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This is a follow up to my previous article, David Ricardo and the Role of Central Banks.
We take for granted the Federal Reserve’s unique powers that, like that of other central banks, include being the sole issuer of currency. But those powers were not always so, and their origin traces to the foresight of Alexander Hamilton.
Three decades after the formal establishment of the United States of America, David Ricardo stated to Parliament’s his objections to the Bank of England having sole authority over its note issue. Ricardo was not objecting to the bank’s notes being legal tender, as they had been even after the bank suspended exchanges for sterling in 1797. Symbolic money was an absolute necessity for society. Without the obvious utility of paper money, both credit and commerce could not grow and Britain’s prospects would be permanently diminished. Neither was he questioning the logic of the monetarist arguments he had made to Parliament in favor of a return to the gold standard. The outstanding volume of bank notes needed to be controlled.
His caution was straightforward. If a central bank was to determine, by committee vote, both the amount of symbolic currency in circulation and the interest rate at which specie could be borrowed, how could open market outcry and private commerce have any influence on the setting of discounts? Experience had proven that the specie content of a country’s money and the amounts of cash outstanding in each country determined the exchange rates of their respective currencies. What gold could buy would fluctuate, as did all prices. In time of war or panic, specie might be hoarded, and promises to pay have to substitute for actual payment. But symbolic money could only continue to work successfully if the Bank of England did not set its price. To do otherwise was, in Ricardo’s view, dangerous both to personal liberty and to national security. The temptations to print and then to remedy “overheating” by restraining credit would be overwhelming.
These were not the temptations that the first Congress of the United States of America faced when it met in 1790. The new country did have its own unit of account – the dollar; but, unlike England, it did not have a currency. When Ricardo made his speeches to Parliament, pound notes were suffering from a 3% to 5% discount to guineas. Nowhere in the United States – not in New York or Boston or Charleston or Philadelphia – had anyone seen a quote for the official American paper currency – the Continental dollar – in a decade.
The war veteran planters, farmers and merchants, many of whom had met in Philadelphia in 1786, were all very much aware of what previous Congresses had done about money. In January 1778, nine million continental paper dollars had been issued; against those notes a reserve of nine million dollars in Spanish silver coin had been held. In April, Congress issued another 21 million dollars in notes, without increasing the specie reserve. In July, another 15 million was issued without further reserve. By February 1779, there were 115 million paper continentals issued and outstanding; by year-end against 200 million paper dollars, Congress held a reserve of 6 2/3 million silver ones. In 1780, there were no further issues of paper money; the reserve dropped to 2.5 million (80-to-1). In March 1781, Congress decided that the situation could be redeemed through an exchange of new paper dollars for old ones at a ratio of 40-to-1. Within two months neither the old nor the new paper money was accepted anywhere as payment.
It was hardly a surprise that the words of the Constitution and the political sentiments of the first Congress were entirely opposed to any new symbolic currency. Even Hamilton, in lobbying for the establishment of a national bank, conceded that “(t)he emitting of paper money by the authority of Government is wisely prohibited to the individual States, by the National Constitution. And the spirit of that prohibition ought not to be disregarded, by the Government of the United States.” Congress would not and could not legally issue “paper money.”
There was equal agreement among the newly-elected and appointed officers, Senators and Representatives meeting that the federal government had to rescue the nation’s credit. When Secretary of the Treasury Hamilton put forward “An Act making provision for the [payment of the] Debt of the United States,” the only opponents were those who favored outright default.
That left the question of a national bank. Americans had had banks for nearly a century; but every bank that had offered up its notes as legal tender symbolic money had failed. Those that had succeeded had limited themselves to being, as Hamilton complained about the first Bank of Pennsylvania, “a subscription of a particular sum of money for a particular purpose.” Yet, even Madison and Jefferson had approved. On July 17, 1780, as a “patriotic scheme of the merchants of Philadelphia” (James Madison’s words) to provide the “property and credit” needed to purchase of “three millions of rations and 300 hogsheads of rum” for the Continental Army. The Army had gotten the supplies; and, with French gold, managed to pay for them and win the Battle of Yorktown. In 1784, the bank had profitably liquidated by distribution of its capital and retained earnings to its owners.
This was not Hamilton’s or any modern person’s idea of what a Bank of the United States should be. Hamilton wanted the U.S. to have a Bank of America to rival the one in England, a central bank of issue. His hope was “the paper of a Bank is to be permitted to insinuate itself into all the revenues and receipts of a country” and “in all the transactions of business”. He did not get his wish.
The charter that Congress approved gave the Bank of the United States no authority to issue symbolic money. Its notes were to be, like foreign bills of exchange, not money itself but only promises to pay money. The bank was not to be an artful evasion of the Constitution’s insistence that money be coin. Its purpose was quite the opposite. It was being chartered by the United States Congress not to print money but to give the federal Treasury a safe place to put its deposits. This mattered. The tariffs already being collected were providing the surplus that the debt bill had dedicated to payments of principal and interest and arrears. Hamilton was actively juggling accounts and securing bridge loans, but he actually had accounts to juggle.
The alternative – having the Treasury place its collections in state-chartered banks, including the one in New York that the treasurer himself had helped organize – raised a serious Constitutional question. Would the state legislature have direct authority over the United States’ deposits? Secretary of State Jefferson clearly thought so. In his memorandum to the president arguing against the bank, he saved to the last his most serious objection: the bill “undertakes…to protect the institution from the control of the State legislatures”.
Hamilton would be equally disappointed. When the bank bill came before the House Committee on Ways and Means, Hamilton promoted an amendment that would extend the bank’s charter until the national debt had been fully repaid. He presumed that this would extend the charter’s term reach to infinity. The committee rejected the amendment. The bank was chartered for 20 years; by the time the Second Bank of the United States’ charter was expiring, the entire debt of the United States of America had been discharged.
It would be almost a century and a half before Hamilton’s three financial wishes – a permanent Federal debt, a central bank of issue and unpriced legal tender symbolic currency – would all come true.
Stefan Jovanovich manages the portfolio for The NJT Company, Inc., a family office based in Nevada.
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