American Finance

Under the Articles of Confederation, the young United States by 1785 was awash in Revolutionary War debt and lacked a stable currency. These conditions can be viewed as the consequences of systems of currencies issued by state legislatures before and after the War of Independence and issues of Federal “continentals” during the War that had depreciated to virtual worthlessness, requiring foreign and domestic debt issues to finance the struggle. The Federal Constitution, ratified in 1789, addressed these issues by forbidding note issues by state legislatures and by implicitly authorizing Alexander Hamilton to form the nation’s first central bank. “Federalist financial revolution” as a leading engine of the nation’s prosperity over the next sixty years. As its name suggests, the “revolution” consisted of the construction and encouragement of the nation’s banking and financial sectors. While the system worked well when the population was concentrated in large cities, the Federalist system of bank incorporation did not anticipate the nation’s growth potential and quickly became constrictive. Early banks needed to obtain unique charters from a state legislature rather than being free to enter and subject to a fixed set of standards. The chartering process was tedious and approval depended on political influence as much as financial resources. State legislatures responded to public demand and began to pass a series of enabling laws which have come to be known as Free Banking Laws. Starting with Michigan in 1837 and continuing through Pennsylvania in 1860, the laws replaced legislative approval with a well- defined set of capital, reserve, and note issue requirements. Contrary to its name, free banking was far from laissez-faire; rather, the term “free” refers to the idea that any person who met the state’s requirements was “free” to open a bank. The specific requirements varied across states but most allowed quick entry with a relatively small sunk cost. Banks and…