Important Dates in the Monetary History of the United States, Part V, 1791-1857 – Fractional Reserve Banking Backed by Coin

By David Liechty

Gold and silver coin conforming to the Act of 1792 formed the basis of the US monetary system for over seventy years. Certain foreign coin, including Spanish dollars, was also allowed to circulate under the Act of April 10, 1806 (ch. 22, 2 Stat. 374). Fractional reserve banking based on reserves of this US and foreign coin developed rapidly during this time.

The Federal government incorporated the first Bank of the United States in 1791 (Act of 25 February 1791, 1 Stat. 191), and gave this private bank, in which the US held 20% ownership, a monopoly right to issue national bank notes up to $10 million over the “monies” held in reserve. The Act made these notes quasi-legal tender by accepting them as payment for any debt owed to the United States government. The number of state-chartered private banks increased rapidly, also, each issuing bank notes redeemable in coin.

The charter of the First Bank of the United States lapsed in 1811 and was not renewed by Congress.
The Federal Government made numerous issues of Treasury Notes during 1812-1816 to fund the War of 1812 and accepted private bank notes as payment. This encouraged vast over-issuance of private bank notes relative to reserves on hand, leading many banks to over-extend themselves. Rather than let these risk-taking banks collapse, state governments often allowed them to suspend payment in coin, transferring loss to those customers holding the notes.

In 1816, Congress incorporated the second Bank of the United States (Act of 10 April 1816, ch. 44, 3 Stat. 266), citing a need for a reliable source of lending in emergencies. The US again retained 20% ownership, gave the bank a monopoly right to issue national bank notes, and made these notes quasi-legal tender by accepting them as payment for any debt owed to the United States government. The Bank was also required to pay $1.5 million as consideration for the rights granted by the statue. As in the first Bank of the US, stock could be purchased using a mix of coin and debt instruments, but as a practical matter the ratio of debt to coin used to purchase stock in this bank exceeded that allowed by the statute.

The constitutionality of the second Bank of the United States was challenged in two primary cases. In McColloch v. Maryland (17 U.S. 4 Wheat. 316 (1819), the Court held that creation of a national bank was ”necessary and proper” (Article I, Section 8, clause 18) for Congress to effect movement of and access to federal money throughout the nation. In Osborn v. Bank of the United States (22 U.S. 9 Wheat. 738 (1824), the court held that a private corporation, even one owned in part by the Federal government, acts as a private corporation, and can undertake activities considered necessary to effect the purposes to which it was created, in this case banking services and emission of notes and bills, regardless of governmental ownership.

In 1832, four years prior to its lapse, Congress voted to renew the second Bank’s charter, but the act was vetoed by President Andrew Jackson. In 1836 the Treasury Secretary moved Federal deposits into a network of state and territorial banks meeting requirements set forward by Congress (Act of 23 June 1836, ch. 115, 5 Stat. 52v) as to reserve and redemption policies. In 1840, Congress began a system of “sub-Treasuries” dispersed throughout the nation which would hold Federal funds, thus dispensing with the use of private banks (Act of 4 July 1840, ch. 41, 5 Stat. 385).

The market value of silver dropped in relation to gold during this time, and in the Coinage Act of 1834 (Act of 28 June 1834, ch. 95, 4 Stat. 699) Congress reduced the amount of gold in the “eagle” to reflect this change, setting an effective statutory exchange rate of silver to gold at 16:1. Congress thus continued to recognize the standard “unit” of value in the US as the silver “dollar” set forward in the Coinage Act of 1792, modifying the amount of gold in the coin “having the value of” ten dollars. In the Coinage Act of 1837 (Act of 18 January 1837, ch. 3, 5 Stat.136), Congress altered the amount of alloy in gold and silver coins to be minted to 1/10 by weight, and expressly recognized all previously minted coin as continuing to be legal tender.

Privately issued bank notes continued to be the main media of exchange circulating in the US at this time, and some states took full or part ownership in these private banks. The constitutionality of these banks and the notes issued thereby challenged in Briscoe v. Bank of Kentucky (36 U.S. 11 Pet. 257 (1837), Woodruff v. Trapnall (51 U.S.10 How. 190 (1850) , and Darrington v. Bank of Alabama (54 U.S. 13 How. 12 (1851). The Supreme Court, however, held that these banks were private corporations, regardless of the extent of government ownership, and therefore the issued notes were not “bills of credit” under Article I, Section 10, Clause 1. These state-owned banks followed their counterparts’ pattern in over-issuing bank notes and suspending payment, often with direct legislative intervention to facilitate suspension where it had been specifically forbidden in legislation creating the banks.

In the Coinage Act of 1849 (Act of 3 March 1849, ch. 109, 9 Stat. 397) Congress introduced “gold dollars … of the value of one dollar, or unit”, thus applying the term “dollar” to a gold coin directly for the first time, though continuing to reflect the silver dollar as the fundamental unit of value (§1, 9 Stat. 397). The actual market exchange rate between silver and gold at this time was such that silver coin became scarce, and in the Coinage Act of 1853 (Act of 21 February 1853, ch. 79, 10 Stat. 160) Congress reduced the amount of silver in coins of half-dollar and lower denominations to 93.1% of their previous weight, but restricted their legal tender status to debts “not exceeding five dollars” (§2, 10 Stat. 160). In the Coinage Act of 1857 (Act of 21 February 1857, ch.56, 11 Stat. 163), Congress repealed all acts “authorizing the currency of foreign gold or silver coins,” thus eliminating the Spanish milled dollar from circulation for the first time, and limiting circulating coin in the US to that minted under the acts of 1792 and 1837 (§3, 11 Stat. at 163).

David Liechty is an attorney who is currently studying for a Phd in Constitution Studies. He is interning with Solari this summer.

See Part (I), (II), (III), (IV) and (VI)
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