National Banknotes As High-Powered Money

The President and Fellows of Harvard College
Monetary Reform and the Redemption of National Bank Notes, 1863-1913

Author(s): George A. Selgin and Lawrence H. White
Source: The Business History Review, Vol. 68, No. 2 (Summer, 1994), pp. 205-243
Published by: The President and Fellows of Harvard College
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George A. Selgin and Lawrence H. White
MonetaryReform and the Redemptionof

NationalBank Notes, 1863-1913
It is well known that contemporarycritics of the National
BankingSystem complainedabout its failure to meet peak
demands for currency.Less often discussed are complaints
about the system's inability to remove excess notes from
circulationduringperiods of slack demand for currency-a
problem that critics attributedto the lack of an effective
redemption mechanism. Beginning in 1864, important
attempts were made to reform redemption arrangements,
both privately and through legislation, and redemption
reformwas a key componentof the "assetcurrency"move-
ment to deregulate note issue. This article examines the
motives and outcomes of redemption reform efforts up to
the passage of the Federal Reserve Act, which substituted
a discretionary control over the currency stock for the
automaticelasticity that the asset currency movement had
originallysought.
r he fifty years during which the National Banking System oper-

ated are among the most eventful in U.S. financial and mone-
tary history: they span the period of Populist demands for free silver,
the debate over returning to the gold standard, and the struggles
over restrictions on bank-note issue and branch banking. During this
period, the country was rocked by a series of banking panics and
associated sharp depressions-particularly in 1873, 1884, 1893, and
GEORGE A. SELGIN is assistantprofessor of economics at the Universityof Georgia.

LAWRENCE H. WHITE is associate professor of economics at the University of
Georgia.
We thank the Institute for Humane Studies and the George Edward Durell Founda-
tion for research support. Helpful comments were received from Peter Selgin, Kurt
Schuler, and participantsat a session of the Western Economics Association meetings. Jim
Michaels provided research assistance.
Business History Review 68 (Summer 1994): 205-243. ? 1994 by The President and
Fellows of HarvardCollege.
George A. Selgin and Lawrence H. White / 206
1907-that sent policymakersand theoristsalikein searchof reforms
that would overcome the bankingsystem'sdefects.
A much-discussedshortcomingof the nationalbanking regime
was its upwardlyinelastic supply of bank-notecurrency.'The stock
of nationalbank notes failed to expand to meet the peak demands
for currencythat arose seasonallywith "cropmoving"and cyclically
with financial crisis; it also failed to grow secularlywith national
income. That the system also sufferedfrom downwardinelasticityof
the currencyis nowadaysseldom mentioned,though contemporaries
complained forcefullythat the stock of notes failed to contract in
conjunction with seasonal troughs in currency demand.2 Critics
attributedthis problemto the lack of an effective redemptionmech-
anism for removingexcess notes from circulation.In this article,we
examine those complaintsand the associatedefforts to reform the
redemptionsystem.
Introduction
Since the expirationof the charterof the Second Bankof the United
States in 1836, the nation'sbankingfunctionshad been carriedout
entirely by state-charteredbanks. Incorporatedstate banks issued
their own notes, in manycases secured by state or federalbonds and
ordinarilyredeemable in specie on demand. These notes moved
around the country and were usually exchanged at par near home
and at a discount as distance (and redemption costs) increased.
There was no "national"currencysave specie.
The NationalBankingSystem,born duringthe Civil War, oper-
ated in the United States from the passageof the NationalCurrency
Act in early 1863 until the signing of the Federal Reserve Act in
1913. Shortagesof reserveshad caused banksto suspend specie pay-
ments in 1861. In early 1862 the Legal Tender Act authorizedthe
federal government issue of "greenbacks"-non-interest-bearing
U.S. notes not redeemablein specie but to be accepted throughout
1 See Vera C. Smith, The Rationale
of Central Banking (1936; Indianapolis, Ind.,
1990); Philip Cagan, "The First Fifty Years of the National Banking System-An Histori-
cal Appraisal,"in Banking and Monetary Studies, ed. Deane Carson (Homewood, Ill.,
1963); Richard H. Timberlake, The Origins of Central Banking in the United States
(Cambridge, Mass., 1978); and Bruce A. Champ, "The Underissuance of National
Banknotes during the Period 1875-1913" (Ph.D. diss., University of Minnesota, 1990).
2
See, for example, 0. M. W. Sprague, "The Distribution of Money between People
since 1893," QuarterlyJournal of Economics 18 (Aug. 1904): 527-28.
National Bank Note Redemption/ 207
the United States as legal tender. This providedan alternativecircu-

lating currencyand bank reserve medium, but it did not deal with
another problem: the inabilityof the U.S. governmentto place its
bonds for furtherwar financing.
The new bankinglegislation,which establisheda series of feder-
ally charteredbankswhose notes had to be backed by U.S. govern-
ment bonds, was therefore most immediately motivated by the
Union government'sneed to finance its war effort. But the move-
ment towardnationalbankingwas given impetus by the secession of
the Southernstates and by the advocacyof Secretaryof the Treasury
Salmon P. Chase (1861-64). Secession removed the heavily Demo-
cratic(and anti-centralbank)Southernmembersfrom Congressand
gave the Republicansenough votes to pass the CurrencyAct of 25
February1863, soon revised by the act of 3 June 1864. These mea-
sures established the office of the comptrollerof the currency to
administerthe grantingof chartersto nationalbanks and to enforce
the rules under which notes could be issued and redeemed: the
amount of paid-in capital required;the percentage of capital and
bond valuationagainstwhich notes could be issued; the aggregate
allowedvolume of notes; the methodsof apportioningdistributionof
note issue allowances; and the methods of redeeming notes for
specie or greenbacks.It is on efforts to change the workingsof the
redemptionsystem that we focus here.
Although the redemption reform movement has been largely
overlookedin the secondaryliterature,it is crucialto understanding
the course of reforms aimed at securing an "elastic"currencyand
leading up to the Federal Reserve Act.3 Legal restrictionswere
clearlyresponsiblefor the problemof upwardinelasticity:note issue
was restrictedby a 10 percent tax on state banks and by an aggre-
gate ceiling on nationalbank notes before 1875, and thereafterby
the costly requirement that a national bank over-collateralizeits
notes with (low-yield)federal bonds. Why then was simple deregu-
lation of note issue not a more popularproposalamong those who
complainedabout inelasticity?We find that the leading advocatesof
monetary reform, particularlythose who proposed some form of
3 One of the few authors to notice the reformers' emphasis, Fritz Redlich, in The
Molding of American Banking, part 2 (New York, 1951), 114-16, dismisses redemption
reform as an "infatuation."Lloyd W. Mints, A History of Banking Theory (Chicago, Ill.,
1945), 230-31, observes that "the paramount importance of 'contractility'of note issues,
as well as of expansionability,was repeatedly emphasized" by reformers, and that "ade-
quate redemption facilities ... were generally insisted upon" as a means of providing con-
tractability,but he does not discuss redemption reform in any further detail.
deregulationto allownotes backedby ordinarybankingassets ("asset

currency"),understandablyfeared that freed-up banks might over-
issue notes unless the system were equipped with an adequate
redemptionmechanism.Attemptsto solve the redemptionproblem
were therefore a key ingredient of the period's monetary reform
proposals.
We first explain briefly why note redemption was inadequate
under nationalbankingand why that mattered.We then surveycon-
temporarycriticismsof sluggish redemption,and trace the reform-
ers' efforts to achieve more active note redemption,both privately
through bankingindustrycooperationand publicly through legisla-
tion. Many of these reformers correctly blamed inadequate note
redemption on legal restrictionsand emphasized the self-adjusting
propertiesof a deregulatedbank-notecurrency.Their proposalsulti-
mately failed to be adoptedbecause the reformersendorsed branch
bankingas a means towardactive redemption,arousingthe opposi-
tion of unit bankingforces.We concludeby consideringwhether the
Federal ReserveAct appropriatelyaddressedthe problem.
Causes and Consequences of Sluggish Redemption
In an unregulatedbankingsystem with pluralnote issue, banksnat-

urally come to accept one another's notes. The banks promptly
return collected notes to their issuers directlyor through an inter-
bank clearing system.4The prompt redemption of its excess notes
confronts an individualbank with rising marginalliquiditycosts of
note issue. Issuingan additionalnote undesiredby the public means
losing an equivalentamount of reserves, and thereby increases the
bank'schances of runningout of reserves.The liquiditycosts accom-
panyingefficient note redemptionare thereforecrucialto limitinga
bank'sdesired volume of note issues. The same costs limit a bank's
desiredvolume of non-interest-bearingdemanddepositsin the stan-
dard analysisof a system lackingstatutoryreserve requirements.5
Severalfeaturesof the NationalBankingSystemdiscouragedthe
active redemptionof notes. In particular,by requiringthat national
bankspurchase$100 in face value of eligible governmentbonds for
4
George A. Selgin and Lawrence H. White, "The Evolution of a Free Banking Sys-
tem," Economic Inquiry 25 (July 1987): 439-57.
5 Ernst
Baltensperger, "AlternativeApproaches to the Theory of the Banking Firm,"
Journal of Monetary Economics 6 (Jan. 1980): 1-37.
every $90 of their circulation,the regime 1) homogenizedthe notes

of all nationalbanks, eliminatingthe usual incentive for a member
of the public to hold only certain preferred brands of notes while
redeeming or depositingothers, and 2) removed the usual profit to
a bank from putting more of its own notes in circulationin place of
the notes of other banks. The system thus suppressed the active
interbankclearingand redemptionof notes. With active redemption
absent, nationalbank notes attaineda "quasi-high-powered"status:
althoughnot a legal reserve medium, the notes circulatedand were
held by banksalmost interchangeablywith legal tender (greenbacks
and gold), thus formingpart of the base supportingbroadermone-
tary aggregates.6 In the aggregate, an increase in the stock of
nationalbank notes would allow a multiple expansionof loans and
deposits, much as if an equal amount of greenbacks had been
issued.7
One especially visible symptom of the sluggish redemption of
nationalbank notes was the notoriouslypoor physical condition of
the notes in hand-to-handcirculation.Under ordinaryconditionsof
plural issue, as the clearingsystem repeatedlysends notes home to
their issuing banks, the banks can replace older notes before they
become too worn. The nationalbank notes' lack of homing power
sentenced them to remain in circulationlong after becoming tat-
tered and filthy, to the point where one observer(apparentlynot in
jest) suggested that bank tellers faced a health risk in handlingthe
currency.8
An importantconsequence of the quasi-high-poweredstatus of
national bank notes was the absence of any reliable market-based
restrainton the volume of notes. An individualbank issuing addi-
tionalnotes faced near-zeromarginalliquiditycosts. The notes could
be expected to circulateindefinitely,as other banks that happened
to receive them in depositsor loan paymentswould routinelyreissue
them instead of returningthem to the issuer for redemption.As has
been noted for the case of fiat currency,a pluralityof unconstrained
issuers of a homogenous high-poweredmoney is inconsistentwith
6 Milton Friedman and Anna
J. Schwartz, A Monetary History of the United States,
1867-1960 (Princeton, N.J., 1963), 50, 781-82.
7
George A. Selgin and Lawrence H. White, "National Bank Notes as a Quasi-High-
Powered Money," unpub. MS, University of Georgia (1992), discuss in more detail the
"quasi-high-powered"status of national bank notes and its consequences. The remainder
of this section draws heavily on that work.
8 F.
Cyril James, The Growth of Chicago Banks (New York, 1938), 399-400.
An Early National Bank Note, 1865 ?This two-dollar note portrayson its reverse side
an engraving of Sir Walter Raleigh displaying corn and tobacco from America to his
English brethren. The Banking Act required that engravings for the national bank notes
be made under the direction of the comptroller of the currency, and notes of several
banks shared design elements. (Photographs reproduced courtesy of the Smithsonian
Institution, Washington, D.C., from its American Numismatics Collection, neg. nos.
94/001/10 and 94/001/11.)
monetarystability.9Recognizingthis problem, contemporarybank-

ing experts sharply criticized the weak homing power of national
bank notes. Charles Dunbar, a Boston financialeditor and the first
chairmanof Harvard'seconomicsdepartment,found it "singularlyat
variancewith the principleof havinga wholesome restraintupon the
operationsof each bank by itself, which governs our treatment of
other demand liabilities."Oliver M. W. Sprague,another Harvard
economist, assailed the "inelasticityon the side of contraction,"
which "removesfrom the banksindividuallyand as a whole some of
9
Benjamin Klein, "The Competitive Supply of Money,"Journal of Money, Credit, and
Banking 6 (Nov. 1974): 423-53.
the consequences of their operations for which they should be

immediatelyresponsible."'0
Before 1875, the ceiling on aggregatenationalbank circulation
ruled out any possibility of secular inflation while also creating a
problem of rationingnote issue among banks in different regions.
Representativesof the South and West complainedthat their share
was too small, frustratingefforts to establishnew banks.l1Proposals
to remove the ceiling (a policy called "free banking"at the time)
were met with the understandableobjectionthat removalwould lead
to over-expansion and inflation unless it were accompanied by
measuresto ensure active redemptionof notes. Fear of inflationwas
accompaniedby concern that resumptionof the gold standard(not
accomplisheduntil 1879) would be delayed. "Free banking"finally
prevailed in 1875, but only following a major (though incomplete)
reformof note-redemptionarrangementsin the previousyear.
The return to the gold standardin 1879 meant that secular
inflationwas no longer a dangerfrom excess note issue, but seasonal
and cyclical disturbancesremained a serious problem. Rather than
being redeemed locally,notes unwantedin the interiorduringperi-
ods of slack currency demand traveled via payments or interbank
deposits to the Northeast and ultimatelyto New YorkCity, where
they appearto have contributedto the seasonalityof interestratesby
spilling over into loanable funds markets.New Yorkbanks, finding
an accumulationof countrynotes in their vaults,were hard-pressed
to convert them into useful assets. Before 1874 they sometimes
resorted to selling notes at a discount for greenbacksor to lending
country notes at zero interest to borrowerswho were expected to
repaytheir loansin greenbacks.'2Much of this lendingtook the form
of call loans for stock market speculation.In the late summer and
fall, as interiorbanks drew cash from their correspondentsto meet
the peak demand for currencyassociatedwith the fall harvest,the
currencymovement reverseditself. The drain of cash into the inte-
rior confronted the Northeast with credit stringency, and occa-
sionally with currency shortage, as reserve losses forced banks to
10Charles Francis
Dunbar, Economic Essays (1897; New York, 1904), 241; Sprague,
"The Distribution of Money," 527-28.
11George L. Anderson, "The National Banking System, 1865-1875: A Sectional Insti-
tution" (Ph.D. diss., University of Illinois, Urbana, 1933), 353. The original ceiling was
$300 million.
12 Friedman and Schwartz, Monetary
History of the United States, 21n8; Commercial
and Financial Chronicle (New York), 22 Jan. 1870, 102-3.
contracttheir balancesheets. On severaloccasions-including 1884,
1893, and 1907-financial stringencygave way to full-blownbanking
panics.
After the 1874 reform (detailed in a later section), New York
banks could redeem unwanted notes and receive immediate pay-
ment from the subtreasuryfor them, but issuerswere not called on
to replenishthe redemptionfund immediately.l3The reformthere-
fore did not discourageseasonal shipments of currencyto the city.
Redemptionsat the subtreasurymerely gave the New York banks
excess reserves,ratherthan excess countrynotes, to lend at call and
did not immediatelyreduce the excess reserves of countrybanks-
thus allowing the seasonal influence on interest rates to persist.
Between 1890 and 1908, increases in the excess reserves of New
York banks, which largely followed interbankshipments of excess
currency to New York,were associatedwith decreases in interest
rates on call loans and on 60-to-90-day paper in the New York
money market.14Edwin W. Kemmererprovidedevidence of such a
linkage in his National Monetary Commission study of seasonal
variationsin money and financialmarketsunder national banking.
The seasonalityof currencydemand thus helps to account for the
markedseasonalityof interest rates between 1890 and 1919, which
reinforcedthe effects of the seasonalcredit demand emphasizedby
several analysts as a contributing factor in nineteenth-century
financial crises.15
13Philip Cagan and Anna J. Schwartz, "The National Bank Note Puzzle Reinter-
preted," Journal of Money, Credit, and Banking 23 (Aug. 1991): 300-301. The second
Independent Treasury Act (1846) had established subtreasuries at New York, Boston,
Charleston, St. Louis, New Orleans, and Philadelphia; subsequent legislation during the
National Bankingperiod removed Charleston and added Baltimore, Cincinnati, San Fran-
cisco, and Chicago.
14 Other determinants of New York banks' excess reserves were, in order of signifi-
cance: 1) movements of gold and greenbacksbetween banks and the public; 2) movements
between the banks and the New Yorksubtreasury;and 3) internationalgold flows (William
A. Scott, "Rates on the New York Money Market, 1896-1906," Journal of Political Econ-
omy 12 [May 1908]: 273-98). From 1902 to 1907, Treasury Secretary Leslie Shaw actively
intervened in the New Yorkmarket by shifting funds from the subtreasuryto the banks in
the fall and back in spring, in an effort to reduce the seasonal fluctuations in banks'
reserves and loan rates. See Timberlake, Origins of Central Banking, chap. 12; Andrew T.
Allen, "Private Sector Response to Stabilization Policy: A Case Study," Explorations in
Economic History 23 (July 1986): 253-68.
15 Edwin W.
Kemmerer, Seasonal Variations in the Relative Demandfor Money and
Capital in the United States (Washington, D.C., 1910); Allen, "PrivateSector Response";
R. Glen Donaldson, "The Sources of Panics: Evidence from Weekly Data," Journal of
Monetary Economics 30 (Nov. 1992): 277-305; and Gregory Mankiw, Jeffrey Miron, and
Had there been regular active redemption of national bank

notes, interiorbankswould not have exportedlocal credit expansion
and contractionto the Northeast. Most excess countrynotes would
have been interceptedby rivalbanks,redeemed, and removed from
circulationbefore leavingthe interior.Notes that did maketheir way
to the Northeastwould have been returnedto their issuerspromptly
for redemption instead of swelling the quantity of high-powered
money in the system as a whole. The originalissuing banks would
not have found it profitableto issue more notes until the demandto
hold their currencyrose. The seasonal movements of funds to and
from the Northeast would consequently have been far less pro-
nounced, reducing the likelihood of panics. The periodic excess of
high-poweredmoney would have been halted at the source, rather
than spilling over into the bond market and causing a temporary
distortionin interest rates and associateddistortionsof savingsand
investment.
The contrast between variations in the currency stock and
interest rates in the United States and correspondingfigures from
Canadaserves to illustratethis point. Seasonalityin the demand for
currency was common to both agriculturalcountries. The actual
circulationof bank notes showed substantialseasonal variationin
Canada during 1890-1908, when there was virtually no seasonal
variationin the United States (see Fig. 1). During the same years,
interest rates on Montrealcall loans showed much less seasonalvari-
ation than New Yorkor Boston rates.16The seasonalpatternin New
Yorkcall loan rateswas in fact roughlysimilarto the seasonalpattern
in the circulationof Canadianbank notes: low in the spring and
summer, high in the fall (see Fig. 2). The greater interest-ratesea-
David Weil, "The Adjustment of Expectations to a Change in Regime: A Study of the

Founding of the Federal Reserve," American Economic Review 77 (June 1987): 358-74.
16Taking the differences between
averages of end-of-quarterinterest rates reported by
Georg Rich, The Cross of Gold: Money and the Canadian Business Cycle, 1867-1913
(Ottawa, Ont., 1988), 49-50, for the period 1902-13, Montreal call loan rates varied only
30 basis points between mid-year and year-end (5.3 vs. 5.6 percent), whereas New York
rates varied 470 basis points (2.5 vs. 7.5 percent), and Boston rates varied 260 basis points
(3.3 vs. 5.9 percent). Consistent with the international arbitrage opportunities seemingly
available, Rich observes that "in the fourth quarter.... Canada typically acted as a lender
to the New York money market"(178). But he notes that before 1914 risks and informa-
tion costs apparently prevented arbitrage from equalizing Canadian and U.S. interest
rates, or even rates within the two countries (151). Citing the variationsin Montreal call
loan rates, both over time and across banks, Rich argues against the view that the Cana-
dian loan rates were fixed by collusive agreements (though deposit rates may have been
thus fixed) (48-51).
Figure 1
Bank Notes in Circulation
1880-1909, Monthly, in $Millions
700
600-
500 -
400 -
National Bank Notes
300-
200-
100- Canadi
100 \ - 1 1t;</1
0 I I I II I I I I I I I I I I I I i i
1880 1883 1886 1889 1892 1895 1898 1901
Figure 2
Index Numbers
CanadianBankNotes in Circulation
Average Monthly Index Numbers, 1875-1908
100
75
50
25
0
0 2 4 6 8 10 12
Month
New YorkCall Loan Rate
Average Weekly Index Numbers, 1890-1908
aD
a
C
N-
0 8 16 24 32 40 48
Week
Note: Index numbersfor the New Yorkcall loan rate and volume of Canadianbanknotes were
calculatedas follows. For each year in the sample,the lowest observationof the variablewas
assigneda value of zero, and the highest observationwas assigneda value of 100. Each of the
other observationsfor that yearwas then scaledcorrespondingly.That is, the index numberfor
an observationof Xi = 100 * [Xi - min(X)] / [max (X) - min(X)],where X is the set of all
observationsfrom the same year. The averageweekly (monthly)index numbers shown were
constructedby takingthe same week (month)from each year in the sample and averagingthe
correspondingindexnumbers.
sonalityof the United States thus appearsto have reflected in part

the seasonalinelasticityof the nationalcurrencystock. Had national
bank notes been activelyredeemed ratherthan reissued, seasonality
in the public's demand for currencywould have led to a seasonal
pattern in the quantityof notes (as it did in Canada),rather then
generating spillover effects in the credit market. Such spillover
effects were undesirable,because they presumablyinterfered with
the normalfunctionof the credit marketin coordinatingintertempo-
ral allocationplans.
Early Fears of Overissue
The inadequateprovisionfor activenote redemptionunder the Cur-

rency Act was criticized even before the act became law in 1863.
RepresentativeStephen Bakerof New York,in the principalspeech
opposing the act, warned that the lack of central redemptionfacili-
ties would cause nationalbank notes to be discounted by banks or
brokers seeking to cover high redemption costs.17 Massachusetts
Representativeand economistAmasaWalkerpredictedthat national
bank notes would "continueto circulate as long as the materialof
which they are made will permit them to last."Walkerargued that
the act's provisionmakingthe notes receivable at par anywherein
paymentsto the federalgovernmentwould remove any incentive for
note-holders to return unneeded notes to their issuers; the notes
would insteadbe held for governmentpayments.Walkerfeared that
"wildcat"nationalbanks would spring up in remote places, issuing
notes that would circulateindefinitely.18
A report issued by the New York Clearing House Association
also doubted that adequate redemptionwould occur, given that a
nationalbank note was redeemableonly at its issuer'scounter:
But how are the peopleto makesucha presentation [at the issuing
bank'scounter]?Orhowcanevenanyinstitution, if it weredisposed,
affordto do it? Supposeeightor ten millions,belongingnominally in
as manydifferentstates,be put afloatin NewYork,howcanthe city
get ridof them?Bywhatprocessprocurea redemption of thisuncur-
rentmoney?Whosebusinesswill it be to savea hundreddollarsof
this bank,anda thousandof that,andsend themto Wisconsinand
17 Albert S. Bolles, The Financial History of the United Statesfrom 1861 to 1885 (New
York, 1886), 215.
18Amasa Walker, "The New Currency of the United States," Bankers' Magazine 12
(May 1863): 833-43, quotation at 836.
Dakota,only to be protested,returnedto New York,then sent to

andafterthirtydaysredeemedthereat par?
Washington,
The report predicted, as Walker had, that holders of bank notes
would keep them for paymentsto the governmentratherthan "sub-
mit to a discount of from one to five per cent" in tradingthe notes
for local money. The report illustratedthe threat of a new kind of
wildcatbankingthrougha hypotheticalexampleof a bank"originally
of $50,000 capital" that could swell its circulation and assets to
$500,000 "withoutperhaps even having redeemed, even with legal
tender, $10,000 at its remote head office."19
Other critics envisioned that wildcat banks in the remote West
would issue notes and have them "sealedup and sent to New York,
where there are alwaysdebtors to the United States that could use
them without trouble." Once received by the federal government,
the notes would be forcedon the government'screditors,whereupon
the "greatcenters of trade [would] be flooded with a depreciated
currency."One contemporarycommentatorinsisted that "not even
the Congress of the United States [can] make a bank-bill,redeem-
able in New Mexico or Utah, of as much value to a merchant of
Boston as one for the same amountpayablein State Street."20
Events bore out several of these predictions. National bank
notes from other parts of the countryappearto have initiallytraded
at a discountin New YorkCity. As earlyas February1864, the banks
of the New YorkClearing House Associationresolved to accept at
par only those nationalbank notes redeemed at par by a member
bank. Other notes were to be traded as "uncurrent money,"
accepted only at a discount, if at all.21 Notes from all parts of the
country accumulated in New York, particularlywhen demand to
hold notes in the interiorwas below the spring and fall peaks. The
existence of a less costly alternativeto selling notes at a discount-
19John Earl Williams and L. Everitt,
J. Report of a Committee on the National Bank
Currency Act, Its Defects and Effects (New York, 1863), 8-9.
20 In
order, the three quotations are from Waldo Flint, Some Strictures on an Act to
Provide a National Currency (Boston, Mass., 1863), 14-15; George L. Stearns, A Few
Facts Pertaining to Currency and Banking (Boston, Mass., 1864), 6; and Flint, Some
Strictures, 15.
21Hunt's Merchants Magazine, April 1864, 307. Redlich,
Molding of American Bank-
ing, 114, dismisses "the fact that National Bank notes were not at par in New York"as the
result of an arbitraryclearinghouse policy. In fact, the policy reflected the costliness to the
banks of redeeming or otherwise dischargingunwanted notes. In Chicago, where by con-
trast national bank notes appear not to have accumulated, the national banks agreed in
April 1864 to accept all national bank notes at par (James, Growth of Chicago Banks,
357-61).
namely, retainingthem for use in paymentsto the government-led

as predicted to few notes being sent home for redemption. The
absence of a redemptionconstraintencouragedbanksto issue all the
notes for which they could get authorization.Hunt's Merchants
Magazinereportedthat two nationalbanksin New Haven, Connect-
icut (hardlythe remote West) had $300,000 in notes outstandingfor
half a year or more without being asked to redeem a single dollar.22
Accordingto economist Francis Bowen, the New Haven situation
was typical.Any nationalbank could "payout its bills on the morn-
ing after it receives them from the Comptroller,with a comfortable
assuranceof not seeing more than a strayone or two of them again
for a twelve-month."Ratherthan returningto their sources,national
bank notes, once issued, became a "partof the permanent money
stock."23
Congresswas at first untroubledby the lackof note redemption.
According to Charles Dunbar, many authorities assumed that
arrangementsfor note redemptionwould be superfluousunder the
greenbackstandardthen in place, because they would merelypermit
the exchange of one paper money for another.24Johns Hopkins
astronomerand economist Simon Newcomb observedthat "the law
which providesfor redemptionprovidesfor a mere farce. The paper
in which the [nationalbank]bills are to be redeemed will answerno
end which the bill itself will not equally answer."25Senator John
Shermanof Ohio, younger brother of the Civil War general, even
praisedthe long circulationperiod of nationalbank notes as a point
of economy in the notes' favor.26Both Newcomb and Sherman
neglected to considerthat interbankredemptionof notes for reserve
money would have helped to limit the volume of bank-issuedmoney
even under a greenbackstandard.
Reform Efforts before 1874
The earliest reform effort-embodied in the 1864 revision of the

National CurrencyAct-was motivated not by the low volume of
22 Hunt's Merchants Magazine, Sept. 1864, 248.
3 Frances Bowen, "The National Banking System," Bankers' Magazine, April 1866,
773.
24 Dunbar, Economic Essays, 238-39.
25 Simon Newcomb, A Critical Examinationof Our Financial Policy during the South-
ern Rebellion (New York, 1865), 209-11.
26
Dunbar, Economic Essays, 289.
National Bank Note Redemption / 219
redemptions,but in part by Congress'ssurpriseat discoveringthat

notes were not trading everywhereat par. Congress had expected
that national bank notes would be a "uniformnational currency,"
circulatingat par throughoutthe countryby virtue of their common
collateralbackingand their public receivability.
One revision proposed to the House Banking Committee in
spring 1864 would have requiredeach nationalbank to redeem its
notes through agents in numerous specified cities as well as at its
home office. Redemptionagents'reserveswould have been counted
as part of a bank'slawful reserves.As the plan moved forward,con-
gressmen scrambledto have cities and towns in their home districts
included on the list of redemptioncenters.27In the end, seventeen
cities were selected, includingeight of the nine originalreservecities
from the act of 1863.28To soften the impact on country banks,
however, the proposalwas modified to allow each nationalbank to
choose just one city from the list as a par redemptionsite, subjectto
the approvalof the comptrollerof the currency.National banks in
reserve-redemptioncities other than New Yorkwere to be required
to redeem at par througha nationalbank in New York.
Committeemembersfeared that allowingbanksto choose a sin-
gle redemptioncity from amongthe seventeen would not be enough
to eliminate all discounts on itinerant notes. They observed that
redemptionagentscould be locatedwell awayfrom the main centers
of trade where a note might be found. As New York City banker
James Gallatin argued, a "'uniformnational currency,'issued and
redeemable at different places, is a chimera. To be 'uniform'it is
indispensablethat it should be redeemed at some central points-
say, New York,Boston, and Philadelphia."29 In responseto this crit-
icism, RepresentativeJames Wilson of Iowa recommendedthat all
banks be required to redeem their notes at par in New YorkCity,
where most notes ended up.30Although the committee was con-
vinced of the need for some further measure to keep notes from
fallingbelow par outside their limited redemptionpoints,it nonethe-
27
28
Congressional Globe, 2 April 1864, 1377.
The seventeen cities were: New York,Boston, Philadelphia,St. Louis, Chicago, New
Orleans, Cincinnati, Baltimore, Louisville, Detroit, Cleveland, Pittsburgh, Milwaukee,
Albany, Leavenworth, San Francisco, and Washington. The first eight cities listed contin-
ued from the 1863 act; Providence, in the 1863 list, was omitted in 1864.
29 James Gallatin, The National Debt, Taxation, Currency, and Banking
System of the
United States (New York, 1864), 15.
30Congressional Globe, 2 April 1864, 1378.
less rejected Wilson's suggestion on the Populist grounds that it
would make the rest of the country"paytribute"to New York.
The committee'sblunt solution,includedin the revisedNational
CurrencyAct of 3 June 1864 (renamed the National Bank Act in
1874), was to require all nationalbanks to receive all nationalbank
notes at par. This measure-which banned any nationalbank from
discountingor refusingany nationalbank note-secured the unifor-
mity of the nationalcurrency,but with unfortunateconsequencesfor
redemption. Discount charges had been instrumentalin financing
what little volume of note redemptionthere was. Once out-of-town
notes could no longer be acquiredat a discount,no spreadremained
to cover the transportationand transactioncosts of redeemingthem.
The abolition of discounts also allowed a national bank's notes to
circulatewell beyond the area within which they could be returned
to their issuer at relativelylow cost.
The par-acceptancerequirementburdened the banks of Phila-
delphia, Boston, and especially New York. Notes were brought to
New York by the "channelsof trade" and-more importantly-by
shipmentsfrom correspondentbankswho thereby acquireddeposits
in the "reservecity"banksthat they could count as legal reserves.31
The banksin all three cities had to accept large quantitiesof national
banknotes from all over the country,withouta discountto cover the
costs of sortingand returningthe notes to their issuers for redemp-
tion in lawful reserves. In May 1865 a committee of officers from
sixteen majorbanksin the three cities endeavoredto solve this prob-
lem. The committee'spreliminaryplan called for all nationalbank
notes redeemablenorth of Cairo,Illinois,and east of the Mississippi
River,but not redeemablein Philadelphia,Boston, or New York,to
be sent daily to a central "AssortingHouse." Notes redeemable in
Philadelphiaor Boston would be sent directlyto assortinghouses to
be established in those cities, and notes redeemable in New York
would be exchangedthroughthe New YorkClearingHouse. Banks
that remitted notes would be paid immediately in negotiable
interest-bearingcertificatesequal to 90 percent of their remittances.
The certificateswould be redeemable(with accumulatedinterest)in
legal tender and canceledwhen the issuersor their agents redeemed
31 In 1837 New York
city banks had resisted a similar state proposal to compel their
par acceptance of upstate notes on the grounds that it would allow the country notes to
"engross the circulation in New York";see Davis Rich Dewey, State Banking before the
Civil War (Washington, D.C., 1910), 97. It is not clear why New York should have been
expected to run a persistent balance of trade surplus with the rest of the state or country.
the returned notes. Assorting house expenses would be assessed

monthly against participatingbanks in proportion to their remit-
tances.32
By the time a meetingwas held at the New YorkClearingHouse
in September 1865 to consider the plan, the interior banks had
already"conceived a not unnaturaldislike"of it. The plan threat-
ened to erode their profitsfrom note issue, and severalrefused even
to send delegates. Disagreementsamong the bankerspresent led to
a "spirited and prolonged discussion."33Some country bankers
regarded the plan as a scheme to make them keep non-interest-
bearingdeposits at New York,as the SuffolkBankhad requiredNew
England country banks to keep deposits at Boston earlier in the
century.34The meeting ended without agreementon the plan.
Followingthat gathering,the Commercialand FinancialChron-
icle pleaded with countrybankersto "rise above the sordidviews of
private advantage"and to "promote rather than hinder" arrange-
ments for active note redemption.35The newspaperarguedthat the
plan would ultimatelywork in the country banks' own interest by
counteringpopularhostilitytoward nationalbank currencyand the
"doubleprofit"(intereston collateralbonds plus interest on loans) it
supposedly allowed. The committee solicited endorsements for its
assortinghouse plan from Secretaryof the TreasuryHugh McCul-
loch (1865-69; 1884-85) and from Comptrollerof the Currency
Freeman Clarke (1865-66). Clarke's statement indicated that the
federal authoritieswere becoming concerned about the danger of
monetaryexpansionstemmingfrom inadequatenote redemption:
Bankshavereceivedandpaid[national bankcurrency] out,andhave
hadno furtherconcernaboutit; consequently all havefoundit profit-
able,as theyreceivedthe intereston the government bonds,pledged
forits security,andlendthe notesuponinterest.Nearlyall,therefore,
areanxiousto increasetheircirculation and,I greatlyfear,willbe able
... to bringsuchinfluenceto bearaswillinduceCongressto authorize
a largeincreaseof the nationalbankcurrency. Thismaybe prevented
if immediateactionis takento provideforthe redemption andreturn
to the placeof issuethe notesof existingbanks.36
32The plan is reproduced in Bankers' Magazine, Sept. 1865, 198-200.

33Commercial and Financial Chronicle, 16 Sept. 1865, 354; Bankers' Magazine, Nov.
1865, 401.
34The views of one country banker are set forth in a letter appearing in the Bankers'
Magazine, Dec. 1865, 460-65.
a Commercial and Financial Chronicle, 16 Sept. 1865, 354.
36 Freeman Clarke, quoted in ibid., 363-64.
As noted earlier, active redemption would confront a note issuer
with rising marginal liquidity costs, limiting its profit-maximizing
note circulationto the quantity of its notes the public desired to
hold.
The committee of city bankersreconvenedin closed session on
19 September, and the members voted twenty-nine to twelve in
favorof carryingits proposalforward.37A new seven-membercom-
mittee, chairedby JamesGallatin,was elected to write a constitution
for a NationalBankNote RedemptionAssociation.This constitution,
embodyingall the importantfeaturesof the draftplan, was adopted
on 12 October.38
This victory for the proponents of active note redemption
proved hollow, however. Many interiorbankswould not voluntarily
cooperate with the Redemption Associationor help to defray its
expenses,which thereforehad to be borne by the banksin the three
organizingcities of New York, Boston, and Philadelphia.Although
the assortinghouse plan promised substantialsavingscompared to
decentralized redemption, it was costly nonetheless, and the law
prohibitedparticipatingbanksfrom discountingout-of-townnotes to
cover expenses. Unable to spread the costs of the assortinghouse
scheme broadly, or to pass them on to the public, the city banks
abandonedthe plan. As the editors of Bankers'Magazinehad pre-
dicted, central redemption would require "more thought, more
experience,more labor,and more capital"than the city bankscould
muster.39In the next severalyears two furtherattemptsto establish
a New Yorkassortinghouse also failed.
After the failure of these private remedies, the movement for
active note redemption focused on legislative reform. In Washing-
ton, Comptroller of the Currency Clarke advocated "compulsory
redemption in the great financial and commercial centers of the
country"to check monetaryexpansion,achieve a fairer distribution
of currencyacrossthe country,and discouragethe establishmentof
national banks purely for "the advantagearising from the issue of
their own promises,withoutthe expectationof being called upon to
redeem them." Conditionalon compulsoryredemption"at the cen-
tral and accessible points mentioned,"which would eliminate the
"danger of bank issues exceeding the limits prescribed by the
demands of legitimate business,"Clarkewas willing to recommend
37 Bankers' Magazine, Nov. 1865, 402.
38 It is
reprinted in the Commercialand Financial Chronicle, 14 Oct. 1865, 489.
39Bankers' Magazine, Sept. 1865, 194.
Early Notefrom Mechanics National Bank, New York. A pointof contentionunder

the National Banking System was the unwillingness of previously established banks to give
up their corporate identities to become "The First (or Second, or Third) National Bank"
of their locality, as Secretary Chase preferred. After 1864, though the choice remained
subject to the approvalof the comptroller, banks could take or retain names without the
numerical designation. (Photographs reproduced courtesy of the Smithsonian Institution,
Washington, D.C., from its American Numismatics Collection, neg. nos. 94/001/5 and
94/001/6.)
an increase in the aggregatelimit on nationalbank notes from $300

to $400 million.40A bill (H.R. 771) reflecting these recommenda-
tions was reported to Congress in 1866. The bill required national
banks in reserve-redemptioncities other than Philadelphia,Boston,
or New York to maintainnote-redemptionagents in one of those
three cities; Philadelphiaand Boston banks would be required to
redeem their notes at par through agents in New York. Interior
banksobjected to the redemptionprovisionsof the bill, while those
wishingfor a rapidreturnto specie paymentsopposed the expansion
40
Comptroller of the Currency,Annual Report (1865), 6-8.
of nationalbank notes.41The bill, minus its originalprovisionfor a
raisedceiling on nationalbank notes, became law in 1867.
The new law had little effect on the frequencyof note redemp-
tion. Clarke'ssuccessor as comptrollerof the currency, Hiland R.
Hulburd(1867-72), observedthat, under the old law, notes of 1,320
of the 1,647 nationalbanks had alreadybeen redeemable in Phila-
delphia, Boston, or New York.42The new concentrationof redemp-
tion points did little to reduce the costs of sorting and transporting
notes, except perhaps to allow minor economies of scale where
several banks happened to share the same redemptionagent. Even
after 1867, redemption-agentbanks in the Northeast that received
notes issued by their own interiorcorrespondents(possiblyshipped
by the correspondents themselves for credit to their reserve
accounts)were apparentlyreluctantto request redemptionin legal
tender, for fear that they would "offend"(impose expenses on) the
correspondentsand drivetheir reserveaccountbusinesselsewhere.43
The redemption-agentbanks could instead dispose of the notes in
"hot-potato"fashionby passingthem back into circulation.
The summertime accumulationof unwanted country notes in
the Northeast therefore continued unabated. IndividualNew York
bankstried to dispose of the countrynotes by lending them free of
interest for up to two weeks on the conditionthat the loan be repaid
in greenbacks.They also sold notes to brokers,at a loss of one-tenth
to one-quarterof one percent.44Manyobserversconcludedthat only
compulsorycentralizedredemptionof all notes in New Yorkwould
prevent accumulationof the notes there. Priorto the passage of the
1867 law, Hulburd had remarkedthat the argumentsurged in its
favor "would, if carried to their logical conclusion, establish the
expediencyof requiringredemptionsat one centralpoint"-namely,
New York.45
Hulburdcontinuedthis theme in his subsequentannualreports.
He argued that centralized redemption at New Yorkwould be "a
healthy reminder to the banks that their circulation is a liability
payable on demand."It would also be a "firststep towardsspecie
payments,"an opinion echoed by the New York Clearing House
41 Commercial and Financial Chronicle, 2 June 1866, 674-75.
42
Comptroller of the Currency, Annual Report (1866), vi. (Clarke had resigned in
mid-1866 in the wake of policy disputes with both McCulloch and Hulburd.)
43
MargaretG. Myers, The New YorkMoney Market,vol. 1: Origins and Development
(New York, 1931), 404.
44
Ibid.; Commercial and Financial Chronicle, 22 Jan. 1870, 102-3.
45Comptroller of the Currency, Annual Report (1866), vi.
Association.As long as remote banks did not have to redeem their

notes at New York, Hulburd warned, they would "be tempted to
undue expansion by the difficulty of returning their notes for
redemption."46 The consequence, reflectingthe operationof Gresh-
am's Law under compulsorypar acceptance, would be a currency
dominated by "inferior"notes. Hulburd proposed that Congress
establish a special non-issuingbank in New York,owned and man-
aged by ordinarynationalbanks,to be "the redeemingagencyof the
whole country, and the clearing-houseof all nationalbank notes."
He suggested, ratherunconvincingly,that the bank could cover the
expensesof note redemptionand still returna profitto its sharehold-
ers by having a separate department devoted to "regularbanking
business."47
The financialpress in the Northeast also campaignedfor com-
pulsory note redemption in New York. Bankers'Magazine stated
that it would prove "a valuabletonic for preventing[the] succession
of excitementand depression,of fever and chill"in New Yorkfinan-
cial markets.48The Commercialand Financial Chronicle declared
that existing redemptionarrangementswere "notoriouslyimperfect
and unsatisfactory"and were responsible for the growing public
outcryto replacebanknotes with greenbacks.It was up to the banks
themselves to protect their interests by renewing the effort to
achieve redemptionfor all notes in New York:
[T]he only way to makesure that the volumeof banknotes shall
increasewhentheyareneededforbusinessandshalldiminishwhen
the wanthas passedaway,is to makeit impossiblefor the banksto
keep out their notes in excess.This is easilyto be done. Banking
experiencehassuppliedaneffectivesafe-guard. It is the safe-guard
of
metropolitan redemption.Let the banksbe compelledto redeem
theirnotesat the metropolis,
wherein timeof plethorathe notesare
sureto accumulate,andwe havethe best remedyforthe elasticityof
the currency,whichthe natureof the caseseemsto admit.
Elsewhere the editors of the Chronicle observed that centralized
note redemptionwould "imposea natural... check upon inflation"
by forcinginteriorbanks "to keep their affairsin a much more con-
servative condition."49
46
Ibid., (1867), vii; Bankers' Magazine, Jan. 1867, 496.
47 of the Currency, Annual Report (1868), xxii.
48
Comptroller
Bankers' Magazine, Jan. 1867, 496.
49 Commercial and Financial Chronicle, 10
July 1869, 37-38; 22 Jan. 1870, 102-3.
Interiorbanks fought all proposalsfor centralizednote redemp-
tion.50In doing so, they inadvertentlylent credibilityto the argu-
ment that active redemption would restrain their issues. The
Chronicleattributedthe oppositionto the interiorbanks' desire to
maximize short-term profits, to their constant fear of becoming
"tributary"to New York,and to the "demoralizationof opinionupon
bankingregulationswhich grew out of the financialexpedientsof the
[CivilWar]."51
The Reform of 1874
By the early 1870s Congress was under considerablepressure to

secure active redemptionof nationalbanknotes for three reasons:to
relieve New YorkCity banksof their accumulationsof excess notes;
to alleviate the filthy and worn condition of the currency;and to
hasten the resumptionof specie paymentsby reiningin the stock of
currency. An equally powerful movement demanded that greater
circulationprivileges be granted to banks in the West and South.
The law of 20 June 1874, enacted after a long series of conferences
and amendments,reflected these pressures.It combined a plan for
centralized note redemption with re-apportionmentof circulation
privilegestoward banks in the South and West in accordancewith
the census of 1870.52
The act of 1874 replaced the old system of redemption agents
with a single National Bank RedemptionAgency under U.S. Trea-
sury auspices in Washington, D.C., making national bank notes
redeemable through the Treasury as well as at their issuers'
counters. Redemptionat other locationswas now prohibited.53The
reserverequirementagainstnotes was alteredso that each banknow
had to contribute legal tender equal to 5 percent of its outstand-
50 For
contemporaryaccounts see J. Laurence Laughlin,Report of the Monetary Com-
mission of the Indianapolis Convention (Chicago, Ill., 1898), 211; Commercialand Finan-
cial Chronicle, 3 April 1865, 422; and Hunt's Merchants Magazine, Oct. 1867, 289, and
April 1869, 247.
51
Commercialand Financial Chronicle, 22 Jan. 1870, 102-3.
52
Congressional Record, 43d Cong., 1st sess., vol. 2. The $300 million ceiling on the
aggregate issue of national bank notes had been raised to $354 million by the act of 12
July 1870.
53 One
possible explanation for this otherwise curious provision of the act is that the
banks, in rent-seeking fashion, wished to restrict costly interbank competition for circula-
tion shares. Providing more redemption points could be a means of competing on note
quality.
ing circulationto a redemptionfund held at the Treasury.When a

bank'snotes were redeemed, the senderswould be paid immediately
out of the fund, which the issuingbankswould then have to replen-
ish. Significantly,the costs of note redemption,including those for
sorting and transportation,were assessed against issuing banks in
proportionto the number of their notes received.
It appearedthat centralizednote redemptionhad at last been
achieved, albeit with redemption centered in Washington rather
than in New York.The choice of Washington,contraveningthe plan
favored by the banks in the Northeast,was inefficient insofar as it
meant additional costs of transporting notes and legal tender
between the Northeast,where most notes accumulated,and Wash-
ington.54The choice, accordingto John Jay Knox (who served as
comptrollerof the currency from 1872 to 1884), was designed to
appease forces at the Treasurywho hoped to use their new powers
to encourage a greater substitutionof greenbacksfor nationalbank
notes.55The choice may also have defused the Populist suspicion
that centralized redemption was a scheme to make interior banks
"paytribute"to New York.
The new law nonetheless won the approvalof the northeastern
bankingcommunity.The Commercialand FinancialChronicle,over-
lookingits previouslyexpressedopinion that the Treasury'sinvolve-
ment in note redemptionwould be "badin principle,"expressedthe
hope that the reformwould finally"rid [the] bankingsystem of one
of its worst defects."56Bankers'Magazinewas even more confident:
The workof redemptionseemsat last to be providedfor;and if
carriedoutin goodfaithit willbe worthmoreto the countrythanany
of the othermeasuresrecentlyproposedto Congress.The practical
difficultyof assortingthe notesandpresentingthemfor redemption
is at once obviated,and the workwill be greatlyfacilitatedby the
[bankcharter]numbersto be hereafterstampedon all bills when
issued.57
54Cagan and Schwartz,"National Bank Note Puzzle,"
point out, citing 1894 testimony
by Treasury Secretary John G. Carlisle (and contradicting Spurgeon Bell, "Profit on
National Bank Notes," American Economic Review 2 [March 1912]: 38-60), that in prac-
tice the subtreasuries in New York and eight other major cities redeemed national bank
notes. The subtreasuries shipped the redeemed notes to Washington, where they were
counted and sorted together along with the relatively few notes that banks themselves
shipped directly to Washington. Fit notes, and notes for replacing unfit notes, were then
returned to their issuers.
55John Jay Knox, A History of Banking in the United States (New York, 1903), 149.
56Commercialand Financial Chronicle, 22
Jan. 1870, 103; 11 July 1874, 27.
57Bankers'
Magazine, July 1874, 75.
The new arrangementdid improvenote redemption.From 1864
to 1873, the only significantredemptionshad consisted of returnsto
the Treasuryof notes unfit for further use. The annual amount of
such redemptionswas at most about 10 percent of the total out-
standingstock of notes.58Following the reform,the volume of cur-
rency received rose dramatically.National banks for the first time
experienced significant note returns. Shipments of worn notes
surged, and the Treasurywas also asked to redeem many notes still
fit for circulation.Duringthe fiscalyear ending 31 October 1876, the
volume of national bank notes shipped to Washington (over $209
million) exceeded 60 percent of the outstandingcirculation.A year
later the figure was over 75 percent.
The new law, accordingto Bankers'Magazine, "workedmore
efficiently than its friends had ventured to expect."59Southernand
western bankers who had anticipated improved opportunitiesfor
note issue were now worriedthat note expansionwould involvemar-
ginal liquiditycosts. One Arkansasbankercomplainedthat the new
arrangementimposed "an unjust hardship"and "an onerous and
outrageousburden"on him and his colleagues.60
Such worries and complaintsturned out to be overblown.The
RedemptionAgency fell far short of achievingthe ideal of compre-
hensive active note redemption experienced in other banking sys-
tems. Even the 75 percent redemptionflow duringthe peak year of
1877 was a trickle comparedto the estimated 1,200 percent reflow
in Canada,where nationwidebranchbankingsponsoredactive note
redemption.The volume of U.S. nationalredemptionsin 1877, $214
million,was not much greaterthan the averageannualvalue of New
England redemptions by the Suffolk Bank during the 1840s and
1850s.61Universityof ChicagoeconomistJ. LaurenceLaughlinesti-
mated that in 1890, when approximately$130 million of national
bank notes were in circulation,national banks received about $4
million of one another's notes daily.62Had all been redeemed,
annualshipmentsto the Treasurywould have been nearly$1 billion,
about 800 percent of the stock. Allowingfor notes received by state
8 This and all related figures are from U.S. Treasury annual reports.
59Bankers' Magazine, Aug. 1875, 82-83.
60
American Bankers'Association, Proceedings (1875), 20.
61 For
comparisons of the redemption facilities of the National Banking System with
those of the Canadian, Scottish, and Suffolk systems, see Selgin and White, "National
Bank Notes." Circulationand Treasuryredemption figures are shown in charts 1 and 2 of
that paper.
62
Laughlin, Report of the Monetary Commission, 339.
banks,which accounted for about one-thirdof the nation'sbanking-

industrycapital at this time, that figure representsa turnovercom-
parable to Canada's. In contrast, the actual Redemption Agency
volume in 1890 was $36 million, less than 28 percent. Even at the
1877 peak, if Laughlin'sestimate roughlycapturesthe ratiobetween
the total circulationand the volume of notes that banks received,
banksredeemed less than 10 percent of the notes received.
Most notes went unredeemedbecause of state banks'continued
inability to issue their own notes and of some interior national
banks'inabilityto accumulatenotes rapidlyenough (that is, without
undue loss of interest) to meet the $1,000 minimum remittance
accepted by the Redemption Agency. Most interior banks
continued to reissue other banks' notes or to ship them to their
city correspondents,extendingthe notes' circulation.63The majority
of notes received by the Treasurywere sent by New York banks,
with shipmentsfrom Philadelphiaand Boston next in size.
Sherman's Order of 1878
Despite the relative paucity of note returns, the treasurer'soffice

was quickly overwhelmedby the "great amount of work suddenly
thrown upon" it. The treasurerwrote in a circularof 4 September
1874 that "withthe greatest exertions,it has been found impossible
to assort enough of the redeemed national bank notes."64It was
thereforeimpossibleto requisitionreplenishmentfunds from issuers
sufficientto avoidexhaustingthe 5 percent fund. Nearly $12 million
of the fund's original$17.5 million was paid out before the sorting
of notes even began.65In vain the treasurer requested voluntary
contributionsto the redemptionfund equal to an additional5 per-
cent of circulation.He finallysuspendedpaymentsfor severalweeks,
beginning 19 September, so that the Redemption Agency could
catch up. An act of 3 March 1875 later moved the agency from the
treasurer'soffice to largerquartersemployingninety-eightfull-time
clerks under the secretaryof the treasury'sdirect supervision.66
63 Bell, "Profit on National Bank Notes," 45-47.

64
Bankers' Magazine, Oct. 1874, 315.
65Ibid., Nov. 1874, 14.
6 Frank W. Lautz gives a detailed description of the new facilities and assortment
process in "How National Bank Notes Are Redeemed," Galaxy 23 (May 1877): 647-56.
Treasury Secretary John Sherman, 1880. Sherman, who had succeeded to Salmon
Chase's Ohio senatorial seat when Chase became Secretaryof the Treasury,was primarily
responsible for the passage of the Currency Act of 1863. After his term at the Treasury
(1877-81), Sherman regained his Senate seat; he was an unsuccessful candidate for the
Republican presidential nomination in 1880, 1884, and 1888. (Photograph reproduced
courtesy of the National Portrait Gallery, N.P.G. 69.7, Smithsonian Institution.)
The Treasury regretted having taken on the burden of note

redemption and soon acted to reduce it. Secretaryof the Treasury
John Sherman(1877-81), who as a senatorin 1864 had praisedthe
long circulationperiod of nationalbanknotes for economizingon the
use of paper, announcedin September 1878 that, effective 1 Octo-
ber, parties transmittingnotes to Washingtonfor redemptionwould
have to pay their own express charges,which the Treasuryhad pre-

viously assessed against the issuers of redeemed notes.67The new
regulation,together with the standingprohibitionagainstcharginga
discount for receivingother nationalbanks'notes, meant that recip-
ient bankswould suffer losses in redeeming those notes.
The New York Clearing House Associationprotested to Sher-
man that the new rule amounted "to a penalty for forwarding
Nationalbank notes for redemption, [impeding]the practicaloper-
ation of the law"of 1874 and renewingthe interiorbanks'incentives
to overissue.68Shermanreplied disingenuouslythat the law "did not
contemplatethe establishmentof a grandclearinghouse,"but aimed
merely at removingworn-outnotes from circulation.He declaredit
a "manifestinjustice"to compel issuers to pay the costs of redeem-
ing their notes, since the issuers "haveno interestwhatever"in hav-
ing their notes returned.He regrettedthat some interiorbankshad
been temporarilydeprived "of the advantagesof the repeal of the
originalact [of 1864], which requiredthem to redeem their circula-
tion in the large cities."69Shermanevidentlywished to view the act
of 1874 not as a remedy for the accumulationof currency in the
Northeast,but solely as an expansionarymeasure.
Following Sherman'sdecision, the volume of notes sent to the
Treasuryfell dramatically.The volume had been $243 millionin fis-
cal 1877 and $213 million in 1878; it dropped to $158 million in
1879 and to $62 million in 1880 (see Fig. 3). As Shermanintended,
most of the decline came in shipmentsof notes still fit for use, which
fell from $151 million in 1877 to $25 million in 1880. Redemptions
of worn notes also declined, from $62 million in fiscal 1877 to $30
million in 1880. Fearing renewed deteriorationof the currency,the
Treasurymodified Sherman'sorder on 1 December 1879 to allow
transportationcosts for worn notes to be paid out of the 5 percent
fund. This measure did not make much difference, because many
bankswere unwillingto undertakethe costs of separatingworn from
fit notes and accumulatingamounts sufficient for forwardingto the
treasurer.70On 13 January1881, just before Shermanleft his Trea-
sury post, his orderwas revokedentirely.The originalarrangements
of 1874 were restored, except that assorting expenses were now
67Bankers'
68
Magazine, Nov. 1878, 326-27.
Ibid., 390.
69Commercial and Financial Chronicle, 12 Oct. 1878, 368.
70
U.S. Treasury,Annual Report (1880), 30.
Figure 3
National Bank Note Redemptions
1875-1908, Yearly,in $Millions
450
400 -
350 -
300 -
250 -
200 -
150 -
100 -
50 -
0 T 1 1 1 I I I
I I I
1875
1875 1878
1878 1881
1881 1884
1884 1887
1887 1890I
1890 I1893I
1893 1896I
1896 I18
assessedon banksin proportionto the value ratherthan to the num-

ber of their returnednotes.71
Redemptionof worn notes reboundedto over $53 millionby fis-
cal 1882. Returnsof fit notes continued to decline, however, reach-
ing a low markof $3.8 millionin fiscal 1882 and not recoveringtheir
1878 level until 1912. The principalcauses of the continuedlow lev-
els of fit-note redemptionswere the risingprice (and fallingyield) of
the bonds required as collateralfor note issue, which made it less
profitablethan ever for banksto issue more notes, and the growthin
the relativeimportanceof non-note-issuingstate banks.72
The lack of active note redemptionafter 1882 was both a conse-
quence of and somethingof a compensationfor the restrictiveeffects
of the bond-collateralrequirement.Had note redemptionsomehow
been as active as in Canadaand elsewhere despite regulatc:y restric-
tions on note issuance, high liquiditycosts would have been added
to the high cost of securing collateral.The secular shrinkagein the
stock of nationalbanknotes would have been even more severe. The
Commercialand Financial Chroniclepointed out the incongruityof
a restrictionthat taxed note issue in one respect while subsidizingit
in others and pleaded for reformsthat would allowthe stock of notes
to attaina naturalelasticity:
Oughtwe notthento makethe lawso thatit willbe reasonably prof-
itablefora bankto obtainandissuenotes?-at the sametimebe sure
andaddto it a planof redemption whichwill be promptandeffec-
tive,takingthe placeof the miserablemake-shift,
whichnowexistsfor
redemption,througha Washington Bureau?In thiswaycan be pro-
duceda perfectautomaticcurrencymachine,as obedientto the laws
of tradeas the circulation
of bloodis to the beatof the heart.73
Active Redemption and the Asset Currency Movement
The banking reform movement intensified following the panic of

1893. The House Committee on Bankingand Currencyconsidered
dozens of bills, all aimed at providing a more "elastic"currency
71
Ibid. (1882), 377.
72
For a contrary view, see Bruce A. Champ, Neil Wallace, and Warren E. Weber,
"Interest Rates under the U.S. National Banking System," Federal Reserve Bank of Min-
neapolis, Research Department Staff Report no. 161 (1993), who argue that the collateral
restriction on note issue was not binding, and that national banks must have faced signif-
icant liquidity costs from redemption of notes.
73Commercialand Financial Chronicle, 20 Nov. 1880, 521.
whose volume would respondappropriatelyto secularand especially
to seasonalchangesin the public'scurrency-holdingdemands.74The
typical proposal for improvingelasticity was to let banks issue an
"asset"currency-that is, to allow bank notes to be matched on the
balancesheet by generalbank assets instead of requiringthem to be
(over)-matchedby specific governmentbonds. This step was meant
to enable banks to accommodate increases in currency demand.
Improved redemption facilities, sometimes supplemented by a tax
on circulation, were to guarantee appropriatecontraction of the
currencywhen demand subsided.
Freer note issue and active redemptionwere viewed as comple-
mentary reforms that together would give rise to an automatically
adjustingcurrency.J. LaurenceLaughlin,writingfor the Indianapo-
lis Commission on MonetaryReform, argued that "to secure real
elasticity it is not enough that the circulationshould expand when
the necessities of commerce require more currency;it is just as
essential that it should promptly contract when those necessities
have gone by."To ensure promptcontraction,"dailyand immediate
redemption of notes" was a necessary counterpart to enhanced
freedom of issue. A naturallydeveloped redemption system, which
the United States lacked,would regulatethe currencyappropriately:
"All [the] anxietyfor somethingto force retirementof a redundant
bank-currencyhas arisen from a failureto appreciatethe important
function of redemption and the way in which, when freely devel-
oped, it serves as a constantregulatorof the volume of currency."75
Banker William C. Cornwall similarly insisted that an asset
currency system with active note redemption would provide auto-
matic elasticity:
[W]itheverybankcrowdingfor redemptionandretirementof all the
notesof everyotherbank,andpressingout all it possiblycan of its
own,it is readilyseen thatonlythe actualamountneededby com-
mercewill stayout..... Thisis the principleof elasticityscientifically
carriedout, suppressinginflation,fosteringenterpriseand working
out its ownfine end underthe test of dailyredemption.76
74Cagan, "First Fifty Years,"21-22, dismisses the elastic currency idea as a specious
offspring of the real bills doctrine, though he elsewhere acknowledges (25-27, 38) the dis-
turbance caused by unaccommodated changes in the public's relative demand for cur-
rency. In our view, the basic aim of the proponents of an elastic currency was simply to
avoid such disturbances.Though the real bills doctrine can also be found in some of their
writings, the case for an elastic currency does not depend on it.
75
Laughlin, Report of the Monetary Commission, quotations at 324, 263, and 325.
76 American Bankers'
Association, Proceedings (1893), 45.
It was widely believed that, in the absence of provisionsfor active

note redemption, greater freedom of note issue might lead to "an
excessive supply of circulationand an illegitimateexpansionof bank
credits."77
Almost all of the reform plans considered by Congress
attemptedto providefor active note redemption.78Manyplans even
emphasizedredemptionover freer note issue, reflectingthe under-
standablebelief that getting more currencyout would be easier than
getting it back in again, as well as the belief that seasonalshortages
of currencywere largelydue to maldistributionsor prior overexpan-
sions that active redemptionwould prevent. Proponentsof reform
disagreed, however, on how to implement active redemption. A
minority,includingthe authorsof the "BaltimorePlan"endorsedby
the AmericanBankers'Association(ABA)at its 1894 Baltimorecon-
vention, arguedor implied that greaterfreedom of note issue would
itself bring about sufficientlyactive redemptionby raisingthe oppor-
tunity costs to banksof reissuingrivals'notes, as experiencein other
nations showed. The majority,however, though recognizing"a very
close connection between the ease or difficultyof issuing notes and
the activityand efficiency of the redemptionsystem,"believed that
legislationredesigningthe redemptionsystemwas needed to prevent
overissueof asset currency.79
Congress quickly abandoned the Baltimore Plan after critics
pointed out that it relied on the "usual, slow process" of note
redemption.80The majorityview was bolstered by the observation
that redemptionunder the National BankingSystem had been hin-
dered not only by banks'inabilityto issue more of their own notes,
but also by the expense of sortingand transportingthe notes issued
by thousandsof other banks. The minorityview appearedto over-
look the fact that banks in the United States were much more
numerousand dispersedthan banksin other nations.
77W. Dodsworth, "Our Paper Currency-As It Is and as It Should Be," in Sound

Currency 1895: A Compendium (New York, 1895), 199.
78
Testimony of James H. Eckels, Comptroller of the Currency, House Committee on
Banking and Currency, Hearings and Arguments, 1896-97, 54th Cong., 2d sess., 8 Jan.
1897, 235.
79
Laughlin, Report of the Monetary Commission, 326.
80J. Laurence Laughlin, "The 'Baltimore Plan' of Bank-Issues,"Journal Political
of
Economy 3 (Dec. 1894): 104-5; Commercialand Financial Chronicle, 15 Dec. 1894, 1033;
House Committee on Banking and Currency, Hearings and Arguments, 1896-97, 54th
Cong., 2d sess., 18 Feb. 1897, 409.
Legislative Proposals for Active Redemption
An obvious but unpopularroute to active note redemptionwas to

repeal the requirement that national banks receive one another's
notes at par. This idea, proposed by ComptrollerKnoxin 1873, was
revived in the late 1890s by Virginiabanker William L. Royall. In
testimonybefore the House BankingCommittee, Royallblamed par
acceptancefor the seasonalglut of notes in New York:"[I]f you put
out notes in a backwoodscommunitythat are good at par in New
York, those notes will leave the backwoodscommunity and go to
New York."81 Non-paracceptancewould make sortingand returning
notes profitableand would prevent notes from circulatingfar from
their places of issue and redemption. He cited the case of ante-
bellum Virginianotes, which traded at a discount in New Yorkand
consequentlywere seldom taken there.
The same sort of localness characterizedCanadianbank notes
before 1890.82 Non-par valuation eventually disappeared, as dis-
counts paved the way for improvedredemptionfacilities.A non-par
currencywas neverthelessviewed in the United States as decidedly
retrograde.T. G. Bush of the IndianapolisMonetaryCommission
told the House BankingCommittee that proponentsof such a solu-
tion "in coming to Washingtonought to have taken the stagecoach
instead of the railroadtrain," as outdated means were "more in
keeping with their views."83
A second proposalfor encouragingactive note redemptionwas
to make it illegal for nationalbanks to pay out one another'snotes,
as Massachusettshad done for state banks in 1843. This proposal,
recommended by Charles Dunbar, was considered but ultimately
abandonedby the authorsof the bill (H.R. 3333) submitted to the
55th Congress by Joseph Walker of Massachusetts,chair of the
House Bankingand CurrencyCommittee.84The proposalfailed to
reckon with country banks' option of sending unwanted notes to
their reserve-citycorrespondents.Instead of helping to spread the
81
Redlich, Molding of American Banking, 116; testimony of William L. Royall, House
Committee on Banking and Currency, Hearings and Arguments, 1896-97, 54th Cong., 2d
sess., 19 Dec. 1896, 199.
82
Legislation enacted in 1890 required all Canadianbanks to provide par redemption
at a specific city in each of the seven provinces.
83 Testimony of T. G. Bush, House Committee on Banking and Currency, Hearings
and Arguments, 1897-98, 55th Cong., 2d sess., 13 Jan. 1898, 277.
84 Dunbar, Economic
Essays, 243; House Committee on Banking and Currency,
Hearings and Arguments, 1897-98, 55th Cong., 2d sess., 20 Jan. 1898, 260.
redemptionprocess more widely, it would have increased the bur-

den on city banks strugglingto dispose of excess notes.
A third and more popularproposalwas to increase the number
of common locations at which banks were obliged to redeem their
notes. Varioussubtreasuriescould officiallybe requiredto serve as
redemptionbureausalongwith the RedemptionAgencyin Washing-
ton, as some alreadywere doing unofficially.85
Alternatively,national
banks could be officially required to redeem their notes at par at
privateclearinghousesapprovedby the comptrollerof the currency.
The bill supported by New Yorkbanker R. B. Ferris (H.R. 2699)
read before the 54th Congressand the bills submittedby Secretary
of the TreasuryLymanGage (1897-1902) (H.R. 5181) and the Indi-
anapolis MonetaryCommission (H.R. 5855) to the 55th Congress
embodied the subtreasury approach. The Treasury Department
proved unwilling, however, to take on any additionalburden. The
clearinghouseapproachfound its way into a large numberof propos-
als, including an early Walker bill and at least four others.86The
banking community opposed these bills because they would have
imposed high costs on banks.
A fourth and still more popular approach,following the Cana-
dian and Scottishmodels, was to allow interstatebranchbankingby
national banks while requiringeach branch to redeem at par the
notes issued by its head office. Branchingwould permit banks to
expandprofitablyinto new areaswhere their notes might circulate.
The branch-redemptionrequirementwould makethem devote some
share of the resulting earnings to maintaining more widespread
redemptionfacilities.The inclusion of branchingprivilegesin asset
currencyplans was seen by some as essential for getting any part of
the banking industry to support legislated redemption provisions.
Others, particularlyRepresentativeCharles N. Fowler-a member
(and later chairman)of the House Bankingand CurrencyCommit-
tee, a member of the IndianapolisMonetaryCommission,and an
uncompromisingpromoterof asset currency-viewed branchbank-
ing as a means to active note redemptionand therebyas a key to the
success of an asset currency.87
85
Cagan and Schwartz, "National Bank Note Puzzle."
86 Walker'sbill was H.R.
171, 54th Cong. The others were bills written or endorsed by
John Dewitt Warner (H.R. 5595, 53d Cong.), Theodore Gilman (H.R. 3338, 54th Cong.),
Samuel Hill and Charles N. Fowler (H.R. 10289, 55th Cong.), and Fowler (H.R. 13363,
57th Cong.).
87
Laughlin, Report of the Monetary Commission.
New Jersey Congressman Charles N. Fowler. A supporter of asset currency and

branch banking, Fowler served on and became chairmanof the House Banking and Cur-
rency Committee, and he was also a member of the Indianapolis Monetary Commision.
(Photograph reproduced courtesy of the Library of Congress, Washington, D.C., no.
404790.)
Branchbanking,however, had politicallyinfluentialopponents.

The smaller interior banks feared the consolidationof the banking
industry that interstate branchingwould bring. The unit banking
lobby was able to prevent the passage of any measure that even
hinted at banking across state lines throughout the 1890s and
beyond.88The path of least resistance,evident in the Gold Standard
Act of 1900, was therefore to relax bond-collateralrequirements
without makingany improvementsin note redemptionto providean
offsetting restraint.As one commentatorobserved, "[T]he plans of
the theorists contemplated that the bank issues should be at the
same time expansibleand contractible.But legislationhas adopted
only one-half of the project, for it has seized upon the idea of
expandingthe bank issues but made no provisionfor their contrac-
tion."89
The Ultimate Failure of the Asset Currency Movement
By obstructing potential improvements in note redemption, the

defenders of unit bankinghelped to undermine the asset currency
movement. They did so knowingly.Andrew J. Frame, a Wisconsin
bankerwho was one of branchbanking'smore outspokenopponents,
made his position clear in a 1907 address:"Enforcedquick redemp-
tion ... will work under a branchbankingsystem, but it is imprac-
ticable under ours. For one, I do not propose to be accessoryto my
own hangingby aidingin bringingabout any branchbankingsystem,
which I confidentlybelieve is the ultimate end in view of many of
the asset currencyadvocates."90
By 1907 the asset currencymovementhad abandoned"itsmoor-
ings in branchbanking."91 It insteadattemptedto devise second-best
means for achievingan elastic currencywith active note redemption.
The clearest exampleof a second-bestproposal,and the last impor-
tant effort to establish an actively redeemed asset currency,was a
88 On country bankers' opposition to branch banking see James Livingston, Origins of
the Federal Reserve System (Ithaca, N.Y., 1989), Richard T. McCully, Banks and Politics
during the Progressive Era: The Origin of the Federal Reserve System (New York, 1992),
96-97, and Eugene N. White, The Regulation and Reform of the American Banking Sys-
tem, 1900-1929 (Princeton, N.J., 1983), 83-90. Livingston appreciates the importance
assigned to branch banking by proponents of asset currency, but he suggests that they
wanted branching mainly as a device for centralizing reserves. By contrast, we believe that
they wanted it as a device for active redemption and thereby regulation of the currency
stock.
89 Roland P. Falkner, "The
Currency Law of 1900," Annals of the American Academy
of Political and Social Sciences, May 1900, 47. The Gold Standard Act allowed national
banks to issue notes up to 100 percent of the par value of the bond collateral.
90American Bankers' Association,
Proceedings (1907), 138.
91 Livingston, Origins of the Federal Reserve
System, 155.
joint product of the ABA'sCurrencyCommissionand the Commit-

tee on Finance and Currencyof the New York State Chamber of
Commerce. Their proposal,put before Congress in 1907 as H. R.
23017, recommendedthat nationalbanks be allowed to issue unse-
cured "credit"notes to supplement their bond-securednotes. The
comptrollerof the currencywould "designatecertain cities conve-
niently located in the various sections of the United States for the
currentdaily redemption"of the credit notes.
Both the New Yorkcommittee and the ABA CurrencyCommis-
sion stressed the importance of note redemption. Economists
Charles Conant and Joseph French Johnson, writing for the New
Yorkcommittee, held that active redemptionwas a matter "of the
first importance,"and that multiple redemptionpoints were neces-
sary to secure it: "If the volume of bank notes is to vary sensitively
with the need for them, there must be incessant daily redemption,
and this can be had only when the redemptionpoints are so numer-
ous that no bank will be more than 24 hours distant from one."92
James B. Forgan, president of the First National Bank of Chicago
and a member of the ABA Currency Commission, argued that
creating an asset currency "without providing means for its contrac-
tion ... would only enhance the evils of our present system." He
elaborated:
It is, therefore,no expansionof the currencythat we are advocating,
but the adjustmentof it to fluctuatingdemandsof commercewith an
adequatepower to contractas these demandsare reduced.... There
is only one possible way by which this attributeof elasticity can be
given to it; that is, by active redemptionand practicalcancellationof
bank notes which are not kept in circulationby the requirementsof
commerce.
Drawing on his experience as a former employee of both Scottish

and Canadian banks, Forgan claimed that, with adequate redemp-
tion facilities, national bank notes would circulate "on exactly the
same basis as checks, bank drafts, and other similar obligations,"
being "presentedalong with these through the Clearing House for
redemption"instead of being treated like gold or greenbacks.93
Others were skeptical that multiple redemption points alone,
unaccompanied by branch banking, could achieve active note
redemption.Frame dismissedthe proposalas "an expensiveluxury"
92
The Currency (1906), 13-14.
93 American Bankers'Association, Proceedings (1907), Appendix, 167-68. Emphasis in
original.
that would make "a picnic for the express companies" at great
expense to the nationalbanks.94But skepticismwas not confined to
the unit banking interests. Frank Vanderlip, a former assistant
secretaryof the treasuryand a member of the New Yorkcurrency
committee, also came to doubt "whetherthe creation of numerous
redemption points would be sufficient to drive in the redundant
circulation."95The New York committee and the ABA Currency
Commissionrespondedby proposinga tax on credit notes in circu-
lation. Taxing circulation,however, penalizes notes generally, not
only excess notes, and does nothing by itself to drive redundant
notes to their issuers.96Forgan admittedthat once a note has been
issued, it may,tax or no tax, remain"entirelybeyond the reachof the
bank that wants to redeem it" if no mechanismexists for returningit
promptly.97
By endorsing a circulation tax, the sponsors of H. R. 23017
played into the hands of the opponents of asset currency, led by
SenatorNelson Aldrichof Rhode Island.Aldrichfavoredallowinga
supplementalcurrency,to be issued only during "emergencies"and
subjectto a heavytax aimed at achievingits promptwithdrawal.The
Aldrich-VreelandAct of 30 May 1908 embodied a compromise
between Aldrichand the supportersof H. R. 23017, authorizingan
emergencyasset currencyunder a heavytax but denyingan ordinary
asset currency with active redemption. The act was, moreover,
adoptedonly as a temporaryexpedient(expiring30 June 1914) while
the NationalMonetaryCommission,which it authorized,looked into
permanentreformsolutions.Ultimatelyit gave way, not to any asset
currency,but to the Federal Reserve Act (1913).
The Federal Reserve Systemprovidedeven less adequatelythan
the National BankingSystem had for active note redemption.Each
of the twelve regional Federal Reserve Banks was required to
receive and prohibitedfrom re-issuing(except at a 10 percent pen-
alty) the notes of any other reserve bank, but the banks seldom had
94Ibid., 138.
95Quoted in Livingston, Origins of the Federal Reserve System, 168. It should be
noted that the New Yorkcurrency committee, unlike the ABA commission, favored a gov-
ernment central bank as the best way to achieve an elastic currency (The Currency [1906],
9-11). In its final report, the committee chose not to advocate that solution only because
they considered it politically unrealistic (see Livingston, Origins of the Federal Reserve
System, 259-63).
96Mints, History of Banking Theory, 240-44, argues on somewhat different grounds
that a tax on notes was unlikely to have given the note circulation the desired degree of
elasticity.
97 American Bankers' Association, Proceedings (1907),
Appendix, 164-65.
the opportunity to redeem one another's notes. The public, as
before, did not seek to redeem unwanted notes directly, but found it
easier to deposit them in their accounts at commercial banks. State
and national banks preferred to hold and re-issue Federal Reserve
notes rather than to redeem them for gold, even though the banks
could not yet count the notes as part of their legal reserves. The
Federal Reserve notes were the favored currency medium of the
public, and the national banks' own profits from note issue were
dwindling. The holding and re-issue of Federal Reserve notes was
also encouraged by a rule preventing a bank from directly receiving
reserve-balance credit from its district reserve bank for a deposit of
notes issued in other districts. Member banks were thus encouraged
to return their own reserve bank's notes, but not to send in the notes
issued by other district reserve banks.98
Federal Reserve notes were therefore as lacking in "homing
power" as national bank notes had been before. Economist F. M.
Taylor concluded that "the new law does not promise to give to the
note issue the degree of contractibility which has hitherto been con-
sidered desirable."99The Commercial and Financial Chronicle noted
the irony of this outcome in light of the original aim of providing a
downwardly elastic currency:
What is now being done ... is just the reverse of what was
intended.... Instead of notes being retired,when their mission as a
medium for carryingmercantile paper has been fulfilled, they are
being forced into circulationand a determinationexists to keep them
afloat indefinitely.Mr. [Benjamin]Strong [Governorof the Federal
Reserve Bankof New York]arguesthat this does no harm and that if
the notes become redundantthey will quicklycome in and be pre-
sented for redemption.As a matter of fact unless some crisis inter-
venes they will stay out just as long as the banks and the trust
companiescontinue to pay them out.100
The Federal Reserve Act had introduced a currency whose volume
was "elastic" only in the sense that it could be increased or reduced
at the Federal Reserve's discretion. Although this sort of discretion-
ary elasticity did succeed in smoothing interest rates and (for a time)
in avoiding financial crises by eliminating seasonal accumulations of
98
F. M. Taylor, "The Elasticity of Note Issue under the New Currency Law,"Journal
Political
of 99 Economy 22 (May 1914): 456-58.
Ibid., 460.
100 Commercialand Financial Chronicle, 17 Aug. 1915, 398.
currencyin New YorkCity, it was far from providingthe automatic

elasticity that reformers throughout the national banking era had
tried to achieve.'10
Conclusion
The inadequacy of note redemption under the National Banking

System in the late nineteenth and early twentieth centuries was
appreciatedby many reformers,who sought improvedopportunities
for redemption as a complement to greater freedom of issue.
Accordingto their diagnosisof the bankingsystem'sproblems, the
interventionsof the federal governmentpreventedthe stock of bank
notes from adjusting,in an automaticand desirableway, in response
to changes in the demand to hold notes. The reformers'goal of
an elastic currency was co-opted, and their deregulatoryprogram
ultimatelydiscarded,in the fashioningof the Aldrich-Vreelandand
Federal Reserve acts. Recent work on the self-adjustingproperties
of the note supply under deregulatedconditionssuggests, however,
that the reformers' diagnosis was essentially correct.102Their
programdeserved a better hearing.
101
Jeffrey A. Miron, "Financial Panics, the Seasonality of the Nominal Interest Rate,
and the Founding of the Fed," American Economics Review 76 (March 1986): 125-40.
102
Lawrence H. White, Free Banking in Britain: Theory, Experience, and Debate,
1800-1845 (New York, 1984); George A. Selgin, The Theory of Free Banking (Totowa,
N.J., 1988); Selgin, "Free Banking and Monetary Control," unpub. MS, University of
Georgia, 1993.
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Cover: New York Clearing House, 1875
By the early 1850s, New York City had aboutfifty

banks, and the task of making daily exchanges
among them had become cumbersome and time-
consuming. In 1853, fifty-two banks in the city
organized the New York Clearing House Associa-
tion (NYCHA). The new institution, by clearing the
obligations of the member banks in both currency
and demand deposits in a central location, proved
extremely efficient. Delivery clerks moved through
the NYCH beginning at 10 o'clock each morning,
presenting their checks or bank notes to the ranks
of settling clerks, and accomplishing in about an
hour a process that had formerly taken all day,
though of course the clearinghouse clerks worked
several hours more to balance the accounts. As the
organization grew, the NYCHA became a lender of
last resort to its member banks, helping to cope
with the financial panics of the period. (Illustration
reproduced from Noble Foster Hoggson, Epochs
in American Banking [New York, 1929], facing p.
178.)
For an article on the significance of the ineffi-
cient redemption of national bank notes between
1863 and 1913, see pp. 205-243.
? 1994 by The President and Fellows of HarvardCollege.

All rights reserved.
ISSN 0007-6805
Second-class postage paid at Boston, Mass.

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The President and Fellows of Harvard College

Monetary Reform and the Redemption of National Bank Notes, 1863-1913

MonetaryReform and the Redemptionof

r he fifty years during which the National Banking System oper-

GEORGE A. SELGIN is assistantprofessor of economics at the Universityof Georgia.

the United States as legal tender. This providedan alternativecircu-

deregulationto allownotes backedby ordinarybankingassets ("asset

Causes and Consequences of Sluggish Redemption

In an unregulatedbankingsystem with pluralnote issue, banksnat-

every $90 of their circulation,the regime 1) homogenizedthe notes

monetarystability.9Recognizingthis problem, contemporarybank-

the consequences of their operations for which they should be

Had there been regular active redemption of national bank

David Weil, "The Adjustment of Expectations to a Change in Regime: A Study of the

sonalityof the United States thus appearsto have reflected in part

Early Fears of Overissue

The inadequateprovisionfor activenote redemptionunder the Cur-

Dakota,only to be protested,returnedto New York,then sent to

namely, retainingthem for use in paymentsto the government-led

Reform Efforts before 1874

The earliest reform effort-embodied in the 1864 revision of the

redemptions,but in part by Congress'ssurpriseat discoveringthat

the returned notes. Assorting house expenses would be assessed

32The plan is reproduced in Bankers' Magazine, Sept. 1865, 198-200.

Early Notefrom Mechanics National Bank, New York. A pointof contentionunder

an increase in the aggregatelimit on nationalbank notes from $300

Association.As long as remote banks did not have to redeem their

The Reform of 1874

By the early 1870s Congress was under considerablepressure to

ing circulationto a redemptionfund held at the Treasury.When a

banks,which accounted for about one-thirdof the nation'sbanking-

Sherman's Order of 1878

Despite the relative paucity of note returns, the treasurer'soffice

63 Bell, "Profit on National Bank Notes," 45-47.

The Treasury regretted having taken on the burden of note

have to pay their own express charges,which the Treasuryhad pre-

assessedon banksin proportionto the value ratherthan to the num-

Active Redemption and the Asset Currency Movement

The banking reform movement intensified following the panic of

It was widely believed that, in the absence of provisionsfor active

77W. Dodsworth, "Our Paper Currency-As It Is and as It Should Be," in Sound

Legislative Proposals for Active Redemption

An obvious but unpopularroute to active note redemptionwas to

redemptionprocess more widely, it would have increased the bur-

New Jersey Congressman Charles N. Fowler. A supporter of asset currency and

Branchbanking,however, had politicallyinfluentialopponents.

The Ultimate Failure of the Asset Currency Movement

By obstructing potential improvements in note redemption, the

joint product of the ABA'sCurrencyCommissionand the Commit-

Drawing on his experience as a former employee of both Scottish

currencyin New YorkCity, it was far from providingthe automatic

The inadequacy of note redemption under the National Banking

By the early 1850s, New York City had aboutfifty

? 1994 by The President and Fellows of HarvardCollege.

Second-class postage paid at Boston, Mass.

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