This system worked well in America until the election of Andrew Jackson, the hero of the Battle of New Orleans after the War of 1812. Jackson believed that the Second Bank of the United States had backed his political opponent, John Quincy Adams, and that this financial backing resulted in his loss of the 1824 election.
Jackson also disagreed with centralized national finance. Jackson and his supporters thought that the people should control the money without interference by global or national elites. This democratized currency was the future of money, according to the Jacksonians.
Jackson defunded the Second Bank, taking its gold reserves and distributing it into his “pet banks,” mostly state banks located across the country. In 1833 the Second Bank of the United States was gone, along with its power to regulate banking in the country. This is when America entered into the era of free banking.
Most states made it very easy for any person to set up a bank if they had enough gold and if they agreed to buy some government bonds to secure their debt. These banks could then issue their own currencies, and they did. During this time, some 8,000 different moneys existed in the country.
Having a plethora of currencies was not new in America but without the Second Bank regulating the system, fractional reserve was taken to the extreme. Banks could lend money way beyond the amount of gold they had in reserve. This devalued the money and reduced people’s faith in it.
When people got word that a particular currency was worthless it was called shinplaster, the term for the paper used to make casts for broken bones. Bank notes could also be devalued if the bank was run poorly or wasn’t making enough money off its loans.
Worse yet, some private banks might set up with little or no gold at all called wildcat banks. These were usually set up by a conman who would come to a small town typically in newly settled parts of the west.
The conman would build a structure, put a big empty safe in it, claim it was full of gold and start printing money. They would take deposits of real gold, silver, or other precious items from the unsuspecting citizens, and collect interest on loans.
One day they would pack up and leave town with all the deposits and interest payments! This was illegal but the conman was only punished if they were caught. A person left holding a note from one of these banks found it was useless. They might have worked hard for this money, or sold something important to get it.
The era of free banking wasn’t a complete disaster. Failed banks and wild cats were rare. People used the Bank Note Registries to perform daily transactions. These registries were published to identify counterfeit bank notes and to determine the discount rate for notes from different banks.
If a bank was overextended or the bank was solvent but far away from where the transaction was taking place, the currency was typically just discounted a few percentages. For example, we pay money to take money out of an ATM that is not owned by our own bank. If you take $20 out of an ATM and the fee is $2.00 that is a 10% discount for the issuing bank.
The era of free banking continued up into the Civil War. Fighting any war is expensive and the Civil War was so expensive that the Union government didn’t actually have enough gold to pay for everything they needed. They started printing green money, or greenbacks, that were not always redeemable for gold.
After the war, the government kept printing greenbacks and they also started taxing other paper currencies in the country. Greenbacks became the most commonly used money in the nation.
There were still many savings banks available. One of them was the Freedman’s Savings Bank which Congress established to help black Americans who were recently freed from slavery. This bank didn’t issue money, but they did claim to keep deposits safe and pay interest on them.
The Freedman’s Savings Bank marketed their services in black newspapers, churches, and social organizations. Thousands of black Americans, and in particular black men who had served in the Union Army, deposited money in the bank. The board of directors of the bank, all of whom were white, used the deposits to make risky investments. In 1874 the bank closed with thousands of depositors losing nearly all their money.
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