Banking and Economic Development

Rockoff, H. T. (1975). "Varieties of Banking and Regional Economic Development in the United States, 1840-1860." The Journal of Economic History 35(1): 160-181.

Although this is essentially an economic history article (meaning it uses and then discusses statistical techniques that I’m not interested in, and don’t necessarily believe), Rockoff makes some points that are helpful to me. First, the general premise, that in “the two decades before the Civil War...the Federal Government withdrew from the regulation of banking” (irrelevant for me, but interesting for our times, Rockoff ultimately concludes that banking deregulation had little measurable effect on economic development in this period).

Rockoff measures “bank deposits and circulating notes...per capita as the measure of financial development.” (160) This approach favors areas where population and wealth (and possibly inequality) are greatest, and not surprisingly urbanity correlates strongly with “financial development.” But this may be misleading. Rockoff seems to ignore other economic
uses of money in favor of its role as a store and signal of wealth. This basically wealth-oriented perspective discounts the (possibly much) greater velocity of money in developing regions, where funds are continuously cycling through the economy as people buy, sell, build, and consume. Rockoff’s lack of interest in this distinction is shown in the fact that New York is treated as a single entity, when in fact between 1840 and 1860, the state was a textbook example of the difference between urban and rural economies.

Rockoff highlights “free banking” laws in his analysis, which “ended the requirement that banks obtain their charters through special legislative acts.” (161) But this did not mean laissez faire. Even under free banking, the law “prohibited banks from investing in real property, [and] banks had to back issues of circulating notes with government bonds deposited with a state authority.” (162) The bond-reserve requirement (he doesn’t say, but I assume it was a 100% reserve) provided some security, but perhaps not as much as a specie reserve would have done. There seems to have been a way to “game” the discrepancy between par and market values of the underlying (state-issued) bonds. And many banks seem to have been started with capital that was immediately returned to investors in the form of loans. (160) But in any case, Rockoff says “from 1845 to 1860 New York experienced virtually no bank failures.” (162)

Rockoff notes that the “rate of growth of money per capita” in New York during this period “was quite rapid: 4.41 percent compared with 2.56 percent for the country as a whole.” (163) Of course, for my purposes, there’s the unresolved question of how much of that money growth was confined to New York City, and whether any of it found its way upstate? Proximity to the city probably increased the velocity of money through producing regions along the canal, but did it also divert
accumulation to banks and their corresponding investments in the city, at the expense of local investment? Rockoff says “level of urbanization...explain[s] about seventy percent of the variance in per capita money balances.” (167) But he also admits “these coefficients refer to stocks of assets rather than flows and should therefore be compared with wealth rather than income.” (169)

And maybe this is the biggest take-away for me --- that there’s a difference between wealth and income. The way money works in a system (or the way you see it working) is different when it’s moving, from when it’s accumulated. I don’t have the language for it yet (and I should probably look for this in period, rather than in contemporary sources), but there’s a crucial difference between stocks and flows of money in the nineteenth century. To the extent that accumulation was an urban phenomenon (even for the rural elite, who deposited their wealth in secure, prestigious urban institutions), this is another “country/city” issue. And maybe it plays a role in the personalities and conflicts I’m seeing in sources like the credit reports...