THE IMPORTANCE THAT THE Washington administration, which took office on April 30, 1789, placed on dealing with the financial situation confronting the government under the new Constitution can be judged by the numbers. While the newly created State Department had five employees, the Treasury had forty.
The tasks before the Treasury were monumental. A tax system had to be created out of whole cloth and put in place. The debt left over from the Revolution had to be rationalized and funded. The customs had to be organized to collect the duties that would be the government’s main source of revenue for more than a century. The public credit had to be established so that the federal government could borrow when necessary. A monetary system had to be implemented.
The last already existed, at least in theory, established by Congress under the Articles of Confederation. In what was to be his only positive contribution to the financial system of the United States, it had been devised by Thomas Jefferson.
As we have seen, before the Revolution, the merchants of the various colonies had kept their books in pounds, shillings, and pence, but the money in actual circulation was almost everything but pounds, shillings, and pence. The question of what new unit of account to adopt was nearly as complex, because the inhabitants of the various colonies “thought” in terms of so many different, often incommensurate units.
Robert Morris, who had done so much to keep the Revolution financially afloat, tried to bridge the differences by finding the lowest common divisor of the most often encountered monetary unit of each state. He calculated this to be 1,440th of a Spanish dollar. Jefferson thought this far too infinitesimal to be practical, and Morris agreed. He proposed that his unit be multiplied by one thousand and made equal to 25/36ths of a dollar. Jefferson argued instead for just using the dollar, already familiar throughout the United States, as the new monetary unit.
The origin of the word dollar lies in the German word for valley, Thal. In the fifteenth century major silver deposits had been discovered in Bohemia, in what is now the Czech Republic. In 1519 the owner of mines near the town of Joachimsthal, the Graf zu Passaun und Weiss-kirchen, began minting silver coins that weighed a Saxon ounce and were called thalers, literally “from the valley.” These coins, new and pure, met with great acceptance from merchants, and other rulers in the Holy Roman Empire began to imitate them with their own coinage.
The Holy Roman Emperor, the Hapsburg Charles V, also adopted the thaler as the standard for his own coinage in both his Austrian and Spanish lands and his new-won, silver-rich empire in the New World. The staggering amounts of gold and silver mined in Spanish America in the sixteenth and seventeenth centuries (just between 1580 and 1626, more than eleven thousand tons of gold and silver were exported to Spain from the New World) made the thaler the standard unit of international trade for centuries. Thaler became dollar in the English language, much as Thal, centuries earlier, had become dale and dell. It also became the most common major coin in the British North American colonies.
Jefferson, in his “Notes on the Establishment of a Money Unit, and of a Coinage for the United States,” advocated not only using the dollar but making smaller units decimal fractions of the dollar. Today this seems obvious. After all, every country in the world now has a decimal monetary system, and as Jefferson himself explained, “in all cases where we are free to choose between easy and difficult modes of operation, it is most rational to choose the easy.” But Thomas Jefferson was the first to advocate such a system, and the United States, in 1786, was the first country in the world to adopt one.
Spanish dollars had often been clipped into halves, quarters, and eighths, called bits, to make small change (which is why they were often called “pieces of eight”). But Jefferson advocated coinage of a half dollar, a fifth, a tenth (for which he coined the word dime), a twentieth, and a hundredth of a dollar (for which he borrowed the word cent from Robert Morris’s scheme). In 1785 Congress declared that the “monetary unit of the United States of America be one dollar.” But the next year Congress, while adopting the cent, five-cent, dime, and fifty-cent coins advocated by Jefferson, decided to authorize a quarter-dollar coin rather than a twenty-cent piece.
The quarter is with us yet, now the last, distant echo of the old octal monetary system of colonial days. But other echoes held on for decades. The New York Stock Exchange still gave prices in eighths of a dollar as late as 1999. And the term shilling long remained in common use to mean twelve and a half cents, an eighth of a dollar, although there has never been a United States coin in that denomination. The east side of Broadway, in New York, where the less fashionable stores were located, was still called the “shilling side” as late as the 1850s, while the west side of the street was called the “dollar side.”
One reason the term shilling held on so long, of course, was that American coinage was not adequate to the ever-growing demand for it, and the old hodgepodge of foreign coins thus held on as well. The first United States coin, a copper cent bearing the brisk motto “Mind Your Business,” was privately minted. The Philadelphia mint was established in 1792 but minted few coins in the early years for lack of metal with which to do so.
ROBERT MORRIS, bent on making money, turned down Washington’s offer to name him as secretary of the treasury in the new government (it was a bad decision—he ended up in debtors’ prison). The president then turned to one of his aides-de-camp during the Revolution, Alexander Hamilton, only in his early thirties.
Hamilton was the only one of the Founding Fathers not to be born in what is now the United States. He was born in Nevis, one of Britain’s less important Leeward Island possessions. He was also the only one—besides Benjamin Franklin, who had made a large fortune on his own and an even larger reputation—not to be born to affluence. Indeed, he grew up in poverty after his feckless father—who had never married his mother—deserted the family when Hamilton was only a boy.
Living in St. Croix, now part of the U.S. Virgin Islands but then a possession of Denmark, Hamilton went to work at a trading house owned by the New York merchants Nicholas Cruger and David Beekman, when he was eleven years old. Extraordinarily competent and ferociously ambitious, Hamilton was managing the place by the time he was in his mid-teens, quite literally growing up in a counting house. Thus, of all the Founding Fathers, only Franklin had so urban and commercial a background. Even John Adams, a lawyer by profession, considered his family farm in Braintree (now Quincy), Massachusetts, to be home, not Boston.
Cruger, recognizing Hamilton’s talents, helped him come to New York in 1772 and to attend King’s College, now Columbia University. After the Revolution he studied law and began practicing in New York City, where he married Elizabeth Schuyler, from one of New York’s most prominent families. After the Revolution he wrote a series of newspaper articles and pamphlets outlining his ideas of what was needed to create an effective federal government. In 1784 he founded the Bank of New York, the first bank in that city and the second in the country.
He attended the Constitutional Convention in Philadelphia and worked tirelessly to get the document ratified, writing two-thirds of The Federalist Papers. When Robert Morris took himself out of consideration, Hamilton, whom Morris called “damned sharp,” was more than happy to take the job of secretary of the treasury.
He was also one of the very few competent to do so. While Americans had already distinguished themselves in many fields of endeavor, they “were not well acquainted with the most abstruse science in the world [public finance], which they never had any necessity to study.”
Hamilton, a deep student of economics, understood public finance thoroughly, a fact that he would make dazzlingly clear in the next few years. But like so many of the Founding Fathers, he was also a deep student of human nature and knew that there was no more powerful motivator in the human universe than self-interest. He sought to establish a system that would both channel the individual pursuit of self-interest into developing the American economy and protect that economy from the follies that untrammeled self-interest always leads to.
Even before the Treasury Department was created on September 2, 1789, and Hamilton was confirmed by the Senate as its first secretary on September 11, Congress had passed a tax bill to give the new government the funds it needed to pay its bills. There was no argument that the main source of income was to be the tariff, but there was lengthy debate over what imports should be taxed and at what rate. Pennsylvania had had a high tariff under the old Articles to protect its nascent iron industry and wanted it maintained. The southern states, importers of iron products such as nails and hinges, wanted a low tariff on iron goods or none at all. New England rum distillers wanted a low tariff on its imports of molasses. Whiskey manufacturers in Pennsylvania and elsewhere wanted a high tariff on molasses, to stifle their main competition.
Congress finally passed the Tariff and Tonnage Acts (the latter imposed a duty of 6 cents a ton on American ships entering U.S. ports and 50 cents a ton on foreign vessels) in the summer of 1789. But, second only to slavery, the tariff would be the most contentious issue in Congress for the next hundred years. Pierce Butler of South Carolina even issued the first secession threat before the Tariff Act of 1789 made it through Congress.
With funding in place, Hamilton’s most pressing problem was to deal with the federal debt. The Constitution commanded that the new federal government should assume the debts of the old one, but how that should be done was a fiercely debated question. Much of the debt had fallen into the hands of speculators who had bought it for as little as 10 percent of its face value.
On January 14, 1790, Hamilton submitted to Congress his first “Report on the Public Credit.” It called for redeeming the old debt on generous terms and issuing new bonds to pay for it, backed by the revenue from the tariff. The report became public knowledge in New York City, the temporary capital, immediately, but news of it spread only slowly to other parts of the country, and New York speculators were able to snap up large quantities of the old debt at prices far below what Hamilton proposed redeeming it for.
Many were outraged that speculators should profit while those who had taken the debt at far higher prices during the Revolution should not see their money again. James Madison argued that only the original holders should have their paper redeemed at the full price and the speculators get only what they had paid for it. But this was hopelessly impractical. For one thing, determining who was the original holder would have often been impossible.
Even more important, such a move would have greatly impaired the credit of the government in the future. If the government could decide to whom along the chain of holders it owed past debts, people would be more reluctant to take future debt, and the price in terms of the interest rate demanded, therefore, would be higher. And Hamilton was anxious to establish a secure and well-funded national debt, modeled on that of Great Britain and for precisely the purposes that Great Britain had used its debt.
Many of those in the new government, unversed in public finance, did not grasp the power of a national debt, properly funded and serviced, to add to a nation’s prosperity. But Hamilton grasped it fully. One of the greatest problems facing the American economy at the start of the 1790s was the lack of liquid capital, capital available for investment. Hamilton wanted to use the national debt to create a larger and more flexible money supply. Banks holding government bonds could issue banknotes backed by them. And government bonds could serve as collateral for bank loans, multiplying the available capital. He also knew they would attract still more capital from Europe.
Hamilton’s program eventually passed Congress, although not without a great deal of rhetoric. Hamilton’s father-in-law, a senator from New York in the new Congress, was a holder of $60,000 worth of government securities he hoped would be redeemed by Hamilton’s program. It was said the opposition to the program made his hair stand “on end as if the Indians had fired at him.”
Hamilton also wanted the federal government to assume the debts that had been incurred by the various states in fighting the Revolution. His main reason for doing so was to help cement the Union. Most of the state debt was held by wealthy citizens of those states. If they had a large part of their assets in federal bonds, instead of state bonds, they would be that much more interested in seeing that the Union as a whole prospered.
Those states, mostly northern, that still had substantial debt were, of course, all for Hamilton’s proposal. Those that had paid off their debts were just as naturally against it. Jefferson and Madison—Virginia had paid off its debts—were adamantly opposed and had enough votes to defeat the measure. Hamilton offered a deal.
If enough votes were switched to pass his assumption bill, he would see that the new capital was located in the South. To assure Pennsylvania’s cooperation, the capital would be moved from New York to Philadelphia for ten years while the new one was built. Jefferson and Madison agreed. Hamilton’s program passed and was signed into law by President Washington, who was delighted at the prospect of the new capital being located on his beloved Potomac River.
The program was an immediate success, and the new bonds sold out within a few weeks. When it was clear that the revenue stream from the tariff was more than adequate to service the new debt, the bonds became sought after in Europe. In 1789 the United States had been a financial basket case, its obligations unsalable, it ability to borrow nil. By 1794 it had the highest credit rating in Europe, and some of its bonds were selling at 10 percent over par.
Talleyrand, the future French foreign minister, then in the United States to escape the Terror, explained why. The bonds, he said, were “safe and free from reverses. They have been funded in such a sound manner and the prosperity of this country is growing so rapidly that there can be no doubt of their solvency.”
Talleyrand might have added that the willingness of the new federal government to take on the debt of the old, rather than repudiate it for short-term fiscal reasons or political advantage, also helped powerfully to gain the trust of investors. The ability of the federal government to borrow huge sums at affordable rates in times of emergency—such as during the Civil War and the Great Depression—has been an immense national asset. In large measure, we owe that ability to Alexander Hamilton’s policies that were put in place at the dawn of the Republic. It is no small legacy.
To be sure, Hamilton, and the United States, had the good fortune to have a major European war break out in 1793, after Louis XVI was guillotined. This proved a bonanza for American foreign trade and for American shipping, which was protected from privateers by the country’s neutrality. European demand for American foodstuffs and raw materials greatly increased, and the federal government’s tariff revenues increased proportionately. In 1790 the United States exported $19,666,000 worth of goods, while imports not reexported amounted to $22,461,000. By 1807 exports were $48,700,000 and imports $78,856,000. Government revenues that year were well over five times what they had been seventeen years earlier.
THE OTHER MAJOR PART of Hamilton’s fiscal policy was the establishment of a central bank, to be called the Bank of the United States and modeled on the Bank of England.
Hamilton expected a central bank to carry out three functions. First, it would act as a depository for government funds and facilitate the transfer of them from one part of the country to another. This was a major consideration in the primitive conditions of the young United States. Second, it would be a source of loans to the federal government and to other banks. And third, it would regulate the money supply by disciplining state-chartered banks.
The money supply was a critical problem at the time. Specie—gold and silver coins—was in very short supply. In 1790 there were only three state-chartered banks empowered to issue paper money, including Hamilton’s Bank of New York, but these notes had only local circulation. Hamilton reasoned that if the Bank of the United States accepted these local notes at par, other banks would too, greatly increasing the area in which they would circulate. And if the BUS refused the notes of a particular bank, because of irregularities or excess money creation, other banks would refuse them as well, helping to keep the state banks on the straight and narrow.
Hamilton had learned not to like the idea of the government itself issuing paper money, knowing that in times of need the government would be unable to resist the temptation to solve its money problems by simply printing it. Certainly the Continental Congress had shown no restraint during the Revolution, but at least it had had the excuse of no alternative. And the history of paper money since Hamilton’s day has shown him to be correct. Without exception, wherever politicians have possessed the power to print money, they have abused it, at great cost to the economic health of the country in question.
Hamilton proposed a bank with a capitalization of $10 million. That was a very large sum when one considers that the three state banks in existence had a combined capitalization of only $2 million. The government would hold 20 percent of the stock of the bank and have 20 percent of the seats on the board. The secretary of the treasury would have the right to inspect its books at any time. But the rest of the bank’s stock would be privately held.
“To attach full confidence to an institution of this nature,” Hamilton wrote in his “Report on a National Bank,” delivered to Congress on December 14, 1790, “it appears to be an essential ingredient in its structure, that it shall be under a private not a public direction—under the guidance of individual interest, not of public policy; which would be supposed to be, and, in certain emergencies, under a feeble or too sanguine administration, would really be, liable to being too much influenced by public necessity.”
The bill passed Congress with little trouble, both houses splitting along sectional lines. Only one congressman from states north of Maryland voted against it and only three congressmen from states south of Maryland voted for it. Hamilton thought the deal was done.
But he had not counted on Thomas Jefferson, by now secretary of state, and James Madison, who then sat in the House of Representatives. Although Jefferson had personally enjoyed to the hilt the manifold pleasures of Paris while he had served as minister to Louis XVI under the old Articles of Confederation, nonetheless he had a deep political aversion to cities and to the commerce that thrives in them.
Nothing symbolized the vulgar, urban moneygrubbing he so despised as banks. “I have ever been the enemy of banks…” he wrote to John Adams in old age. “My zeal against those institutions was so warm and open at the establishment of the Bank of the U.S. that I was derided as a Maniac by the tribe of bank-mongers, who were seeking to filch from the public their swindling, and barren gains.”
Jefferson, born one of the richest men in the American colonies—on his father’s death he inherited more than five thousand acres of land and three hundred slaves—spent money all his life with a lordly disdain for whether he actually had any to spend. He died, as a result, deeply in debt, bankrupt in all but name. And regardless of his own aristocratic lifestyle, his vision of the future of America was a land of self-sufficient yeoman farmers, a rural utopia that had never really existed and would be utterly at odds with the American economy as it actually developed in the industrial age then just coming into being.
Jefferson and his allies Madison and Edmund Randolph, the attorney general, fought Hamilton’s bank tooth and nail. They wrote opinions for President Washington saying that the bank was unconstitutional. Their arguments revolved around the so-called necessary and proper clause of the Constitution, giving Congress the power to pass laws “necessary and proper for carrying into Execution the foregoing Powers.”
As the Constitution nowhere explicitly grants Congress the power to establish a bank, they argued, only if one were absolutely necessary could Congress do so. This “strict construction” of the Constitution has been part of the warp and woof of American politics ever since, although even Jefferson admitted that it appealed mostly to those out of power. The fact that the Constitution nowhere mentions the acquisition of land from a foreign state did not stop Jefferson, as president, from snatching the Louisiana Purchase when the opportunity presented itself.
Hamilton countered with a doctrine of “implied powers.” He argued that if the federal government were to deal successfully with its enumerated duties, it must be supreme in deciding how to do so. “Little less than a prohibitory clause,” he wrote to Washington, “can destroy the strong presumptions which result from the general aspect of the government. Nothing but demonstration should exclude the idea that the power exists.” Further, he asserted that Congress had the right to decide what means were necessary and proper. “The national government like every other,” he wrote, “must judge in the first instance of the proper exercise of its powers.” Washington, his doubts quieted, signed the bill.
The sale of stock was a resounding success, as investors expected that the bank would prove very profitable, which it was. It also functioned exactly as Hamilton thought it would. The three state banks in existence in 1790 became twenty-nine by the turn of the century, and the United States enjoyed a more reliable money supply than most nations in Europe.
With the success of the Bank of the United States stock offering, the nascent securities markets in New York and Philadelphia had their first bull markets, in bank stocks. Philadelphia, the leading financial market in the country at that time, thanks to the location there of the headquarters of the Bank of the United States, established a real stock exchange in 1792. In New York a group of twenty-one individual brokers and three firms signed an agreement—called the Buttonwood Agreement because it was, at least according to tradition, signed beneath a buttonwood tree (today more commonly called a sycamore) outside 68 Wall Street. In it they pledged “ourselves to each other, that we will not buy or sell from this day for any person whatsoever any kind of Public Stock, at a less rate than one quarter per cent Commission on the specie value, and that we will give preference to each other in our negotiations.”
The new group formed by the brokers was far more a combination in restraint of trade and price-fixing scheme than a formal organization, but it proved to be a precursor of what today is called the New York Stock Exchange.
A speculative bubble arose in New York, centered on the stock of the Bank of New York. Rumors abounded that it would be bought by the new Bank of the United States and converted to its New York branch. Numerous other banks were announced and their stock, or, often, rights to buy the stock when offered, was snapped up. The Tammany Bank announced a stock offering of 4,000 shares and received subscriptions for no fewer than 21,740 shares.
An unscrupulous speculator named William Duer was at the center of this frenzy in bank stocks. He had worked, briefly, for the Treasury, but had resigned rather than obey the rule Hamilton had put in place forbidding Treasury officials from speculating in Treasury securities. Hamilton was appalled by what was happening on Wall Street. “’Tis time,” he wrote on March 2, 1792, “there should be a line of separation between honest Men & knaves, between respectable Stockholders and dealers in the funds, and mere unprincipled Gamblers.”
It didn’t take long for Duer’s complex schemes to fall apart, and he was clapped into debtors prison, from which he would not emerge alive. Panic swept Wall Street for the first time, and the next day twenty-five failures were reported in New York’s still tiny financial community, including one of the mighty Livingston clan.
Jefferson was delighted with this turn of events. “At length,” he wrote a friend, “our paper bubble is burst. The failure of Duer in New York soon brought on others, and these still more, like nine pins knocking down one another.” Jefferson, who loved to calculate things, estimated the total losses at $5 million, which he thought was about the total value of all New York real estate at the time. Thus, Jefferson gleefully wrote, the panic was the same as though some natural calamity had destroyed the city.
In fact, the situation was not nearly that dire, especially as Hamilton moved swiftly to stabilize the market and ensure that the panic did not bring down basically sound institutions. He ordered the Treasury to buy its own securities to support the market, and he added further liquidity by allowing customs duties—ordinarily payable only in specie or Bank of the United States banknotes—to be paid with notes maturing in forty-five days.
The system Hamilton had envisioned and put in place over increasing opposition from Thomas Jefferson and his political allies worked exactly as Hamilton had intended. Several speculators were wiped out, but they had been playing the game with their eyes open and had no one to blame but themselves. The nascent financial institutions, however, survived. “No calamity truly public can happen,” Hamilton wrote, “while these institutions remain sound.” The panic soon passed and most brokers were able to get back on their feet quickly, thanks to Hamilton’s swift action.
Unfortunately, Thomas Jefferson was a better politician than Hamilton, and a far better hater. The success of the Bank of the United States and its obvious institutional utility for both the economy and the smooth running of the government did not cause him to change his mind at all about banks. He loathed them all. The party forming around Thomas Jefferson would seize the reins of power in the election of 1800 and would not lose them for more than a generation. In that time, they would destroy Hamilton’s financial regulatory system and would replace it with nothing.
As a result, the American economy, while it would grow at an astonishing rate, would be the most volatile in the Western world, subject to an unending cycle of boom and bust whose amplitude far exceeded the normal ups and downs of the business cycle. American monetary authorities would not—indeed could not—intervene decisively to abort a market panic before it spiraled out of control for another 195 years.
Thomas Jefferson, one of the most brilliant men who has ever lived, was psychologically unable to incorporate the need for a mechanism to regulate the emerging banking system or, indeed, banks at all, into his political philosophy. His legion of admirers, most of them far less intelligent than he, followed his philosophy for generations as the country and the world changed beyond recognition. As a direct result, economic disaster would be visited on the United States roughly every twenty years for more than a century.