History Repeating Itself

In the aftermath of the dissolution of the First Bank of the United States the individual states continued to charter and regulate banks. Paul Johnson writes [P285]: “Each state bank was allowed by the state legislature to issue bills up to three times its capital … literally a license to print money. During the War of 1812 America was awash with suspect $2 and $5 bills … Such gold as there was flowed straight into Boston, whose state banks were the most secure … [by 1814] every bank outside New England was forced to suspend payment.”

The Federal debt incurred by the War of 1812 and the nationalism that follows war led to an abandonment of the constitutional objections to a Second Bank of the United States, which was created as a national monopoly to bring about the discipline of specie-backed bank notes. It did just the opposite.

After initially restraining the state banks, William Jones, the bank President reversed course. Sean Wilentz describes Jones’ new outlook [P206]: “The original BUS [Bank of the United States] … had been too conservative in its credit operations.” Thus, a new credit expansion was born. “Rather than force state banks to curtail their inflated emissions of notes and loans, Jones approved lavish lending, especially by its new branches on the western urban frontier. By putting so many BUS notes into circulation, Jones abdicated the leverage he had had over the state banks early in 1817—for no longer could the national bank demand specie payments without being pressed for such payments in return.”

Paul Johnson explains the effect of this policy [P285]. “Indeed, he managed to create a fragile boom which was a miniature foretaste of the Wall Street boom on the 1920s leading to the crash of 1929. Jones’ boom was in land. From 1815 the price of American cotton rose rapidly and that in turn fed the land boom. At that time public land was sold primarily to raise revenue rather than to encourage settlers, who needed no encouragement anyway. Each was charged $2 an acre in minimum blocks of 160 acres. But they only had to put 20 percent down, borrowing the rest form the banks on the security of the property. The $2 was a minimum; in the South potential cotton land was sold at $100 an acre in the boom years. The SBUS, fueling the boom by easy credit, allowed purchasers to pay even the second installment on credit, again raised on the security of the land, like a second mortgage.”

“Jones … ran this federal central bank like a bucket-shop. He actually allowed the SBUS to deal in ‘racers,’ short for Race Horse Bills. These were bills of exchange paid for by other bills of exchange, which thus raced around rapidly from one debtor to another, accumulating interest charges and yielding less and less of their face value.”

“Jones’ easy-credit policy was further undermined by the activities of the SBUS’s branch offices… In Baltimore the branch was run by two land speculators … who financed their speculations by taking out unsecured loans from their own bank… Here was a typical example of the general credit expansion Jones encouraged, raising the debt on public land from $3 million in 1814 to over five times that amount ($16.8 million) three years later. Some of this went into house purchases—it was the first urban boom in the US history too.”

Of course it was not to last. “Suddenly, the cotton bubble burst, as Liverpool cotton importers, alarmed by the high prices, started shipping in Indian raw cotton in huge quantities. In December-January 1819 the price of New Orleans cotton halved, and this in turn hit land prices, which fell from 50 to 75 percent. The banks found themselves with collateral in land worth only a fraction of their loans, which were now irrecoverable. Jones compounded his earlier errors of inflation by abruptly switching to savage deflation, ordering the branches of the SBUS to accept only its own notes …”

The result was the Panic of 1819 and following depression.