0n one point at least, most Republicans, Democrats and Progressives were agreed during the memorable 1912 presidential campaign: the country's financial structure needed fixing. As economist Edwin Kemmerer put it, foreigners envied Americans for everything but their banking system. Since the Civil War, Southern and Western farmers had clamored for currency reform, blaming the National Banking System and at times " an international banking conspiracy" for both seasonal and long-range deflation in farm prices.  Periodic panics, especially the shocking "bankers' panic" of 1907, convinced many other Americans--bankers, politicians and the public generally--that some kind of reform was essential.

Banking and currency had been a central political issue since the first years of the Republic. Secretary of the Treasury Alexander Hamilton, believing that the nation would not survive without the confidence of foreign and domestic creditors, startled Congress in 1790 with a plan to fund the national debt at par, assume the debts of the states and provide a national money supply through the agency of a national bank of issue modeled on the Bank of England.

Noting that the first beneficiaries of these proposals would be the Northern commercial interests, which held most of the depreciated national and state securities, Southern agrarians exploded in angry opposition, seeing themselves as the ultimate payers of the bill. Ironically, that opposition was led in Congress by James Madison, the principal author of the federal constitution whom agrarians had distrusted as a small-scale Hamilton.  The issues raised in the ensuing debate were at the heart of the struggle between commercial and agrarian interests, which led to the formation of the Federalist and Republican parties.

The Bank of the United States was to be a depository for government funds and the collecting and disbursing agent for the Treasury, and it would issue notes that would become the nation's principal circulating medium. The federal government was to own one-fifth and private investors four-fifths of the bank's stock, three-fourths of which they could pay for in government bonds. This would ensure a demand for the bonds, give the bank an incentive to support their price, and the holders of bank stock and government securities would ally themselves with the central government.

Agrarians were outraged by this "engine of corruption," which they believed would enrich speculators and commercial interests at the expense of farmers and planters. One congressman said he would as soon be seen entering a house of ill fame as a bank.[1] James Madison, Secretary of State Thomas Jefferson and Attorney General Edmund Randolph argued that the Constitution did not authorize Congress to charter corporations. But the Federalist Congress passed the bill, and President Washington was persuaded by Hamilton's argument that the "necessary and proper" clause of the Constitution empowered Congress to carry out its enumerated functions as it saw fit. A national bank was the best instrument for collecting taxes and supporting the military.

When he became president in 1801, Thomas Jefferson, who had once characterized Federalists as rogues, surprised nearly everyone by leaving Hamilton's financial system intact. He still thought the Bank of the United States was a perversion of national power, but he wanted to win over moderate Federalists, and he thought the Bank too entrenched to be rooted out. This forbearance saddened the agrarian purist John Taylor of Caroline, a prominent Virginia planter who denounced the paper system as "artificial property" designed to rob owners of "natural property" (land and its produce). For the life of him, Taylor could not see the difference between a Federalist bank and a Republican bank.

When its charter came before Congress for renewal in 1811, the Bank of the United States (B.U.S.) could claim to be a success. For 20 years, there had been an orderly expansion of credit and a stable currency. Its notes had circulated throughout the country at par or close to par, and it had kept the pressure on state banks by presenting their notes for redemption in specie. But Jefferson, out of office but still powerful, had continued his anti-bank rhetoric, and constitutional objections were raised again.  Speaker of the House Henry Clay struck the Anglophobic chord by pointing out that foreigners owned 70 percent of the Bank's stock. More important, except in New York and Philadelphia, a majority of state banks, restive under the federal bank's restraints and anticipating a share of its business, lined up in opposition. Even so, the Republican House of Representatives defeated the re-charter bill by only one vote.

After the central bank's demise, the state banks tripled in number, to nearly 250, and a stream of banknotes of varying quality flooded the country. The absence of a stable national currency proved to be a paralyzing weakness during the War of 1812, and in 1815 President Madison suggested that Congress should either charter a national bank or create a federal paper currency.[2] Inconclusive as the war had been, it had stirred strong nationalist feelings, and the "New Republicans" led by John C. Calhoun and Henry Clay chartered the Second Bank of the United States. Except for its larger capital, the new bank was virtually a carbon copy of its Hamiltonian model.[3] Investors who had helped finance the war, such as Stephen Guard and John Jacob Astor, were delighted that the government bonds they had purchased at large discounts would be accepted at par in payment for the Bank's stock.

In its early years, the Second Bank was hardly a national blessing. Its Baltimore branch went down in fraud and disgrace, and, despite its promise to furnish a safe money supply, the Bank fed a speculative frenzy by discounting recklessly. By July 1818, its demand liabilities were 10 times its specie reserve and its notes were at a 7 percent discount. Nearly 400 chartered state banks and a host of unchartered banks and counterfeiters added to the blizzard of paper. Niles Register lamented that all that was needed to start a bank was "plates, press, and paper." Even informed merchants were burned by highly discounted or worthless notes, and ordinary farmers or workers were the ultimate victims.

In January 1819, a discredited William Jones resigned as B.U.S. president. His successor, Langdon Cheves, immediately contracted credit, and in less than three months the Bank was on a sound footing. William Gouge, the leading apostle of hard money, summed it up: "the Bank was saved, and the People were ruined."[4] The Bank's foreclosures prompted Missouri Senator Thomas Hart Benton's famous diatribe: "All the flourishing cities of the West are mortgaged to this money power...They are in the jaws of the Monster...one gulp, one swallow, and all is gone."[5] Within two years, the B.U.S. had forfeited its original good will, and it had reinforced the popular hostility to banks. Having helped fuel the speculative fever, it was widely believed to have caused and then aggravated the financial panic, though the collapse was primarily attributable to a sharp decline in European demand for cotton and other American commodities. Certainly the B.U.S. had not functioned properly as a central bank. When restraint was called for, it discounted; when it should have expanded credit, it could not.

In Missouri, the territorial legislature had chartered two banks: the Bank of St. Louis in 1813 and the Bank of Missouri in 1817. Both of these were initiated by Auguste Chouteau, the co-founder of St. Louis who had made a fortune in the Osage Indian fur trade and St. Louis real estate. His associates in these ventures were the leading merchants, fur traders, lawyers, politicians and land speculators in the territory, including Manuel Lisa, Sylvestre Labbadie, Rufus Easton, J.B.C. Lucas, Moses Austin, and Bartholomew Berthold.  A long delay in completing the capital subscriptions for the Bank of St. Louis and political wrangling among its founders prompted Chouteau to start the Bank of Missouri.[6]

The territorial banks fed the speculative rise in land prices that accompanied the rush of settlers to the area following the War of 1812, but the honeymoon was short. A combination of corrupt management and excessive loans secured by land purchased at inflated prices so weakened the Bank of St. Louis that it succumbed to the sharp deflation in July 1819. The Bank of Missouri, with better political connections, survived the 1819 debacle chiefly because it was a depository for federal funds. But it had permitted its directors, who bought most of its capital stock, to make downpayments for their subscriptions and then borrow the balance due from the bank itself using all of their stock as collateral (called hypothecation). In addition, the bank had made large loans to directors on other security. When an apparent insider revealed these dealings in the press, depositors began to worry. Business failures and a rapid population exodus further undermined confidence, and in the summer of 1821 depositors started a run on the bank. Its notes fell to a 12½ percent discount by July, and in August the Bank of Missouri closed. Two-thirds of its loans outstanding had been made to its nine directors, despite a charter limitation of $3,000 each on borrowing by directors. A legislative investigation committee found no dishonesty involved in the bank's failure, which had cost its creditors $150,000.[7] This finding persuaded a good many citizens that banks, honest or not, were inherently vicious. During the next 16 years, Missouri chartered no banks.

When Nicholas Biddle took over as president of the B.U.S in 1823, he set it on its proper course. He understood and used its power to affect the economy. Though state banks did not keep reserves in the B.U.S., Biddle's policy of keeping a large specie reserve enabled it to be a lender of last resort for state banks and at times for business firms. By presenting their notes for redemption regularly, Biddle kept state banks in line, thus providing a uniform national currency. But the B.U.S. had its shortcomings as a central bank. It could not restrain credit by raising interest rates because the statutory limit of 6 percent on its discounts was well below the usual market rate. Nor did it handle government debt as it should have: when recession threatened, Biddle sold government bonds to protect his specie reserve.

Nonetheless, when Andrew Jackson became president in 1829, the B.U.S. had proved its worth. It had transferred funds readily throughout the country, and it had facilitated the movement of commodities by providing a stable currency. The Bank had not been an issue in the presidential race, but Jackson shared the Old Republican aversion to monopoly and he had bitter personal experience with defaulting and usurious banks. In his first annual message, he suggested that a truly national bank, with its notes obligations of the government, might be preferable to the B.U.S. Biddle tried several times to placate the president, but their relationship steadily deteriorated. As Jackson viewed it, the Bank was a great rival power, performing a major public function virtually free of public control.

With Biddle's consent, Henry Clay pushed a bill to re-charter the B.U.S. through Congress in 1832, four years early, in order to create an issue for his presidential race against Jackson. "The Bank is trying to kill me, but I will kill it," fumed the president, and he vetoed the bill as expected. Jackson's decisive victory over Clay in the election was widely regarded as a referendum on the B.U.S., but modern scholarship has shown that mass support for the president transcended the issues. Many Democratic B.U.S. supporters had voted for Jackson, hoping that eventually he would soften his views. But they miscalculated: Jackson was in for the kill. Since he could not close the bank until its charter expired, he ordered the Secretary of the Treasury to deny it further federal deposits. After two Secretaries were fired for refusing, a third, Roger B. Taney, directed all deposits to state banks while continuing to write checks on the B.U.S. Biddle fought back by contracting credit to embarrass the administration, but an inflow of British capital nullified his effort.  Thomas Hart Benton of Missouri had led the fight against the Bank in the Senate, and when the mid-term elections in 1834 produced a like-minded majority in both Houses, the bank was doomed.

The economy expanded rapidly between 1834 and 1837 and crashed in the latter year. Democrats and Whigs took credit and assigned blame for the boom and crash as it suited them, but there is little evidence that either Jackson or Biddle had much to do with either event. But they had fought mightily, and between them they had destroyed the central bank.[8]

During the depression that followed the Panic of 1837, President Martin Van Buren orchestrated the government's removal from the banking system altogether. The Independent Treasury, or "divorce" bill, which finally passed in 1840, provided that all federal funds would be collected and paid out at sub-treasuries in New York, Boston, Philadelphia, St. Louis, Washington, New Orleans and Charleston. After a brief hiatus during the Whig (Tyler) administration, the Independant Treasury was re-enacted in 1846, and it was the basis of the U.S. fiscal system until the passage of the Federal Reserve Act. The sub-treasuries were finally closed in 1920.

As it turned out, the divorce did not mean total separation. Treasury officials relied on banks to transfer funds from time to time, and in response to its large surpluses in the 1850s, the Treasury bought government bonds in the open market to replenish banks' specie reserves. Even without a central bank, a combination of gold discoveries, foreign investments (often encouraged by state government guarantees) and monetization of private debt by the banks provided sufficient funds for rapid economic expansion during the 1850s.[9] Transportation, manufacturing and the wholesale and retail trade boomed, but there were heavy casualties. Treasury intervention was often too late to save overextended banks, and the lack of control over credit encouraged reckless plunging, especially in transportation securities, with painful results for investors, business and workers.

In 1837, the Missouri legislature chartered the Bank of the State of Missouri, at the time the only chartered bank permitted by the state constitution. It reflected the hard-money principles of the majority, slightly modified by the "soft" views of St. Louis merchants.  It's authorized $5 million in capital stock was to be shared equally by the state and private investors, and the legislature elected the president and six of the 12 directors. Its notes were limited to denominations of $10 or more, and their circulation could not exceed twice the value of the paid-in capital stock.  The state could issue bonds to pay for its stock; private subscribers had to pay in specie. The bank could not discount paper of more than 12 months maturity, and twice each year the bank had to submit a detailed statement of its accounts to the governor and at least two newspapers.[10]

As the depository for state and some federal funds, the state bank was profitable, and its conservative charter and management enabled it to survive the nationwide financial stringency of its early years. But the "Gibraltar of the West," as its friends called it, did little to meet the rapidly growing state's need for credit, either in good or hard times. Banks in neighboring states, Illinois and Kentucky especially, furnished most of Missouri's circulating medium. These bank notes, many of dubious quality, were handled in Missouri chiefly by note brokers, who dominated banking in the state in the 1840s and 1850s. By 1852, more than a dozen of these private banks together did 11 times the business of the chartered state bank.[11]

In addition to discounting banknotes, private banks accepted deposits and made business loans. Page and Bacon and J.H. Lucas & Co., in the early 1850s the largest banks in the West, bet heavily on westward expansion, investing in railroads and mining operations, the latter chiefly through their branches in San Francisco. Page and Bacon failed in 1855 and Lucas and Co. closed (without losses to its creditors) in 1857, during brief but devastating financial panics. A third large St. Louis bank, L.A. Benoist & Co., survived these crises in good shape, primarily because it had avoided railroad securities. Private banks were important in Missouri until well after the Civil War, despite an amendment to the state constitution in 1857 which permitted the chartering of additional banks of issue. In 1866, the state got out of the banking business by selling its stock in the Bank of the State of Missouri to a consortium headed by James B. Eads.[12]

During the Civil War, Secretary of the Treasury Salmon P Chase initiated significant changes in the nation's financial structure. Instead of raising taxes, he relied on fiat money (greenbacks) and borrowing to finance the war. Rapid inflation followed this first issuance of paper money by the federal government and early Union military reverses weakened demand for government securities. Chase needed a way to strengthen the bond market and he favored a uniform paper currency, but neither he nor other former Jackson Democrats in the Republican party would consider a central bank. Instead he proposed a system of "national" banks which as finally perfected in 1864 provided that five or more persons could obtain a federal bank charter by filing articles of association with the Comptroller of the Currency. Capital stock required, which had to be fully paid-in before opening for business, ranged from $50,000 (later reduced to $25,000) for banks in towns of less than 6,000 population to $200,000 for those in cities of 50,000 or more.

Each national bank had to buy U.S. bonds in an amount not less than one-third of its capital stock. These bonds were to be deposited with the Treasury as security for the bank's notes, which could be issued up to 90 percent of the value of the bonds so deposited but not in amounts exceeding the bank's capital stock. Reserves, which had to be at least 15 percent of deposits for the country banks and 25 percent for reserve city banks--at least 40 percent in vault for country banks (non-reserve city banks). The 15 reserve city banks had to keep 50 percent of their reserves (specie or greenbacks) in vault, the rest in New York banks. In 1887, Chicago and St. Louis joined New York as "central reserve cities."[13]

At first, state banks were slow to switch to national charters as the Treasury had expected, so in 1865, at the department's request, Congress imposed a 10 percent tax on state bank notes, thus eliminating them from circulation. Most state banks responded quickly to the spurs, reducing their number from nearly 1,000 to 247 by 1868--in Missouri from 42 to eight. National banks had increased to 1640 in number, including 18 in Missouri. But in the East, many larger banks kept their state charters, having already stopped issuing notes. Instead they credited the checking accounts of borrowers with the amounts of their loans, a more convenient and less expensive procedure. Checks had been in use in larger centers for decades, but they had not been practical over long distances. As improving communications expedited transfers and clearances, banknotes declined in importance.

By the 1870s, the trend toward national charters had reversed. Capital and reserve requirements were usually lower for state banks, supervision and examinations were less rigorous and national banking regulations and procedures virtually barred them from real estate and crop loans, both significant areas for state banks. The number of banks increased rapidly during the last quarter of the century, but a majority of the new ones were state-chartered. In 1898, state banks outnumbered national banks by a four to three ratio, and by 1913 there were nearly 17,000 state and 7,500 national banks including 1,308 and 133, respectively, in Missouri. Banks had kept pace in numbers with deposits and gross national product, which rose by 800 percent between 1865 to 1908.

Major banking crises in 1873, 1893 and 1907 (above) spread hardship throughout the country, and illuminated the weakness of the U.S. financial structure.

During the half-century after the passage of the National Banking Act, the system it created repeatedly proved to be inadequate. Major crises in 1873, 1893 and 1907, which spread hardship throughout the country, illuminated the weakness of the financial structure. Bad economic news, whether caused by natural disasters, changes in foreign markets or investments, or other negatives, could start a run on banks that the system could not handle. Despite substantial reserve requirements, only excess cash in vaults was readily available on demand. Required reserves could not be reduced without violating the law and inviting disciplinary action by the Comptroller of the Currency. When distressed country banks asked reserve city banks to return their reserve deposits, the latter were usually under pressure from their own depositors. The same applied to the relationship between reserve city and central reserve city banks. Even a single large withdrawal, for whatever reason, could force a bank to curtail its loans and alarm its depositors.

The lack of unity and central control in the system was the critical weakness. There was relatively little communication between banks in an area; those temporarily embarrassed could seldom get help from their neighbors. Even after Chicago and St. Louis became central reserve cities, the bulk of bank reserves were held in New York because the New York call money market was the only significant outlet for surplus cash. When banks in the agricultural areas, for example, made unexpected demands for cash, the New York banks could not respond readily without seriously disrupting the stock market. At the root of the problem, there was no central agency that could strengthen bank reserves by open-market purchases of government securities or other means.

One charge brought frequently against the banking system during the prolonged deflation of the last quarter of the 19th century was that national bank notes had "reverse elasticity" When increased business activity called for monetary expansion, both the Treasury, by lowering its debt, and the banks, by seeking higher returns elsewhere, could gain by reducing bank holdings of government bonds. Since bank note issues were tied to these bonds, their circulation dropped from $350 million in 1883 to $170 million in 1891. Having increased sevenfold between 1870 and 1900, bank deposits were a much larger element in the money supply than bank notes, greenbacks, gold and silver combined, but the increase in deposits was not sufficient to reverse the deflationary trend.

Deflation was both a political and economic problem. Every presidential administration after 1869, bankers, industrialists and "respectable" citizens shared the deflationary bias. "Sound money," meaning the gold standard after 1879, was an article of faith with decision-makers, and this faith fastened a punishing price deflation on the country. In the present context, this bias is hard to understand, but the recent experience with greenbacks, which had fallen as low as 35 cents against the gold or silver dollar during the Civil War, and memories of "rag money" antebellum bank notes no doubt affected post-war attitudes. In addition, Radical Republicans during Reconstruction had identified "reflationists" with disloyalty. In the election campaign of 1868, Radicals wrapped the Union Flag around redemption of greenbacks in gold. Agrarians responded with charges that the gold standard was a British scheme to keep the world subservient to London, or that creditors were united in a conspiracy against debtors. Why creditors should have preferred deflation to expansion was not explained, since many of them had equity in businesses or real estate and stood to gain from expansion. Even those without equity interests were at risk when tight money led to business failures or debt repudiation.

Southern and Western cotton and wheat farmers were the chief victims of deflation and the most vigorous in their protests. Merchants and bankers in those regions shared the farmers' plight and views, as did some urban and railroad workers who took pay cuts or lost their jobs during the depressions of the 1870s and 1890s. There were reasons for farmers' difficulties unrelated to the financial system, such as the protective tariff, discriminatory railroad rates, and overproduction caused by increasing productivity (technological advances), expansion into the high plains and the opening of vast new growing areas in western Canada, Australia and Argentina, but the agrarian protest was focused on the money question.

As the farmers saw it, they had responded to wartime needs in good faith by borrowing to buy land at greenback-demoninated prices. These legal-tender notes were not redeemable in specie and were heavily discounted against gold during the war and immediate post-war years. Deflating prices by bringing greenbacks to par with gold or by any other means was a betrayal of trust, forcing producers to pay debts in hard dollars that they had acquired in cheap dollars. In the agrarian view, not the workings of a free economy, but a deliberate government policy was ruining them. After sporadic attempts to reduce greenback circulation, Congress passed the Gold Resumption Act in 1874, making greenbacks convertible into gold at par after January 1, 1879. From 1879 to 1900, when the gold standard became law, the United States was on a de facto gold standard, because the Treasury in both Republican and Democratic administrations elected to redeem all forms of currency in gold

Before 1873, the United States had been on the bimetallic standard, with silver and gold interconvertible at a 16 to one ratio (since 1837). Gold strikes in the mountain West in the forties and fifties elevated the market price of silver to well above the mint price, and little silver was coined thereafter. In 1873, though silver prices were easing as European nations abandoned bimetallism, Congress omitted the silver dollar from the Coinage Act. Huge silver strikes in the Sierras and Rockies soon brought a clamor from miners and farmers for the re-monetization of silver at 16 to one. Congress compromised, agreeing in the Bland-Allison Act (1878) and the Sherman Silver Purchase Act (1890) to purchase limited amounts of silver. This legislation did not affect prices because the Treasury redeemed the silver produced by it in gold on demand.

In 1893, a negative foreign trade balance and a steady flow of Treasury notes (issued in return for silver) back to the Treasury for redemption in gold so depleted the government's gold stock that it threatened the de facto gold standard. But President Grover Cleveland first persuaded Congress to repeal the Silver Purchase Act and then repeatedly borrowed gold from J.P Morgan and other New York bankers to meet the gold drain. To "goldbugs," as the silverites called them, Cleveland was a hero, to a majority of his fellow Democrats, a villain.

By 1896, wholesale prices had fallen nearly 50 percent since 1870, farm prices somewhat more. Wheat prices declined from $1.06 to 63 cents a bushel in the December eastern markets and cotton fell from 15 to six cents a pound. Harvest-time prices at the farm averaged half or less of these amounts. Foreclosures had turned tens of thousands of owners into tenant farmers; in western Kansas, loan companies owned 90 percent of the land in 1893.

William Jennings Bryan's political support was critical at various stages of the Federal Reserve Act's progress.

The agrarian protest climaxed in 1896, when William Jennings Bryan was nominated for president by the Democratic, Populist and Silver Republican parties. The reformers called for abolition of the national banking system, but Bryan's rallying cry was the free and unlimited coinage of silver at the ratio of 16 to one. His opponents charged that unlimited silver coinage would drive gold out of circulation and lead to runaway inflation. With the market ratio at 30 to one, this argument was persuasive, but it should be noted that the demonetization of silver was itself a major reason for its low price and the high price of gold.

Gold Democrats bolted the party to form their own ticket, but Bryan conducted a vigorous and nearly successful campaign, carrying the former Confederate states, Missouri and the Western states except California and North Dakota. With the press and pulpit denouncing Bryan as a radical revolutionary and his program as immoral, Republican nominee William McKinley carried the East, the upper Midwest and the election. Neither labor nor corn and hog farmers had rallied to the silver standard. In St. Louis, the Democratic leadership, led by former governor David R. Francis and Rolla Wells, supported the Gold Democratic ticket.

Ironically, the long deflation had run its course. The nation's gold supply, though not the Treasury's, had been rising for a number of years before 1893 with little effect on prices, but after 1897 it rose spectacularly. Advances in mining technology and gold recovery from ore and huge gold strikes in South Africa, the Klondike and Australia did what the agrarians had tried to do: end deflation and bring prosperity. These fortuitous events were hailed by sound-money advocates as verification of their wisdom. Between 1897 and 1914, the nation's gold stock more than tripled, and wholesale prices rose on the average 2.5 percent a year. Farm prices nearly doubled during the same period, still remembered as agriculture's golden age.