How to Kill a Central Bank

Central banks, the institutions that control nations’ money supply, are receiving an enormous amount of criticism these days. Even some central bankers are casting doubt upon their own institutions.

For instance, a former Governor of the Bank of England, Mervyn King blames central banks for inflation, Reuters reports. To elaborate, King thinks central banks created inflation by engaging in too much quantitative during after the COVID-19 pandemic.

Similarly, a Reserve Bank of Australia report admits that institution’s experts got the response to the pandemic wrong, The Washington Post notes. The report speculates the Reserve Bank’s policies of zero interest and quantitative easing could trigger economic instability and inflation.

The Guardian speculates central banks’ current policy of raising interest rates to control inflation will fail. Moreover, Guardian writer Greg Jericho thinks central bank policies are creating a debt crisis that will lead to economic catastrophe.

Thus, central banks are under attack. Yet most of us cannot imagine a world without central banks or getting rid of them. Interestingly, history offers an example of a nation that killed its central bank. Strangely, that nation was the United States of America.

Andrew Jackson and the Bank War

Notably, the United States is the only nation in history to abolish its central bank.

During the 1830s, President Andrew Jackson (D-Tennessee) killed America’s central bank, the Second Bank of the United States, through a series of political maneuvers. Jackson’s actions became known as the Bank War. The Bank War was a definitive struggle in American politics and the rise of the Democratic Party.

Interestingly, the Bank War was a class and regional struggle. To explain, in the early 19th century, a small coastal elite controlled most American institutions. For example, all the presidents before Jackson came from a tiny group of Virginia planters and New England intellectuals.

Similarly, New York and Philadelphia financiers dominated the economy through the Bank of the United States. The Bank of the United States was a private institution based on the Bank of England. Yet the Bank of the United States controlled the nation’s money supply and debt.

Western politicians, such as Jackson, accused the Bank of the United States of concentrating economic power in the hands of a few Philadelphia bankers. Additionally, Jackson’s followers alleged the Bank corrupted politics by bribing and employing politicians. Such critiques were valid. The Bank of the United States employed some powerful politicians, including US Senator Daniel Webster (W-New Hampshire) as lobbyists and lawyers.

Jackson hated the Bank of the United States and opposed its policy of issuing paper money. To explain, Jackson was a hard money man who believed gold was the only legitimate currency.

The Plan to Save the Central Bank

In 1828, Jackson overturned America’s political order by getting elected President with an impressive majority. However, there was little Jackson could do about the Bank of the United States because its charter did not expire until 1836. Hence, Jackson had to win reelection twice to kill the Bank.

In 1832, with Jackson’s reelection looking probable, Bank of the United States president Nicholas Biddle and US Senator Henry Clay (W-Kentucky) came up with a plan to save the central bank. Clay was the leader of the opposition and Jackson’s opponent in the 1832 presidential election.

The two guessed that a majority in both houses of Congress wanted to preserve the Bank. Hence, Clay and his allies introduced legislation rechartering the bank for 15 more years (until 1847). The new Bank Charter passed both houses of Congress and made its way to the president.

Jackson kills the Bank of the United States

Clay and Biddle bet that Jackson, a savvy politician, would not veto the charter to preserve peace within his Democratic Party. On 10 July 1832, their gamble failed as Jackson returned the charter bill to Congress unsigned.

Jackson attached a message explaining his action to the veto. Interestingly, Jackson’s message resembles modern critiques of central banks and financiers. Old Hickory charged that the Bank of the United States existed only to generate huge profits for its shareholders. The president called the shareholders “foreigners” and “our own opulent citizens.”

 “It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes,” Jackson wrote. Jackson was also worried about foreign influence over the Bank. “If we must have a bank with private stockholders, every consideration of sound policy and every impulse of American feeling admonishes that it should be purely American.”

The recharter legislation went back to Congress and died because its supporters lacked the two-thirds majority needed to override the President’s veto.

The Bank became the central issue of the 1832 presidential campaign. The election’s results show Jackson had better political instincts than Biddle and Clay. Jackson won the 1832 presidential election by a margin of 219 Electoral College votes. His opponents received just 69 Electoral College votes. Jackson’s victory meant a central bank was a dead issue in the United States until the early 20th century.

The Bank War

Jackson’s veto triggered the Bank War. To destroy the Bank of the United States, Jackson moved all the federal governments’ deposits to state-chartered banks.

Additionally, Jackson ordered the federal government to only accept gold as payment for federal land purchases. Jackson’s gold order was a deliberate attack on banks because most land purchases were in bank issued paper money. In the early 19th century, the sale of undeveloped land was one of the US government’s primary sources of income.

In retaliation, Biddle restricted loans and tightened the money supply. To explain, Biddle hoped economic distress would turn the public against Jackson and destroy public support for Old Hickory’s Democratic Party.

Similarly, Jackson’s opponents organized the Whig Party as an alternative to the Democrats. They named the Whigs for a British anti-monarchist party to which many of the Founding Fathers had belonged. In 1834, US Senate Whigs censured Jackson for moving the federal deposits. In 1837, Senate Democrats reversed the censure.

Biddle’s Revenge

Although he lost the bank war. Biddle got his revenge as history showed his economic ideas were correct.

The Second Bank of the United States charter expired in 1836, giving state-chartered banks the ability to print money. Ironically, the Bank of the United States itself became a Pennsylvania state-chartered bank.

The flood of paper money led to economic chaos and high inflation. Many state banks, including the Bank of the United States, collapsed because they issued more money than they could back. An economic collapse called the Panic of 1837 paralyzed America’s economy.

The Panic was catastrophic because the government had no means of dealing with the crisis. One casualty of the Panic of 1837 was Jackson’s successor President Martin Van Buren (D-New York). Van Buren lost the 1840 presidential election to Whig William Henry Harrison (I-Indiana) because of popular anger at the horrible economy.

Once again, history proved Jackson’s political instincts correct. Old Hickory left the White House before the effect of his horrendous policies became apparent.

A Nation Without a Central Bank

The major result of the Bank War was that America lacked a central bank from 1836 until 1914.

The concept of a central bank was so unpopular politicians created alternatives. Van Buren was one of many Democrats who backed the independent treasury system. Under the independent treasury system, the US Treasury Department took on many of the responsibilities of a central bank.

For example, during the Civil War, the Treasury Department printed banknotes (paper money) and issued debt to fund the war effort. Hence, the US Treasury Department created the US Dollar or greenback, which became America’s currency. During the Civil War, private paper money disappeared and most Americans began using federal paper.

Another Civil War measure was the federally chartering of national banks. Consequently, a banking system regulated by the federal government emerged. America developed a decentralized financial system closely tied to the global economy dominated by the Bank of England and dependent on pound sterling.

In 1914, after several financial crises and a near collapse of federal finances in the 1890s. The US Congress chartered a new central bank, the Federal Reserve System.

Unlike the Bank of the United States, the Federal Reserve is a government institution with directors appointed by the president and approved by Congress. Another difference is that the Federal Reserve is a decentralized institution.

Unlike most central banks, which comprise one national bank. The Federal Reserve is a cartel of regional banks. However, the largest components of the system, the New York Fed, functions as America’s central bank.

Can a Nation Function without a Central Bank?

Jackson’s Bank War shows that politicians can destroy a nation’s central bank if given the chance. However, the effects of the Bank War show a modern economy cannot function without central banking.

The lack of a central of bank has two unsatisfactory outcomes. First, another country’s central bank dominates the nation’s economy. For example, America’s financial center moved to London after the panic of 1837 and stayed there until after the Civil War. The Bank of England became America’s central bank. An outcome that the anti-British Andrew Jackson would have hated.

Second, other institutions assume the duties of a central bank. For example, the Treasury Department began issuing money and federal debt. Worse, by the 1890s some New York investment banks were assuming the role of a central bank.

For example, during the Panic of 1893, the Federal Treasury almost ran out of gold. A desperate President Grover Cleveland (D-New York) reached out to investment banker J.P. Morgan Sr. Morgan prevented collapse by loaning the Treasury $65 million in gold.

During the Crash of 1907, Morgan organized a group of financial titans who bailed out several failing financial institutions. In particular, Morgan pressured banks to bail out the New York Stock Exchange and save the stock market.

The political backlash against Morgan’s role in the Crash of 1907 prompted Congress to create the Federal Reserve. One reason for the creation of the Federal Reserve was to prevent private banks from becoming the nation’s lenders of last resort and getting control of the economy.

Jackson’s Bank War shows politicians can kill a central bank. However, Jackson proved no nation can survive without a central bank.