The Panic of 1819 (26 page)

The author, however, was not sure about the efficacy or desirability of the specie check, and advocated in addition a direct check on the bank’s issue, by a Board of Commissioners appointed by the federal government. The Board would engage in careful study of the foreign exchange market, and would require the bank to keep its
note issue limited to that amount which would tend to preserve the average foreign exchange rate of the dollar at approximately par, never depreciating more than 5 percent below. In this way, the author proclaimed, in an early version of a specie exchange standard, that since the European currencies would be kept at par with specie, the American currency would also be kept at par, though not directly redeemable. The writer finally envisioned a Treasury note supply of $20 million supporting a total monetary circulation of $100 million at par value in foreign exchange.

The outstanding advocate of a national inconvertible paper money was unquestionably Thomas Law, one of the leading citizens of Washington.
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Law came from a remarkable English family. His father was a bishop, patron of the famous Dr. William Paley, and his brothers numbered two bishops, an M.P., and Edward Law, Lord Chief Justice of England. Thomas Law himself had been a topflight civil servant in India and had married a daughter of Martha Washington. He was a friend of the leading Washington figures, including John Quincy Adams, William Crawford, John C. Calhoun, and Albert Gallatin. Law had first propounded his plan years before the depression began, but the advent of the panic spurred him to truly zealous efforts on its behalf.
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His influence in Washington was such that despite the poor opinion held of his scheme by the editors of the leading semi-official
National Intelligencer
they gave him space to expound it in almost every issue.
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Law’s articles are to be found under various pseudonyms, the most prevalent being “Homo,” and others being “Parvus Homo,” “Philo Homo,” “H,” “Statisticus,” “Justinian,” and “Philanthropus.” He also carried on debates between his various pseudonyms on his monetary views.

Law criticized the Bank of the United States, which he considered an evil source of restriction on monetary expansion. He proposed to substitute a National Currency Board, to be appointed by the President and Congress.
⁹
The board was to issue an inconvertible national paper currency, in denominations above one dollar, with mixed coins to be issued for small change. A daring feature of the plan was that the new notes were to be loaned in perpetuity, with no necessity for repayment of principal while the interest payments were maintained. The board would lend the notes in perpetuity to the state governments at an interest of 2½ to 4 percent, in proportion to their population, on condition that the states in turn lend them to individuals at 5 percent in perpetuity.

Law asserted that these notes would not be issued in unlimited amounts. Their supply would be limited by the maintenance of the interest rate at 5 percent. When the rate of interest for loans prevailing on the market fell below 5 percent, the board would cease issuing its notes, since no one would come to the government to borrow. In fact, Law believed that if the market rate of interest fell below 5 percent debtors to the government would borrow on the market on cheaper terms in order to repay their debt at 5 percent. In this way, there would presumably be a stabilizing of the money supply and of the rate of interest. One flaw in Law’s plan was that debtors to the government would hardly borrow at 4 percent to repay their debts, since they need never repay the principal in any case. Such generous terms could never be received from private lenders. Law’s limits, therefore, would have proved in practice to be virtually non-existent.

Law envisioned the loans of the board and state governments to consist of subscriptions to corporations for roads, canals, and bridges; purchase of government and private stocks, and private loans. The principal object of the plan, according to Law, was “for the community to have a sufficiency of the circulating medium, without fluctuations in value by excess or scarcity, and that the interest of money may be low.”
¹⁰
Law pointed to England—his birth
place—as a model of prosperity, because it had sufficient (and inconvertible) currency to keep its rate of interest low.
¹¹
Law asserted it undeniable that a certain quantity of money was necessary for current expenses.
¹²
This included pocket money, money for purchase of raw materials and goods, and money to build factories. Law ignored the classical economic position that in the long run any quantity of money serves as well as any other. Instead he estimated that the minimum monetary requirement was $15 per capita, i.e., $150 million for the country’s 10 million population. In one sense, Law agreed with the “hard money” critics of the banking system that the banks caused ruin through first encouraging credit and investments, and then curtailing their loans and bankrupting their borrowers. His objection, however, was solely to the curtailment. What was needed, he concluded, were permanent loans at low interest, in order to increase productive capital and stimulate industry. Contrasting the National Currency with a system of bank notes, he declared that while banks issued promises to pay specie that they did not have, the board would issue notes on the “property of the nation,” notes which did not have to be redeemed. While bank notes could be refused by other banks and fall to a discount, this could not happen to the National Currency, which would be uniform and receivable everywhere, including payments to the government. Instead of curtailing the note issue because of specie drain, the board could rectify any deficiency of currency caused by such a drain.

It is doubtful if Law was actually concerned to have limits on excess currency, because to Law such excess was mainly hypothetical. He was actually concerned with providing “sufficiency” of currency. One of the features of his plan was that the board could
never call in the currency, and, therefore, could never diminish the circulating medium. This contrasts to the banking system where banks may call in their notes at any time. The board could always increase the circulating medium if it desired, by lending more, or by buying stock (the latter proposal being a rudimentary forerunner of open-market operations). The fact that this was considered an important advantage by Law demonstrates his eagerness to increase the money supply. The sufficiency of circulation would promote all industry, and the “nation” rather than the banks would reap the profits from the loans. Furthermore, the interest rate (5 percent) would be lower than the existing rate, which Law estimated at about 6½ percent. In 1820, Law estimated the minimum currency needed at $100 million. Such an amount would more than double the circulating medium and approximately return the money supply to boom levels.
¹³

With a lower rate of interest assumed to be an advantage for stimulating industry, Law did not discuss whether any limits needed to be set in lowering the interest rate. Indeed, he admitted that a 5 percent rate was chosen only for the purposes of expedience; that a 4 percent rate would be far better.
¹⁴
To Law, it was self-evident that the rate of interest could be lowered by an increase in the quantity of money; for when the supply of any commodity increased, this decreased its “value.”
¹⁵

To advance his plan,
¹⁶
Law attributed the depression mainly to a deficiency of currency, which caused shopkeepers to lose their markets and mechanics to lose employment.
¹⁷
Law also declared that his monetary expansion plan, not protective tariffs, was the proper cure
for the distress of the manufacturers. To Law, domestic manufactures were distressed from

the want of money, for the home manufacturers cannot afford to sell on long credits. They must have quick returns to pay workmen. I know of manufactures which have stopped, not because they were undersold by foreign goods, but solely because they could not get money. Money is the means to pay workmen, to set up machinery.
¹⁸

Protectionists had pointed out that small handicraft manufacturers were suffering less from the depression than the large manufacturers. To the protectionists, this was clear evidence that the more heavily capitalized manufactures suffered the most, and that therefore a protective tariff was needed for larger capital. To Law, on the other hand, the lesson was different:

When specie diminished, the banks curtail, and the large masses of money are . . . diminished; those therefore who have to purchase raw materials and to pay two or three hundred workmen every week, and who rely upon collecting large sums—first feel the want of money.
¹⁹

Elaborating on the benefits from increased money, Law pointed to the great amount of internal improvements that could be effected with the new money. He decried the slow process of accumulating money for investment out of profits. After all, the benefit was derived simply from the money, so what difference would the origin of the money make? And it would be easy for the government to provide money, because the government “gives internal exchangeable value to anything it prefers.” All it need do, concluded Law, was spend five millions of newly issued currency per year on
public works, and, in a pump-priming effect, “the money thrown into circulating would, in the course of a year, enable individuals to make a number of improvements also.”

Other advantages for his plan cited by Law: that national paper could not be affected by an external drain, that specie would be used to buy goods from abroad instead of “being locked up at home,” and that America would be insulated from the fluctuating fortunes of foreign gold and silver mines. Law also cited Hume to support the advantages for production of increases in the circulating medium.
²⁰

Law admitted, in answer to critics of inconvertible paper, that his paper might depreciate, but he asserted that this was of minor importance compared to the beneficial lowering of the interest rate and the activation of industry. To those who maintained that a nation could satisfy its monetary needs by importing specie, Law retorted that this could only happen through a favorable balance of trade, which “rarely happens” in any country, particularly a new country, which had “so many wants” that it could not develop a large favorable balance. Merchants, furthermore, always preferred importing goods, upon which they could make a profit, to importing specie.

Law’s preference for his plan over the existing banking system did not prevent him from preferring bank paper to specie. The imperative was to reverse the contraction of the money supply. Thus, he commended the various state legislatures for permitting banks to continue in operation without paying in specie.
²¹
In fact, Law proposed as an alternative that the Bank of the United States convert its existing assets of seven million dollars of 5 percent government bonds into new non-interest bearing Treasury notes. The bank would then use these notes, with the advantage of not being acceptable abroad, as a base for a two or threefold expansion of credits.
²²
Law, however, far preferred his national paper plan to the existing system or to loan offices in the separate states.
²³

One of Law’s most interesting contributions was his attempt to grapple with the embarrassing fact that, toward the end of 1820, New York City experienced an abundance of money for lending, and had low interest rates. This phenomenon presented two difficulties for Law: it seemed to eliminate the need for Law’s planned reduction of the rate of interest, while, on the other hand, the fact that the depression still remained seemed to indicate that low interest was not the sovereign remedy. Law countered that the low interest rates in New York were purely temporary and the result of sudden remittances by foreigners—particularly from Spain, Portugal, and Naples—to take advantage of the high interest rates here, and especially, to obtain security for their funds during their domestic political convulsions, “which they may withdraw when quiet is restored.” This is an early example of a “hot money” analysis.
²⁴

Law upheld his plan against an alternative scheme put forward by Littleton Dennis Teackle of Queen Annes County, Maryland. Teackle wished to base his proposed national currency on the “solid and immovable value” of the nation’s real estate—the valuation to be made by a tribunal of lawyers, financiers, and commissioners.
²⁵
Law countered with the shrewd objection that it would be impossible to evaluate accurately all of the nation’s real estate. His major complaint was that Teackle envisioned the retirement of the notes in ten years, which would again cause severe monetary scarcity. The only remedy was a note issue maintained in perpetuity.
²⁶

A Boston writer attacked Law’s plan, chiefly basing his argument on a distinction between “fictitious currency” and “legitimate currency.” The latter consisted of idle capital of intrinsic value, or its representative. Thus, specie or bank notes backed by actual specie deposits or redeemable in specie were legitimate currency. Artificial currency was any currency not backed by specie.
²⁷

Another plan for a national note issue based on land was presented by an anonymous writer in
Niles’ Register
.
²⁸
He advocated a maximum note issue of $30 million. Notes would be redeemable in gold or silver after sixteen years. They would be loaned at 6 percent interest and preferably applied to the development of internal improvements. The notes would, of course, be receivable in all dues to the government. Bank notes would be redeemable in this new government paper, although the bank would also have the option of paying in specie. The writer did not advocate that the notes be made legal tender. These notes could not depreciate because they would be redeemable in public land, possessing “certain” and intrinsic value, while gold and silver would revert to their “true character” as articles of commerce. Under an inconvertible currency, the writer proclaimed, there would be an automatic balancing of foreign trade. If imports exceeded exports, then merchants could not obtain specie for export as they could under redeemable currency. Therefore, foreign exchange would rise above par, prices of imports would rise, and imports would diminish in favor of domestic purchases, while conversely, exports would be promoted by the relative fall in their prices. The burden on imports would spur the development of domestic manufactures. The writer was not content to assert a new equilibrium exchange rate—and a depreciated one at that—as his final conclusion; instead, he maintained that the balance of trade would swing to becoming favorable again and the exchange rate would revert back to par. He failed to realize, of course, that with the currency inconvertible, there would be no mechanism to assure a maintenance of the original par.