[THOMAS.BEHNKE]

Hello!

I am writing an essay on the creation of the Federal Reserve. The first few paragraphs of my body are dedicated to a synthesized account of banking history before the Fed. However, I’m not sure if it’s entirely accurate. Your help is appreciated.

“Before discussing banking history, it is important to briefly recall that until the early twentieth century, gold was essentially America’s currency. No one wanted to carry around bulky rocks, though, so individuals deposited them to banks for a small monthly fee. In exchange for each gold deposit, bank customers would receive a bank note, a paper receipt which they could exchange for the amount of gold they deposited at any time. Today, we would call these notes dollar bills. During this time, though, there were thousands of banks, all of which had their own currency. American citizens had confidence that their notes were equivalent in value to the amount of gold specified – remember, they paid a monthly fee to ensure its security – so they did not frequently cash them in. After all, why would they exchange an easy-to-carry piece of paper for something less portable?

This is where the problem began. Since customers were not redeeming their notes for gold often, banks assumed that they could make more loans than they had on deposit without their customers noticing. Thus, if a bank had $15,000 in gold deposits, it started to lend out ten times that amount. In other words, it only kept one-tenth of the gold that it had on deposit. Remember, though, during this time, there were thousands of banks, each of which had its own currency. Someone could go to a grocery store and pay for their order with a note or check from their own personal bank. If the store used a different one, its bank would send the check off to the grocery store customer’s bank to be redeemed in gold. When this process was repeated enough times, the bank would run out of gold, and a run would occur. The bank would close its doors, and the depositors would lose all of their deposits.”

[jmherbener]

I suggest you take a look at the first two chapters of Murray Rothbard’s account in his book, A History of Money and Banking in the United States:

http://mises.org/books/historyofmoney.pdf

From colonial days, Americans used both silver coins and gold coins as money. There were only a few banks in America until after the War for Independence. They were given the legal privilege of issuing bank notes only fractionally backed by a reserve of money and they were partially cartelized under the First Bank of the United States (1791-1811) and the Second Bank of the United States (1816-1836). During the War Between the States, the Federal government established the National Banking System which chartered national banks and brought state charted banks into a nation-wide banking system. This system was subject to booms and busts as banks would overextend their lending and issue of un-backed bank notes and deposits and then face bank runs and collapse when customers lost confidence in the redemption of their notes and deposits. This was the money and banking system on the eve of the establishment of the Federal Reserve System in 1913.

[THOMAS.BEHNKE]

Thanks so much Dr. Herbener.

[THOMAS.BEHNKE]

Dr. Herbener, the source that you provided is helping a lot. It made me think of one additional question though.

I know I read somewhere (possibly Rothbard’s The Case Against the Fed?) that before people earned interest on their deposits, they paid a small fee to keep their deposits in banks. Essentially, banks were nothing more than storage vaults. Banks made their money exclusively from the storage fees.

When did this occur? It doesn’t look like it happened in America at all, because even the 1790 central bank was operating on a fractional-reserve system. During this time, were people still paying that small fee (and not collecting interest on their deposits) even though the banks weren’t keeping the deposits 100% secure.

Thanks again for your help.

[jmherbener]

American banks had the legal privilege to issue fractional-reserve notes and deposits from the beginning. Perhaps the last prominent example of a 100 percent reserve bank was the Bank of Amsterdam in the 17th and 18th centuries.

http://wiki.mises.org/wiki/Bank_of_Amsterdam

Also, take a look at Guido Huelsmann’s article on fractional-reserve v. 100-percent-reserve banks.

http://www.independent.org/pdf/tir/tir_07_3_hulsmann.pdf

[THOMAS.BEHNKE]

That article is brilliant. Thanks so much

[Author]

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