History Of Central Banking in the United States of America History of Central Banking

This paper discusses the history of central banking system in the United States of America. It analyses the establishment, operations and functions of the central banks that existed in the history of the United States of America. The closing of these historic central banks is also being discussed in the preceding paper. It also puts light on the main functions of the central banks.

History of Central Banking in the United States of America

A central bank can be defined as an authority that is responsible for formulating strategies that directly affect the supply of money and credit in a country. In specific terms a central bank uses its monetary policy tools, including open market operations, discount window lending and changes in reserve requirements, in order to adjust the rates of interest and the monetary base in the short run to achieve the key goals of the monetary policy, such as, price stability, high employment and stable economic growth. ( Bordo, 2007)

History of Central Banking in the United States of America:

It has been proved by a number of studies that in the past years central banks were established to support the countries in times of wars. Unlike the present era, in the past era the central banks were not established to support the countries in monetary terms or to act as the lender of the last resort instead they were established to improve the country's ability to issue loans in the times of wars. It was mandatory for such banks to invest their funds in the government bonds. All the central banks that came into existence before 1850 were established in the context of wars. (Broz, 1998)

The two major central banks that existed in the United States of America between 1791 to 1850 were the first and the second bank of the United States of America. ("First bank of," 2000)

The First Bank of the United States

The First bank of the United States of America was given a charter to operate by the United States Congress on the 25th of February in the year 1791. The charter was to expire after twenty years of its provision. The major objective behind the establishment of this bank was to take care of the financial needs and responsibilities of the newly born United States of America. As before the war of independence, there had been thirteen different states and each of these states had its own banks, currency and policies. ("First bank of," 2000)

The secretary of the treasury, Alexander Hamilton, officially presented the concept for establishing a bank in the first session of the United States Congress in the year 1970. This concept was supported by both the northern merchants and a number of England state governments. The southern state representatives, however, viewed this concept dubiously as their basic occupation, agriculture, had no requirement for banks that were concentrated centrally. ("First bank of," 2000)

The charter of the First Bank of United States expired in the year 1811. A bill was presented in the house of representatives to recharter the bank but it failed by a single vote, the statistics for votes was sixty five to sixty four. The charter expired under the presidency of John Madison. In the year 1816, John Madison reestablished the bank as the Second Bank of United States. This bank was established due to the rising rate of liabilities because of the war of 1812 and because of the inefficient performance of various state banks. ("First bank of," 2000)

Functions of the First Bank of United States of America

The First Bank of United States of America, also known as the Bank of the United States, started its operations in Philadelphia on the 27th of December in the year 1971. The first office of the Bank of the United States was housed in the Carpenter's Hall. But after six years the bank was shifted to new quarters on Third Street. In the year 1972, a number of branches of the First Bank of United States of America were established in areas such as Boston, New York, Charleston and Baltimore. ("The first bank," 2009)

Initial Capital:

The bank started its operations with an initial capital of dollar ten million. Out of $10 million, 2 million dollars were in the hold of the government, whereas, the remaining 8 million dollars were being held by some private investors. This amount of capital was very unusual and large in that era, therefore, such large capitalization made the First...

("The first bank," 2009)
Initial Investment and Stock Holders

The sale of the shares of the First Bank of United States of America was the largest Initial Public Offering (IPO) that the United States of America has ever seen. Most of the investors of this bank were foreigners. Americans did not like the idea of this heavy foreign investment. The foreign investors, however, did not have the right to vote in the general meetings. ("The first bank," 2009)

Management of the First Bank of United States of America

The bank was managed by a Board of Directors which had 25 members. The majority of the members of this board came from Philadelphia, New York and Boston. But the representatives of Maryland, North Carolina, South Carolina, Virgina and Connecticut were also included in the Board of Directors. The members of the board were lawyers, merchants, Senators and Congressmen as well. ("The first bank," 2009)

Fiscal Agent of the Government

The First Bank of United States of America played the role of the fiscal agent of the government. It collected the tax revenues for the government, paid the bills of the government, transferred the deposits of the government through its widely spread network, controlled the debt ratio of the government and provided security to the funds of the government. The bank also paid interest to the European investors who had invested in the American securities. Apart from that, the bank collected deposits from the general public and made loans to them. According to its charter, the bank charged six percent rate of interest on all the loans. ("The first bank," 2009)

Formulation of Policies

Unlike the 21st century central banks, the First Bank of United States of America did not formulate official monetary policies neither did it regulate other banks. But it formulated a simple policy. The notes issued by this bank were backed up by gold reserves and they provided the United States of America with a stable currency. By controlling its lending operations and flow of funds, the bank controlled the supply of money and credit and hence changed the interest rates in the short run. In order to increase the growth of money the First Bank of United States of America increased the reserves of the State banks and allowed them to issue more notes by the loan making process. In addition to that, the bank notes issued by First Bank of United States of America were widely accepted and were the only notes that were used as the medium of payment for federal taxes. ("The first bank," 2009)

The Second Bank of United States of America

In the year 1815, John Madison who was against the establishment of the First Bank of United States, admitted that a bank was necessary to maintain financial stability in the country. He, however, withdrew his idea when he realized that England wanted peace, as he thought that banks were needed only in the times of wars. Several plans and proposals were presented at the congress regarding the establishment of a new central bank in the years 1814 and 1815 but all of these proposals failed. Finally on the 10th of April 1816, after lengthy debates, Madison signed the bill for the establishment of The Second Bank of United States of America. ("The Second bank," 2010)

Role Played by The Second Bank of United States of America

Although, The Second Bank of United States of America did not officially formulate the monetary policy but it controlled the money supply through state banks. It accumulated the reserves of the state banks and kept them in its vault. Whenever, it wanted to decrease the money growth, it would use the reserves of State banks for collection in gold or silver. By reducing the reserves of the State banks it reduced their ability to circulate bank notes in the economy. Whereas, whenever it wanted to increase the money growth it would not use the notes in gold and silver collection and hence it enhanced the ability of the state banks to circulate bank notes in the economy. ("The State and," 2011)

No uniform Currency

As The Second Bank of United States of America allowed the state banks to issue their own notes, therefore, there was no uniform currency in the United States of America. In addition to that, it also exchanged the notes of other state banks at a discounted rate so the values…