The monetary purposes of central banking in early
industrialization: lessons from the U.S., 1791-1863
Jane Knodell, The University of Vermont
Prepared for the 2012 Money and Banking Conference
of the Central Bank of Argentina on “Central Banks,
Financial Systems and Economic Development”
Central banking in the early U.S.: on, then off
• 1791-1832: US had central bank-like
institutions during most of this early period,
the 1st and 2nd Banks of the US; also a growing
sector of state-chartered commercial banks
• 1832-1863: No central bank; state-chartered
commercial banks and a growing sector of
unincorporated private banks
• 1863: Start of national banking system.
The monetary purposes of the 1BUS and 2BUS:
nation-building over central banking
• 1BUS, 1791-1811: establishment of a
separate, single national money and a national
debt
• 2BUS, 1816-1836: advancing internal
monetary and fiscal integration
• Both banks performed central banking
services as a by-product of their fiscal roles
1BUS and the establishment of the US $
• Spanish $ the best and predominant coin, and
used as monetary anchor even after
independence: values of states’ pound currencies
pegged to Spanish $. Examples:
o In Pennsylvania, 1 Sp $ = 7 s 6 d (90 pence)
o In New York, 1 Sp $ = 8 sh (96 pence)
• Banks kept accounts in a blended monetary unit:
“Mexican dollars” with fractional parts = # of
pence in the local pound (same unit used for
Continental currency)
1BUS and the establishment of the US $
• 1783-89: Under Confederation, fiscal and
monetary decentralization. Strong state
governments, weak federal government in terms
of fiscal powers. Multiple “pound currencies.”
• Throughout 1780s, federal government collected
revenue and made payments in “dollars and
pence” notes issued by the Bank of North
America.
• Businesses, other banks, state governments
continued to keep their accounts in local monies.
1BUS and the establishment of the US $
• 1792: Coinage Act defined (for the 3rd time since 1782)
the US $ as = the Spanish peso, with 100 “parts” (a
decimal unit). Adoption of the US $ as a unit of account
was only required of the federal government itself.
• 1BUS, chartered in 1791 by federal government, was
first bank in US to keep its books and issue its liabilities
in the US money of account
• The state-chartered commercial banks chose to switch
their accounts to the US $ soon after the chartering of
the 1BUS.
• Why? A dominant-leader story?
1BUS and the establishment of the US $: A
dominant-leader story?
• 1BUS the largest bank in the US with its 5
branches. But in individual cities, it was not
dominant in terms of size.
• The 5 state-chartered banks in existence (NY,
Boston, Philadelphia, Baltimore, Charleston)
were accustomed to operating in a world of
multiple currencies, all of which were pegged
to the Sp $, including the new US $
1BUS and the establishment of the US $: A
public debt story
• Over 1780s, progressive devolution of public
debt to the states; shift in debt denomination
from $ to local (NY, Pennsylvania, etc) pounds
• This debt was primary form of financial wealth
and primary form of collateral for bank loans.
Bank borrowers and government creditors
largely drawn from same group of merchants.
• Devolution of debt reinforced state monies.
1BUS and the establishment of the US $: A
public debt story
• Opening of a 1BUS branch, using US $ in its
accounts, in a city where most of the stock of
public debt is denominated and serviced with
state pound-denominated currency, would not
 choice by other banks to switch their
accounts to US $
• But refunding of the public debt would.
1BUS and the establishment of the US $: A
public debt story
• US Constitution (effective 1789) gave direct taxing
power to the federal government, and sole
authority to tax imports.
• Hamilton’s refunding of the federal debt and
assumption of the war debt issued by the states
converted denomination of entire stock of public
debt to US $,  state banks switch to US $
• 1BUS the vehicle for this process: as fiscal agent
of the federal government, its liabilities used to
collect revenue and meet federal payment
obligations, inc. debt service
Monetary stabilization as a by-product of the
1BUS’s fiscal role
• The Bank’s fiscal role resulted in its holding a
disproportionately large share of the national
stock of high-powered money (gold + silver)
• “The specie in the vaults of the Bank, collected on
government account, was not regarded as the
exclusive property of the U.S.; it was considered
as an aggregate fund in which the Government
and the Bank were jointly interested.”
(Holdsworth, First Bank, 53).
Monetary stabilization as a by-product of the
1BUS
• The centralization of reserves through the
Bank’s fiscal role permitted the Bank and the
Treasury to perform monetary stabilization
o Preserve and reserve scarce stock of specie for its
“highest and best use” as monetary base, buffer
stock against adverse shifts in external balance
o Assistance to individual banks with liquidity
problems
• Successful institution, but charter renewal
narrowly failed
1816-1836: The Second Bank of the U.S. and
internal monetary integration
• Political support for central banking restored by
results of waging War of 1812 without a central
bank: federal government lacked source of bridge
finance and national circulating medium; state
bank notes circulated at discount (except New
England)
• 2BUS chartered to provide a uniform national
money, which it eventually accomplished through
management of the domestic bill of exchange
market
The fiscal role of the Second Bank of the U.S.
• The 2BUS’s charter required it to perform
fiscal transfers, including debt service, for
federal government free of charge. Primitive
transport, long distances.
• Provided strong motivation to figure out way
to eliminate use of specie in long-distance
payments both domestically (where shipping
costs from Ohio to NY > 4% of face value in
early 1820s) and internationally
The solution: central management of the
“domestic exchanges”
• Each of the Bank’s branches bought bills of
exchange payable at their counters drawn at
all other branches, and sold 2BUS drafts
payable at sight at all other branches.
• Matrix of 23 by 23 cross-city rates of exchange
• The cost of making long-distance payments
with 2BUS drafts remained well below the
cost of shipping specie in the 1820s.
Monetary stabilization as a by-product of the
2BUS’s fiscal role
• As central manager of payment flows, 2BUS
prevented loss of high-powered money (specie)
through internal drain out of reserves to nonbank
domestic holdings, or to the rest of the world (as
specie is used to make payments abroad)
• By 1830, 2BUS held virtually all gold held in the
country and 30% of all specie reserves in banking
system; did not sell to earn arbitrage profits as state
banks had during War of 1812 (during 1820s,
domestic mint price < world market price)
2BUS  larger stock of high-powered money
available to support inside money creation
• Retained specie within national economy
through management of domestic and foreign
markets in bills of exchange
• 2BUS notes were good substitutes for gold for
large-value bank reserves against large-value
bank liabilities
• Good performance of bank notes increased
confidence in bank money and the banking
system’s share of the stock of HPM
But ambiguous effect of 2BUS on reserve ratio
• Historically observed 2BUS reserve ratio
higher than that of the state banks
• Without 2BUS stabilization, state banks’
reserve ratios might have been higher than
historically observed; net effect uncertain
• Conclude: ambiguous effect of 2BUS on size of
money supply in 1820s; possible trade-off
between stability and growth
1836-1859: Opportunity to judge impact of the
removal of the central bank (2BUS)
• Impact on the cost and stability of longdistance payments: negative
• Impact on monetary and financial stability:
negative
• Impact on real growth: positive
Impact of the demise of the Second Bank on
cost of long-distance internal payments
• After exit of the 2BUS, cost of inland payments
fell, but less than expected based on
transportation and communication
improvements
• Private system (multiple payments networks
centered in NY) a reasonably good substitute for
the 2BUS
• But note that the private system was modeled
after the 2BUS system: correspondent networks
functioned much like the 2BUS branch system
had
Impact of the demise of the Second Bank on
monetary stability
• Closure of the 2BUS stimulated frontier expansion
through equity investment in new banks with less
conservative lending policies; loss of automatic
monetary stabilizer
• Financial overexpansion following closure of 2BUS 
1839-43 crisis
• Institutional second-best solutions to instability:
countercyclical Treasury borrowing, suspension of
specie payments, issuance of clearinghouse loan
certificates during panics
• Ability to free-ride on stabilization provided by trading
partners’ central banks
Impact of the demise of the Second Bank
on real economic growth
• Compared to other western industrializers of
19th c. which had central banks, US had:
o higher nominal interest rates (in part due to more
frequent and more severe banking panics),
o higher real interest rates, but a
o better growth record
Conclusion:
• The monetary purposes of the early U.S.
central banks were linked to nationhood:
monetary separation from other nations, and
monetary unification inside the nation
• Stabilization was a by-product of the banks’
role as federal government’s fiscal agent
• By 1830s, the 2BUS constrained growth.
Closing the bank led to greater instability, but
also greater growth