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U.S. History/Further questions about the National Bank and the Federal Reserve


QUESTION: No problem regarding my last question. I know that I tend to fixate on minutia, and it certainly wouldn't be reasonable to expect anyone to know about all of the individual instances in which the Bank of the US made a loan.

I guess the important points that I want to make sure I've grasped are that the Bank of the US *could* make loans to banks and *did* make loans to banks; in those instances it was not seeking to protect the economy in any way, but was simply acting on good business opportunities; and generally speaking, whenever a bank has given a loan to another bank (either in Washington's time or today), it was probably giving the loan to a struggling bank; however there are other circumstances under which banks give loans to each other, and banks probably sought loans from the Bank of the US for a variety of reasons.

Does that sound about right? :)

If my questions have reached the point of excessive, then you can just respond to the part above, and I'll give you a rating of ten across the board. You've already been a huge help. However, if you're up for continuing, then I'd like to move on to what you said about the Bank of the US being able to manipulate the bank notes of other banks.

You said:

"If the Bank wanted to slow the growth of the money supply and credit, it could demand specie for the bank notes of other banks it accumulated in the normal course of business.  If it wanted a looser supply, it could simply hold onto those notes."

I'm not familiar with the term "specie", but I looked it up and the definition that I found reads, "money in the form of coins rather than notes." Is that how you're using the term? So, the Bank of the US accumulated bank notes through its regular operations, then demanded specie for those notes - who was it giving this demand to? The banks that had originally given it the notes? The federal government? Some other entity? And how would this process "slow the growth of the money supply and credit"? Would it simply hold onto the coins/specie in a vault somewhere, essentially keeping it out of circulation for a while?

ANSWER: I think you have the first part about right.  The bank could and did make loans to other banks but was always looking out for its own best interests.  Sometimes those intersected with the economy generally, sometimes not.

As far as specie, that requires more discussion of how the monetary system worked back then.

The US currency operated on the gold standard.  In other words, the value of a dollar was based on the value of gold.  During the Revolution, the government had issued dollars not tied to gold and had led to inflation that made dollars nearly worthless.

Although I will refer to gold here, other precious metals including silver, platinum, copper, and nickel were also considered specie.  But gold was the predominent and most valuable metal, so I generally just refer to that for the sake of simplicity.

The big problem with gold was that it could not increase in supply when the economy demanded it.  This led to money shortages and could cause deflation.  Gold was also very heavy and hard to carry around in large amounts.  

To get around this, banks issued bank notes.  A bank note was simply a promise that a bearer could exchange the note for gold or silver whenever he wanted.  Just walk into the bank and get your gold coins (specie).

Banks, however ofent issued more notes than they had specie to cover.  A bank with $1000 worth of gold in its vault might issue $10,000 worth of bank notes.  This was fine as long as everyone had confidence in the bank.  Few people ever bothered to go in and get their gold.  The notes simply circulated as money.  The problem came when people lost confidence in the bank for some reason.  Then, there would be a run on the bank.  The first people there got their gold.  Everyone else got stuck with worthless paper and the bank went out of business.

For this reason, bank notes often traded at a discount to specie.  The discount rate was based on the confidence of the bank.  Larger, more highly capitalized banks had notes that were preferred over smaller or out of state banks.  Banks always had to operate conservatively to maintain the public confidence and ensure the value of their notes.

Banks often traded in the currency of other banks.  So Bank A might be given some notes from Bank B from a customer who had to pay off a debt or make a deposit.  

So, with that background, the Bank of the US would sometimes accumulate notes of other banks from its customers and business dealings.  By demanding another bank pay off its notes with specie, it could force that other bank to take more notes out of circulation so that its ratio of notes to specie did not get too dangerously out of whack.  If it held onto the other bank's notes, that bank was free to keep even more notes in circulation.  Keeping more notes in circulation generally increased the money supply and made all banks more likely to provide more credit to customers.

---------- FOLLOW-UP ----------

QUESTION: Ah, okay. It sounds like you're describing a process very similar to fractional reserve banking (which I'm only familiar with, because I read about it a few weeks ago - it's probably the only complex banking concept that I know about).

This brings me to one of the other main questions I had about the Bank of the US. My book says that the Bank of the US "issue[d] notes that could serve as a national currency", which, along with some of the information you provided above, raises several questions about how currency worked in those days.

It sounds like you're saying that each bank issued its own currency. Is that right? And they continued to do so even after the Bank of the US began issuing a national currency?

Would banks issue both paper money (bank notes) and coins? Or was some other entity responsible for issuing the latter? When did the federal government take over the process of printing paper money?

ANSWER: The federal government was responsible for coining money (specie) since the creation of the Constitution where it was granted that power.  This was solely for coins, which were always made from specie (primarily gold, silver, and copper).  Neither State governments nor banks had the legal authority to coin money.  The government did not make paper money at all once the Constitution was established.

All "currency" circulating at the time took the form of bank notes.  Banks were typically chartered by the State in which they operated and were subject to restrictions on how much they could circulate in notes based on the amount of specie they had.  The bank of the US was the same thing, except that it got its charter from the Federal government rather than a State government.  But bank notes from the Bank of the US were private notes from a private bank just like all other bank notes.

The reason bank notes from the Bank of the US are sometimes said to have served as a "national currency" was that the Bank of the US was the largest, and by far the most highly capitalized bank in the country.  It's risk of default was lower than any other bank and the amount of notes it had in circulation dwarfed all other banks.  But other banks can and did continue to issue their own notes based on the amount of specie they had.

It was not until the Civil War that the federal government began to print its own paper currency.  Even then, it issued gold and silver certificates which authorized the bearer to trade in the currency for gold or silver.  Gold certificates disappeared in the 1930's when it became illegal for private citizens to possess gold coins, bullion or certificates.  Silver certificates were retired in the 1960's.  These were replaced by the federal reserve notes we use today, which are essentially backed by nothing other than the belief that the federal government will not print so many as to make them worthless.

Private bank notes began to fall off after the Civil War, but were used into the 1930's in some places.  Once the government dollars became the standard, bank notes were seen as less stable.  The Government ban on private gold certificates in the 1930's pretty much put an end to the already far reduced practice.

---------- FOLLOW-UP ----------

QUESTION: Fantastic! That clears things up a lot. :)

It sounds like then, that the Bank of the US functioned more or less like any typical bank of the day, only on a much larger scale. Would that be correct?

I've been wondering for a while, and probably should have asked for clarification much sooner, whether the Bank of the US accepted deposits from regular citizens. Initially, I assumed that it did not, as my book describes the Bank of the US as a "central bank", and I did not think that your average Joe could simply walk into a central bank and set up an account. Would the term "central bank" actually be accurate in describing the Bank of the US?

Both you and my book have detailed how $8 million of the bank's initial capital came from private investors - but unless I'm mistaken, this would be different from a deposit, right? Likewise, the $2 million that the federal government contributed as start-up capital would not have been the same as the federal tax revenues that were deposited with the bank, correct?

Yes, the Bank of the US engaged in the same sorts of operations as any other commercial bank of the time.  It took in private deposits and issued private loans.  When President Jackson removed all Federal tax revenues from the Bank, it continued to operate on a much weakened basis for several years based on private deposits and loans.

The initial capital was not the same as deposits.  Those investors were buying shares in the ownership of the bank.  That money was used to build new buildings, hire staff, and contribute to the initial specie deposits of the bank.  But the bank owners could not simply withdraw  their investments.  They would need to sell their bank stock to get their money back.  Government or private depositors of money got their deposits out simply by withdrawing them.

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Michael Troy


I can answer just about any question on early American History. My specialties are the American Revolution through the Civil War/Reconstruction. I also have greater expertise in matters relating to military, political or legal history.


I have lectured at George Washington University regarding the Civil War, as well as several elementary school Civil War demonstrations. I was also a member of a Civil War reenactment group for about 10 years.


J.D. University of Michigan B.A. George Washington University

Awards and Honors
Truman Scholar

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