The visionary Founding Father, Alexander Hamilton (1757-1804), was a highly controversial figure in his day. Although from quite low origins in the Leeward Islands of the Caribbean, he was sponsored to be sent to attend King’s College (now Columbia) in New York. He got caught up in the political fervor of Revolutionary War and in 1776 he joined to fight, then shortly organized a 60 man Artillery Company of whom he was elected captain. They participated in the battles of White Plains and Trenton and in 1777 at the Battle of Princeton. He was recommended to George Washington and served him as his closest Aide to Camp, as Lieutenant General for four years until he insisted on the chance to lead his own troops. He participated in the decisive battle of Yorktown in 1781 that saw the surrender of the British and the eventual end of the Revolutionary War.
He served in the Continental Congress and as an Assemblyman in the New York legislature prior to Constitutional government. In 1784 he established the Bank of New York along with Aaron Burr, his eventual killer in a duel in 1804; that bank continues today as New York Mellon Bank (BNY Mellon). He served as delegate to the Constitutional Convention, as well as writing the majority of the Federalist papers along with Madison that championed its ratification.
In 1791 he was appointed Secretary of Treasury in Washington’s administration under the new Constitution. He was an advocate of what would later be termed the American System, most closely associated to Senator Henry Clay (John Quincy Adams and Abraham Lincoln, as well). The platform of the American System included protective tariffs, national bank and internal improvements. His “Report on Manufactures” to Congress in 1791 recommended active measures to promote business ventures along with a protective tariff, a nationalist economic program.
He pressed for an America that was meant to assimilate the business elites into its governance. Their participation was essential to good government. The Bank would be the vehicle to do this for one by holding the deposits of the U.S. Treasury. As such he advanced high tariffs to promote American industry and actually the Whiskey Tax to pay for the military to fight western Indian Wars (1791-1795).
For many, including the Federalist, there was great distrust of direct democracy that can easily descend into mob rule and disorder. Our Constitution is designed for government NOT to work well, since it is thought a government that governs least governs best. It’s divided into three branches; the legislative branch bifurcated into Senate, originally meant to be elected by state legislatures and the House. And virtually from the beginning the Judiciary, designed to check the other two branches, was filled by Federalists, appointed by President Adams, the party most suspicious of governing competence of the common man.
Agrarian America opposed the idea of Hamilton’s schemes. Part of the controversy was fact that a Federal bank was not part of the enumerated powers (Article 1, Section 8) set forth in the Constitution. From the beginning of the Republic there was debate over the idea these Enumerated Powers and the concluding section called the Necessary and Proper clause:
“To make all Laws which shall be necessary and proper for carrying into Execution the foregoing Powers, and all other Powers vested by this Constitution in the Government of the United States, or in any Department or Officer thereof.”
The debate continues to this day between the Constitution as a Living Document as opposed to one interpreted towards the Original Intentions of the Founders.
Agrarians had little use for these suspect artifices called banks. Banks were devices which “covetous” persons enriched themselves at the expense of the honest and diligent. Many efforts were made to ban banking completely. Governor of Kentucky in 1819 proposed a Constitutional ban on banking. Texas in 1845 prohibited banking absolutely. Iowa and Arkansas in 1846 prohibited the same. Free banking had led to abuses with suspect bank notes and many farmers left stuck with worthless bank paper.
An idea that echoes today’s Libertarians can be heard in William Gouge’s thoughts, “The business of lending [printing] money is no part of the duty of any government, either Federal or State.” And several periods in American history there was no Central bank with government currency. The policy of a national currency has great advantages but as has been seen in our recent history to harbor terrible risks.
There were many still, who saw state charted banks as a boon with its circulating paper. Many state banks had been chartered in the first decades of the Republic. Upon the closing of the First U.S. Bank in 1811 these state banks began to accelerate bank note lending, lacking the restraint provided by the Federal Bank. The amount of the bank notes rose from $28 million to $68 million between 1811 and 1816. It must be noted this is during the War 1812 where war time demands always strain the resources economies. That reckless interim prompted Congress to charter the Second U.S. Bank in 1816. As a depository of the U.S. Treasury it would accept specie, Fed bank notes and state bank notes redeemable on demand as payment of taxes. A significant segment of polity opposed the bank and the debate would arise again in 1832 for re-charter. President Jackson was incontrovertibly opposed to the U.S. Bank and vetoed the re-charter. The bank would cease to be a depository of the U.S. Treasury in 1833.
Hamilton, a Federalist, saw the bank as essential to the new Nation. The monied elites would have a stake in the new Republic. For that matter the majority of the delegates of the Constitutional Convention held debt, deeply discounted, of the revolutionary States of the Confederation. The prevailing wisdom held that these debts incurred during the Revolutionary War would never be honored. Hamilton and many others, representing business and mercantile interests, who were promoting the new Constitution desired to see these redeemed in full. Madison only wanted the original holders to be reimbursed in full, the speculators only partially. Hamilton and his party would see that they would be repaid in full. This helped to create a foundation for promoting business interests; America would become a patron of the Industrial Revolution.
Agrarian interests were very skeptical of what would become the standard financial lexicon of the Industrial Revolution. The change Hamilton was pushing was an economy of obligations, contracts, negotiable instruments and other invisible artifices as opposed to the agrarian idea of direct exchange with money for a good between two honest men without these artifices. Corporations were held to be suspect associations of men that allowed them to act immorally; that is act in a way they wouldn’t individually. First Bank of U.S. was one of these artificial corporations.
We live in Hamilton’s America not Jefferson’s. Under his purview he set up the contentious U.S. Bank (also known as the First Bank of the United States) in 1791 situated in Philadelphia with several branches throughout the country shortly thereafter (Boston, New York, Baltimore, Charleston, Washington, Savannah and New Orleans). The bank was capitalized with $10,000,000. This bank imitated the Bank of England’s partnership of moneyed interests and the crown’s interest. The U.S. government was to contribute $2 million to the bank. This was done by sleight of hand. Government commissioners sold $2 million government securities in Amsterdam then deposited the drafts into the First Bank of the United States as the government capital contribution. Then the U.S. Treasury borrowed $2 million from the U.S. Bank to take up the $ 2 million in drafts, so a large claim of specie wouldn’t be presented to the fledgling bank. The reminder of the $8,000,000 was contributed by private interests of the country. $ 2 million in specie was to have backed the bank, but in fact no more than $400,000 was collected. Later this amount was to grow but the reality was the bank was lacking specie to back the bank. All to the good since the bank was run properly and no run was made on the bank.
This was a Fractional Reserve bank, established with a fraction of total deposits backed by specie. In this case ideally at 4 to 1, deposit to specie ratio, it was similar to the Bank of England. Fractional Reserve Banking became the dominant type of banking in the industrial world. The TBFT (Too Big to Fail) banks like Citibank, JpMorganChase or Wells Fargo currently have capital ratios higher than 10 to 1. That is only $1 backing $10. These fractional reserve banks are subject to collapse. Thus Big Government with the complicity of duped taxpayers is called on to bail them out from time to time to prevent economic chaos. Despite the fact that they could have bailed themselves out as they had done prior to the Federal Reserve Bank was established in 1913. The biggest disaster related to this fractional reserve banking was the Great Depreciation, in which the banking system collapsed like an accordion. Federal Reserve Bank, established in 1913 to allay these disasters, stood on the sidelines. There were thousands of bank failures; Iowa had 1200 alone in the 1930’s.
Banking, fractional reserve banking that is, began with an immoral scam. Once banks fulfilled the purpose of a safe storage and prevention from loss for your valuables, gold, silver or jewels; then banks provided the convenience of a bank note that represented your value in safe keeping. That was so much easier than carrying that bar of gold around and safer too. But then banks realized particular customers hadn’t bothered to redeem their bank note for specie for a lengthy period. An unscrupulous banker hatched the idea to lend at discount the same specie. Another bank note is originated on the same store of specie and bank makes more profit. The bank note is used to pay someone else, with the assumption that it’s redeemable in specie. If ever those two show up at the same time…oops! Let me get back to you about that gold, says the banker… It’s around here somewhere, I think. The Founding Fathers realized this too:
“Every dollar of a bank bill [note] that is issued beyond the quantity of gold and silver in the vaults represents nothing and is therefore a cheat upon somebody,” John Adams, 2nd President of U.S., said in 1809. This view might be one reason he and Thomas Jefferson had a dim view of Hamilton and his fractional reserve bank.
Later in the 1830’s John Quincy Adams identified suspension of redemption by banks with counterfeiting (the “let me look for your gold, I know, it’s right around here somewhere” response).
Banks were disinclined to promote redemption of paper to specie. It was far easier to loan a bank note and then postpone redemption to specie. In a classic case of the golden rule where the gold makes the rules, banking law came to accommodate this chicanery. In fact before the American Civil War state legislatures began to see the benefit of banks delaying or even refusing to redeem its bank notes in specie. Specie, gold and silver, which had always been considered real money, was always in short supply. Ordinarily paper money possessed value only when it had the prospect of being redeemed by gold or silver. But more often than not the bank had issued far more bank notes than actual specie on hand. Honest redemption, paper for specie, will cause the accordion to collapse, the banks would caution.
Paper money, as many advantages as it possesses, can be frightfully abused. Bank notes can indeed be passed hither and yon. And in fact fractional banks (paper money backed by a fraction of specie) can create money. The bank would loan a sum represented by a bank note (or bank check) and this note could be re-deposited or deposited to another bank or given to someone else as payment. In 19th century America that discounted check might not even be presented back to the originating bank. Nice for the bank, which would earn interest on the loan and never have to face redemption. Better than counterfeiting. As a result unregulated banking led to massive expansive of bank notes and acted as currency. One egregious example back at the beginning of banking, in March 1808 The Farmers Exchange Bank of Gloucester, Rhode Island had $22,514 bank notes circulating with promise of redemption in gold or silver and $380.50 of specie on hand. Unscrupulous bankers might have more than one bank in which they would write bank notes on the other. Nothing more than sophisticated kiting.
At the foundation, banks were expected to stand ready to redeem the bank note for specie, generally gold. Many times they failed to do so.
Incidentally, Revolutionary War state governments had shamelessly abused the issue of bills of credit. Since there was little to finance the Revolutionary War, states began to issue I.O.Us or bills of credit, actually a Fiat Currency. The abuse led the Constitution to prohibit States issuance of Bills of Credit (Article 1, Section 10). And many thought banks charted by the states and issuing bank notes were virtually the same mechanism prohibited by the Constitution; people preferred the circulation of paper, however.
If you didn’t know, the Union Government in the Civil War did much the same with its Greenbacks. Of course Confederate money once again a fiat currency was far worse and was known to be worth little more than paper, even before they lost the war.
The First Bank of U.S. was America’s first central bank and acted to regulate the currency. This in itself caused hostility from the public. The bank insisted on redemption of specie from bank notes written on state banks and transferred gold balances to the bank in Philadelphia. The criticism of the South and the West was that it drained gold from the branches to pay to demands on the Eastern banks. America exported agricultural products, much of it cotton. The South produced the bulk of the exports that the North borrowed on. And thus the South paid for the imports. And so it was thought that it was the North’s buyers and bankers that took the South’s profit, adding insult with North’s advocacy of the tariff. Nonetheless, without the gold that the Federal bank transferred from South and West to the East imports would have largely ceased.
I conclude by re-emphasizing that Hamilton, so accomplished and visionary, prompted an idea of a Central Bank remarkably controversial for the predominately agrarian society. It regulated banking by insisting redemption of specie from the state banks’ notes, something hated by the banking sector in general. It rankled Southern and Western regions by transferring gold balances from branches to the central bank in Philadelphia. The bank only dealt with state banks ready to redeem their bank notes in currency, a restraining policy on private banks that profited by floating its bank notes. Absent a bank, farmers with good reputation could often obtain credit from monied individuals within the community; this is how credit demands were fulfilled in the agrarian society without banks. Admittedly, this would undoubtedly make it far harder for less established agrarians to obtain credit.