Since the creation of Federal Reserve, the value of the dollar has fallen by more than 90 percent, and that is not a surprise.
We come now to the final and perhaps most important part of McCraw’s Founders and Finance: the practical effects of Hamilton’s political economy. Here is where Hamilton’s ultimate legacy is often said to be. The precedent of the idea of a national bank or ultimate regulatory authority over money became, at this point in time, inextricably part of American politics. This is not to say that the idea of national banking was inextricable institutionally. Andrew Jackson ended the second Bank of the United States, and the idea of the Independent Treasury held sway until the National Bank Acts of the Civil War. But Hamilton had established the first political precedent of national involvement in money and finance. That history and its supposed success would be continually asserted to pave the way, at least in part, for the Federal Reserve System in the early twentieth century.
The first post in this series began by drawing attention to the lost opportunities that result when government proffers general solutions to given sets of problems. Trade-offs are unavoidable whatever decisions are made, but when interventions occur in areas dealing largely with matters of economic coordination, society is deprived of the chance to develop modes of interaction that grow out of the bedrock of individual experiences. Such interventions discourage the accumulation of learning over time by tempting people to think in terms of ultimate solutions, a one-size-fits-all approach that invites centralized discretionary power to replace multiple poly-centric institutional responses. Despite orthodox opinion, money appears to be just such a case. Government intervention has in all likelihood made things worse, not better.
Government solutions have this tendency because they do not need to build from consensus. Because government can fall back on the use of compulsion, the temptation will always be to cut through disagreement through the use of sanctions once a majority faction has been achieved. The quick solution will be equated with the efficient one, and the incentives, for even the most experienced statesmen, will be to become impatient with particulars when dealing with complex legislative issues.
And this inherent tendency towards impatience will be exacerbated further by the fact that a full consideration of human imperfections requires sustained consideration of the imperfections of those doing the intervening. What regulator or reformer wants to question his or her own motives and capacities? At some level, the equation of the regulator’s interests with the common interest will simply be asserted because it is the easiest and quickest assumption to make. Nowhere has this been more true than with the claim that currency and finance must be politically managed.
What was actually a minor premise in Hamilton’s case for the national bank, i.e. the role of such an institution in the maintenance of a sound currency, has today, in the context of the modern administrative state, become the major dogma of money and banking, despite the fact that considerable scholarship has been done to bring that assertion into doubt. An excellent historical treatment of this is Richard Timberlake’s Monetary Policy in the United States (1993). On the other hand, Hamilton’s major premise, the utility of a national bank to public finance, and to the financing of defense in particular, has rarely ever been challenged. McCraw asserts both points. Certainly these make it easier to move his narrative along, but, again, reality is more complex.
The first assumption has its roots in Hamilton’s opinion on the Bank to President Washington. Specifically he observed that the “institution of a bank has … a natural relation to the regulation of trade between the States, in so far as it is conducive to the creation of a convenient medium of exchange between them, and to keeping up a full circulation, by preventing the frequent displacement of the metals in reciprocal remittances.” But McCraw has added all of the subsequent agglomerations to this theme.
The main contention is that the Bank of the United States served the singularly important role of forcing state and private bankers to redeem their notes in full. Since it could carry on transactions throughout the country, and was the repository of the government’s receipts, the national bank would collect notes from all banks and present them to their issuing institutions for redemption in specie. Should any be unable to comply, the national Bank could then inflict monetary discipline, discounting the notes of the offending institution and even compelling it to close. Knowing this fact, the first Bank served as a check to keep the smaller institutions in line.
That the Bank could and did serve this function for a time is clear enough, but that it was essential to it, is what is at issue. The usual historical interpretation contends that the sheer number of private and state banks exploded in the absence of national bank constraints once the national charter was allowed to expire. Motivated primarily for profit (i.e. greed), these bankers could not/would not constrain themselves in their paper issues, flooded the market between 1811 and 1816, inflated prices, and eventually precipitated a bubble that initiated a general run and derangement of the currency.
This is how the proponents of the second Bank of the United States (which included Albert Gallatin and a young John Calhoun) interpreted the economics of the intervening years (1811-1816). It is what Bray Hammond asserted in the 1950s (227), and it is what McCraw repeats, observing indignantly that “Most [state and private banks] issued their own currency, subject to almost no regulation.” (296). The story is simply incomplete. Richard Timberlake’s history gives a fuller perspective.
In the absence of a national bank, the federal government turned to issuing treasury notes in large denominations, many of them interest bearing, to pay for the prosecution of the War of 1812. Initially, as McCraw observes, most of the subscriptions were taken up by large financiers (301), yet, like any monetary instrument, once in circulation, they filtered into private and state banks. These viewed the interest-bearing notes as investment grade capital secured by the US government.
It was only after the significant expansion of these instruments, that private note issues dramatically increased—not before. In 1812 Treasury notes stood at 2.84 million; in 1813, 4.91 and then suddenly in 1814 they shot up to 10.65 and to 15.46 in 1815. The really major expansion in the number of bank notes occurred precisely at this time, going from 7.23 million in 1813 to 19.91 million in 1815. Yet, the number of Banks had already expanded heavily in number before 1814 with only modest expansion of bank notes. Thus Timberlake noted: “During the period 1814-1817, the issues of treasury notes were the fuel that moved the inflation vehicle. The number of banks was both incidental and irrelevant to the increase in the quantity of money and the inflation that developed.” (17)
Bank runs began shortly after the burning of the capital in August of 1814. The result was a sustained period of non-redemption of notes. It is important to realize, however, that this occurred almost entirely in the middle and southern states. New England banks continued for various reasons to maintain specie payments, but certainly part of the explanation rested with their general disapproval of the war and a subsequent lack of interest in holding treasury notes.
McCraw notes this dramatic increase in Treasury notes (302), but does not seem to notice the tension with his earlier assertion about the number of banks, nor the fact that specie suspension continued well into the founding of the Second Bank. Instead, he moves quickly to the second assumption respecting the management of the government’s finances, asserting that matters were made “much worse” by the refusal to renew the Bank and that it would have proven the “most important single source of wartime loans to the government, exactly as Alexander Hamilton had predicted in 1791.” (300) But it is unclear how he means “much worse.”
Were things “much worse” because a bank could have managed a credit expansion without a subsequent inflation and suspension? This is highly doubtful. National bank loans would still have expanded credit, and would still have filtered into the system in general. One could imagine that the central bank could have refrained from demanding specie redemption on the part of state and private banks, but would this really have prevented a run in the face of an invasion of the capital? Unlikely. I suspect people would not have found United States bank paper any more reassuring than treasury paper.
Is it then, perhaps, that the absence of a national bank delayed military preparations by delaying the finances? In point of fact, the delay was caused, not by the absence of a national bank, but by the very policies McCraw observed earlier as stemming from Gallatin’s anti-militarism. As he noted earlier in the book, the Jeffersonians had resisted expansions of the navy and army and this would take time to reverse regardless of how funds were to be raised. (265)
In neither case, then, was a national bank anything more than convenient, but time and again the purveyors of government management have simply chanted the mantras of monetary regulation. Specie suspension was a likely outcome no matter what financial instrument or instruments the national government had had at its disposal. The fact is, it was a consequence of the exigencies of the time—an unfortunate outcome of policy necessitated by unfortunate circumstances—always the stuff of bad law. It neither disproves the capacity for markets to function in currency nor the necessity of a national bank for national administration.
The best examples to counter these assertions are the continuing historical developments in the New England states, where specie continued to be had and where notes continued to circulate at par. The most interesting aspect of this on-going evolution was a system of checks that evolved through the experience of bankers to counter bad practices when they arose. The Suffolk bank system is an example of a private clearing house system for the prompt redemption of notes. It has sometimes been criticized because the Suffolk bank profited from its relationship with other banks who were members of its association, but like any other private organization, it worked through commercial challenges over time, undergoing changes in response to other private clearing-house competitors that arose later. Notes of more distant or less trusted non-members continued to circulate but at a discount. Later, those who felt poorly served were able to form another association, but notes in general were a stable and convenient medium in the region. Even those scholars who have been the ardent champions of Hamiltonian finance, such as Hammond, have recognized the virtues of the Suffolk system. (Hammond, 555, 562/3) That system only ended because of the need to finance the Civil War.
Here now, we come to the last point: The necessity of a national bank for war finance. The great fly in the ointment of the traditional interpretation is its complete lack of consideration of both the tremendous economic growth that characterized that time and the successful prosecution of the third most expensive war up to that point under what became the independent treasury of Martin Van Buren. All this was well after the end of the Second Bank of the United States. And whereas the former was purely defensive, the latter resulted in the conquest of a foreign capital no less.
Nowhere do the champions of Hamilton ever make this connection, but again, some have noticed a bit of the relevant history, if only obliquely. To quote again the Ur-source of so much of the orthodox Hamiltonian view: “In the last previous war, that with Great Britain in 1812,” wrote Bray Hammond, “the federal Treasury had been nearly paralyzed by the difficulty of obtaining money that the economy either did not have or would not trust it with [re. New England]. But now, such was the solid accumulation of means within one generation, the government’s loans were taken at a premium and in specie. And this was before the acquisition of California and the discovery two years later of its gold.”(672) Or, as Timberlake notes: “During the Mexican War the Independent Treasury under Walker operated unexceptionably. Its monetary policies were limited, but it transferred specie for military purposes without even rippling the money market while it floated three major loans to finance the war.” (78)
What does this tell us? Surely it says that much of the original Jefferson/ Madison critique of the bank was justified; that a poly-centric monetary system is not antithetical to fiscal or economic efficiency; that national interventions are not a necessity in the area of money and banking. Systems had evolved and were evolving in response to market dynamics. That system was based on the solid lessons of individual experiences over time. The Civil War ended the process of that learning and what was potentially a highly stable set of evolved institutions was swept aside. The cry of emergency once more ushered in the politics of impatience, and ever since we have relentlessly erased even the memory of this history.
If that is Hamilton’s legacy, as McCraw would have it, it is an unfortunate one.