Chapter 6: Money and Banking
6.2 How Freedom in Money and Banking Was Lost
We are all familiar with this present financial crisis which began in 2008. Most people have heard that this event is “unprecedented” except for the Great Depression of the 1930s. This is largely nonsense. Due to our limited historical experience and our short historical memories, we either do not know or have forgotten the many financial bubbles and bank bailouts caused mostly by dishonest banking and money all throughout American history. Today is just a variation on the same old theme—played particularly loudly. Here are the true stories of how freedom in money and banking were lost in America.
Like the story of taxation and centralization in general in America, the history of money involves ratcheting tyranny. And like the story of taxation, an honest money and banking system has rarely existed in the United States. We could be picky about the point at which we start the criticism and the first acts to blame, but for all practical purposes it doesn’t matter. The point is that with few exceptions, most influential American banks 1) have never remained honest, 2) have never been forced to be honest, and 3) have actually been encouraged and promoted in their dishonesty by the government itself.
This has been especially true when the governments have been a partner in the money and banking business. Instead of providing a primary service which States should do—the enforcement of contracts—the State and Federal governments have done just the opposite. They have created moral hazard by engaging in fractional reserve banking and inflating the paper and/or digital money supply time and again. In times when private banks have inflated their bank notes against the amount of hard currency held in reserve, the State should have upheld any suit against the bank for theft by fraud. The bank should have been liable for any losses. Instead, more often than not, the scenario has been allowed reach crisis status, and the crisis has been used to justify further fiat currency, and the creation of central banks that also create more paper. This is often coupled with the government-enforced forbiddance of any redemption of paper for hard currency. In other words, the government often refused to punish the fraudulent banking practice, refused to uphold the contract between the client and the bank, and instead enforced the exact opposite of the contract—that the people cannot redeem their bank or state-issued paper for gold or silver.
This has been true of private banks, State banks, and all nationally-chartered Federal banks. Most modern discussions of this topic evade this fact because they are politically motivated. Most people today read the modern Republican-Democrat, conservative-liberal divide back into the nineteenth century (with some justification), then choose sides, and then try to paint the other side with as many warts as possible. Like modern politics, the one who emerges with the least mud on their face is supposed to be the “good guys.” Problem: both guys are covered in mud. Both sides have historically prostituted themselves to the fraudulent banking system. Colonial banks did it, the Continental Congress did it. Hamilton did it, Jefferson did it. Lincoln did it, the Confederate States did it. Republican Progressives did it, Wilsonian Liberal Progressives did it. Republicans love the Fed, Democrats love the Fed. Only a handful of politicians, historically, have opposed the system in general: Andrew Jackson was one; he inspired a whole party to oppose fractional reserve banking at one time. Ron Paul today is another.
From very early, the national Congress tried to decree wealth into existence. When it failed, they tried to impose legal tender laws—forcing people by law to accept paper money according to its face value, despite its declining worth. When this failed, the notes eventually sank into oblivion, and Congress eventually gave up. Speculators bought the notes for fractions of a penny on the dollar. From just the one very early example of the Continental paper dollar, the Philadelphia merchant and astute observer Peletiah Webster noted: “Perhaps this whole transaction affords the most striking proof conceivable, of the absurdity of all attempts to fix the value of money by a law, or any other methods of compulsion.”1 When later Congress considered a resolve to forgo even interest payments on their worthless paper, the great minister and statesman John Witherspoon stood and decried “the last stab at public credit.” A government, he iterated, without honest money and banking should not be trusted in any other matter either: “It will be in vain, in [the] future, to ask the public to believe any promise we shall make—even when the most clear and explicit grounds of confidence are produced.”2
This early and very tragic lesson was immediately ignored, and has been ignored countless times over and again since. How was freedom in money and banking lost? Here’s a partial list:
It was lost with the Bank of North America in 1781.
It was lost with the first Bank of the United States in 1791.
It was lost with the second Bank of United States in 1816.
It was lost with Lincoln’s National Bank system in 1861 and forward.
It was lost with the Federal Reserve Bank in 1913.
It was lost with countless government attempts to manipulate the value of money by decree: whether Continentals, Greenbacks, Federal Reserve Notes, or other.
It is lost every time a single bank or government agency inflates the money supply by fiat, and the government refuses to stop the fraud.
It has been lost in modern times as the Dollar has lost 96 percent of its purchasing power since the Federal Reserve takeover in 1913. It takes almost $100 today to buy what $1 would buy in 1913.
It was lost in every government-enforced refusal of banks to redeem their paper for gold or silver: 1814, 1837, 1861, 1933, 1971, an others.
It was lost when Roosevelt confiscated the entire nation’s gold supply by executive order. He grabbed it for a government-mandated price of $20.67/oz, and then began selling it to foreign governments and banks nine months later for $35/oz. This executive tyranny was joined by congressional action in 1934. Thus did the federal government realize a return of 69 percent, by decree, on the gold it stole from the American people. (The Gold Reserve Act of 1934 also invalidated many contracts retroactively, thus illegally creating a virtual ex post facto law.)
It was lost in 1971 when Nixon unhinged the dollar from the last remaining vestige of a gold exchange standard, refusing the redemption of international debts for gold coin. This act floated the dollar completely. The result has been the exponential skyrocketing of the national debt ever since (a graph of the national debt shows an exponential curve upward beginning roughly in the early 1970s).
Need we say more? Is this not enough to show how honest money and banking have been long lost and kept lost in American history?
For those who desire some more specifics, we can oblige. Space is not warranted here to tell the whole story, but here are some brief and partial historical highlights:3
Under the First B.U.S. (1791-1811), designed by Hamilton, the number of paper-issuing banks jumped from three to 18. The paper currency supply was immediately inflated. Wholesale prices rose 72 percent over the space of a five years. The Jeffersonians, who ostensibly opposed the process, were worse when they controlled it. Instead of abolishing the system (which would have been more consistent with their purported views of liberty), they subsequently ballooned the number of banks to 117. By the end of the first Bank’s twenty-year charter, roughly four paper dollars were circulating for every dollar of metal in reserve. In other words, what was a dollar twenty years prior was now worth 25 cents.
While there was an interim between to first and second Banks of the U.S., the federal and state governments were by no means inactive in manipulating the money supply. Indeed, this is where there greatest mistakes were made. First was the reaction of the easy-money addicts to the failure of an immediate re-charter. Second was the decision to enter and then finance the War of 1812.
When the charter of the first bank was up, Madison was president. He had opposed the first bank originally on more than one ground, not the least of which was his strict constructionist view of the Constitution. A very slight majority in Congress opposed the re-charter as well. While many today think the central bank’s purpose was to control the inflationary wildness of State and local banks, the political support for re-charter at the time overturns this view: support from State banks, as well as the subsidized merchants, was overwhelming. Indeed, Hamilton’s own Bank of New York applauded the institution specifically for its bail-out potential:
[It was able] in case of any sudden pressure upon the merchants to step forward to their aid in a degree which the state institutions were unable to do.4
The bill for re-charter nevertheless failed. This did not deter the Federal government from encouraging more fiat paper. Congress simply turned to State banks and local banks. In doing so, the government perpetuated and exacerbated regional animosities. New England banks opposed a war with Britain, and were fairly conservative on inflation. But the government needed inflation to finance its war and to buy arms and supplies manufactured mostly in the North. So, the administration encouraged the proliferation of new government-friendly, fiat-friendly banks throughout the middle, southern, and western colonies. These banks inflated wildly in exchange for government debt. The government then took the loans and bought the manufactured goods in the North. Thus, in this interim period, 1811–1815, the number of banks jumped to 212. In addition to these, the government’s wartime measures allowed for 35 unincorporated banks which were otherwise illegal in most States.
The inflation ratio during this period grew from 4:1 to 6:1 paper-to-specie. But this does not really capture the picture. It was really a federal-government-driven regional war of newly created banks against New England banking integrity (what there was of it). The regional results are disturbing: the inflation ratio in Massachusetts was less than 2:1. Rhode Island was around 2.4:1, and New Hampshire was at 2.7:1. Pennsylvania, however, had ballooned to over 19:1, and South Carolina and Virginia were well above 18:1 each. So the comparison shows how much the federal government was using new banks as fronts to steal the wealth of its political opposition in the North.
This situation was completely unsustainable, of course. When the New England banks went calling upon the paper-issuing banks to redeem their currency, a massive shakeup was on the horizon. There was no way these massively counterfeiting banks could sustain covering while at 19:1. They clearly faced bankruptcy.
Not to fear: the government stepped in with a bank bailout. It was by no means the first, but definitely was a massive bailout by the government. While there was, of course, no Federal Reserve to inject yet more fiat reserves as today, the bailout simply came in another form: the federal and implicated State governments colluded and declared that banks in their States were no longer required to redeem in specie. It was that simple. When fraudulent behavior faced exposure, the government protected fraud and outlawed exposure—at the expense of the defrauded. It was almost exactly the same scenario as the big banks today faced in 2008. The solution was mildly different, but the result was the same: protect and encourage fraud.
In short, in one of the most flagrant violations of property rights in American history, the banks were permitted to waive their contractual obligations to pay in specie while they themselves could expand their loans and operations and force their own debtors to repay their loans as usual.5
As I said earlier, instead of enforcing contracts and ending the fraud, the government did just the opposite. And as a result, this moral hazard led to more of the same fraudulent behavior: in the following year, the number of paper-issuing banks jumped yet again, to 246, accompanied by further inflation. Again, during this period, wholesale prices jumped 35 percent. This was government-mandated, easy-money time. It lasted until the change of administrations in 1817. Worse than the immediate perturbations was the precedent. Rothbard explains,
It thus became clear to the banks that in a general crisis they would not be required to meet the ordinary obligations of contract law or of respect for property rights, so their inflationary expansion was permanently encouraged by this massive failure of government to fulfill its obligation to enforce contracts and defend the rights of property.6
If this is not fabulously prophetic of our current crisis, nothing is. The banks have been too big to fail since at least 1814, if not 1791. We hear today of an imminent collapse of the “entire financial system” and thus the need for multi-trillion dollar bailouts. But it has been the specially-protected fraud of bankers in this nation for over two hundred years.
We should reiterate that while central banking was the baby of big financiers and big-government Federalists like Hamilton, the allegedly freedom-loving Jeffersonians, including Madison, showed even worse restraint in robbing the people through inflation. They did so through Federal debts, including war debt, and they allowed, indeed encouraged, the States to do so as well.
Indeed, the Democratic-Republicans in 1816 pushed as hard for a second bank as Hamilton had for a first. And whereas Madison had fought the first bank, he would nevertheless sign this new bill against his own views of strict construction. Why? The State and private banks wanted to maintain their source of easy money. Senator William Jones (DE), despite being a Federalist, opposed the second bank. His understanding of its subversive purposes can stand as a valid criticism of all the national banks before and since. He saw that it was
ostensibly for the purpose of correcting the diseased state of our paper currency by restraining and curtailing the overissue of bank paper, and yet it came prepared to inflict upon us the same evil, being itself nothing more than simply a paper-making machine.7
A paper-making machine it was indeed. Within the first two years of its existence, the bank ballooned its paper money supply to over a 9:1 ratio with specie, increasing the total national money supply by close to double. In the same period, the number of new banks rose to 338. In the great bubble-boom of this period, the exchange of paper stocks led to the creation of both the New York Stock Exchange (NYSE), and the beginnings of large-scale investment banks (though the latter would not become a significant feature until the Civil War).
The Monroe administration noticed the Banks were out of control, but it was too late. The Second bank of the U.S. was in danger of bankruptcy due to massive inflation and fraud. Frantically, they began to contract their paper issues. The result was a huge contraction in credit and a pop of the investment bubbles. The economy collapsed overnight in the so-called Panic of 1819. Prices plummeted, banks went bust, businesses went bankrupt, unemployment jumped, rural areas were reduced again to barter. Finally, honest money re-emerged, if only in a crude and partial scene: whisky once again acted as currency.
But the Second Bank of the U.S. survived the spell. In a line ominously echoed in the bailouts of today, one eyewitness noted, “the Bank was saved, and the people were ruined.”8
The Second Bank also learned nothing from the recession. Immediately after 1819, it began inflating again. In 1823, with the ratio of paper to specie at about 4:1, it ramped up the rate of increase. By 1832, the ratio was approaching 7:1. It is clear the central national bank was neither fiscally sound in itself, nor a improvement upon State and local banks.
Again, many historians and their readers today think that the purpose of the central bank was to rein-in these wild local banks who were doing all of the inflating. The opposite was true. The central bank paid lip service to the hard money crowd in promising redemption in coin. This was the deal on paper, anyway (no joke intended, promise!). In reality, a backroom deal was made just prior to passage of the bill in 1816: it would create a $6 million injection of government paper to favored banks before it would require resumption of payment in specie. In this meeting, the stodgy New England banks were excluded. In addition to the huge subsidy, the banks pledged mutual support in case of emergency, a deal which everyone knew would lean in favor of the local banks. It was the assurance of a bailout given up front.
It is no wonder that the State and local banks favored the creation of another national bank. While this goes against the popular story, the facts support it. Indeed, part of Madison’s justification for ignoring his own constitutional scruples involved “the entire acquiescence of all the local authorities.” Although not entirely true in that not “all” acquiesced, this appeal to “local authorities” shows that a central national bank was no obstacle to them—they in fact profited from it just as they had without it. All through the period of the Second Bank of the United States (1816–1836), the State banks could profit. It is no surprise that when Bank president Nicholas Biddle ramped up his campaign for re-charter early in 1832, he complained how the Jackson administration had already poisoned the public with, as he saw it, anti-bank propaganda. This included “the imaginary injury done to the State Banks,” and led Biddle to start a campaign for “proofs that the State Banks are in the main friendly to his institutions.”9 The historian’s analysis shows that Biddle was correct: among the South and West, only Georgia had a State Bank that opposed a national bank. In New England, support was understandably minimal, but the Middle States largely supported the measure.
Biddle’s re-charter passed Congress, but met its demise at the desk of Andrew Jackson. Jackson opposed the Bank in principle as a looter of the people and feeder of a privileged few fraudsters. While the Bank would remain in theory to the end of its charter in 1836, Jackson vetoed the 1832 attempt. He then immediately began disemboweling the national bank by moving its assets to several State banks. These numbered 91 by the end in 1836. In that year, the Second Bank of the U.S. lost its charter and devolved into ordinary bank. Five years after losing its government-enforced monopoly privileges, it went bankrupt.
Meanwhile, Jackson had vetoed nearly every massive spending bill, and sold off hoards of federally-owned lands. Despite his deficiencies in other areas, he was the first and only president to pay off the national debt in its entirety, and the only president ever to be able to claim a true surplus in the treasury. This occurred in 1835. It has never happened again.
The Second Bust of the Bank of the United States again did not stop State and local banks from inflating paper, although they did maintain a consistent ratio of inflated paper for several years afterward. Nevertheless, an influx of silver specie into the country with this constant ratio meant that banks on average, 1833–1837, were inflating paper constantly as new specie came in. In that latter year, a disruption in international markets helped precipitate another credit contraction. The Panic of 1837 resulted. Again, however, had there been no inflation allowed to begin with, there could have been no subesquent malinvestment, bubble, and trouble to redeem. Credit contraction is simply not an issue in a world where inflation of credit is not practiced to begin with.
We have not even touched on many other issues of the nineteenth century: the Panic of 1857, The Civil War and Greenbacks, the Panics of 1873, the Recession of 1882–1885, the Panic of 1893. In all of these, official coercive attempts to uphold fraud extenuated social evils and pain.
In a mere three years of the Civil War, Congress created over $400 million in Greenback currency out of nowhere. Over the period of the war, the total money supply (including pre-existing fiat money and State bank notes) was pumped from $745.4 million to $1.77 billion—a huge 138% increase. (Not without flabbergasting irony, the original Greenback act (Legal Tender Act of 1862) specified stiff penalties for counterfeiting: up to $5,000 fine and 15 years hard labor. We can’t have people running around just printing money willy-nilly, now, can we?)
We have also barely have mentioned the culmination and behemoth of them all, the Federal Reserve System, born in 1913. We have not discussed government attempts to fix the ratio of gold to silver, again by both sides—Hamilton in 1792, and Jackson in 1834. Plus many other failed exchange fixes: FDR in 1933 and 1934, Bretton Woods in 1944, Nixon in 1971 for example. We have also not put much emphasis on legal tender laws which are tantamount to armed robbery. The list is legion, because this demon is legion. It has never been exorcised from American life.
The main point here is that the biblical (and common sense) principles of money and banking have not been followed in this country from day one. We have not yet had a chance at a free market in money and banking. We have never seen honest money enforced on fraudulent, cheating banks and government treasuries. Not only have they not been followed or upheld by the government, but government has been the most active agent in abusing them and encouraging their abuse by others. Instead, perpetual fraud has been the rule, and government has instigated, encouraged, and protected it. We have no precedent for the pains of honest liquidation. We have way too much precedent for the public being stiffed and robbed by colluding governments (often voter-backed!) and bankers.
It is time this began to change. With a whole generation of people waking up to the fraud inherent in the international banking systems—the fraud that is the Federal Reserve System—and to the standard of truly sound money and accounting, there is great hope that things can indeed begin to change at all levels. The questions will be: What exactly needs to be one? What can we average people do? And are we willing to make the sacrifices necessary to do it? We’ll talk about these in the next discussion.
- Pelatiah Webster, “Remarks on the Resolution of Council Of the 2d of May, 1781, for raising the Exchange to 175 Continental dollars for 1 hard,” Political Essays On the Nature and Operation of Money, Public Finances and Other Subjects, 175n. [↩]
- John Witherspoon, On Money and Finance (Powder Springs, GA: American Vision, Inc., 2010), 81. [↩]
- The following histories are based largely on Murry N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, AL: The Ludwig von Mises Institute, 2002), 45–147. See also Bray Hammond, Banks and Politics in America: from the Revolution to the Civil War (Princeton, NJ: Princeton University Press, 1967); Herman E. Kroos, ed., Documentary History of Banking and Currency in the United States, 4 vols. (Chelsea House Publishers, 1983). [↩]
- Rothbard, 72. [↩]
- Murry N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, AL: The Ludwig von Mises Institute, 2002), 74. [↩]
- Rothbard, 76. [↩]
- Murry N. Rothbard, A History of Money and Banking in the United States: The Colonial Era to World War II (Auburn, AL: The Ludwig von Mises Institute, 2002), 85. [↩]
- Quoted in Rothbard, 90. [↩]
- Quoted in Jan Alexander Wilburn, Biddle’s Bank: The Crucial Years (New York: Columbia University Press, 1967), 32–33. [↩]