The Free Banking Era

Abstract

The period from 1837 to 1863 is known as the free banking period in the history of American banking. After two attempts at establishing a central bank for the country (the First Bank of the United States and the Second Bank of the United States), the federalists lost the power struggle to the advocates of states’ rights, and all banks began to be chartered by the states. The result was a proliferation of banks. Each of these banks issued their own banknotes against their deposits of gold and silver. These notes did not trade one for one, and their value mostly depended on the size of the issuing bank. Issuing paper currency wasn’t just limited to banks; even drugstores and railroad and insurance companies sometimes issued their own notes. The notes were also of varying size and color, and forgers had a field day: approximately a third of all paper currency during this period was counterfeit. Benchmarks like the reserve ratio, the capital adequacy ratio, and interest rates were set by the states. About half of these banks failed, and their average lifespan was five years.