EXERCISES
Exercise 1. Answer the following questions.
1. What does the term «dollar diplomacy’ mean?
2. How did U.S. Administrations pursue «dollar policy’ in the 20th century?
3. Does the U.S. adhere to «dollar diplomacy’ now?
Text 7. Banking
Not banks but merchants were the sources of money and credit in the colonial period of American history (1607–1783). It was only after independence that the first commercial bank received a charter of incorporation – the Bank of North America, in 1781. British merchant banking houses stood at one end of a long chain of credit that stretched to the American frontier. They gave short-term (less than a year) credits to American merchants who then extended them to wholesalers of their imports, and the wholesalers passed them on to both urban and rural retailers – country stores and wandering peddlers.
When the Constitution went into effect in 1789 the nation boasted three commercial banks, the Bank of North America, chartered by Congress at the behest of Robert Morris, the superintendent of finance, and two state banks, those of Massachusetts and New York. The primary function of these and later commercial banks was the making of short-term loans, which they did either by issuing their own bank notes or by creating a deposit in the name of the borrower (opening an account to the person’s credit) and dispersing checks to draw against it. Since the bank notes were promises to pay specie to the bearer on demand, banks had to maintain adequate reserves in order to do so. Defining adequacy, however, was no easy task, and numerous banks were forced into bankruptcy because they had overexpanded their loans and discounts.
Conservatism was the hallmark of the earliest commercial banks. The thinking of the time favored the establishment of a single quasi-governmental bank in each state that would operate in the public interest under private management. The overriding fear of political leaders was that excessive numbers of banks or loans too much in excess of specie reserves would hobble the taxing and spending functions of government by swamping the economy in depreciated paper. Political leaders also recalled very well the wild inflation resulting from unrestrained governmental issues of continental and state bills of credit (paper money) during the Revolution, and in the Constitution they barred the states from issuing them.
The management of the first Bank of the United States (bus), chartered by Congress in 1791, reflected these concerns. Although the bus was a large commercial bank providing loans to the private sector as well as to government, its board of directors managed the institution in a highly conservative manner. Balance sheets for the years 1792–1800 reveal a generally high degree of success in maintaining the Bank’s specie reserves. The ratio between bank notes in circulation and specie holdings was quite small.
Growing population and trade, however, created a need for comparable growth in the volume of money and credit – for a policy of accommodation rather than restraint. Sharp increases in the number of state banks and in their authorized capital stock represented a response to this need. During the life of the first bus (1791–1811) banks chartered by the states increased in number from 5 to 117, and their combined capital stock went from $4.6 million to almost $66.3 million.
The British raid on Washington in 1814 induced banks throughout the country (except in New England) to suspend specie payments. The bank note currency circulated at a variety of discounts from place to place, and since the government was compelled to accept it for taxes and imposts, the public finances became so disordered as to threaten the operations of the federal government. It was in this context of nationwide inflation and governmental derangement that Congress decided to charter a second bus (1816–1836). The expectation was that the institution would be able to force the state banks to resume specie payments and restore soundness to the currency.
The Bank’s success in achieving those objectives is mainly attributable to its president Nicholas Biddle (1823–1836). The mechanism was simple. The nation’s currency was largely made up of bank notes, most of it placed in circulation by state banks, so payments made to the federal government were likely to be in that form. And far more payments were made to that government than to any other transactor of business in the nation. In consequence, the government deposited large quantities of state bank notes in the bus and its branches, which therefore were creditors of the state banks and as such could insist on payment in specie. This threat, or its implementation, induced the state banks to keep their loans and discounts within bounds, which in turn enabled them to redeem their notes in specie at par.
But the bus could not succeed equally well in both its fiscal and its monetary functions. If, as a great commercial bank, larger than any other and receiver of the government’s deposits as well, it could succeed in maintaining sound money, it could not at the same time make available to the expanding population and economy the credit that was needed. The nation’s money was good, but there was not enough of it. Wholesale price indexes for all commodities from 1790 to 1860 reveal a long-term downward drift that commenced in 1820 and lasted till the eve of the Civil War, a drift that was interrupted only by speculative surges in the mid-1830s and mid-1850s. The policy of restraining credit expansion in the interests of monetary stability was the wrong policy for the times.
Not surprisingly, that policy was vigorously opposed by political forces determined not to renew the Bank’s charter. Although the «bank war» (1829–1832) between the administration of President Andrew Jackson and the supporters of the Bank had other elements – most notably, Jackson’s deep conviction that hard money rather than paper was the only sound money and that the economic power of the Bank threatened democratic government – it was Secretary of the Treasury Roger B. Taney’s belief in free competition that led him to stop the deposit of government funds in the Bank in 1833. Moreover, he objected to the Bank’s power to restrain the country’s economic development. The enactment of the Free Banking Act by New York in 1838 and later by other states reflected the same views. Previously, the states had granted charters to banks only by special legislative acts that were semimonopolistic in nature.
Meanwhile, since the government had stopped depositing its funds (mainly state bank notes) in the bus, that institution lost its power to influence the volume of business done by the state banks. Freed of restraint, the latter increased in number from 506 in 1834 to 901 in 1840 and 1,601 by the time of the Civil War. Some of these «pet» banks were for a while selected depositories of federal funds, but in the main those funds were deposited at sub-treasury offices in major cities. These offices represented an effort in the 1840s and 1850s to establish an independent system that would separate the operations of the U.S. Treasury from any connection with the banks. The effort was unsuccessful, however. The system fell far short of the purposeful influence over money and credit that a central bank would have been able to exercise. The vacuum created by the federal government’s withdrawal was later filled by the large Wall Street banks.
The effort to divorce government from the banking system came to an end in 1862 because of the chaotic condition of the currency caused by the government’s need to finance the costs of the Civil War. The National Bank Act of 1863 invited state banks to take out federal charters, thereby becoming known as national banks. Each was required to buy government bonds in an amount equal to one-third of its paid-in capital stock. The bonds had to be deposited with the U.S. Treasurer, who then turned over to the bank bank notes equal to 90 percent of the current market value of the bonds. To discourage undue credit expansion the act required national banks to keep reserves not only against their bank notes but also against their deposit liabilities. The amount of reserves depended on the size and location of the national banks. Small «country banks» had to maintain reserves of at least 15 percent of their notes and deposits. Reserves for large banks in «reserve cities» and for the «central reserve city» of New York were 25 percent (in 1887 Chicago and St. Louis were added to the category of central reserve cities).
The growth of the national banking system was slow until Congress imposed a prohibitive 10 percent tax on state bank notes in 1865.