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The Founding Wizard
Two hundred years ago the United States was a weakling republic prostrate beneath a ruinous national debt. Then Alexander Hamilton worked the miracle of fiscal imagination that made America a healthy young economic giant. How did he do it?
July/august 1990 | Volume 41, Issue 5
He got Southern votes for the bond bill by making a deal: he would see that the nation’s capital was moved to the muddy, fever-ridden banks of the Potomac.
(Historians should probably be required to swear a solemn oath never to play the game of what if. Still, one can hardly help speculating on how different would have been the history of this country, not to mention the history of New York City, if its political capital had been located in the city that so swiftly became its financial, commercial and cultural capital.)
The deal was made, and the bill was passed and then signed into law by President Washington. Hamilton was right that the bonds would find acceptance in the marketplace; the entire issue sold out in only a few weeks. The new government, with a monopoly on customs duties and possessing the power to tax, was simply a much better credit risk than the old government and the states had been.
When it became clear that the U.S. government would be able to pay the interest due on these bonds, they quickly became sought after in Europe, just as Hamilton had hoped. In the 1780s the United States had been a financial basket case. By 1794 it had a higher credit rating than any country in Europe, and some of its bonds were selling at 10 percent over par. Talleyrand, the French foreign minister, explained why. The United States 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.” By 1801 Europeans held thirty-three million dollars’ worth of American securities, and European capital was helping mightily to build the American economy.
Less than two years after Hamilton’s funding bill had become law, trading in stocks and bonds became so brisk in New York that brokers who specialized in them joined together and formed an organization to facilitate trading. This organization would evolve into the New York Stock Exchange, and within a hundred years it would be the largest such exchange in the world, eclipsing London.
The third major portion of Hamilton’s program, after redeeming the old national debt and nationalizing the states’ debts, was the creation of a central bank, modeled after the Bank of England. Hamilton saw it as an instrument of fiscal efficiency, economic regulation, and money creation. Jefferson saw it as another giveaway to the rich and as a potential instrument of tyranny. Furthermore, Jefferson and Madison thought it was patently unconstitutional for the federal government to establish a bank.
A central bank acts as a depository for government funds and a means of transferring them from one part of the country to another (no small consideration in Hamilton’s day). It is also a source of loans to the government and to other banks, and it regulates the money supply.
The last was a great problem in the new Republic. Specie—gold and silver—was in critically short supply. Colonial coinage had been a hodgepodge of Spanish, Portuguese, and British coins. (Spanish dollars, the monetary unit upon which the dollar was originally based, were called pieces of eight because they comprised eight real’s, or bits. This is why a quarter is still known as two bits and why the New York Stock Exchange to this day quotes fractional prices in eighths, not tenths, of a dollar.)
The lack of specie forced merchants to be creative. In the Southern colonies warehouse receipts for tobacco often circulated as money. Hamilton knew that federal bonds could serve the same purpose: “It is a well-known fact, that, in countries in which the national debt is properly funded, and an object of established confidence, it answers most of the purposes of money. Transfers of stock or public debt are there equivalent to payments in specie; or, in other words, stock, in the principal transactions of business, passes current as specie. The same thing would, in all probability, happen here, under the like circumstances.”
Hamilton saw a central bank as an instrument of efficiency, regulation, and money creation. Jefferson saw it as another giveaway to the rich and tyrannous.
But the bonds were necessarily of very large denomination. There were a few state banks (three in 1790) to issue paper money, but these notes did not circulate on a national basis. Many business deals had to be accomplished by barter simply because there was no money to facilitate them.
Hamilton did not like the idea of the government itself issuing paper money because he thought that governments could not be trusted to exert self-discipline. Certainly the Continental Congress had shown none when it came to printing paper money. Hamilton thought that an independent central bank could supply not only a medium of exchange but the discipline needed to keep the money sound. If it issued notes that were redeemable in gold and silver on demand and accepted by the federal government in payment of taxes, those notes would circulate at par and relieve the desperate shortage of cash. Further, because the central bank could refuse the notes of state banks that got out of line—a position that would mean that no one else would take them either—it could supply discipline too.