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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Sprache: Englisch
Discover where America's monetary system is heading—and how it will impact you—in the years to come
In the newly revised second edition of Inflated: How Money & Debt Built the American Dream, veteran investment banker, author, and Chairman of Whalen Global Advisors LLC delivers the latest installment of his concise history of the United States' monetary system, putting contemporary financial phenomena like inflation and high housing costs into context. You'll learn to understand how issues like the public debt and the rise of cryptocurrencies can be understood through the lens of how the United States government exploits debt and the monetary system to fund its operations.
The author explains:
- How contemporary concepts like Modern Monetary Theory fit into and influence the American economy
- How and why the United States' debt has tripled in the last fifteen years and the necessary consequences of that increase
- The likelihood and potential impacts of another economic correction during the 2020s
An engrossing and essential read for anyone interested in the economic and monetary realities driving our markets, politics, and societies, the second edition of Inflated is an eye-opening discussion of the drastic changes unfolding in the American economy and the even more dramatic transformations that lie just beyond the horizon.
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Seitenzahl: 769
Veröffentlichungsjahr: 2025
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Table of Contents
Cover
Table of Contents
Title Page
Copyright
Dedication
Preface
Notes
Introduction
Chapter 1: Free Banking and Private Money
The Bank of the United States
State Debt Defaults
The Age of Andrew Jackson
The Panic of 1837
The Gold Rush
Notes
Chapter 2: Lincoln Funds Civil War with Inflation
The Lincoln Legacy
Financing the War
Salmon Chase and Jay Cooke
Fisk and Gould Profit by Inflation
The Panic of 1873
Gold Convertibility Restored
Silver and Tariffs
Notes
Chapter 3: Robber Barons and the Gilded Age
Republicans Embrace Silver and Inflation
The Panic of 1893
The Cross of Silver
The Turning Point: 1896
Notes
Chapter 4: The Rise of the Central Bank
The Progressive: Theodore Roosevelt
A Flexible Currency
The Crisis of 1907
The National Monetary Commission
The Federal Reserve Act
Notes
Chapter 5: War, Boom, and Bust
An Elastic Dollar
A Return to Normalcy
The Roaring Twenties
New Era Finance
The Rise of Consumer Finance
America Transformed
Prelude to the Depression
Stocks Fall, Tariffs Rise
Deflation and Crash 1929
Notes
Chapter 6: New Deal to Cold War
Broken Promises
Gold Seizure and Devaluation
Devaluation and Tariffs
Rise of the Corporate State
The Reconstruction Finance Corporation
Central Planning Arrives in Washington
Federal Deposit Insurance
Centralization of the Fed
Eccles and the Corporatist Revolution
America Goes to War
Wartime Finance
Bretton Woods
Notes
Chapter 7: Debt and Inflation
Revenues Grow
The Fed Regains Independence
Postwar Growth
Cold War, Free Trade
The Golden Age
Global Imbalances Return
Nixon's Betrayal
The Dollar Peg Ends
Sovereign Dollar Debt
Notes
Chapter 8: Leveraging the American Dream
The New Uncertainty
Full Employment
Balanced Budgets and Inflation
Shock Treatment
The Crisis Managers
Latin Debt Crisis
Reagan Reappoints Volcker
The Neverending Crisis
Volatility Returns
Boom to Subprime Crisis
The Greenspan Legacy
Notes
Chapter 9: Financial Crisis and Malaise
Quantitative Easing
The Powell Pivot and COVID
The Fed Goes Big
Deficits and Central Bank Independence
Offshore Dollars and Taxes
Notes
Chapter 10: New American Dreams
The Growth Illusion
Inflation and Stagnation
A Flexible Currency
Tricentennial Dollar?
Endgame
Notes
Selected References
Acknowledgments
About the Author
Index
End User License Agreement
List of Illustrations
Chapter 1
Figure 1.1 U.S. Federal Debt/Annual 1791–1849 ($).
Chapter 7
Figure 7.1 U.S. Military Spending as a Percent of GDP (1945–1996).
Figure 7.2 GDP, Federal Debt, and Military Spending (Billions of $).
Figure 7.3 U.S. Balance of Trade (1960–1972).
Chapter 8
Figure 8.1 Federal Outlays, Receipts, and Balance (1968–1976) (Millions of $...
Figure 8.2 Federal Debt, Outlays, Receipts, and Balance (1979–1988) (Million...
Chapter 9
Figure 9.1 Return on Earning Assets.
Figure 9.2 Federal Reserve Balance Sheet.
Guide
Cover
Table of Contents
Title Page
Copyright
Dedication
Preface
Introduction
Begin Reading
Selected References
Acknowledgments
About the Author
Index
End User License Agreement
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INFLATED
Money, Debt, and the American Dream
Second Edition
R. Christopher Whalen
Copyright © 2025 by R. Christopher Whalen. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey.Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permission.
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Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Further, readers should be aware that websites listed in this work may have changed or disappeared between when this work was written and when it is read. Neither the publisher nor authors shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
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Library of Congress Cataloging-in-Publication Data is Available:
ISBN 9781394285716 (Cloth)ISBN 9781394285723 (ePub)ISBN 9781394285730 (ePDF)
Cover Design: Paul McCarthyCover Image: © Getty Images | Ali Majdfar
I do not think it is an exaggeration to say that it is wholly impossible for a central bank subject to political control, or even exposed to serious political pressure, to regulate the quantity of money in a way conducive to a smoothly functioning market order. A good money, like good law, must operate without regard to the effect that decisions of the issuer will have on known groups or individuals. A benevolent dictator might conceivably disregard these effects; no democratic government dependent on a number of special interests can possibly do so.
—F.A. Hayek
Denationalization of Money
Institute of Economic Affairs (1978)
Preface
What is the American dream? The historian and Pulitzer Prize–winning author of The Epic of America, James Truslow Adams, was the first to define the ideal:
The American Dream is “that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”1
Adams's observation was as much a reflection on the nation's past as it was asking about its future. He published Epic of America in 1931, during the early days of the Great Depression. His world view was more egalitarian and libertarian than the corporate perspective that today governs much of American life. Adams expressed hope for a world that was not merely defined by commercial standards but comprised of a society where individuals were free to pursue their own definitions of liberty and success.
In the twentieth century, the concept of the American dream can be said to trace its roots back to the promise of “Life, Liberty and the pursuit of Happiness,” the most famous line in the Declaration of Independence. Simply stated, when immigrants came to this country centuries ago, they expected to be able to achieve a level of personal freedom and material security substantially better than that available in other nations. Today, Americans as well as the thousands of immigrants who come to the United States each year still have that same promise in mind, even if the reality has greatly changed.
A big part of achieving success and security in America is earning money, defined in 1776 as gold coins. In 1776, everything in Western finance that was not money, that is gold, was a form of debt. Yet the national debate over paper versus gold as money was part of the history of America: George Selgin of CATO Institute put the history of gold in perspective:
There is a tendency to treat U.S. monetary history as divided between a gold standard past and a fiat dollar present. For some the dividing line marks the baleful abandonment of a venerable pillar of sound money; for others it marks the long-overdue de-consecration of an antediluvian relic. In truth, the “money question”—which is to say, the question concerning the proper meaning of a “standard” U.S. dollar—was hotly contested throughout most of U.S. history. Partly for this reason a gold standard that was both official and functioning was in effect only for a period comprising less than a quarter of the full span of the U.S. history, surrounded by longer periods during which the dollar was either a bimetallic (gold or silver) or a fiat unit. A review of the history of the gold standard in the U.S. must therefore consist of an account both of how the standard came into being, despite not having been present at the country's inception, and of how it eventually came to an end.2
The role of money in society is important. Americans as a whole view themselves as reasonably prudent and sober people when it comes to matters of money, though the choices we make at the ballot box and in Washington seem to be at odds with that self-image. As a nation we seem to feel entitled to a national agenda and standard of living that is beyond our current means, a tendency that goes back to the earliest days of the United States. In 2024 as this revised edition was prepared, the administration of President Joseph Biden was borrowing 25 percent of federal spending. We pass laws that promise our people “price stability” to protect the value of wages and savings, but pursue policies and practices that require steady inflation of the currency. This book examines this remarkable dichotomy by reviewing our nation's past from a political and financial perspective.
Events such as the Gold Rush of the 1840s, the Civil War, the period before the creation of the Federal Reserve System, Depression and two World Wars, and the appearance of crypto currencies in the twenty-first century, are scrutinized in the context of the changing monetary aspirations of a nation. Whether taming the frontier in the 1800s, fighting the Civil War, or bailing out private banks and corporations in the twenty-first century, successive American governments turned debt and inflation into virtues in order to make ends meet, a choice not unlike that made by other nations of the world. Americans took the tendency to borrow from the future to an extreme and in the process made it a core ethic of our society. In pursuing the American dream today without limitation, we make our tomorrows ever less certain.
The generations of Americans that have come since World War II and the subsequent half century of Cold War believe that we are somehow exempted from the laws of gravity as regards finance and economics. We speak of our “special” role in the global economy even as we repeat the mistakes of Greece, Rome, and the British Empire who ultimately faltered due to currency debasement and inflation.
The same popular delusions about inflation and debt that have affected societies such as Weimar Republic, in Germany or Argentina are also present in America today. Modern Monetary Theory, which essentially says that government can create and spend endlessly, seemed attractive in the 2020s when interest rates touched the zero lower bound. But the first rule of any successful fiat system must be no fiscal deficit. Leverage is already baked into the currency. Layers of leverage, the thesis of Inflated, are often dangerous.
By highlighting the work of some of the great researchers of the past two centuries in the context of today's political economy, we tell the unique American story of money and debt from the perspective of an investment banker and financial historian who has worked with banks, mortgage lenders, and financial markets for four decades. And by describing the use of the printing press and credit as enduring features of the American dream, the story of a nation that is just two-and-one-half centuries old, we will hopefully illuminate these matters and thereby encourage a broader national discussion about the future of America and our role in the world economy.
Notes
1
. Adams, James Truslow,
The Epic of America
(New York: Little Brown, 1931), 404.
2
. Selgin, George, The Rise and Fall of the Gold Standard in the United States (June 20, 2013). Cato Institute Policy Analysis No. 729, Available at SSRN:
https://ssrn.com/abstract=2282720
Introduction
In my experience, books are written after a dedicated and serious person has an “Aha!” moment. I witnessed that moment with Christopher Whalen in 2009 while we were together in a canoe looking for a hungry smallmouth bass. Our guide slowly paddled us down Tomah Stream, a tranquil tributary of the St. Croix River, which defines the border between Canada and the United States known as Down East.
We were fishing together on the private land of the Passamaquoddy Indian Township Reservation in Washington County, Maine, with our longtime guide Ray Sockabasin. Grand Lake Stream has been the destination of Americans seeking to enjoy the outdoors for hundreds of years. Upon passing the Massachusetts bar exam in 1867, Supreme Court Justice Oliver Wendell Holmes set off from Boston with his friend Charles P. Horton for a salmon fishing trip to Grand Lake Stream.
Tomah Stream
All morning, we had been discussing the issues around the monetary and banking history of the United States. Christopher's wealth of knowledge on the subject fueled our debate. This was the time of the Great Financial Crisis of 2007–2009 and its aftermath. It was the time of an extraordinary experiment in American central banking history. Only during World War II had the Federal Reserve maintained such an extended low-interest-rate policy. But in the 1940s, the patriotic Fed assisted the nation in fighting a war by keeping interest rates very low and also stable for years, while wartime inflation reached double digits and the debt/GDP ratio topped 100 percent. This time the culprit was the Great Financial Crisis. Chris and I recalled how it took six postwar years to unwind the wartime policy. The Treasury-Fed Accord was born in 1951 under Chairman Thomas McCabe, and the Fed era of William McChesney Martin commenced soon thereafter.
My fishing friend Christopher is first and foremost a scholar and a historian. We are sympatico in our pursuit of the details within history so that history's lessons may be articulated. As a writer and researcher, Chris goes after the details with zest, in scrupulous pursuit. We both hope that reciting history may help guide those who contend with policymaking in the present day. That is what this second edition of his original, 15-year-old book is about, but with an added chapter covering the 2008–2024 period.
This second edition is a necessary update. The weaving into a mosaic of all that has happened in 15 years requires building on the first edition of the book. We realized this importance of history as we floated on Tomah Stream and again now since the last decade and a half has added monetary and banking history that has no precedent.
There are many examples to cite, and this book attempts to capture the most important elements. My thought in writing an introduction is to plant a seed for the reader with some recent and some ancient history.
Ask yourself about your own recollections of the Great Financial Crisis. The Lehman moment may come immediately to mind, and then the sequence of interventions involving Citigroup, AIG, and Bear Stearns may be quickly recalled. But does anyone remember that the first primary dealer to fail and be merged was Countrywide? The system of primary dealers created by the Fed after World War II was decimated by the Great Financial Crisis.
Does anyone think about the fact that all votes by the Board of Governors of the Federal Reserve were 5-0 when the Fed invoked its power for emergency actions? Does anyone contemplate that the reason they were five to zero is that the law at the time required five votes, not four, to use that emergency interventionist authority?
Does anyone recall that there were two vacancies on the board during the entire Great Financial Crisis (GFC) because of politics, as the two political parties took turns holding up each other's appointments to the central bank board of the United States?
In some ways it seems like nothing in the political spectrum has changed. I can only imagine the confidential conversations when one of the five said to Chairman Bernanke, “I cannot vote with you, Ben; it will be giving away too much.” Oh, to have been a fly on that wall!
In March 2023 we had three bank failures in a row, starting with Silicon Valley Bank (SVB). The three banks combined totaled more than Washington Mutual, which previously held the record for failure size. There was no Lehman moment. There was no contagion to melt down the entire banking system. There was no Depression-era plummeting of the economy following the SVB event. Were lessons learned from the Great Financial Crisis? And are there more lessons to be observed in the future?
The most intense discussion involves debt, federal and other. Most market agents focus on the federal debt and how it has grown in relation to GDP. Let's look at the total debt of all types. Christopher is interested in the addiction to debt usage and the distortions from that debt. The ratio of total debt to GDP peaked in 2008 during the GFC. It has fallen slightly since, but can the U.S. economy outrun the debt?
Those are the 15 years that included the GFC and post-GFC recovery, an inflation flare, a 3–4-year Covid shock, zero interest rates, and many special Fed programs designed to avoid a banking system meltdown or contagion. And then there was the Fed's abrupt policy change to raising interest rates. There were large Trump deficits. They were followed by large Biden deficits. And the 2024 election year rounds out the list of challenges with the return of President Trump for a second term. That political influence really started in 2023. It included a debt-ceiling threat of default, no federal budget mechanism, and a series of political failures with short-term and temporary continuing budget resolutions.
If we dig deeper, we see that the composition of the total debt has changed. Debt burden issues have improved for households. Corporate debt has been manageable. Even mortgage debt, while pressured by the Fed's balance sheet shrinkage of mortgage-backed securities, is in better shape than it was during the GFC period. So, the increase in the federal debt to GDP ratio is essentially offset by the decrease in the nonfederal debt-to-GDP ratio. The total ratio remains about the same.
If total debt to GDP is unchanged or slightly lower, and it's the shift in composition that is the concern, then financial-market impacts should be observable if we look for them. Sure enough, they are there. The cost of credit insurance on the federal debt is rising. We can measure this by examining the market-based pricing of credit default swaps (CDS) on U.S. government debt. Meanwhile, corporate credit spreads have been narrowing.
So, is the federal debt load crowding out the private sector? This is much harder to observe. We may discuss it as a concept, but we have difficulty finding measures to estimate whether it is and by how much. Crowding out? Maybe, maybe not.
When Christopher wrote the first edition, Bitcoin was an unknown. The tokens existed, but in obscurity. Now crypto is a multi-trillion-dollar asset class. Some folks believe it's money. Others say it will replace reserves. Still others claim the U.S. dollar and all fiat currencies are doomed. These are strong words. Christopher captures two centuries of American history to guide us on our crypto learning curve, but reminds us that the paper money created by Abraham Lincoln to finance the Civil War was the first crypto currency.
Here, let me reach back to a much earlier time to augment our learning.
Consider the first coin, minted about 2,600 years ago by the Lydians. It was in gold, and thus began the use of state-issued money and the hegemony of rich King Croesus—history shows us that money is power. Croesus eventually fell to the Persians, and the Persians lost to the Greeks—they had silver mines. The drachma replaced other coinages and developed into the world's reserve currency of that era. The Greeks never debased their coin, even during the Peloponnesian War. And the Athenian “owl” was accepted throughout the Mediterranean long after regional hegemony began transferring from Greece to Rome. Those few city–states that did debase money ended as losers. So did Rome after the “Golden Age,” when the debasing of currency was serially repeated. And we know what happened to Rome when it started to decline.
Are there lessons for today? Christopher Whalen warns us about them, but reminds us that repeating past mistakes is human nature. That is what makes this book in its second edition form so timely. Chris's and my time fishing on Tomah Stream was years ago and before Covid. Recently, as we were wrapping up a discussion about the world of money and banking and central banking today, I said, “Chris, you must write the second edition of your book.”
And here it is. Aha!
David Kotok
November 2024
Chapter 1Free Banking and Private Money
In his December 1776 pamphlet The Crisis, Thomas Paine famously said, “These are the times that try men's souls.” He then proceeded to lay out a detailed assessment of America's military challenges in fighting the British. But after the fighting was over, America faced the task of creating a new, independent state separate from British trade and especially independent from the banks of the City of London. The story of creating new money and debt in early America is the chronicle of how a fragment of the British empire broke off in the late 1700s and supplanted and surpassed Great Britain in economic terms by the end of World War II. Britain for centuries was the dominant economic system in the world, yet in just 250 years America grew to lead the global economy.
The English pound was not the first great global currency, nor will the dollar likely be the last. Mankind has been through cycles of inflation and deflation more than once, going back to before Greek and Roman times. The story of money in each society is a description of the ebb and flow of these states in economic as well as political terms. The latest version of this repeating narrative features a still very young country called America, which used money and the promise of it to build a global economic empire based upon the dollar.
When the 13 colonies reluctantly declared independence from Great Britain in 1776, the young nation had no independent banking system and no common currency, although most colonists knew the political and financial traditions of Europe. The Articles of Confederation adopted in 1777 did not even give the central government the ability to levy taxes to retire war debt. European banks and governments met America's capital needs via loans and gold coins. Pawnbrokers were the predominant source of credit for individuals, and businesses obtained commercial credit from banks, mostly foreign. Foreign coins and some colonial paper money were in circulation, yet barter was the most common means of payment used by Americans from the start of the nation's existence through the Civil War.1
Sidney Homer and Richard Sylla wrote in the classic work A History of Interest Rates:
The American colonies were outposts of an old civilization. Their physical environment was primitive, but their political and financial traditions were not. Therefore, the history of colonial credit and interest rates is not a history of innovation but rather a history of adaptation.2
One early adaptation of the states was to issue paper debt to pay bills. Going back to the revolution and the inception of the republic, America's leaders have always been reluctant to raise taxes. After the adoption of the Articles of Confederation, tax collection was loosely enforced and the increase in paper currency drove inflation higher in the last decades of the 1700s. Issuing IOUs was easier than collecting taxes, although the tax was paid via currency inflation.
Upon winning independence, the colonies formed states and issued colonial currency. Bonds were issued, when possible, with individuals and even the government of France subscribing in the earliest days of the young nation. The Bank of North America was established in Philadelphia by the Continental Congress in 1782 and became the first chartered bank in the United States. Creating a new bank under the control of the American government was an effort to gain some independence from private banks and also foreign nations.
David McCullough's Pulitzer Prize–winning biography John Adams presents several scenes where the ambassador of the new American government goes literally hat in hand to the capitals of Europe seeking foreign currency loans. The tireless Adams was able to secure huge sums that sustained the colonial war effort. But as Adams knew too well, his family and other Americans suffered horribly due to inflation and privation in those early years.
“Rampant inflation, shortages of nearly every necessity made the day-to-day struggle at home increasingly difficult,” McCullough relates. “‘A dollar was not worth what a quarter had been,’ Abigail [Adams] reported. ‘Our money will soon be as useless as blank paper.’”3 This need was acute since the U.S. government lacked the power to tax or the means to collect it. Nor would the American people tolerate higher taxes, because of the unhappy experience with Britain. The leaders of the American revolution led a political revolt against unfair taxation; thus they were not in a position to then raise taxes.
Adams was no apologist for debt, but he believed that having a national debt was a good thing because it created relationships with other nations that helped the nation survive and grow. In his correspondence with Thomas Jefferson, Adams showed the sharp contrast between on the one hand wanting to create a constituency among financial powers for America's national debt while on the other hand expressing his opposition to having private bankers and banks.
The Mississippi Bubble, a financial scheme in eighteenth-century France that led to a speculative frenzy and market collapse, lent a new meaning to the term “bubble.” The term denoted deception. Speculators were known as “bubblers” and to be cheated was to get bubbled, Harold James reveals in Seven Crashes: The Economic Crises That Shaped Globalization.4
Owing somewhat to the shortcomings of banks and bankers, Adams advocated creating a single, publicly owned national bank to serve the needs of the country, with branches in the individual states. He wanted to prohibit the states from chartering banks and to have one single, national institution. Ron Chernow wrote in his 2004 biography Alexander Hamilton that Adams viewed banking “as a confidence trick by which the rich exploited the poor.” He quoted Adams similarly saying that “every bank in America is an enormous tax upon the people for the profit of individuals.”
Adams wanted one state bank with branches around the nation, but no private banks at all.5 He differed significantly from Alexander Hamilton on these issues, even though like Hamilton, Adams was interested in strengthening the country's finances. Hamilton, a New York lawyer who became the first Treasury secretary and a future leader of the United States, was a great advocate of private banks and debt. He believed that finance was the key both to political power and economic growth. Author Joe Costello summed up Hamilton's significance:
Hamilton understood the control of money as a fundamental component of the rule of the modern state. At the time or now for that matter, he was one of a very few to understand the role debt played as the foundation of modern money. As the first Secretary of the Treasury, in a report to President Washington, Hamilton astutely noted “government debt had a ‘capacity for prompt convertibility' to currency, potentially rendering transfers ‘equivalent to a payment in coin.'” In part, the constitution was established to make good the debt incurred during the revolution. Just as importantly, Hamilton understood the new federal government incurring greater debt would help unite and develop the infant nation.6
The charter of the Bank of North America lapsed in 1790 and two years later, the State of New York chartered The Bank of New York, which is the corporate predecessor of the company now known as Bank of New York/Mellon. Supported by New York's powerful merchants, the bank was first organized in 1784 and was led by Hamilton.
So important was the Bank of New York to the local economy that much of the region's commercial activity was financed by this single institution for decades even as other institutions were chartered. The formation of the bank was not just a financial event, but a very significant political milestone as well that greatly elevated the power of New York.7, There was no real money nor any payment system in existence for the country. Commerce had been financed by English and other foreign banks up until the Revolutionary War. Now the United States had to create a new financial system to replace these trade relationships, a process that would take more than a century.
The demise of the Bank of North America at the end of the 1700s came as a political battle raged over whether the federal government should assume the debts incurred by the states and cities during the war against Britain. The final agreement from southerners to support the assumption of state debts was tied to the compromise over moving the location of the capital city from New York to Philadelphia temporarily and eventually to an entirely new capital on the Potomac River to be called Washington. But this Compromise of 1790 engineered by Jefferson and Hamilton did not deal with the issue of a national bank.
The Bank of the United States
President George Washington chartered the First Bank of the United States in 1791. This was the government's attempt at creating a permanent central bank of issue for the infant nation. Madison and Jefferson opposed the bank, but Adams ironically led a sizable majority in the Congress that favored the measure.
The First Bank of the United States had just a 20-year charter. While it was a bold and novel innovation, the bank only provided credit to established merchants. During the presidency of Thomas Jefferson, the agrarian and other interests not served by the Bank successfully pushed for the establishment of state-chartered institutions to serve the need for credit of a very rapidly growing nation. State-chartered banks also created alternative sources of political power in the states. Yet the First Bank's charter was not renewed due to intense attacks by the advocates of Jeffersonian cheap money principles. Taking the lesson of King George III and his taxes, local interests rightly feared that a “central bank” would be dominated by the central government. Even or, worse, it could be dominated by the bankers and merchants in Philadelphia, New York, and New England.8
In 1811, the First Bank of the United States was resurrected as a private entity by the New York merchants who controlled it and chartered anew by the State of New York. Today the successor to that corporation is known as Citibank N.A., the lead bank unit of Citigroup Inc. Now two of the largest banks in the new nation were located in New York. This point was not lost on representatives of the other states in the union and especially the Jeffersonian faction in the Congress, who represented agrarian interests dependent upon New York banks for trade credit.
The decision not to renew the First Bank of the United States left the country to fight the War of 1812 against Britain with no means to finance the military struggle, much less the general operations of the federal government. Then Treasury Secretary Albert Gallatin, who was no advocate of public debt, made careful plans to borrow up to $20 million via the First Bank to finance the war. Instead, Gallatin was forced to seek loans from abroad after the First Bank was dissolved.
Along with Hamilton, Gallatin was one of America's first great financial geniuses, and a talented bond salesman as well. He is memorialized in a large statue by James Earle Fraser that stands in front of the Treasury building in Washington. Gallatin founded New York University and also served as commissioner for the Treaty of Ghent, as well as minister to both France and Great Britain. Because America's position with the nations of Europe was that of debtor and former colonial possession, Gallatin's financial expertise was invaluable. His role recalled the invocation of Hamilton and also of Adams of the virtue of increasing the number of nations willing to hold the American government's debt.
As the nation reeled from the financial disaster of the War of 1812, a heated debate continued in the Congress regarding the need for a common currency and a new central bank. Notes issued by New York banks, for example, could not be used at face value to settle debts in other states. The scarcity of adequate medium of exchange that had existed since colonial times often made it difficult for creditors to secure payment from customers, even if the customer wished to pay!
By 1814, the federal government itself was unable to pay its bills and was on the brink of financial collapse. Treasury Secretary Alexander Dallas (1814–1816) was forced to suspend payments on the national debt in New England due to a lack of hard currency. By law, all Treasury debts had to be paid in gold or silver. Following the capture of Washington by the British in that year and the default on the national debt, the United States was on the verge of financial and political dissolution.9
The creation of the Second Bank of the United States was the American government's next attempt at establishing a central bank, an effort that came only after significant political debate and negotiation. Many Republicans fought the resurrection of the Bank of the United States, fearing that its size and ability to do business across state lines would give it unchecked political power. There was also a strong suspicion by representatives of southern states that the Second Bank would be controlled by New York business and financial interests. But after the destruction of the Federalist Party following the War of 1812, the Republican majority in the Congress eventually chartered the Second Bank of the United States, albeit with very limited powers.
The first time the measure to create the Second Bank came up before the Senate in February 1811, it was defeated by the tiebreaking vote of Vice President George Clinton of New York, who cast the deciding vote in his role as presiding officer of the Senate. He justified his action because the “tendency to consolidation” reflected by the proposal for a national bank seemed “a just and serious cause for alarm.”10 The subsequent proposal to charter the Second Bank was not passed by the Congress until 1815, but was vetoed by President James Madison. A year later, the bill passed and President Madison signed it into a law.
The late Senator Robert Byrd, the West Virginia Democrat who was one of the longest serving members of the body, wrote in his 1991 history of the Senate that the early debates regarding a central bank “were far from over and would surface again within the coming decades to alter significantly American political history.” Byrd also noted that coincident with the authorization for the Second Bank, the Congress for the first time dared to provide themselves with an annual salary. Previously, members of the Congress had been paid $6 per day or about $900 per year. Wartime inflation had greatly reduced the purchasing power of this per diem compensation, so the Congress voted itself a $1,500 per year annual salary. The decision was a political disaster and led to the defeat of two-thirds of the members of the House in the following election.11
Many Republicans who supported the Second Bank considered themselves heirs to the libertarian legacy of Thomas Jefferson. When they finally supported the proposal, however, they followed the plan of Alexander Hamilton of New York and other supporters of a strong central government. These same Republicans, who effectively held a one-party lock on the Congress during that time, opposed funding for interstate roads, canals, and even railroads to help the economy. Yet the fact was that the United States was changing as fast as it was growing and, with that change, lost many of its libertarian attributes. Susan Dunn, professor of humanities at Williams College, wrote:
Jefferson and Madison's Republican Party championed the enterprising middling people who lived by manual labor. But the year before he died, Jefferson felt lost in a nation that seemed overrun by business, banking, religious revivalism, “monkish ignorance,” and anti-intellectualism … The Founders' revolutionary words about equality, life, liberty, and the pursuit of happiness, along with their bold actions, had unleashed a democratic tide—one so strong that within a few decades many of them found themselves disillusioned strangers living in an egalitarian, commercial society, a society they had unwittingly inspired but not anticipated.12
After the creation of the Second Bank of the United States, the American economy grew rapidly and more private banks were created. The largely powerless federal government offered virtually no support to this growth. The Congress preferred to leave this task instead to the cities and states, which, naturally enough, turned to borrowing rather than taxation to finance economic expansion. By 1840, the total debt of the states amounted to some $200 million, a vast sum by contemporary standards given that total U.S. gross domestic product, or GDP, was just $1.5 billion. Much of this debt was issued by banks chartered by the states and was held by foreigners.13
Though the Founders made provision under the Commerce Clause of the Constitution for trade between the states free of tariff, there was no provision for a common currency or banking system to tie together the nation or even the individual states. A similar problem is evident today in the European Union, which has a common currency, the euro, but no real economic integration or unified banking system. State-chartered banks issued various forms of notes to the public in return for some future promise to pay in hard money—that is, gold or silver. The major difference between the private money of the 1700s and modern crypto tokens is that the former promised payment in a tangible asset—gold. The latter explicitly promises nothing save a speculative flutter on price appreciation.
In America before the Civil War, there was no common means of exchange nor any backstop for banks, which from time to time needed emergency infusions of funds. Panics occurred when public unease about particular financial institutions caused deposit runs that could grow into a general financial crisis affecting regions or even the entire country. Crises of just this sort would become the hallmark of the U.S. economy for the next century.
In 1809, for instance, the Farmer's Exchange Bank in Gloucester, Rhode Island, failed—one of the first significant bank failures in the United States. There was no Federal Deposit Insurance Corporation to organize the orderly liquidation of the bank. This task fell to state and local authorities. The demise of the Farmer's Exchange Bank illustrated the types of financial failures and bank panics that troubled the United States for decades to come.
Financial-pioneer-turned-confidence-man Andrew Dexter, Jr., writes Jane Kamensky, “challenged the notions of his Puritan ancestors by embarking on a wild career in real estate speculation, all financed by the string of banks he commandeered and the millions of dollars they freely printed. Upon this paper pyramid he built the tallest building in the United States, the Exchange Coffee House, a seven-story colossus in downtown Boston. But in early 1809, just as the exchange was ready for unveiling, the scheme collapsed. In Boston, the exchange stood as an opulent but largely vacant building, a symbol of monumental ambition and failure.”14
A democratic society and a free market economy cannot exist without both great aspiration and equally great defeat. However, in the American experience, financial fraud and the tendency of politicians to use debt and paper money, rather than taxes raised with the active knowledge and consent of the voters, are common elements from colonial times right through to the present day. The collective failure of the Subprime Debt Crisis of 2008 is a larger reprise of the types of mini crises that occurred in the United States centuries before this period, calamities that were limited by the relatively primitive state of communication and transportation.
State Debt Defaults
By the mid-1830s, the United States was in the midst of an economic boom characterized by inflation and growing speculation in public land sales. Many of the projects for roads or canals were badly needed but were often poorly conceived. American states employed borrowing to finance needed improvements in order to avoid increasing taxes, and even used sales of public land to reduce debt.
States along the Atlantic coast, where the economy was more developed and other sources of revenue such as tariffs were available, generally avoided costly property taxes, while less developed inland states could not sustain their governments with low property taxes and ran into financial trouble. The low or no property tax regimes in many western states are a legacy from the colonial period. This unequal development became even more acute because the areas needing investment and growing rapidly were precisely the western states and territories that were starved for cash, not so much for investment but simply as a means of exchange.15
In some western states, the need for money was met in a primitive way by discovering and extracting gold and silver from the ground to be minted into coins. During the 1830s, speculation in land also flourished, with state-chartered banks providing the financing to fuel the rising land values. This investment bubble had the effect of making the states look fiscally sound because of rising land prices. Some inland states even suspended property taxes due to supposed “profits” on bank shares. But the illusion of wealth and public revenue faded with the Crisis of 1837, the fourth and most stunning depression in the United States up to that time and the first financial crisis that was truly national in scope.16
Between 1841 and 1842, Florida, Mississippi, Arkansas, Michigan, Indiana, Illinois, Maryland, Pennsylvania, and Louisiana ran into serious fiscal problems and defaulted on interest payments. The first four states ultimately repudiated $13 million in debts, while others delayed and rescheduled their debts, in some cases years later. Alabama, Ohio, New York, and Tennessee narrowly avoided default during this period.17 Because many states used state-chartered banks as vehicles for borrowing, the public naturally became alarmed when the states ran into financial problems.
In the early 1800s, paper money issued by private, state-chartered banks generally traded at a steep discount to the face value when converted into precious metal. This was especially true for banks outside of the state or local market where it was presented for payment. The notes used at that time generally promised to pay the bearer of the note a certain amount of physical gold or silver upon demand. The experience of banks failing to honor that promise was all too common for Americans in that period. Mark Twain described the experience of Roxy in The Tragedy of Pudd'nhead Wilson: “The bank had gone to smash and carried her four hundred dollars with it.”
The skepticism about state-chartered banks was one reason that payments by and to state and federal agencies were done only in metal coins, not paper. Most contracts of the day likewise specified metal as consideration. In the early 1800s there was no telephone, no internet or even telegraph, and no local clearinghouse for banks to validate the authenticity of paper money. People in America and around the world preferred the security and certainty of gold and silver coins to paper money, even when the banks issuing the paper were backed by sovereign states.
The negative view of paper money was part of a broader suspicion of bankers and the economically powerful that flowed through most of American society. Fleeing the religious and economic oppression of European society, Americans came to the New World for a fresh start and also an opportunity to live free of the stratified economic system of Europe. Even in the eighteenth-century opportunities for advancement were few. Having money that was independent of political authority granted individuals a level of financial freedom that was a key part of the American ideal.
When the states began to falter financially, however, the cohesion of the entire nation was threatened. Americans still identified themselves with a home state or town rather than as citizens of the United States. The political fact of union among the states had still not quite been settled because of the issue of slavery, but the overall fragility of the state-run financial system contributed to the mounting political pressures on the nation.
As many states fell into default on their obligations during the 1840s, repudiation of debt by state-chartered banks was hotly debated. In Arkansas, for example, Governor Archibald Yell explicitly urged debt repudiation in his 1842 message to the state legislature, which created various state-chartered banks as vehicles for funding state expenditures via borrowing. As a result of the debt defaults and political uproar that followed, Arkansas adopted a constitutional amendment in 1846 to liquidate all state-chartered banks and prohibit the creation of any new banks in that state.18
In Pennsylvania, starting in the mid-1830s the Commonwealth chartered the United States Bank of Pennsylvania to cover fiscal shortfalls with debt. By 1839, the bank defaulted on its obligations several times. In a troubling presage to America's fiscal deficit in the 2020s, the response from the state legislature was to authorize more borrowing. The present-day problems of federal deficits are not a new phenomenon. In fact, Pennsylvania delayed making any meaningful fiscal reforms until the mid-1840s, by which time it was in default on its obligations.
In payment on the Commonwealth's $40 million in debt, its citizens were forced to take scrip bearing 6 percent interest because the state was broke.19 Pennsylvania began to issue its own currency when it could not borrow or would not tax in sufficient amounts, a phenomenon that has reappeared in the United States in the twenty-first century. As the states, most notably California, New York, and Illinois, struggled under mountains of debt, unfunded pension obligations, and other expenses, issuing scrip again become a popular alternative to tax increases.
In the years before the Civil War, American states carried a well-deserved reputation in Europe for not repaying loans, although the U.S. government managed to service the federal debt in good order. From $75 million in debt in 1791 to a peak of $100 million after the War of 1812, the Treasury paid down the federal debt to a mere $63 million in 1849. The U.S. government only paid down its debt once in the 1830s and then only by the accident of having Andrew Jackson as president. In general, fiscal restraint at the federal level was the rule in the first century of the nation's existence. Since the federal government was not really involved in financing the economic growth of the nation, the remarkable stability of the federal debt contrasts with the spendthrift behavior of the states, counties and cities.
Figure 1.1 shows the total federal debt of the United States from 1791 through 1849.
States such as Louisiana defaulted on loans, evaded debts, and delayed settlement with creditors until the twentieth century. Many foreign investors had believed, incorrectly, that the success of New York and other Atlantic states in building profitable canals and other commercial infrastructure would be repeated in the western and southern states and territories. But in fact, looking at both the federal and state debts before the Civil War, the United States was a heavily indebted, rapidly developing country with neither organized financial markets nor even a common currency, and with a dysfunctional central government.
When the overheated economy and related financial crisis first started to boil over, many European banks refused to lend further to the U.S. government or the various states, putting intense pressure on the small nation's liquidity and political unity. In states such as Michigan and Indiana, the number of banks dwindled as first private institutions and eventually the state-chartered banks were wound up and closed. Willis Dunbar and George May noted in Michigan: A History of the Wolverine State:
Figure 1.1 U.S. Federal Debt/Annual 1791–1849 ($).
Source: U.S. Treasury.
The speculation in Michigan land values of the early thirties, for example, was fantastic. The enormous note issues of the banks were obviously out of proportion to their resources. And the internal improvement programs adopted by the states were far beyond their ability to finance. The nation was importing, primarily from Great Britain, much more than it was exporting, and piling up a steadily mounting debt to British exporters and manufacturers. A day of reckoning was inevitable.20
The failure to make progress on the more basic issue of a national currency made the situation in the American financial markets inherently unstable. This structural deficiency, combined with the political ascendancy of Andrew Jackson and the proponents of the Jeffersonian, anti-Federalist view of banks and currency, set the stage for not merely a crisis at the end of the 1830s, but for a catastrophe. When the disaster finally occurred, it was one of the worst economic and financial meltdowns seen in Western society up to that time.
The Age of Andrew Jackson
Much of the economic instability experienced by the country in the late 1830s owed itself to one factor: the rise a decade before of Andrew Jackson. The arrival in Washington of this Indian fighter and hero of the War of 1812, known as “Old Hickory,” signaled the end of the political dominance of Virginia in American politics. Jackson lost his first bid for the presidency to John Quincy Adams of Massachusetts in the election of 1824, even though the Tennessee native won a larger proportion of the popular vote and also the plurality of votes in the Electoral College. But Jackson still lost the election.
Senator Henry Clay, a Whig from Kentucky and long-time enemy of Jackson, threw his support to Adams when the election went to the U.S. House of Representatives. Henry Clay's dirty political deal ensured the election of Adams but also made the election of Jackson in 1828 certain. Clay was appointed secretary of state by President Adams as the quid pro quo for his support in the House. Although Clay sought the presidency on four occasions, he repeatedly underestimated the popular support for Jackson, the man who defeated the British at New Orleans in spectacular fashion—albeit several weeks after the United States and Britain agreed to peace. News traveled slowly in those days.
Jackson's succession to the presidency in 1828 followed an unremarkable political career, but was notable as the first time that a southerner swept into power in Washington on a wave of popular support. Jackson was the first modern chief executive because his victory marked the earliest instance where an American president was chosen by the popular vote rather than by the nation's Founders and their descendants.
The 1828 presidential campaign was a vicious affair, as might be expected when an established order is ended. Jackson was opposed by most of the nation's newspapers, bankers, businessmen, and manufacturers, especially in the Northeast, but still won 56 percent of the popular vote in 1828. Comparisons between President Jackson and Donald Trump's surprise victory over Hillary Clinton in the 2016 race and the defeat of Kamala Harris in 2024 are not unreasonable. Thus began the Jacksonian Age.21
Andrew Jackson's presidency was in political terms one of the most difficult in American history. Northern and southern interests competed with new western states for political advantage, even to the point of secession from the Union. Against this contentious political backdrop, Jackson and Congress fought bitterly over many issues, but none of more consequence for the economy and the U.S. financial system than the renewal of the Second Bank of the United States.
With its charter set to expire in 1836, Jackson proposed that a new government bank be set up as an arm of the Treasury. The Whigs led by Henry Clay decided to reauthorize the Second Bank early and were able to get the measure passed by both houses of Congress during the summer of 1832, but the legislation was vetoed by President Jackson on July 10, 1832.
President Jackson's objections to the Second Bank is one of the great libertarian statements against big government and the power of private interests in American history. It also predicted many of the problems caused by the creation of the Federal Reserve System 80 years later. The final paragraph of the Jackson veto message reads:
