The easy dream of someone else’s dollars

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The writer is an FT contributing editor

In April of 1835, Edmund J Forstall in New Orleans wrote a letter to Thomas Baring in London. Over a long career, Forstall had a finger everywhere in commercial Louisiana — importer, banker, legislator and sugar planter with enslaved labour. For Baring, he was a correspondent, advising on opportunities in New Orleans.

The city was approaching what would turn out to be the top of a cycle of explosive export-driven growth, where flatboats carrying wheat and hogs for Havana and the Caribbean met steamboats packed with cotton for Liverpool and sugar for Philadelphia.

In his letter, Forstall pitched the bonds of the Citizens’ Bank, “bound upon the best property of the country”, he wrote, which “must ultimately succeed”. He made an argument for the bank — and for Louisiana — familiar to anyone urging the dollarisation of economies today. The banks of New Orleans had good loans, and the city’s exports guaranteed plentiful reserves of silver Mexican dollars, the hard global currency of the day. But they came to grief anyway after the Panic of 1837 — of 16 banks in the city before the panic, there were six left by 1843.

The Citizens’ Bank landed in receivership. Its bonds, guaranteed by the State of Louisiana and backed by mortgages on sugar plantations that included lists of the enslaved as assets, remained subject to negotiations with Dutch investors into the early 20th century.

When you are a taker of someone else’s dollars, all the macroadvantages of an exporter don’t matter if local banks and local governments scratch each others’ backs. Like the rest of America, money in New Orleans rested on a hard foreign currency standard. But that did not fix Louisiana’s governance problem. Powerful legislators in the state were too dependent on the state’s private banks to be able to regulate the bank dollars of the country’s then most important port.

Economic historians often say that the US in the early 19th century was on a bimetallic standard — the dollar was defined as a specific weight and fineness of both silver and gold. This is true, legally. Practically, however, the US was on a single, foreign standard, over which it had no control. Until just before the Civil War, when Americans referred to a “dollar”, what they meant was a Spanish milled dollar or, after independence, a Mexican dollar — a large silver coin that had become a global standard for long-distance trade. 

America was a taker of foreign dollars. In theory, this shouldn’t have posed a problem. Countries bring in specie — money in the form of coins — in proportion to the goods they can sell on global markets. In New Orleans in particular, the produce coming down the Mississippi created a trade surplus that guaranteed a better supply of silver dollars than any other American port.

In his letter, Forstall explained that the city’s banks all carried at least a third of the value of their notes and deposits in precious metals. “Indeed,” he wrote, “no part of the commercial world can boast of a sounder paper currency than the city, for it is wholly based upon specie.”

We are familiar with the problems an external supply of dollars poses for an emerging market — such as Argentina today or the US in the early 19th century. When they flow in, as they did in the early 1830s, credit expands. If there’s ever an interruption in credit, as there was when cotton prices collapsed in 1836-37, merchants and planters will start to fail, creating a temptation to make bad loans in bad times. Forstall was right — at first. The Citizens’ Bank was well prepared for the panic, but then succumbed to a self-reinforcing cycle of corruption.

As the historian Sharon Murphy has pointed out in her book Banking on Slavery, Citizen’s wouldn’t always foreclose on its powerful sugar planters, sparing them (and the enslaved on their land) the liquidations that could have cleared its balance sheet. It also continued to make new mortgage loans to get planters through several years of low sugar prices. And as loan quality deteriorated, it remained in the interests of the planters, the state, the investors in Europe to keep the bank open, hoping it might work out.

Nothing about the restraint of silver dollars from Mexico spared the city of New Orleans or the State of Louisiana from the pain of bank failures. No matter how many hard silver dollars came in through trade, the city still had to create a supply of its own domestic bank dollars. And the reliability of these dollars improved only slowly, through painful governance reforms — after 1837, for example, regular disclosures to a board of examiners and a legal mandate that banks had to keep a reserve of silver or gold equal to a third of their deposits and circulating banknotes.

It is tempting still today to think of someone else’s dollars as a corset, a way to force yourself to suffer discomfort. But you fix a governance problem by fixing the governance problem. The arbitrary restraint of someone else’s dollars can’t do it for you.