CENTRAL BANKING IN THE UNITED STATES

In the early days of the United States, banking became a hot topic as some of the founding fathers were opposed to the establishment of a centralized national bank.  Their reasoning came from Britain’s attempt to place the American colonies under the financial control of the Bank of England, that was seen as another act of oppression and to some the last straw.  But every economy needs sound banking to grow, as business, trade, and commerce all require the facilitation of payments and credit to flourish.  As banking began and grew in this country, the smaller states generally opposed a universal bank believing that a central bank’s monetary resources would wind up under the control of one of the larger states, enabling them to get everything.  How then did the United States get to have the powerful central banking system that it has today?

Bank of North America:   The first significant attempt to establish a bank in this country took place in Philadelphia, July 17, 1780—The Bank of Pennsylvania.  Its mission was to help furnish funds for the revolution.  A year later after the war ended, The Bank of Pennsylvania was superseded by the Bank of North America, chartered by Congress in 1781 and open to the public in January, 1782.  This became the first bank to accept deposits, make loans, and facilitate credit throughout the fledgling economy.  It would also act as the sole fiscal and monetary agent for the government making it de facto the country’s first central bank.  As the confederation government of the 1780’s proved itself to be a failure, a number of state banks were chartered by several different states to distribute their own currency, not the least of which was the Bank of New York and the Bank of Massachusetts.  After the establishment of the constitution, the country had three durable working banks, but many different currencies including English, Spanish, French, Portuguese, and those issued by different states.

First Bank of the United States:  Congress chartered the First Bank of the United States in 1791 after Pennsylvania reincorporated the Bank of North America under state law.  The First Bank of the United States operated as a national bank, but drew political disfavor when it sought gold from state banks to redeem their bank notes.  As a consequence, the First Bank of the United States’ charter was not renewed in 1811 largely due to political opposition by state banks.  Six years later the Second Bank of the United States was chartered to stop runaway inflation that had blossomed after the War of 1812.  Although opposed by some in high places, the Second Bank of the United States replaced the First Bank of the United States and helped the country through its first financial crisis, the Panic of 1819. 

Free Banking Era:  Partisan politics rose again to the forefront when the Second Bank of the United States was up for charter renewal in 1836.  Numerous state banks opposed the Federal Government’s policy of depositing its revenue into one bank—The Second Bank of the United States.  The charter passed Congress, but was vetoed by President Jackson, who previously had issued an executive order to move the Federal Government’s funds to a series of state banks.  Beginning with the decline of the Second Bank in 1837, only state-chartered banks existed, but their numbers had grown to 712.  Many of these banks failed after only a few years of existence owing primarily to their inability to redeem their notes held by other banks.  A few others, such as the Suffolk Bank in Boston, acted as a clearing house for other banks notes, securities, and derivative transactions.  Banking issues such as inflation and bank panics persisted throughout the period.

The Rise of National Banks:   While the country was in the throes of the Civil War, Congress passed the National Bank Act of 1863 to re-establish national banking and consolidate Federal Government authority over banking.  The act allowed for the creation of a national currency that was backed by Federal Government securities, and facilitated the sale of war bonds to prosecute the Civil War.  The new national banks faced tighter regulations making their deposits and investments safer.  The National Bank Act of 1864 established the Federal post of the Comptroller of the Currency, with the responsibility and authority of managing National Banks.  Many state banks converted to national banks, but later on in the 19^th century, state banks rallied and outnumbered national banks by better than a 2-1 margin in 1913.

The Federal Reserve:  Throughout the 19^th century and up until 1907 the country was subject to a number of bank panics, where depositors withdrew their monies faster than banks could pay them resulting in economic mayhem.  Further, up until 1913 the United States was the only industrial economy that did not have a central bank, and thereby relied upon a cabal of private financiers such as John Pierpont Morgan to provide relief for banks in financial trouble.  After the panic of 1907, Congress appointed a commission to study European central banks and come up with a plan that would provide a lender of last resort to troubled banks.  The Aldrich Plan, as it was labeled, would provide for a central bank that promoted financial stability, had expanded international roles, was controlled by an independent board of experts, and was at the same time decentralized.  After much debate, Congress finally passed the Federal Reserve Act in 1913, creating twelve regional Federal Reserve Banks controlled by an independent board of directors.  The board’s appointments were to be made by the President of the United States and approved by the United States Senate. 

Conclusions:  Dating back to early times in this country, politics has often gotten in the way of sound banking practices.  The resistance came in the form of the smaller colonies and states fearing economic oppression by the larger colonies and states—a process that could take place with centralized banking.  During the next century, the United States economy had to endure numerous bank panics and other inter-banking issues such as redeeming other banks’ notes, that culminated with the panic of 1907.  The solution was the Federal Reserve founded in 1913 that consisted of twelve independent central banks with mandates to protect the currency and regulate banking from the Federal level. 

Sources:  Wikipedia, History of Central Banking in the United States.