Tuesday, November 28, 2006

Andrew Jackson and "the Monster" - Part I

Many historians blame Jackson for causing an undue inflation for his war on the Second Bank of the United States, which he referred to as "the Monster." Jackson vetoed the Bank re-charter and moved the government funds from the Bank to selected state banks. Thus, Arthur M. Sclesinger, Jr., in The Age of Jackson, says Jackson "removed a valuable brake on credit expansion" by destroying the Bank. Even laissez-fiare advocate William Graham Sumner was inconsistent in his analysis. While praising the Jacksonians for putting "a metalic currency high up on [their] banner," he also condemned them for attacking "a great and valuable financial institution." As economic historian Jeffrey Rogers Hummel writes, Sumner, though critical of Bank president Nicholas Biddle, "considered the Bank [on the whole] a successful restraint on the inflationary proclivities of the state banks."

According to Hummel writers who have created the traditional interpretation of the Jacksonian war on the Bank, which blames Jackson and his supporters for the ensuing inflation, have at the core of their analysis an economic theory known as the sound banking doctrine. He explains:
Banks have always issued more notes or deposit
liabilities than they have monetary reserves to
cover. This process is called fractional reserve
banking, and through it, banks create money.
Thus, an ante-bellum bank which issued $1000
in notes with only $100 in specie (gold or silver
bullion and coin) as reserves in its vault, had
created $900 and had a reserve ratio of 10%.
The sound banking doctrine holds that fraction-
al reserve banking is necessary and beneficial
for a prosperous economy. There are insuffici-
ent quantities of gold and silver in existence to
satisfy monetary needs. Money creation by
banks is a needed service. However, monetary
creation can go too far. Banks will overissue
their notes and deposits and reduce their
reserve ratios to dangerous levels if governed
solely by the banker's desire for profit. That leads
to inflation, economic instability, and wildcat
banking. People will drown in a deluge of
unbacked paper money. Therefore, external
checks are necessary to insure that fractional
reserve banking stays within certain limits and
that reserve ratios stay at certain levels, and
government must provide the checks. It can be
seen that this doctrine occupies the middle
ground between the extremes of hard money on
the one hand, and inflationary banking or fiat
money on the other.
To be continued in Part II.

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