A Masterclass in Central Banking
In this episode, Jack Farley of Forward Guidance is joined by Jane Knodell to discuss the history of banking, panics, depression and more.
Read our notes below to learn more.
About Jane
Professor of economics at University of Vermont.
Author of “The Second Bank of the United States: Central Banker in an Era of Nation-building”.
First bank of the U.S.
The first bank was chartered in 1791 and it had a 20 year charter.
The purpose of the 1st bank was to assist with Alexander Hamilton’s project to place finances of the new federal government on a firmer footing.
There were no stable monetary units and very few banks.
The bank assisted with the refinancing of the debt, the debts became long-term debts then gave the U.S. government the customs revenue and all that built the credibility of the federal government and its ability to service the debt.
The U.S. government needed some entity that it would use to buy services and collect taxes.
The Coinage Act of 1970
The dollar was defined by the coinage law where there will be one nation and one dollar.
The silver and gold coins were minted in South America.
Specie (coin money) was the best form of money.
When the U.S. borrowed money abroad, they were borrowing specie equivalents of Sterling and French Francs then the U.S. had to pay the debts using the specie equivalents of the currencies in order to maintain a good standing as a borrower.
The Financing of Revolutionary War
During the war, the U.S. was not issuing any kind of securities.
The French were always at war with England so they were happy to support the rebels.
There was a continental congress which was managing the financing of the war.
There were colonies who were still issuing their bills of credit and they’re helping finance the war with their borrowing and currency emissions.
The continental congress also issued a currency which is continental dollar.
There was high inflation.
During the war, there is less output and the government is trying to bid up the price of all the stuff just to get their hands on it.
Towards the end of the war, the government was just seizing people’s goods and services.
The first bank was keeping its money on par with a specie.
The first bank was offering an attractive deal to people who hold U.S. government debt that lets them convert to a stock or equity and they’re going to buy the debt at a price above the market price and they did the same thing with the second bank of the U.S.
The debt worked like Consols which means there’s no maturity or return of principal, only interest payments.
How Successful was the First Bank?
It went down eventually.
In 1811, there were a lot of banks around already.
The states had power within that period of time and the federal government didn’t have that much power.
Second Bank of the U.S.
The payment system is a basic infrastructure and if it’s not done right, there will be crises, loss of well-being, loss of output and a lot of other things.
The territory under the control of the federal government has expanded significantly.
The second bank was the largest bank in the country, it had branches and it was a player because it’s also the U.S. fiscal agent.
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Mechanics of Discounts, Exchange and Treasury Debt
Discounts are commercial paper and business loans.
Discounts are more like personal IOUs.
The second bank’s job was to improve the monetary system.
Many banks in this period, not just the second bank, lent money to people then people used the loans to buy stocks.
Any bank had an exposure to insider fraud.
The Panic of 1819
The branches of the second bank had lent collateral on real estate that turned out to be lands that lost value after the panic and the second bank foreclosed on the borrowers.
By the time the 20 year charter was up for renewal, it had a lot of support from the Western states because the banks exchanged businesses.
The bill of exchange is a signed, unconditional, written order binding one party to pay a fixed sum of money to another party on demand or at a predetermined date.
The bill of exchange created a lot of liquidity in the Western markets, it improved the marketing and it was a lot cheaper to move goods around using it than specie.
The Panic of 1825
The second bank didn’t really step in to help banks that were in trouble; instead, they actually profited from the rising value of the specie that they held.
A central bank is supposed to become less liquid when the banking system needs liquidity.
When the demand of trade finance was growing and the second bank was accommodating, it increased the risk of the bank in a sense that the bank had less capital behind every dollar of assets.
The Panic of 1837
Some of the shareholders rolled over their stock to the stock of the Bank of United States in Pennsylvania and probably lost everything.
The removal of the deposits out of the central bank in 1834, there was a real rapid growth in the state banking system and a lot of new banks were formed then ended up failing in 1842.
The closure of the second bank’s branches led to a vacuum of banking services.
When the second bank closed, the bank notes just got withdrawn, the notes got paid back into the bank and they stopped issuing notes.
The Panic of 1907
After the Civil War, there was a dual banking system.
The national banking act was set up in 1863 which enabled banks to get a charter from the state government or the national government.
The national banks were regulated by a new department with a new treasury.
Shareholders of national banks had double liabilities until 1934.
J.P. Morgan organized a group of New York City bankers and they as a group decided which banks to bail out and banks not to bail out.
Morgan organized borrowing gold from one of the European countries.
The main purpose of the Feds is to prevent banking panics that had been experienced.
The Financial System’s Plumbing
The idea behind the federal reserve panics is that they would be a source of currency when there was a shortage of currency.
The idea was after the period of currency shortage was over, the federal notes would be retired.
Financing of WWII
In war finance, there’s a need for some way to float debts and as they’re floating those debts, they’re not having much success of having the banks to buy it because the banks are supposed to maintain the convertibility into gold.
In June of 1917, there were a bunch of amendments made to the federal reserve act which some of the leaders of the fed have been wanting for years.
The banks were buying U.S. government debt and at the same time, they were borrowing from the fed.
The Great Depression
The federal reserve was widely thought to have failed during the great depression which was probably true due to bad rules.
There were a lot of bank failures during 1929 to 1933 and the failures were happening to banks that were not members of the Fed.
Members of the Fed had access to the discount window.
There were some district reserve banks that provided some good lender last resort and stabilized their regional banking systems.
The Fed could print money in this period by issuing bank notes.
There were a lot of people who didn’t have access to the banking system.
The banking panics ended in the 1930s because Roosevelt, banking holiday and deposit insurance which increased the price of gold and devalued the dollar.
At some point, the gold convertibility was only allowed between countries.
Bretton Woods
It put the dollar to the center of the international monetary system.
The idea was the dollar is the only currency that’s convertible to gold and all the other currencies will convert to dollars at a fixed price.
Treasury-Fed Accord
In a recession, they will care more about unemployment.
In an overheated economy, they will care more about price stability.
Rate Hikes
The 2020s is not the same as the 1980s.
A lot of problems in inflation are supply chain problems which were not really a problem in the 1980s.
The Western world is used to having an abundance of everything all the time.
Fall of FTX
This was a turning point that led to major regulation and rethinking of continuing to segregate the banking system to crypto.
Check out these important links
TODAY’S EDITION IS BROUGHT TO YOU BY TREZOR HARDWARE WALLET
Navigating the waters of crypto is risky; even the biggest CEXs & stable coins can have huge risks…
Act now, click the link below & become your own bank via self-custody.