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The American System

By — McGraw-Hill Professional
Updated on Feb 4, 2012

The American System

The U.S. economy really began to take shape in the first quarter of the nineteenth century. Congress had refused to renew the charter of the Bank of the United States in 1811, which meant that the government had to look to state banks for funds to repay the debt of the War of 1812. Since state banks did not always have sufficient gold or silver to back up their paper currency, other banks would often refuse to honor that currency. Speaker of the House Henry Clay of Kentucky offered a solution to this emerging economic crisis. His proposal, called the American System, found substantial support in Congress. It consisted of three parts: a national bank, protective tariffs on imports, and a national transportation system.

The National Bank

In 1816, Congress sent a bill to President Madison, asking for a charter for the Second Bank of the United States. Its purposes would be twofold: to establish a standard national currency and to fund federal government services such as the armed forces. Madison promptly signed the bill into law.

In 1818, the Second Bank called in all outstanding loans from state banks. These banks had borrowed more money than they could pay back, and the result was the Panic of 1819. In a frantic attempt to get enough money to pay their debt to the government, banks foreclosed on mortgages and called in loans to customers. In their turn, individual borrowers could not pay back the loans on such short notice, and many had to sell their homes or businesses. With no one to buy the businesses, they closed down, and their workers were suddenly unemployed. The resulting economic depression lasted for several years.

President Andrew Jackson looked with disfavor on the Second Bank, believing that it catered to the interests of the wealthy at the expense of the common working people. The voters apparently agreed with Jackson; when the fate of the bank became a major campaign issue in 1836, Jackson easily defeated his opponent, Henry Clay, who supported renewing the bank’s charter. Once reelected, Jackson took steps to close down the Second Bank. He transferred funds to various state banks rather than putting them into the federal bank. Bank President Nicholas Biddle attempted to save the bank by triggering a financial crisis, hoping to show Jackson and the public that they should sup- port an institution that stabilized the national economy. Neither Jackson nor the public was converted to this view; instead, they felt that Biddle was demonstrating conclusively that the bank was a tool to be used against the public.

The bank closed down in 1836, triggering the Panic of 1837. State banks loaned money readily, which meant that speculators were able to buy land. They resold the land at inflated prices, clearing a fast profit. As land prices soared, so did all other prices. President Jackson tried to stem the tide of inflation by stating that the federal government would accept only gold or silver as payment for public land—no paper currency would be accepted. Land sales dropped precipitously, because few people had gold or silver. They tried to trade paper money for gold and silver at the banks, and the banks quickly ran out and then failed. The Panic of 1837 resulted in an economic depression from which the nation did not begin to recover until 1843.

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