Chapter Eighteen: Loaves and Fishes and Civil War

Attempts to stabilize the banking system by political measures, including regulation of fractional-reserve ratios and establishing bank-failure insurance funds; the failure of all such schemes; the resulting economic conditions that led up to the Civil War.

As detailed in the previous chapter, by 1836 the hydra-headed monster had been slain and, true to the President’s campaign promise, the nation had Jackson and no Bank.

In April of that year, the Administration moved to consolidate its victory and pushed a series of monetary reforms through Congress. One of these required all banks to cease issuing paper notes under five dollars. The figure later was increased to twenty dollars, and its purpose was to compel the nation to return to the use of gold and silver coin for everyday use, leaving bank notes primarily for large commercial transactions. The White House also announced that, in the future, all federal land sales would require full payment in lawful money, which, of course, meant precious-metal coins.

It must be remembered, however, that even though the Bank of the United States was dead, banking was very much alive, and so were Jackson’s enemies. Much to the disappointment of the hard-money advocates, these measures were not sufficient to usher in the millennium. Not only were they inadequate by themselves, they were soon circumvented by the development of new banking techniques and eventually were dismantled completely by a fickle Congress.

The prohibition against bank notes of small denomination deserves special notice. It was an excellent concept, but what the legislators failed to understand, or at least pretended not to understand, was that banks at this time were increasingly dealing with checkbook money, technically called demand deposits. As people gradually became accustomed to this new method of transferring funds, the importance of bank notes declined. Placing a limit on the issuance of bank notes without any restriction on the creation of demand deposits was an exercise in futility.

In 1837, as the Bank of the United States slipped into history, the nation was at the tail end of an economic boom. Professor Rothbard tells us that this expansion and the accompanying inflation had been fueled by the central bank, Total money in circulation had risen by eighty-four percent in just four years. Then, as inevitable as the setting sun, that portion of the money supply which had been created by fractional-reserve banking — in other words, the part which was backed by nothing — began to contract. Sixteen percent of all the nation’s money totally disappeared in just that first year. Again, men were put out of work, businesses went into bankruptcy, homes and savings were lost. Many banks folded also, but their operators walked away with the spoils. Only the depositors were left holding the empty bag.

There were numerous proposals advanced regarding how to infuse stability into the banking system. But, then as now, none of them dealt with the real problem, which was fractional-reserve banking itself. As Groseclose observed, these proposals were each according to a particular theory of how to multiply loaves and fishes, or how to make candy wool. Since the proposals presented then are identical to the ones being offered today, and since each of them was actually tried, it would seem appropriate to inquire into the actual results of these experiments.

Proposal To Base Money On Bank Assets

There were four schools of thought regarding the multiplication of loaves and fishes. The first of these was that the creation of money should be limited to a ratio of the bank’s assets. This was the formula that was tried in the New England states. In Massachusetts, for example, the issuance of bank notes was limited to two times the amount of the bank’s capital actually held in the vault. Furthermore, this could not be in the form of paper money, bonds, securities, or other debt instruments; it had to be strictly gold or silver coin. Also, the banks were limited in the number of small-denomination bank notes they could issue and, in this, Massachusetts served as the model for Jackson’s attempted reform at the federal level. By previous standards, and certainly by the standards that prevail today, this was an exceptionally conservative policy. In fact, even during the previous stress of the War of 1812, when banks were failing by the hundreds across the country, the Massachusetts banks, and most of the other New England banks as well, were able to maintain full payment in specie.

With fhe passage of time, however, the limit on bank notes became less important, because the banks now were using checkbook money instead. Their paper notes may have been limited to two-hundred percent of their capital, but there was no effective limit to the numbers they could ink into people’s deposit books. So the fraction in fractional-reserve banking began to shrink again. Consequently, the monetary contraction of 1837 was like a scythe bver the crop, says Groseclose, and thirty-two Massachusetts banks collapsed between that year and 1844.

The state attempted to patch the system by instituting a network of bank examiners and by increasing the liability of bank stockholders for the lost funds of their depositors, but the underlying problem was still ignored. A new crop of banks then sprang into existence and a new wave of speculative mania swept through the economy. By 1862, even though the law still limited bank notes po two times capital, the banks had created $73,685,000 in total money, including checkbook money. This was supported by a base of only $9,595,000 of specie, a reserve of only thirteen percent. Massachusetts had not solved the problem.

Proposal to Protect Deposits with a Safety Fund

The second theory about how to have stable banking and allow the banks to create money out of nothing was to create a safety fund. This fund, supported by all the banks, would come to the aid of any member which needed an emergency loan to cover a sudden drain of its reserves. It was the forerunner of today’s Federal Deposit Insurance Corporation and related agencies.

The first safety fund was established in New York in 1829. The law required each bank to contribute annually one-half of one percent of its capital stock until the total reached three percent. The fund was first put to the test during the crisis of 1837, and was almost swamped. The only thing that saved it was that the state agreed to accept the worthless notes of all the defunct banks as payment for canal tolls. In other words, the taxpayers were compelled to make up the difference. When the fund was exhausted, the solvent banks were punished by being forced to pay for the deficits of the insolvent ones. Naturally, this impelled all banks to act more recklessly. Why not? The up side was that profits would be higher — for a time, at least — and the down side was that, if recklessness got them into trouble, the safety fund would bail them out. The result was that the system provided a penalty for prudence and an incentive for recklessness; a situation with perfect parallel to that which exists in the banking system today. Groseclose says:

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:

So rampant was the note-issue mania that the notes came to be called by the appropriate name of red dog 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.

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:

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.

Money, based on the full faith and credit of the state, met similar fates in Illinois, Kentucky, Florida, Tennessee, and 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 percent 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.

The free banks were no less fraudulent than the chartered banks. The old custom was revived of rushing gold coins from one bank to another just ahead of the bank examiners, and of putting a ballast of lead, broken glass and (appropriately) ten-penny nails in the box under a thinner covering of gold coins. 1 When one such free bank collapsed in Massachusetts, it was discovered that its bank note circulation of $500,000 was backed by exactly $86.48.

Professor Hans Sennholz writes:

Although economists disagree on many things, most see eye to eye on their acceptance of political control … These economists invariably point at American money and banking before the Civil War which, in their judgment, confirms their belief. In particular, they cite the Free Banking Era of 1838-1860 as a frightening example of turbulent banking and, therefore, applaud the legislation that strengthened the role of government.

In reality, the instability experienced during the Free Banking Era was not caused by anything inherent in banking, but resulted from extensive political intervention … Free banking acts … did not repeal burdensome statutory provisions and regulatory directives. In fact they added a few.

For banking to have been truly free, the states would have had to do only two things: (1) enforce banking contracts the same as any other contract, and then (2) step out of the picture. By enforcing banking contracts, the executives of any bank which failed to redeem its currency in specie would have been sent to prison, an eventuality which soon would have put a halt to currency overissue. By stepping out of the picture and dropping the pretense of protecting the public with a barrage of rules, regulations, safety funds, and guarantees, people would have realized that it was their responsibility to be cautious and informed. But, instead, the banks continued to enjoy the special privilege of suspending payment without punishment, and the politicians clamored to convince the voters that they were taking care of everything.

In short, throughout this entire period of bank failures, economic chaos, and fleecing of both investors and taxpayers, America tried everything except full redemption by gold and silver. As the name of Andrew Jackson faded into history, so did the dream of honest banking.

Not all banks were corrupt, and certainly not all bankers were conspirators against the public. There were many examples of honest men striving to act in an ethical manner in the discharge of their fiduciary responsibilities. But they were severely hampered by the system within which they labored, a system which, as previously illustrated, punished prudence and rewarded recklessness. In balance, the prudent banker was pushed aside by the mainstream and became but a footnote to the history of that period.

Industrial Expansion in Spite of Dishonest Banking

Another positive aspect to the picture is that it was during this same time that many business enterprises came into being and greatly prospered, albeit at the expense of those who had no desire to contribute. The great canals were dug, the railroads pushed back the frontier, boom towns sprang up along the way, prairies were turned into agricultural land, and new businesses followed in their wake. Much of this expansion was facilitated by a flood of fraudulent money created by the banks. Apologists for fractional-reserve banking have been prone to look at this development and conclude that, in net balance, it was a good thing. The fact that some people were cheated in order for others to prosper did not seem to be important. America just wouldn’t have grown and prospered without funny money. Galbraith, for example, exudes:

As civilization, or some approximation, came to an Indiana or Michigan crossroads in the 1830s or 1840s, so did a bank. Its notes, when used and loaned to a farmer to buy land, livestock, feed, seed, food or simple equipment, put him into business. If he and others prospered and paid off their loans, the bank survived. If he and others did not so prosper and pay, the bank failed, and someone — perhaps a local creditor, perhaps an eastern supplier — was left holding the worthless notes. But some borrowers from this bank were by now in business. Somewhere, someone holding the notes had made an involuntary contribution to the winning of the West … The [banking] anarchy served the frontier far better than a more orderly system that kept a tight hand on credit could have done.

William Greider continues this rationale:

Reckless, booming anarchy, in short, produced fundamental progress. It was not a stable system, racked as it was with bank failures and collapsed business ventures, outrageous speculation and defaulted loans. Yet it was also energetic and inventive, creating permanent economic growth that endured after the froth had blown away.

This, of course, is a classic example of the failure of liberal economics. When evaluating a policy, it focuses only on one beneficial consequence for one group of people and ignores the multitude of harmful effects which befall all other groups. Yes, if we look only at the frontiersmen who acquired new ranches and established new business, the fractional-reserve system looks pretty good. But, if we add in to the equation all the financial losses to all of the people who were victimized by the system — what Galbraith calls an involuntary contribution, and what Greider lightly dismisses as froth — then the product is zero at best and, in terms of morality, is deeply in the negative.

Galbraith, Greider, and other popular economists assume that the West could not possibly have been won with honest banking. Logic does not support such a conclusion. There is every reason to believe that the bank failures and the resulting business failures on the frontier all but canceled out the gains that were made by hard work and honest industry. Had these destructive convulsions been absent, as most of them would have been under a less chaotic system, there likely would have been fewer business starts, but a greater number would have finished, and it is entirely possible that the West would have been won even faster than it was.

It’s too bad the theory has never been tried.

The Union in Jeopardy

As chronicled in a previous section, economic conflict has always played a major role in fomenting war. There is no time in American history in which there was more economic conflict between segments of the population than there was prior to the Civil War. It is not surprising, therefore, that this period led directly into the nation’s bloodiest war, made all the more tragic because it pitted brother against brother.

There are many popular myths about the cause of the War Between the States. Just as the Bolshevik Revolution is commonly believed to have been a spontaneous mass uprising against a tyrannical aristocracy, so, too, it is generally accepted that the Civil War was fought over the issue of slavery. That, at best, is a half-truth. Slavery was an issue, but the primary force for war was a clash between the economic interests of the North and the South. Even the issue of slavery itself was based on economics. It may have been a moral issue in the North where prosperity was derived from the machines of heavy industry, but in the agrarian South, where fields had to be tended by vast work forces of human labor, the issue was primarily a matter of economics.

The relative unimportance of slavery as a cause for war was made clear by Lincoln himself during his campaign for the Presidency in 1860, and he repeated that message in his first inaugural address:

Apprehension seems to exist among the people of the Southern States that by the accession of a Republican administration their property and their peace and personal security are to be endangered … I have no purpose, directly or indirectly, to interfere with the institution of slavery in the states where it now exists. I believe I have no lawful right to do so, and I have no inclination to do so.

Even after the outbreak of war in 1861, Lincoln confirmed his previous stand. He declared:

My paramount object in this struggle is to save the Union, and it is not either to save or destroy slavery. If I could save the Union without freeing any slave, I would do it; and if I could save it by freeing all the slaves, I would do it; and if I could do it by freeing some and leaving others alone, I would also do that.

It may come as a surprise to learn that, by strict definition, Abraham Lincoln was a white supremacist. In his fourth debate with Senator Stephen Douglas, he addressed the subject bluntly:

I am not nor ever have been in favor of bringing about in any way the social and political equality of the white and black races — that I am not nor ever have been in favor of making voters or jurors of Negroes, nor of qualifying them to hold office, nor to intermarry with white people; and I will say in addition to this that there is a physical difference between the white and black races which I believe will forever forbid the two races living together on terms of social and political equality. And inasmuch as they cannot so live, while they do remain together there must be the position of superior and inferior, and I as much as any other man am in favor of having the superior position assigned to the white race.

This is not to say that Lincoln was indifferent to the institution of slavery, for he felt strongly that it was a violation of personal and national morality, but he also knew that slavery was gradually being swept away all over the world — with the possible exception of Africa itself — and he believed that it would soon disappear in America simply by allowing the natural forces of enlightenment to work their way through the political system. He feared — and rightly so — that to demand immediate and total reform, not only would destroy the Union, it would lead to massive bloodshed and more human suffering than was endured even under slavery itself. He said:

I have not allowed myself to forget that the abolition of the Slave trade by Great Britain was agitated a hundred years before it was a final success; that the measure had its open fire-eating opponents; its stealthy don’t-care opponents; its dollar-and-cent opponents; its inferior-race opponents; its Negro-equality opponents; and its religion and good-order opponents; that all these opponents got offices, and their adversaries got none. But I have also remembered that though they blazed like tallow-candles for a century, at last they flickered in the socket, died out, stank in the dark for a brief season, and were remembered no more, even by the smell. School boys know that Wilbeforce and Granville Sharpe helped that cause forward; but who can now name a single man who labored to retard it? Remembering these things I cannot but regard it as possible that the higher object of this contest may not be completely attained within the term of my natural life.

If Lincoln’s primary goal in the War was not the abolition of slavery but simply to preserve the Union, the question arises: Why did the Union need preserving? Or, more pointedly, why did the Southern states want to secede?

Legal Plunder, Not Slavery, the Cause of War

The South, being predominantly an agricultural region, had to import practically all of its manufactured goods from the Northern states or from Europe, both of which reciprocated by providing a market for the South’s cotton. However, many of the textiles and manufactured items were considerably cheaper from Europe, even after the cost of shipping had been added. The Southern states, therefore, often found it to their advantage to purchase these European goods rather than those made in the North. This put considerable competitive pressure on the American manufacturers to lower their prices and operate more efficiently.

The Republicans were not satisfied with that arrangement. They decided to use the power of the federal government to tip the scales of competition in their favor. Claiming that this was in the national interest, they levied stiff import duties on almost every item coming from Europe that was also manufactured in the North. Not surprisingly, there was no duty applied to cotton which, presumedly, was not a commodity in the national interest. One result was that European countries countered by stopping the purchase of U.S. cotton, which badly hurt the Southern economy. The other result was that manufacturers in the North were able to charge higher prices without fear of competition, and the South was forced to pay more for practically all of its necessities. It was a classic case of legalized plunder in which the law was used to enrich one group of citizens at the expense of another.

Pressure from the North against slavery in the South made matters even more volatile. A fact often overlooked in this episode is that the cost of a slave was very high, around $1,500 each. A modest plantation with only forty or fifty slaves, therefore, had a large capital investment which, in terms of today’s purchasing power, represented many millions of dollars. To the South, therefore, abolition meant, not only the loss of its ability to produce a cash crop, but the total destruction of an enormous capital base.

Many Southern plantation owners were working toward the day when they could convert their investment to more profitable industrial production as had been done in the North, and others felt that freemen who were paid wages would be more efficient than slaves who had no incentive to work. For the present, however, they were stuck with the system they inherited. They felt that a complete and sudden abolition of slavery with no transition period would destroy their economy and leave many of the former slaves to starve — all of which actually happened in due course.

That was the situation that existed at the time of Lincoln’s campaign and why, in his speeches, he attempted to calm the fears of the South about his intentions. But his words were mostly political rhetoric. Lincoln was a Republican, and he was totally dependent on the Northern industrialists who controlled the Party. Even if he had wanted to — and there is no indication that he did — he could not have reversed the trend of economic favoritism and protectionism that swept him into office.

Mexico and The Monroe Doctrine

In addition to the conflicting interests between North and South, there were other forces also working to split the nation in two. Those forces were rooted in Europe and centered around the desire of France, Spain, and England to control the markets of Latin America. Mexico was the prime target. This was the reason the Monroe Doctrine had been formulated thirty-eight years previously. President James Monroe had put the European nations on notice that the United States would not interfere in their affairs, and that any interference by them in American affairs would not be tolerated. In particular, the proclamation said that the American continents were no longer to be considered as available for colonization.

None of the European powers wanted to put this issue to the test, but they knew that if the United States were to become embroiled in a civil war, it could not also cross swords in Latin America. To encourage war between the states, therefore, was to pave the way for colonial expansion in Mexico. The Americas had become a giant chess board for the game of global politics.

In the American Heritage Picture History of the Civil War, we read:

The war had not progressed very far before it was clear that the ruling classes in each of these two countries [England and France] sympathized strongly with the Confederacy — so strongly that with just a little prodding they might be moved to intervene and bring about Southern independence by force of arms … Europe’s aristocracies had never been happy about the prodigious success of the Yankee democracy. If the nation now broke into halves, proving that democracy did not contain the stuff of survival, the rulers of Europe would be well pleased.

The global chess match between Lincoln on the one side and England and France on the other was closely watched by the other leaders of Europe. One of the most candid observers at that time was the Chancellor of Germany, Otto von Bismarck. Since Bismarck was, himself, deeply obligated to the power of international finance, his observations are doubly revealing. He said:

The division of the United States into federations of equal force was decided long before the Civil War by the high financial powers of Europe. These bankers were afraid that the United States, if they remained in one block and as one nation, would attain economic and financial independence, which would upset their financial domination over the Europe and the world. Of course, in the inner circle of Finance, the voice of the Rothschilds prevailed. They saw an opportunity for prodigious booty if they could substitute two feeble democracies, burdened with debt to the financiers,… in place of a vigorous Republic sufficient unto herself. Therefore, they sent their emissaries into the field to exploit the question of slavery and to drive a wedge between the two parts of the Union … The rupture between the North and the South became inevitable; the masters of European finance employed all their forces to bring it about and to rum it to their advantage.

The strategy was simple but effective. Within months after the first clash of arms between North and South, France had landed troops in Mexico. By 1864, the Mexicans were subdued, and the French monarch installed Ferdinand Maximilian as the puppet emperor. The Confederacy found a natural ally in Maximilian, and it was anticipated by both groups that, after the successful execution of the War, they would combine into a new nation — dominated by the financial power of Rothschild, of course. At the same time, England moved eleven-thousand troops into Canada, positioned them menacingly along the Union’s northern flank, and placed the British fleet onto war-time alert.

The European powers were closing in for a checkmate.


The Second Bank of the United States was dead, but banking was very much alive. Many of the old problems continued, and new ones arrived. The issuance of banknotes had been severely limited, but that was largely offset by the increasing use of checkbook money, which had no limits at all on its issue.

When the Bank of the U.S. slipped into history, the nation was nearing the end of the boom phase of a boom/bust cycle. When the inevitable contraction of the money supply came, politicians began to offer proposals on how to infuse stability into the banking system. None dealt with the real problem, which was fractional-reserve banking itself. They concentrated instead on proposals on how to make it work. All of these proposals were tried and they failed.

These years are sometimes described as a period of free banking, which is an insult to truth. All that happened was that banks were converted from corporations to private associations, a change in form, not substance. They continued to be burdened by government controls, regulations, supports, and other blocks against the free market.

The economic chaos and conflict of this period was a major cause of the Civil War. Lincoln made it clear during his public speeches that slavery was not the issue. The basic problem was the North and the South were dependent on each other for trade. The industrialized North sold its products to the South which sold its cotton to the North. The South also had a similar trade with Europe, and that was an annoyance to the North. Europe was selling many products at lower prices, and the North was losing market share. Northern politicians passed protectionist legislation putting import duties on industrial products. This all but stopped §he importation of European goods and forced the South to buy (from the North at higher prices. Europe retaliated by curtailing the burchase of American cotton. That hurt the South even more. It was a classic case of legalized plunder, and the South wanted out.

Meanwhile, there were powerful forces in Europe that wanted to see America embroiled in civil war. If she could be split into two hostile countries, there would be less obstacle to European expansion on the North American continent. France was eager to capture Mexico and graft it onto a new empire which would include many of the Southern states as well. England, on the other hand, had military forces poised along the Canadian border ready for action. Political agitators, funded and organized from Europe, were active on both sides of the Mason-Dixon line. The issue of slavery was but a ploy. America had become the target in a ruthless game of world economics and politics.