Banking: Early Banking
Few banks existed in the colonies. England exerted significant control over the colonists’ financial affairs, and there was limited commerce within the colonies themselves. The general lack of banks and banking services meant that the exchange of goods and services was largely governed by bartering or the use of commodity money, including such goods as beaver pelts, tobacco, rice, and other commodities.
As America gained its independence and enjoyed increased manufacturing and business activity, particularly in the northern colonies, a more efficient method of exchange became necessary. More businesses and individuals, as well as trading partners in other countries, required cash rather than warehouse bills for payment. As a result, the nation’s first three commercial banks were founded.
The first of these was the Bank of North America, chartered by the Congress of the Confederation in 1781. This bank was granted near monopoly power for banking services in the Confederation, although the wide distances between major population centers limited its effective reach to Philadelphia and the surrounding area. The bank issued paper currency that, according to its face, was convertible to gold or silver. The bank, however, was allowed to maintain a fractional reserve system, meaning that it was not required to back the issued notes on a oneto- one basis with gold or silver.
The Bank of North America was relatively shortlived. In a recurring situation, businesses and individuals in more outlying areas of the country found it difficult to convert paper money issued by the bank to spendable funds in their communities. (Consider the challenge of traveling from Charleston, South Carolina, to Philadelphia to convert these notes to gold.) They therefore demanded a premium price for goods when paid with banknotes. The resulting inflation increased the demand for conversion of these notes back to gold or silver. The fate of the bank was sealed when demand for conversion exceeded the bank’s gold reserves, leading to its closure in 1784.
New York and Massachusetts chartered their own state banks in 1784—the Bank of Massachusetts, in Boston, and the Bank of New York (founded by Alexander Hamilton, future secretary of the Treasury). These banks had higher reserve requirements than the Bank of North America and, at least initially, confined their operations to New York and Boston. Both banks flourished for centuries. Bank of Boston was acquired by Bank of America in 2005, and Bank of New York merged with Mellon Financial in 2007.
In 1791, the First Bank of the United States became the first central bank to be chartered by Congress. The bank was to issue a paper currency that would be used to pay government obligations and would be accepted in payment of taxes, effectively giving paper money legal tender status for the first time. These notes were also convertible to gold or silver on presentment to the bank. The unanticipated consequence of this new currency was a flood of money into the economy, which in turn created substantial wholesale price inflation. Private bank charters also began to increase in response to the rising demand for banking services: Eighteen new private banks were chartered by 1796.