Inspired by the 11 Tony awards won by the smash Broadway hit Hamilton, last month I wrote about Alexander Hamilton as the father of the US national debt and discussed the huge benefit the United States derives from having paid its debts promptly for more than two hundred years. Despite that post, no complementary tickets to Hamilton have arrived in my mailbox. And so this month, I will discuss Hamilton’s role as the founding father of American central banking and the vital importance central banking has played — and continues to play — in supporting America’s economic health. Hope springs eternal.
Hamilton had first proposed the formation of a government bank as early as 1779. He detailed his plan in the Second Report on Public Credit, submitted to Congress in December 1790. Hamilton’s arguments in favor of a government bank were prescient, stating that it would contribute to monetary stability, encourage credit creation, and help the government raise money.
Hamilton envisioned a banking system in which private banks issued paper currency that was backed by gold and silver, rather than a circulation consisting solely of the gold and silver. This way, the currency supply could expand and contract with the needs of trade. By allowing the expansion of credit beyond the precise quantity of gold and silver in circulation, Hamilton argued that a government bank could provide credit and stimulate commerce, noting that banks “have proved to be the happiest engines that ever were invented for advancing trade.” By making the currency redeemable in gold and silver, the plan ensured that banks would be cautious in how much currency they issued, since they could not issue more than they could redeem in gold and silver. Finally, Hamilton argued that a bank would afford “[g]reater facility to the government, in obtaining pecuniary aids, especially in sudden emergencies”—in other words, it would help the government to borrow money.
Hamilton’s plan for the Bank of the United States (BUS) was supported by the (largely northern) commercial and moneyed classes who liked the idea of providing more credit to support trade. It was opposed by farmers and those who mistrusted expansive central authority, particularly southerners who thought that a powerful federal government might one day outlaw slavery. The bill passed Congress and was signed into law by President Washington, over the objection of Secretary of State Thomas Jefferson and Attorney General Edmund Randolph, who argued that the bank represented an unconstitutional expansion of federal power.
The Bank of the United States was established in 1791 with headquarters in Philadelphia. It soon established branches around the country. The only way of preventing private banks from over-issuing currency was to make sure that bank notes were promptly returned to the issuing bank for redemption in gold or silver. Because the BUS was the only bank chartered by the federal government, it was the only bank that could operate nationwide and was therefore uniquely qualified to restrain the excessive growth of the money supply by finding notes that had spread far and wide from their issuing bank and returning them in exchange for gold or silver.
The Bank’s 20-year charter was set to expire in 1811; however, the political landscape had change since the Bank’s establishment, making a renewal difficult. Bankers and business interests resented the BUS’s restraining influence on the banks’ ability to issues notes, and congressmen and senators from states that had supported the Bank’s establishment now voted against renewing its charter. Despite the support of former opponents Jefferson and Madison, who by now saw the wisdom of having a government bank, the effort to renew the charter failed.
Five years later, sobered by a financial panic in the intervening years, Congress chartered the Second Bank of the United States (2BUS). Led from 1822 by the innovative Nicholas Biddle, the Second Bank began to take on even more functions of a modern central bank (e.g., macroeconomic management, lender of last resort) and became a stabilizing force in the American economy. A charter renewal of the 2BUS was passed by Congress in 1832, but vetoed by President Andrew Jackson. Jackson, a frontiersman and brawler, had a deep mistrust of entrenched and educated elites — in short, he was the polar opposite of Biddle and, arguably, Hamilton. Jackson was an avowed foe of the bank for several reasons, not the least of which was that he believed it had supported John Quincy Adams, his opponent in the presidential election of 1828. Congress’ inability to override Jackson’s veto was the final shot in the “Bank War.” The United States would remain without a central bank until the establishment of the Federal Reserve in 1914.
The failure to renew the charters of Hamilton’s bank and its successor appears to have led to some remorse on the part of Congress. Shortly after the closure of each bank, Congress moved to charter a successor institution. The First Bank of the United States was succeeded five years after its closing by the Second Bank of the United States. Five years after the demise of the Second Bank, Congress voted to charter a third national bank, but the legislation was vetoed by President John Tyler and never became law.
The demise of the first two central banks increased economic and financial instability. Although causality is difficult to prove with certainty, it is undeniable that the United States experienced about one financial crisis per decade between the passing of the Second Bank in 1836 and the establishment of the Federal Reserve in 1914. With Nicholas Biddle at the helm, the 2BUS had begun to master many of the tools that Hamilton envisioned, and that are now successfully employed by modern central bankers. And although central banks frequently come in for harsh criticism by politicians, it is certain that prompt and effective action by the Federal Reserve during the subprime meltdown — and by other central banks subsequently — kept that crisis from developing into something much worse.
Alexander Hamilton recognized the benefits of a central bank 135 years before the United States permanently established such an institution. Although he could not have foreseen how important the successor of his brainchild would become, he was clearly far ahead of his time.
Featured image credit: First Bank of the United States (1797-1811) by Davidt8. Public domain via Wikimedia Commons.