The Panic of 1819 and the Almighty Dollar

America's most influential force, in my opinion, is not its military might, but rather its economy. It is fascinating to see how our great economy struggled in its early infancy. In reading Out of Many, I took a special interest in the description of the Panic of 1819, part of the period known as the ‘free banking era’. Free banking wasn't completely free of regulation, since the States did regulate banks that operated within their borders, albeit very loosely. The lack of true regulation, coupled with a great reluctance to use the Second Bank of the US, brought forth the free banking era. During this period of free banking we see the importance of a stable centralized banking system and the FDIC insurance we all take for granted. The book really sums it up when it states that “The Panic of 1819…showed how far the country had moved since 1800, from Jefferson’s republic of yeoman farmers toward a nation dominated by commerce” (Faragher).

Free banking appeared destined to fail, with runaway state banking operations throughout America setting up for a grand failure. One example of why free banking was set to fail is that of ‘wildcat banks’, termed as irresponsible lending institutions in Out of Many. The book just briefly mentions wildcat banks, which historically are viewed as crooked banking institutions based on planned failure. It is thought that wildcat banks would open shop in rural, backcountry areas (in areas where wild animals roamed, hence the wildcat name) issuing notes it never planned to honor. Their inaccessibility bought them time, delaying the redemption by the note holder, until the bank was able to close up shop and move somewhere else. But this colorful characterization may be untrue; instead “the value of the bond reserves [held by banks] could and did decrease substantially. This suggests that backing notes with a constant promised value by long-term bonds with large price fluctuations was a major defect of free banking”, and not irresponsible lending (Hasan). The bond reserves held by the banks were based on the Second Bank, and the Second Bank was in the middle of credit contraction.



During this period, bank runs also became commonplace (due in part to the wildcat banking fears and the Second Bank’s credit contraction), and contributed to, if not led, the failure of free banking during this time. Bank runs can be explained this way: banks do not hold all the money deposited into them, but rather they lend most of it out as loans, thus their ‘reserve’ is limited. If all depositors were to try and withdraw their money, the bank could not convert all of the notes (paper money) to specie (coin or metal value), and would either have to call the loans in, or go bankrupt. A surge in depositors who choose to withdraw their funds based on speculation of the bank’s insolvency or impending failure (even if only perceived) can lead to the bank’s actual failure. This is called a bank run (see picture to left).

Had you lived in the free banking era, your wallet would not contain just one form of currency, but many different notes from various state banks. Here are some pictures from Beeslife.com that show the currency of 1857, printed on onionskin paper.

Sources:


“Broken Bank Notes - Pre-1861.” Beeslife.com. 7 July 2007. URL.

Faragher, John, et al. Out of Many - A History of the American People. Fifth Edition. Upper Saddle River, New Jersey. 2006.

Hasan, Iftekhar, and Gerald P. Dwyer Jr. "Bank runs in the free banking period." Journal of Money, Credit & Banking 26.n2 (May 1994): 271(18). Expanded Academic ASAP. Thomson Gale. CCL Diablo Valley College. 14 July 2007. URL.

Pictures source:

“The war of wealth” by Strobridge & Co. Lith. Library of Congress – Prints and Photographs Online Catalog. URL.

“Broken Bank Notes - Pre-1861.” Beeslife.com. 7 July 2007. URL.