Creature From Jekyll Island by G. Edward

The conservatively managed institutions, lending upon the safer risks, upon which naturally the margins of profit were smaller, found the assessments burdensome, and were compelled to embark upon the more speculative business in order to carry the charges.

Gradually, all banks sank into the quagmire and, in 1857, the Massachusetts safety-fund was abandoned.

Michigan's experience with a safety fund was perhaps more typical of the period. It was established in 1836 and was completely blown away the next year, during the panic of 1837.

PROPOSAL TO BASE MONEY ON SECURITIES

The third proposal for maintaining a stable monetary system while, at the same time, allowing the banks to operate fraudulently was to base the money supply on government securities; in other words, upon paper certificates of government debt. This was the scheme adopted in the 1850s by Illinois, Indiana, Wisconsin and other Midwestern states. It also set the precedent for the Federal Reserve System sixty years later. Groseclose continues:

1. Groseclose, Money and Man, p. 186.

LOAVES AND FISHES AND CIVIL WAR 365

So rampant was the note-issue mania that the notes came to be called by the appropriate name of 'red d o g ' and 'wild cat'

currency.... The rising crop of banks created a fictitious demand and a rising market for securities (to be used as capital stock) and a consequent stimulus to the creation of public debt by the issue of securities. This was followed by more bank notes being issued against the securities, demand increasing and the market rising, more securities issues, more bank notes, and so on in an endless chain of debt creation and the inflation of paper wealth. The process was finally brought to a stop by the panic of 1857.1

PROPOSAL TO BACK MONEY WITH STATE CREDIT

The fourth proposal for producing something out of nothing was to back the issuance of money by the full faith and credit of the state. This was the method tried by many of the Southern states and it, too, has survived to become one of the cornerstones of our modern-day banking system.

Alabama, for example, in 1835 created a state bank funded by a public bond issue of $13,800,000. Instant money flooded through the economy and people were joyous over the miracle prosperity.

The legislators were so intoxicated with the scheme that they completely abolished direct taxation and decided to run the government on bank money instead. In other words, instead of raising state revenue through taxes, they found it easier to raise it through inflation.

Like all the others, this bubble also burst in the panic of 1837. A postmortem examination of the Bank showed that $6,000,000 of its assets were completely worthless. The people who had loaned their real money to the venture, backed by the full faith and credit of the state, lost almost all of their investment—in addition to what they had paid through inflation.

Mississippi put its full faith and credit behind a state bank in 1838 and issued $15,000,000 in bonds as backing for its bank notes.

The bank was belly-up within four years, and the state completely repudiated its obligations on the bonds. This infuriated the bond holders, particularly the British financiers who had purchased a large portion of the issue. The devastating effect upon the state and its people is described by Henry Poor:

L Groseclose, Money and Man, pp. 188-89.

366 THE CREATURE FROM JEKYLL ISLAND

The $48,000,000 of the bank's loans were never paid; the

$23,000,000 of notes and deposits were never redeemed. The whole system fell, a huge and shapeless wreck, leaving the people of the State very much as they came into the world.... Everybody was in debt, without any possible means of payment. Lands became worthless, for the reason that no one had any money to pay for them.... Such numbers of people fled ... from the State that the common return upon legal processes against debtors was in the very abbreviated form

'G.T.T.'—gone to Texas.1

Money, based on the full faith and credit of the state, met similar fates in Illinois, Kentucky, Florida, Tennessee, arid Louisiana. When the state bank collapsed in Illinois in 1825, all of the

'full-faith' bank notes left in its possession were ceremoniously burned at the public square. Another bank was formed in 1835 and collapsed in 1842. So devastating were these experiences that the Illinois Constitution of 1848 stipulated that, henceforth, the state should never again create a bank or own banking stock.

In Arkansas, even real estate was tried as a magic wand.

Subscribers to the state bank, instead of putting up cash, were allowed merely to pledge their real estate holdings as collateral.

The bank notes rapidly plummeted in value to only twenty-five per cent of their face amount, and within four years, the bank was gone.

THE MIRAGE OF FREE BANKING

There was a parallel development at this time called 'free banking.' The name is an insult to truth. What was called free banking was merely the conversion of banks from corporations to private associations. Aside from no longer receiving a charter from the state, practically every other aspect of the system remained the same, including a multitude of government controls, regulations, supports, and other blocks against the free market. George Selgin reminds us that 'permission to set up a bank was usually accompanied by numerous restrictions, including especially required loans to the state.'2

1. Henry V. Poor, Money and Its Laws (London: Henry S. King and Co., 1877), p. 540.

2. George A. Selgin, The Theory of Free Banking: Money Supply under Competitive Note Issue (Totowa, New Jersey: Rowman & Littlefield, 1988), p. 13.