A story about trade wars and bank failures
Skylines of cities are graveyards of hubris.
“Never since the Battle of Lexington have I seen this country in such a state of exasperation as at present, and even that did not produce such unanimity.”
Thomas Jefferson
1807
We seem to have found ourselves in the opening salvos of a trade war with China — or maybe we haven’t, it depends on the hour. Either way, given that we don’t have much experience with trade wars, it’s worth looking back to a time when one did impact the American economy, and banking in particular.
The story begins on June 22, 1807.
At 7am that morning, the USS Chesapeake set sail from Norfolk, Virginia. It was one of six frigates commissioned by Congress thirteen years earlier for the U.S. Navy. The Chesapeake had a crew of 375 sailors and was equipped with 38 cannons. But America wasn’t at war, so the guns were stowed.
After sailing out of the harbor, the Chesapeake was hailed by the HMS Leopard, a 50-gun British warship patrolling the Atlantic Coast. Britain and France were locked in the Napoleonic Wars. The Leopard’s primary mission was to keep a pair of french warships blockaded in Norfolk harbor.
The Chesapeake’s officers knew this. But what they didn’t know was that the Leopard had also been ordered to capture four deserters of the British Royal Navy who had joined the Chesapeake’s crew.
When the captain of the Chesapeake refused to muster the deserters, the Leopard opened fire with its canons. Three sailors on the Chesapeake died and eighteen were wounded, including its captain, who struck colors and surrendered. Three of the four deserters were impressed back into service of the Royal Navy; the fourth was executed by hanging.
Thomas Jefferson was incensed. He was nearing the end of his second term in the White House and was tired of being pushed around by Britain and France. Both had been interfering with American commerce by impressing its sailors into their navies for years.
Congress responded with the Embargo Act of 1807. It legislated a complete embargo on trade into and out of American ports. It was by starving Britain and France of the transatlantic trade, Jefferson believed, that he could bring them to respect the freedom of the seas.
It would months, maybe years, to know if Jefferson was right. In the meantime, the embargo broadsided the U.S. economy and set in motion the nation’s first bank failures.
We’ve all met a guy like Andrew Dexter — a Brooks Brothers-wearing douchebag who assumes his surname entitles him to the same status as his humble, hardworking forbearers.
He was born in 1779 into the type of New England family that arrived on the Mayflower. His father was among the first cloth manufacturers in America. His father-in-law served as the Massachusetts Attorney General. His uncle was a Boston attorney who spent two years in the cabinet of President John Adams.
Dexter harbored similar grand ambitions. After attending law school, he passed the bar and worked in his uncle’s law practice. But jurisprudence didn’t interest Dexter. He had something else in mind. Something bigger and more memorable than drafting legal briefs. His dream was to build Boston’s first skyscraper — a seven-story tower in the heart of the financial district. Excluding church steeples, it would reputedly be the tallest building in America.
Dexter resigned from his uncle’s law practice and broke ground on the project in early 1807. He named the building after a luxury beverage sweeping cosmopolitan culture at the time: the Exchange Coffee House. It would lease office space to tenants and provide a common area to serve as Boston’s financial nerve center. It would also sell coffee.
The plan was ambitious. Especially for a 28-year-old with no real estate experience. But ambition was the zeitgeist of the times. “The gospel of ascent seeped into every sphere of life in the early republic,” wrote Jane Kamensky in The Exchange Artist: A Tale of High-Flying Speculation and America’s First Banking Collapse. “And wherever it touched, aspiration took shape.”
Capital was the soft underbelly of Dexter’s plan. There were only 80 banks in the United States in 1807, none of which would have judged the construction of the Exchange Coffee House to be a prudent risk. Dexter found a way around this. If he couldn’t beat the financiers, then he would join them.
It didn’t take much capital to start or buy a bank in the early 1800s. Truth is, you hardly needed any capital at all. The founding stockholders of a bank during this era typically paid in a fraction of the amount claimed as shareholder’s equity on the bank’s balance sheet. They capitalized the rest with personal IOUs. This became so widely accepted that a debate emerged in banking circles as to whether capital was even necessary in banking, given that banks, in the estimation of the argument’s proponents, lent credit not capital.
It’s worth keeping in mind as well the alchemy of banking during Dexter’s life. This was a time when banks printed their own currencies. So by buying a bank, you were in effect buying a currency-printing machine.
The system relied on a self-correcting mechanism. When a bank printed too much currency compared to the value of gold it held on reserve, its currency wouldn’t be accepted at face value. It would be discounted based on the issuing bank’s perceived ability to redeem its currency for gold. If things got too bad and depositors lost confidence in this ability, there would be a bank run.
There was one way to circumvent this, and Andrew Dexter was one of the first people to happen upon it. Rather than gaining control of banks in Boston, where it would be easy for holders of the banks’ currency to redeem the bills for gold, he chose banks in places like Maine, Michigan and Rhode Island. The nearest bank by distance was in the Berkshires, the highlands of Western Massachusetts. In this way, so long as the five banks Dexter assumed control of printed currency in small denominations, the time and cost of redeeming the bills could easily exceed their value in gold.
So that’s what Dexter did. He turned on the money-printing machine. At one of his banks, Dexter instructed the cashier to endorse currency through the night, as he couldn’t get enough signed during business hours without attracting unwelcome attention. Instead of giving the currency to customers in the form of loans, however, Dexter used it to finance construction of the Exchange Coffee House.
It was a brilliant plan.
Until it wasn’t.
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