Alexander Hamilton on Finance, Credit, and Debt, by Richard Sylla and David J. Cowen (introduction)

Alexander Hamilton on Finance, Credit, and

Debt Richard Sylla and

David J. Cowen

Introduction Hamilton and the U.S. Financial Revolution Hamilton was without doubt the best and most foresighted economic policy maker in U.S. history. . . . As Treasury Secretary [he] put in place the institutional basis for the modern U.S. economy.

—ben bernanke, former federal reserve chair, 2015

One of the most important, yet least acknowledged, developments in the entire history of the United States occurred during just a few short years at the start of the 1790s. We call it the U.S. financial revolution. During those years, the new nation saw the emergence of virtually all of the key components of a modern financial system.

Before 1790, it essentially had none of them.

Why did this matter? It mattered because modern financial arrangements, along with modern technologies, are the drivers of economic growth and national power. Only in recent decades have economists and economic historians come to understand and document that finance is a driver of growth and power. That this connection has only recently achieved acceptance among academic specialists may account for its failure, so far, to make much of an impression on more general historians.

We think it interesting that Alexander Hamilton, the real author of this book, made the connection running from finance to growth and power more than two centuries ago. During his relatively short life (1757–1804), Hamilton, after making the connection when he was a

2 Introduction

young soldier in the Continental Army, went on as the nation’s first Secretary of the Treasury from 1789 to 1795 to engineer the U.S. financial revolution. He did so to promote economic growth and national power. He was ahead of his time. Indeed, since we have only of late come to appreciate what he knew long ago about finance’s or credit’s connection to growth and power, he remained ahead of his time right down to the present.

In the case of the United States, modern economic growth appears to have emerged at the time of the financial revolution of the 1790s. By modern economic growth, we mean sustained increases in economic output (or income) per person of 1 percent or more a year on average.

The best estimates we have indicate that such rates of growth began in the 1790s, gradually accelerating to around 2 percent per year on average by the middle decades of the twentieth century.1 Sustained modern growth began at the time of the financial revolution. Indeed, quite recent research suggests that the United States, not Great Britain with its pioneering industrial revolution (as many historians until recently have contended), may have been the first country to achieve modern economic growth.2 Rates of economic growth of 1 to 2 percent per year may not sound like a lot, but when they continue for more than two centuries, the results can be astounding. In real, inflation-adjusted terms, the average American in the early twenty-first century has an income some fifty times greater than the average American of 1790. Meanwhile, the United States, in 1790 a country of fewer than 4 million people on the periphery of a Western European–centered world, grew to a nation of more than 325 million. It quadrupled its territory, mostly in its first century, in good measure because its excellent finances made it easy to pay the costs of acquiring more land. It became a country of enormous wealth and power. The numbers given here imply that the output of the modern American economy is more than 4,000 times what it was in 1790. It is likely that no other country comes close to an expansion of that size during the same period, or just about any other lengthy period of modern economic history.

Hamilton would have been pleased. His main goals for the United States, along with constitutional government and national security, were wealth and power. His policies that modernized U.S. financial arrangements, as we hope readers of this book may discover, got the ball rolling toward all of those goals.

Introduction 3

The U.S. financial revolution was hardly unprecedented. Italian city-states introduced some of the key components of modern financial systems in the late Middle Ages and Renaissance. Roughly two centuries before the United States gained independence, the Dutch Republic (the United Provinces), the modern-day Netherlands, had its own financial revolution. It helped that small country to win its independence from Spain, a seemingly larger and more powerful country.

Armed with modern finances and an entrepreneurial mercantile spirit, the Dutch Republic became the leading and richest economy—some term it the first modern economy—of the seventeenth century.

Amsterdam became the world’s leading financial center, and it was where Hamilton floated loans in the 1790s to restructure U.S. debts.

New Amsterdam was Dutch before it became New York.

Great Britain, the mother country of the United States, followed in the footsteps of the Dutch by handing its throne to a Dutch prince, Willem of Orange, in the Glorious Revolution of 1688. As William III of Britain, he brought over experienced Dutch financiers, who together with Britons launched an English financial revolution. Similar to the ways in which the Dutch exploited credit to defeat the Spanish, England used it to win all of its protracted wars with France, a larger county, between 1688 and 1815.3 Hamilton knew all this financial history, as his writings in the early chapters of this book will show. It is what led him to realize that credit was a new and great power in the affairs of nations and individuals. If the United States was to become a great nation, its governments—federal, state, and local—needed to have public credit. So he restructured the national debt, eased the financial burdens of the states, and founded the first central bank. These measures established public credit. If America’s economy was to grow, individuals and business enterprises needed to have private credit. So Hamilton had his central bank lend also to them; he helped to found other banks and nonfinancial corporations; and he fostered the growth of securities markets to encourage investments in economic infrastructure and new technologies by making the stocks and bonds representing them attractive, liquid investments.

But we may be getting a little ahead of our story. Hamilton is better known to historians and those who read their works as a political reformer and spearhead of the movement for the Constitution than as a founder of the U.S. financial system. In truth, he would not have

4 Introduction

been able to execute his financial revolution unless he and others had first achieved the reform of American government represented by the Constitution. In his letter to James Duane (chapter 2), Hamilton had indicated that the Articles of Confederation, America’s first constitution, were defective even before they were ratified because they failed to provide the national government with adequate revenues. Without adequate revenues, the government would not be able to establish its credit, and without good public credit, it would be difficult to establish private credit on firm foundations.

So the first task after winning the War of Independence, or even before that was accomplished, was to reform the national government.

In the 1780 letter to Duane, seven years before the Philadelphia convention that drafted the Constitution, Hamilton says that Congress should immediately call a convention of the states to come up with a better plan of government. Although Hamilton was a twenty-threeyear-old lieutenant colonel and General Washington’s principal aide at the time, he was the first American leader (in his case, perhaps, a leader in the making) to call for such a convention. Then, in his Continentalist essays of 1781 and 1782 (chapter 4), he went public with his analysis of the defects of American government.

Thereafter, Hamilton served a term as a New York State delegate to the Confederation Congress, where an inability of that body to get much of anything done hardened his views on the need for governmental reform. Even less was done at the Annapolis Convention of 1786, where several states sent delegates—they included Madison from Virginia and Hamilton from New York—to ease trade disputes between states. The one thing that was accomplished at Annapolis was to agree to, and appoint Hamilton to draft, a request to the states to ask Congress to call a convention of all the states the next year to reform an increasingly ineffective plan of government.

The request met with success when Congress asked the states to send delegates to Philadelphia in 1787, leading to the new Constitution.

Hamilton was one of New York’s three delegates at the Philadelphia convention, and the only one to sign the Constitution. To help get it ratified, Hamilton then organized The Federalist, a series of eighty-five newspaper essays (he wrote fifty-one of them, with James Madison and John Jay penning the others) explaining why the new Constitution should be adopted and how its ratification would make the U.S. government far more effective. And he was a leader of the forces that were

Introduction 5

successful in getting New York State to adopt the Constitution at its state ratification convention in mid-1788.

A year later, President Washington appointed Hamilton Secretary of the Treasury, and he launched the financial revolution. In what did that revolution consist? To our mind it had six key components: 1. Establishing effective institutions of public finance—revenues and

spending—and public debt management to finance the government, restructure its unpaid debts, and establish public credit so the U.S. government would always be able to borrow on good terms.

2. Founding a central bank to aid the government’s finances and serve as the central node of the country’s emergent banking and financial systems.

3. Creating the U.S. dollar as the country’s unit of account and medium of exchange, and basing it on gold and silver as the monetary base into which banknotes and deposits were convertible, to give it the stability of value that would make it a safe basis for long-term contracts (such as bonds) and a safe asset in which to hold savings.

4. Fostering the growth of a banking system by encouraging state governments to create more banks to aid their own finances and lend to businesses and individual entrepreneurs—i.e., to establish private credit and bank money.

5. Fostering the growth of securities markets to make financial assets—government bonds, private sector bonds, and company equities (stocks)—liquid and transferrable, for the benefit of issuers and investors.

6. Fostering the growth of business corporations, both financial (such as banks and insurance companies) and nonfinancial (such as utilities; road, bridge, and canal companies; and manufacturers), to pool the capital of individuals to allow large enterprises to be created and economies of scale to be achieved.

As Treasury Secretary from 1789 to 1795, Hamilton had direct authority concerning the first three items on the list. Public finance and debt management are the subjects of the documents in chapters 6, 7, 8, 9, 10, 16, and 17 of this book. The central bank, the Bank of the United States, is the subject of chapters 10 and 12. The U.S. dollar is the subject of chapter 11.

6 Introduction

Hamilton had to rely on others—state authorities and private entrepreneurs—to flesh out his financial revolution by implementing components 4, 5, and 6, but he prompted them to do that with his work on components 1, 2, and 3. The reforms of public finance established a government of law, order, and justice across the nation. The national debt restructuring and assumption of state debts allowed the states more easily to encourage development via tax cuts or spending on economic and social infrastructure, and it created a lot of new and prime debt securities—$63–64 million of domestic debt and $12–13 million of foreign debt—to foster the emergence of securities markets and stock exchanges, which happened in major cities in the early 1790s. Foreign investors viewed U.S. Treasury securities as safe and profitable investments, and their purchases, which Hamilton welcomed, transferred foreign capital to the United States.

The Bank of the United States issued more securities—$8 million of stock in public hands—and that also encouraged securities market development. The Bank also lent to private borrowers, fostering private credit. And Hamilton’s Bank Report (chapter 10), by making the federal government a part owner of the Bank and saying that it would be a profitable public investment, encouraged state legislatures to follow that example by chartering more and more state banks. Hamilton’s charter for the Bank became a model emulated by American and, later, Canadian banks.

By defining the U.S. dollar in his Mint Report (chapter 11), Hamilton gave the country a standard unit of account, creating a nationwide currency union. That facilitated interstate trade and economic growth.

States, as Hamilton had hoped, chartered more and more banks.

In 1790, there were three local banks, in Philadelphia, New York, and Boston, and they were hardly a system because they had few if any connections. By 1795, some twenty additional banks had been created, and the Bank of the United States had established branches in several cities, giving the country interstate banking. The Bank kept large reserves of specie, and its notes were treated as good as gold and silver by other banks, which held them as a part of their reserves. That expanded the monetary base for lending and credit.

With all the new public and private securities, private brokers and dealers developed regular securities markets to trade them. Philadelphia and New York brokers established exchanges in 1790 and 1792, respectively. The New York Stock Exchange, long the world’s largest by

Introduction 7

market capitalization of its listed securities, traces its founding to May 17, 1792, when some twenty brokers met under a buttonwood (sycamore) tree on Wall Street and agreed to form a private traders’ club to launch a more reliable trading system. In the chapters that follow, the reader will note that Hamilton a number of times stresses the importance of securities’ being negotiable—i.e., tradable—because by being liquid they, in varying degrees, were almost a substitute for money.

Finally, Hamilton did all he could to promote corporations with limited liability. His first mention of a Bank of the United States in 1780 (chapter 1) made it a large trading company. His letter to Robert Morris a year later (condensed in chapter 3) mentioned, in the detailed outline of a proposed charter (the detail is left out of our condensation), that the bank would “be erected into a legal corporation,” with a comment to Morris, who no doubt understood such things, that “This article needs no illustration.” Morris, like Hamilton, knew that limiting stockholders’ liability to the amount of their investment would be attractive to investors, making it easier to raise larger amounts of capital.

Then we see Hamilton himself drafting company charters in chapters 5, 10, 13, and 18. Two of these (Bank of New York and Merchants Bank) called for the companies to have limited liability even before they had obtained state charters of incorporation, which both eventually did. This was a controversial, but apparently legal, maneuver.

Corporations have always been controversial in U.S. history, no less today than when they first emerged in large numbers during the financial revolution of the early 1790s.

The texts that follow were downloaded from the National Archives’ Founders Online website, https://founders.archives.gov. We have condensed the longer documents to omit detail that mattered more to readers of Hamilton’s writings when they came out than they would to readers more than two centuries later. Most of the documents are available in hard copy in the twenty-seven-volume series, The Papers of Alexander Hamilton, edited by Harold C. Syrett et al. and published

by Columbia University Press (1961–1987). We have also modernized some of Hamilton’s eighteenth-century spellings and punctuation, often quite heavy on commas, to make this volume easier for a modern reader to read and understand. Hamilton’s writings that were not edited and copied by others—for example, his opinion on the constitutionality of the Bank of the United States and his Defense of

8 Introduction

the Funding System in this volume—are both clearer and less commaladen than his state papers, such as the reports on public credit, manufactures, and the national bank, which were edited and copied by government scribes. One wonders if they were paid by the comma!

For more than two centuries, much has been written about what Hamilton stood for, said, and thought. Those who told his story sometimes had their own agendas, leading to inaccuracies and distortions of what Hamilton actually wrote. An example is the oft-stated argument that Hamilton wanted the federal government to assume state debts primarily to enlarge the body of Treasury bondholders, who then would be beholden to and supportive of the federal government and less beholden to the states. The argument did occur to Hamilton (see chapter 17), but he deemed it a weak one because an enlarged federal debt would require more unpopular taxes to pay the interest, because the debt was to be extinguished “in a moderate term of years” and in the interim much of it would be purchased by foreign investors.

To Hamilton, then, the oft-repeated argument “was the consideration upon which I relied least of all. . . . Had this then been the weightiest motive to the measure [assumption], it would never have received my patronage.”

What Hamilton himself wrote is a better guide to his thought and his economic policies than what others have said he thought and believed. We hope that readers of this volume will agree.

“Hamilton’s writings always impress for their clarity of argument and, especially, for their prescient vision of the future of the American economy.

Thanks to Richard Sylla and David J. Cowen for reminding us of that.”

Sylla and

to this day, making his founding-era writings on topics such as the national debt, trade, foreign investment, and central banking both resonant and relevant to contemporary readers. Sylla and Cowen provide helpful historical context, but they largely let Hamilton’s genius speak for itself. From short essays that resemble the modern op-ed to legal documents to his reports to Congress as Treasury Secretary, the book offers a compelling window into Hamilton’s visionary thinking on economic matters.”

— Robert E. Rubin, co-chair emeritus, Council on Foreign Relations, and former U.S. Treasury Secretary

“Seen the musical? Now read Hamilton’s original letters setting out his vision for the financial revolution that created today’s American economy— all excellently and helpfully edited by Sylla and Cowen.”

— Lord Mervyn King, former Governor of the Bank of England

“Sylla and Cowen make clear to readers that Hamilton had a solid historical foundation

david j. cowen is president and CEO of the Museum of American Finance. He is author of The Origins and Economic Impact of the First Bank of the United States, 1791–1797 (2000) and coauthor of Financial Founding Fathers: The Men Who Made America Rich (2006).

and a farsighted vision for his policy prescriptions. Without their expert guidance, this structure would often be missed even if one were to read through a larger set of writings. I could not imagine a better team to write this book.”

— Matthew Jaremski, Colgate University

on Finance,Credit, and Debt

is professor emeritus of economics and the former Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University Stern School of Business. He is a research associate of the National Bureau of Economic Research and chairman of the Museum of American Finance. Among his books are Founding Choices: American Economic Policy in the 1790s (2011) and Alexander Hamilton: The Illustrated Biography (2016).

Alexander Hamilton

richard sylla

While serving as the

Cowen

— Ben Bernanke, former chairman of the Board of Governors of the Federal Reserve System

“Alexander Hamilton was the architect of the American financial system that endures

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Alexander Hamilton on Finance, Credit, and

Debt Richard Sylla and

David J. Cowen COLUMBIA UNIVERSITY PRESS / New York

Jacket design: Noah Arlow

cup.columbia.edu

Jacket image: © Fabrizio Annovi/123rf

Printed in the U.S.A.

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first Treasury Secretary from 1789 to 1795, Alexander Hamilton engineered a financial revolution. Hamilton established the Treasury debt market, the dollar, and a central bank, while strategically prompting private entrepreneurs to establish securities markets and stock exchanges and encouraging state governments to charter a number of commercial banks and other business corporations. Yet despite a recent surge of interest in Hamilton, U.S. financial modernization has not been fully recognized as one of his greatest achievements.

This book traces the development of Hamilton’s financial thinking, policies, and actions through a selection of his writings. The financial historians and Hamilton experts Richard Sylla and David J. Cowen provide commentary that demonstrates the impact Hamilton had on the modern economic system, guiding readers through Hamilton’s distinguished career. The book showcases Hamilton’s thoughts on the nation’s founding, the need for a strong central government, confronting problems such as a depreciating paper currency and weak public credit, and the architecture of the financial system. His great state papers on public credit, the national bank, the mint, and manufactures instructed reform of the nation’s finances and jumpstarted economic growth. Hamilton practiced what he preached: he played a key role in the founding of three banks and a manufacturing corporation, and his deft political maneuvering and economic savvy saved the fledgling republic’s economy during the country’s first full-blown financial crisis in 1792. Sylla and Cowen center Hamilton’s writings on finance among his most important accomplishments, making his brilliance as an economic policy maker accessible to all interested in this Founding Father’s legacy.