The Mystery of Banking

Jour-
nal of American History
58 (December 1971): 591–621; and James Roger
Sharp, 
The Jacksonians versus the Banks: Politics in the States After the Panic
of 1837
(New York: Columbia University Press, 1970).
were allowed to pyramid a multiple expansion of bank notes and
deposits. This meant that the more public debt the banks pur-
chased, the more they could create and lend out new money.
Thus, banks were induced to monetize the public debt, state gov-
ernments were encouraged to go into debt, and government and
bank inflation were intimately linked. 
In addition to allowing periodic suspension of specie pay-
ments, federal and state governments conferred upon the banks
the highly valuable privilege of having their notes accepted in
taxes. And the general prohibition of interstate (and sometimes
intrastate) branch banking greatly inhibited the speed by which
one bank could demand payment from another in specie. The
clearing of notes and deposits, and hence the free market limit on
bank credit expansion, was thereby weakened. 
The desire of state governments to finance public works was
an important factor in their subsidizing and propelling the expan-
sion of bank credit. Even Bray Hammond, scarcely a hard money
advocate, admits that “the wildcats lent no money to farmers and
served no farmer interest. They arose to meet the credit demands
not of farmers (who were too economically astute to accept wild-
cat money) but of states engaged in public improvements.”
11
Despite the flaws and problems in the decentralized nature of
the pre-Civil War banking system, the banks were free to experi-
ment on their own to improve the banking system. The most suc-
cessful such device, which imposed a rapid and efficient clearing
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Central Banking in the United States II
217
system on the banks of New England, was the privately developed
Suffolk System. 
In 1824, the Suffolk Bank of Boston, concerned for years
about an influx of depreciated notes from various country banks
in New England, decided to purchase country bank notes and sys-
tematically call on the country banks for redemption. By 1825,
country banks began to give in to the pressure to deposit specie
with the Suffolk, so as to make redemption of their notes by that
bank far easier. By 1838, furthermore, almost every bank in New
England was keeping such deposits, and was redeeming its liabil-
ities in specie through the medium of the Suffolk Bank. 
From the beginning to the end of the Suffolk System
(1825–58), each country bank was obliged to maintain a perma-
nent specie deposit of at least $2,000 ranging upward for larger
sizes of bank. In addition to the permanent minimum deposit,
each bank had to keep enough specie at the Suffolk Bank to
redeem all the notes that Suffolk received. No interest was paid
by the Suffolk Bank on these deposits, but Suffolk performed the
invaluable service of accepting at par all the notes received from
other New England banks, crediting the depositor banks’
accounts the following day. 
As the result of Suffolk acting as a private clearing bank, every
New England bank could automatically accept the notes of any
other bank at par with specie. In contrast to the general state bank
approval of the Bank of the United States (and later of the Fed-
eral Reserve System), the banks greatly resented the existence of
the Suffolk Bank’s tight enforcement of specie payments. They
had to play by the Suffolk rules, however, else their notes would
depreciate rapidly and circulate only in a very narrow area. Suf-
folk, meanwhile, made handsome profits by lending out the per-
manent, noninterest paying deposits, and by making overdrafts to
the member banks. 
Suffolk System members fared very well during general bank
crises during this period. In the Panic of 1837, not one Connecti-
cut bank failed, or even suspended specie payments; all were mem-
bers of the Suffolk System. And in 1857, when specie payment was
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suspended in Maine, all but three banks (virtually all members of
the Suffolk System) continued to pay in specie.
12
The Suffolk System ended in 1858 when a competing clearing
bank, the Bank of Mutual Redemption, was organized, and the
Suffolk System petulantly refused to honor the notes of any banks
keeping deposits with the new bank. The country banks then
shifted to the far laxer Bank of Mutual Redemption, and the Suf-
folk Bank stopped its clearing function in October 1858, becom-
ing just another bank. Whatever the error of management in that
year, however, the Suffolk System would have been swept away in
any case by the universal suspension of specie payments at the
start of the Civil War, by the National Banking System installed
during the war, and by the prohibitive federal tax on state bank
notes put through during that fateful period.
13