are chargeable to politicians than the destruction ofthe bank of the United States R Caterall

The motivation behind this paper is to analyse from the perspective of ahistorian of economic thought and policy the rationale and implications of thedestruction of the Second bank of the United States. The account is valuableas an account of the way in which economic thought, political ideology andvested interests can combine to shape policy. The debate also raised issueswhich are relevant to our modern economic system. The case for statesupervision over the banking system is considered by almost all economists asto be so self-evident. But this has not always been the case and the debateover the banks future is a pointed reminder of this fact. Some of thearguments furnished against the bank may challenge some of the complacentlyheld axioms of modern thought.

Other issues of this period relevant today include the benefits or otherwise ofinter-regional monetary union. (Frass (1974) has shown how the BUS acted tostandardise local regional exchange rates and nominal price levels and theeffect which this had on peripheral areas.) Likewise the conflict laid baresome differing, and still widely held, preconceptions regarding both theoptimal and the legitimate magnitude of government intervention. This accountmay not offer exact policy prescriptions for modern economists, since theeconomy, society and prevailing values have changed so much, but they can offerfresh perspectives to modern thinkers.

TheBanks Destruction In Historical Context

The second Bank of the United States (BUS) was founded in 1816 on the basis ofa twenty year charter. This charter empowered the bank to act exclusively asthe federal governments fiscal agent, holding its deposits, making inter-statetransfers of federal funds and dealing with any payments or receipts with whichthe federal authorities would be involved. Like all other chartered banks, theBUS also had the right to issue bank notes on the basis of a fractional reservesystem and to carry out the usual commercial banking activities. In return forthese privileges certain conduct of a central bank-like nature was expected ofthis institution: in the words of the charter the bank will conciliate and leadthe state banks in all that is necessary for the restoration of credit, publicand private.[45] Despite being 80%privately owned, its operations were subject to supervision by Congress and thePresident. Pessen gives details which show the banks size and the nature ofthe activities immediately prior to the assault on it in 1830. It was largerelative to other banks, responsible for 15-20% of bank lending in the USA andaccounting for 40% of the bank notes then in circulation. It was cautious inits note issuing function, holding a specie reserve of 50% of the value of itsnotes whilst the norm for the remainder of the banking system was 10-25%.

The 1820s and 1830s in the United States were a time of extremely rapid, butalso volatile economic growth. New natural resources were being exploited asthe frontier expanded and the new techniques of the industrial revolution werebeing introduced. The old money supply of gold and silver specie was stretchedand found inadequate for the liquidity needs of the growing economy. (Teminindicates that in 1830 the total value of the gold and silver specie incirculation in the economy amounted to only l/30th to l/50th the value of GNP.)The emergence of a number of banks operating fractional reserve note-issuingsystems was the result. The notes were underwritten by varying proportions ofspecie and although not legal tender were widely accepted in payment for debts,although usually discounted below their par value.

The quality of bank notes varied. Fraud was commonplace by unscrupulousbankers who could persuade or bribe the local state legislature to grant themthe charter necessary to commence a banking business. For instance Pessennotes that in 1828 the 17 banks chartered in Mississippi circulated notes witha face value of $6 million from a specie base of $303,000. It was in such anenvironment that the Bank of the United States operated. One of its functionswas to discipline and support state banks. As the federal governments fiscalagent it received bank notes in payment for taxes. The BUS would then presentthese to the issuing state bank in order to redeem them for the gold necessaryto pay the taxes it had collected to the federal treasury. In this way statebanks were forced to keep a higher stock of specie on reserve than wouldotherwise be necessary.[46] Conversely theU.S. could also act as a lender of last resort to banks in trouble by notpresenting these notes for redemption but rather allowing these banks to runinto debt to it.

The political environment of that period was marked by the ascendancy of anideology termed Jacksonism. Focused around Andrew Jackson, elected presidentin 1828, this ideology was an uncomfortable, perhaps inconsistent, mixture ofa*grarianism, nationalism, populism and libertarianism. However the one elementwhich unified this group was a deep hostility to a privileged east-coast basedaristocracy. The Philadelphia-based bank of the United States with itsobviously patrician president, Nicholas Biddle, could hardly prove to bepopular with this new regime.

The Jackson administrations assault on the bank began in 1830. In 1832 Jacksonused his presidential veto to thwart the Banks supporters attempt to useCongress to enact a new charter for the Bank. Jackson then used his secondpresidential election victory later that year as a mandate to order thewithdrawal of all federal funds from the bank in 1833. When the Banks originalcharter expired in 1836 it succeeded in being re-chartered, albeit now only onas a much reduced state bank under the auspices of the Penneslvyania statelegislature as the United States bank of Penneslvyania. In 1841 it wentbankrupt as a result of speculative dabbling in the cotton market. I shall nowconsider the motives which inspired the attack on this institution.

TheAnatomy Of The Anti-Bank Forces: Vested interests

The role played by vested interests in motivating the anti-bank forces has beengiven particular emphasis by both Caterall (1902) and Hammond (1947). Theypoint to the substantial personal gains which would accrue to key members ofJacksons administration should the bank be destroyed. Hammond ascribes animportant role to the New York financial community which at the time wascompeting with Philadelphia to be the countrys premier commercial centre.Martin Van Buren, Jacksons 2nd vice-president and eventual successor wasparticularly identified with the Wall Street element in this Wall Street (NewYork) versus Chestnut Street (Philadelphia) battle.

Both Pessen and Hammond add an additional group to this coalition; the statebanks, who disliked being constrained by the BUSs policy of redeeming theirbank notes. This enforced a much higher reserve ratio and hence restrictedtheir lending activities. Hammond also adds to this element the class ofnouveau riche entrepreneurs and speculators, a class to which, he maintained,Jackson and many of his associates belonged, and which also disliked therestriction of credit. However, I would argue that the importance of thisproposed group in effecting the banks destruction has been over-emphasised bypro-BUS writers such as Hammond and Caterall.

Firstly, the actual existence of such a coalition is questionable. Pessengives evidence that the New York financial community were divided over thequestion of the wisdom of the attack on the Bank. Also he shows that at leastsome of the state banks grudgingly acknowledged one banks role in discipliningthe banking system and its activities as a lender of last resort. Thehom*ogeneity of Hammonds speculative entrepreneurial class is one for which heoffers merely anecdotal evidence and no quantitative evidence. Secondly, toconcentrate upon vested interests is to ignore the other influences onpolitical action. Ideologies and economic logic also play a role. Hammond,the primary exponent of the self-interest theory, fails to explainsatisfactorily why the measure was extremely popular.[47] Only a tiny proportion of the populationwould have gained directly and immediately from the destruction of theinstitution. We must examine the political philosophy and economic logicbehind the opposition of the bank. These arguments had much public supportwhich was vital to Jacksons destruction of the bank.

ThePolitical Ideologies

The ideology which underlay the struggle is a highly variegated, and perhapsultimately inconsistent one. It was a blend of moral judgements, economicargument and populism to attack both the political legitimacy of the bank andits economic rationale.

One branch of the school consisted of states rights advocates, who stronglyopposed the substantial power wielded by the federally-chartered bank.[48] Many considered the chartering of thebank an unconstitutional extension of the power of the federal congress. Theirposition was summarised by Jackson who described the bank as a threat todemocratic institutions by the federal authorities. With the destruction ofthe bank, the power of intervention in the banking and monetary system was leftin the hands of individual states until the civil war.

Another stream within the anti-bank framework were the libertarian thinkers.They postulated the illegitimacy (on moral grounds) of any governmentintervention in the economy or in society beyond a bare minimum. This periodwas the golden age of Laissez Faire. This group was related to and associatedwith the Free Banking school which challenged on economic grounds the necessityof government intervention in the monetary system.

TheFree Bankers

This group were in favour of a paper currency based on a fractional reservesystem. They argued that the banks regulatory function was unnecessary andinefficient because in a completely unregulated financial system freecompetition would ensure that the public receives whatever security againstfraud it so desires.[49] They argued thatwhat was wrong with the banking system was that free competition was obstructedby the monopolistic privileges granted to the BUS in its charter. It isimportant to place these views in the context of the dominant economic paradigmof the day. Today as I have outlined, the importance of the states role inregulating the money supply is considered self-evident by most economists.(Hayek, Glasner and Greenfield and Yeager being some noteworthy exceptions tothis consensus.)

This was not the case in 1832. We have Schumpeters (1954) comment that in thefirst part of the 19th century most economists believed in the merit of aprivately provided and competitively supplied currency. Glasner shows howSmith differed from Hume in advocating state non-intervention in the supply ofmoney. Smith argued that a convertible paper money could not be issued toexcess by privately owned banks in a competitive banking environment. Today wesee money as a natural public good owing to the externalities caused byvariations in its quantity. So the free bankers views were consistent witheconomic logic of the day.

TheHard Money School

The anti-monopolistic and anti-regulatory free banking school were joined byunlikely bed fellows from the opposite end of the spectrum of economic ideas,agrarian and proletarian mistrust of banks in general and paper money inparticular. This mistrust may have been justified in the context of thewidespread level of fraud within the system, relative to today. Many saw papermoney as a tool used by employers and rich financiers to trick working men andfarmers out of what was due to them.

This groups most prominent exponent was Andrew Jackson himself. In hisfarewell speech he refers to the paper money system and its natural associatesmonopoly and exclusive privilege. The value of paper, he states, is liable togreat and sudden fluctuations and cannot be relied upon to keep the medium ofexchange uniform in amount. Jacksons views on this topic may be due to anincident early in his career when he was almost bankrupted after accepting banknotes which turned out to be worthless in return for a debt.

In contrast to the free-banking school this group could be termed conservative,wishing to destroy the system of fractional reserve paper money by removing thekingpin of the banking system which produced it; the Bank of the United States.Even within this group there was a severe division between those advocatinggold specie, those advocating a silver specie, and those advocating abi-metallic medium of exchange.

TheBattle Of Ideas And Its Outcome

Thus, was the coalition against the bank of the United States. Both advocatesof the free banking (or soft money) school and proponents of a return to aspecie economy (or hard money) saw the destruction of the bank as veryimportant, but for both of them, its destruction was a means to divergent andconflicting ends. Against this coalition supporters of the bank such as itspresident Nicholas Biddle and politicians such as Henry Clay and John QuincyAdams were placed in extreme difficulty. Both anti-federalism andlaissez-faire were in the ascendancy at the time.[50] On the economic front the bank was beingassaulted from both the left (free-banking advocates) and from the right(anti-paper advocates).

Advocates for the bank did emphasise its moderating role in regulating,informally, the fractional reserve system and hence its publicly-interestedcentral-bank type nature. Such arguments were almost certain to fall on barrenground. Only two major institutions were available for comparison. The firstone was John Laws bank from early 18th century France, and the chaotic andinflationary experience of this scheme was hardly one to inspire confidence.The other example was the Bank of England which was at the time subject toscathing attacks during the bullionist controversy, (Hammond (1947) andGlastner (1989)).

EvaluatingThe Arguments

The final verdict on the validity or otherwise of the differing arguments mustwait until the consequences of the banks destruction have been fullyconsidered. However the following points can be made at this stage. Firstly,the arguments of those opposed to the banks existence on ethical grounds,namely the classic libertarians and the states rights advocates, cannot beassailed on empirical grounds given that they are normative judgements.

Secondly, those who attack the bank on the grounds that it was a predatorymonopolist within the banking system have had their arguments somewhat refutedby the evidence garnered by Highfield, OHara and Wood, who carried out asystematic econometric survey with regards to the banks decision variablesduring its existence and found no evidence that its dealings with itscompetitor banks or with its markets were marked by any of the predatorypractices associated with monopolists. However perhaps the anti-bank forcescould argue that it was the banks potential as a monopolist rather than itsactual behaviour which justified the withdrawal of its charter. Themethodology of such evidence and the quality of the data upon which they arebased may also be attacked but such studies must be considered none the less.

TheImplications Of The Banks Destruction For Output And Employment

Firstly, over the period 1790 to 1860 the general movement in the price levelwas downwards (with some fluctuations). Output followed a similar fluctuatingand variable pattern over the same period, albeit with a strong upward trend.The pattern over the 1830s and 1840s diverges somewhat from this . The period1830 until end of 1833 was marked by a slight though pronounceable upward trendin prices. 1833 marked the withdrawal of federal deposits from the bank and inearly 1834 Nicholas Biddle, trying to convince the government of the need forthe bank, massively contracted credit. The result was a short sharp fall inprices and output in what was termed Biddles contraction. However, by late1834 prices, output and the money supply were strongly rising as boom-likeconditions prevailed once again. In 1837 this upward movement was againsharply reversed. It was not until the early 1840s that output began to expandsignificantly once again. Over this period of the 1840s the money supply alsobegan to grow once again, although more moderately such that the extra outputseemed sufficient enough to soak it up, and so the price level resumed its longterm downward path.

There are two different interpretations of these events. The first one,expounded by Hammond and Caterall, blames Jacksons actions in destroying thebank for the inflationary boom and resultant recession over the period 1834 to1837. In their view, dismantling the BUS took a restraint off the fractionalreserve system and led, post-1834, to an increase in the money supply whichcaused the boom. Of course, this was checked in 1837 by a downturn, a downturnmade worse by the fact that at this stage the banking system, due to its lowreserve ratio, was now very unstable and experienced significant levels of bankcollapse. On the face of it the hypothesis has some factual support. Over theperiod 1833 to 1837 the amount of bank notes in circulation rose from a valueof $10.2 million to $149.2 million.

However data from Temin and Engerman show that the banks aggregated reserveratio did not fall over 1834-1837. It had remained steady from the mid-1820s.Thus, the BUSs demise had not caused the money supply to rise by allowingreserve ratios to fall.

An alternative hypothesis was advanced by Temin. He argued that monetaryexpansion did not come from a falling reserve ratio but rather from an inflowof silver into the United States in the 1830s. He backs his argument up byshowing how this inflow in the 1830s would have resulted from increased silverproduction in Mexico, from an increase in British investment in America andfrom the fall in US imports of opium from China, which stopped the outflow ofsilver. So it is possible to dismiss the relationship between the Banks demiseand the panic of 1837 as a coincidence.

TheRegional Dimension: Monetary Union For The USA

Frass (1974) notes how the bank acted under a congressional mandate toestablish and maintain a uniform national currency by policing the state banksto ensure that convertibility was maintained at a high level. Using data fromOhio, Frass argues that this involved restricting the lending of banks alongthe western frontier in particular. This, as well as having adverse effects initself in a capital-scarce region, depressed the general price level in thisarea relative to the price of unsettled land (which was set arbitrarily byCongress), and discouraged movement to settlement in these areas.

Frass study does not extend beyond 1834 but we can assume that the removal ofthe bank led to the cessation of these harmful activities. However, we mustnote that a trade off would have had to be made. A higher level of financialinstability may have been the price paid for freer availability of capital andcheaper land in these peripheral regions.

TheLong Term Impact On Americas Monetary And Financial Structure

Ultimately the Banks destruction marked a pyhrric victory for the hard moneyforces. Van Buren, Jacksons successor, was no supporter of a purely metalliccurrency. Return to a purely metallic currency would have met severeopposition from their former allies, the free banking and libertarian schools(the latter felt that the state had no ethical right to regulate any commercialtransactions between consenting individuals including paper currency). Thechanging economic and social structure would have made it unfeasible to returnto a purely specie exchange economy. Cameron posits that a medium of exchangebased on bank liabilities and a fractional reserve system and/or governmenttaxable capacity is essential to an industrialising economy. Abolishing papermoney could be considered, the modern economic equivalent of attempting todis-invent the wheel. The true victors then in the struggle were soft money orfree banking advocates. Instead of destroying the fractional reserve systemthe hard money men had removed a force which acted to restrain it.

Similarly, after 1837 the reserve ratio of the banking system was much higherthan it had been during the period of the BUSs existence. This reflectedpublic mistrust of banks in the wake of the panic of 1837 when many banksfailed. This lack of confidence in the paper money system, could have beenameliorated by a central-bank type institution. Hence one result of the demiseof this bank may in fact have been a higher reserve ratio, less availability ofcredit and a lower money supply during the 1840s and 1850s. The evolution ofthe American banking system was also probably affected. The BUS was one of thefirst and last banks chartered by the federal authorities for commercialbanking activities nation-wide. Had it survived it is unlikely that Americasretail banking market today would have been so localised and fragmented in away which is extremely uncharacteristic of other large industrialisedeconomics. After the banks destruction, banking returned to being adecentralised business in which institutions were chartered by the individualstates.

The banks defeat also had profound implications for the role of the state inAmerica in managing monetary policy. Large scale Federal intervention in thesupply of money did not take place again until the American Civil War. HoweverJacksons victory had imbued US political culture with dislike of centralisedinstitutions with large influence over the banking system. The United Statesdid not develop a central banking agency until 1913. This institution washighly decentralised consisting of twelve autonomous components one in each ofAmericas largest cities. One result of this de-centralisation may have beenthe incoherent response of the monetary authorities to the 1929 crash and theresultant run on the banking system, possibly one cause of the 1930s greatdepression. Hence one interpretation might see the destruction of the bank ofthe United States as leading to the worlds most severe economic recession acentury later.

Conclusion:The Case For Further Study

This topic offers an area where rich analytic rewards may be reaped by furtherstudies which employ modern economic techniques. The episode marks a cruciallyformative event during the nascent period of the monetary system of what iscurrently the worlds dominant economy. In spite of these facts this subjecthas been much neglected, the attention given to the English Bullionistcontroversy. In over twenty-five years not one book has been published dealingspecifically with this topic. This paper, I hope, contributes to correctingthis deficiency.

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