In his analysis of how capital formation was financed from 1830 to 1930, Dr. Harold Moulton discovered this was, in point of fact, the case. Contrary to the accepted accounts, issues of state and private banks used to finance capital formation were not backed by specie (gold and silver) to any great degree, whether or not imported from Europe. On the contrary (as a number of authorities make clear), paper money backed with commercial loans made for productive purposes ("mercantile paper"), equity shares of sound companies (including other banks), and other instruments conveying liens on existing, "hard" assets were absolutely essential if the United States was to develop economically, or even stay where it was. Popular misconceptions aside, paper money could and did, in fact, make up the bulk of circulating media, inadequately supplemented with foreign coin, notably the Spanish American dollar or "Piece of Eight," on which the U.S. monetary system was based.
Consistent with classic bank of issue theory, paper issues were backed by loans made for the purpose of forming capital. Banks purchased these loans by printing money or creating demand deposits (with the former being much more common), and retaining the loan paper as reserves until redeemed by the borrower. At that time the money was canceled or held in treasury until reissued.
This is the way an honest bank operated. There were also "wildcat banks," so-called because to redeem the bank notes you had to present them for payment at headquarters, located in an area so remote that there were only howling wildcats as neighbors. Wildcat banks would typically operate only long enough to print up a few bushels of paper money not backed by any commercial loans or specie (effectively counterfeiting), then go out of business . . . to open up a few months later in another area under another name. This practice was common enough to embed a deep and lasting distrust of all banks in the American psyche.
Citing official Congressional reports, George Tucker, a noted early 19th century American Congressman, novelist (he wrote one of America's first science fiction novels under a pseudonym, "Joseph Atterley": A Voyage to the Moon, 1827), and political economist, observed that the circulating media of the United States were primarily paper representing credit extended by commercial banks of issue. While the net imports of gold from 1834 through 1838 seem enormous at nearly $50 million, this was dwarfed by the amount of bank paper in circulation meeting the needs of commerce. As Tucker stated, writing in 1838,
By far the largest proportion of this class of credits is in promissory notes, especially in the mutual dealings of mercantile men. We may form some idea of their vast amount, when we find those which were discounted at the several banks in the United States, amounting, on the 1st of January [1838] to $485,000,000, and on the 1st of January preceding [1837], to 40,000,000 more. These discounts, moreover, constitute but a part, and, perhaps, not the largest part, of this description of credits. (George Tucker, The Theory of Money & Banks Investigated (1839), 132.)No, the vast bulk of financing for America's economic growth in the 19th century was not gold and silver, whether from Europe or mined domestically. It consisted of making promises to repay loans made for capital formation out of the future profits generated by the very capital whose formation the loans financed.
