Banks: Capital or Credit

Howard Bodenhorn
A History of Banking in Antebellum America: Financial Markets and Economic Development in the Era of Nation-Building

Bodenhorn focuses on the capital formation function of banks -- I’m more interested in their transactional nature, as facilitators of exchange and sort-term credit. Seems like their might be two ways of looking at banks, and thinking about their role in antebellum America. One believes that growth was based on “capital deepening”: the accumulation of assets that were devoted to investment rather than consumption. The other believes that growth was based on overextension -- on basically living beyond your means, and juggling credit as best as you can to keep the foreclosers at bay.

Bodenhorn says “by 1820...banks became better known, more reputable, more established, and therefore more trusted,” presumably convincing more people (whether as shareholders or depositors) to put their money in banks (8). This is capital deepening, a supply-side argument: growth happened when banks began to accumulate enough money to lend to industrialists or invest. But then, growth has to await savable surpluses. This does not seem to have been the case in Western NY.

Maybe it’s a regional difference. Maybe the upstate banks (and the businessmen who declared themselves to be bankers so that they could
write their own notes rather than running around the county looking for currency) were taking advantage of an earlier “deepening” of the type Bodenhorn describes, that took place in Boston, Philadelphia, and New York. “Bank-supplied currency,” he says, “performed [a] dual role as both a medium of exchange and a store of wealth” (9). But since banknotes were a claim on assets (always provided you didn’t claim them, as noted elsewhere), they were basically debt. And the rest of the paper circulating as money was out-and-out debt: promissory notes. So it’s borrowing (even if only in the form of drafts written against shipped -- but not received -- products) that drives the money supply. Even the ability to take your note and deposit it at a neighboring bank, and then draw against that deposit, suggests that capital formation, at least in the sticks, is based on credit.

Bodenhorn says Hugh Patrick called these competing views “demand-following” and “supply-leading,” but the way he uses them is not exactly what I was talking about. In the “demand-following” model, “financial intermediaries were passive agents, permissive of growth” (11). The economy grew, and when people needed banking services, bankers appeared to supply them. The “supply-leading” model, on the other hand, says “the creation of financial institutions and the supply of financial services must arise prior to the demand for them” (13) How does this happen? Bodenhorn suggests a compromise, in which the banks arise “prior to the development of a modern manufacturing sector” (14). Agricultural growth enriches people, who then put their money in banks where it becomes available to new industrial enterprises. As proof, Bodenhorn cites New York’s bank commissioners, who said in 1835 that banks were “among the most useful and powerful agents in developing the resources and stimulating the industry of the country” (15). “Banks, it seems clear,” he concludes, “were attributed leadership status by contemporary Americans.” But bank commissioners would be expected to say that. Even if they were completely sincere, they were bureaucrats, not entrepreneurs. It would be completely natural for them to put the cart before the horse.

I don’t really see a big difference between Patrick’s two models of banking. In my mind, they’re both “supply-side,” because they both focus on the role of the bank. Bodenhorn says there was about $41 million of specie in the US economy in 1820, but half of it was tied up in bank reserves. There were $36 million in bank notes, and $27 million in deposits (which are also considered liabilities of the banks, because they can be drawn against, 16-17). So “Of the $83 million in currency chasing goods around the economy, about 76 percent of it was bank-supplied” (17). But in spite of this, Bodenhorn insists that “Money creation by banks, however important it may have been, was incidental to their most fundamental task--that of intermediating between borrowers and lenders, savers and investors” (18). The rest of the book focuses very tightly on this intermediary function, which makes it less useful for my needs.

Why? Because I don’t think that’s what the guys I’m studying in upstate New York were up to. Maybe it’s just a case of emphasis, but I really see the banks’ role as providing a circulating medium without which
deals can’t be done. Bodenhorn admits that “a fractional reserve system [was] a cheaper way to provide a given volume of money than...a pure specie basis,” but he ignores the huge impact this would have in areas where money was tight (18). Especially after the Specie Circular in 1837, when all the hard money was either in eastern cities or on the frontier, the need for money in the middle (the farmland) was extreme. A fractional reserve system allows banks to inflate the currency. It also speeds up the velocity of money, because paper can be handed from buyer to seller to supplier to next seller much faster than bags of gold. And faster money (higher velocity of transactions) is the same as more money. Then there’s all the notes and drafts that are being endorsed from one hand to the next (not even counted in Bodenhorn’s $83 million -- he specifically set aside credit between individuals on p. 16). So the actual comparison ought to be between $41 million of gold and silver on the one hand, held by hoarders or moving very slowly and heavily through the economy; and something like $60 to $100 million of paper on the other, issued by banks and merchants, speeding its way from hand to hand, making transactions happen every step of the way. Looked at this way, what’s the most important role of antebellum banks?

The other big difference between these models of capital formation, which focus on banks as either conduits of wealth from holders to users, or as creators of a money supply that enables trade, is that in the first one, the rich get richer, by definition. The wealthy stop hoarding their assets and put them into play in the market by handing them over to bankers to lend or invest. But in the second model, it’s not so clear. Millers “on the make”
* write notes against shipments of flour to market, and discount them at their local bank, then hand those notes to the next batch of farmers who show up with wheat. Yeah, this is credit -- but it’s not the “freeing up wealth for capital investment” thing Bodenhorn is talking about. The bold may have a fighting chance, even if they start with less of a “hoard.” Bodenhorn suggests that “Bank credit...influenced the pace of industrialization” when it “freed mercantile and industrial capital for fixed investment” (107). Ultimately, his argument hangs on the relative importance of “fixed” vs. “working capital.” While this importance varies significantly with time and place, it seems to me that the much greater volume of “working capital” transactions in the antebellum economy (due in part to the smaller nature of machinery, plant and equipment in antebellum industry but also to the sheer number of credit transactions enabling all trade in a cash-poor farm sector) argues for recognition that in many cases, it wasn’t the bankers’ awakening of old money from its slumber, but their creation of new money, that made America grow.

*Why is it that people who are generally well-disposed towards business and entrepreneurs, still allow themselves to look down their noses and say that everybody in Jacksonian America was “on the make”? Is it because this was the moment when outsiders, people with no social standing or wealth, first got involved in “making money”?