summary of this article
Founding Choices: American Economic Policy in the 1790s This PDF is a selection from a published volume from the National Bureau of Economic Research Volume Title: Founding Choices: American Economic Policy in the 1790s Volume Author/Editor: Douglas Irwin and Richard Sylla, editors Volume Publisher: University of Chicago Press Volume ISBN: 0-226-38474-8 (cloth); 0-226-38475-6 (paper) ISBN13: 978-0-226-38474-0 (cloth); 978-0-226-38475-7 (paper) Volume URL: http://www.nber.org/books/irwi09-1 Conference Date: May 8-9, 2009 Publication Date: December 2010 Chapter Title: Financial Foundations: Public Credit, the National Bank, and Securities Markets Chapter Authors: Richard Sylla Chapter URL: http://www.nber.org/chapters/c11737 Chapter pages in book: (59 - 88) 59 2 Financial Foundations Public Credit, the National Bank, and Securities Markets Richard Sylla The fi nancial foundations of the United States and its federal government were created in three years, 1790 to 1792. Before 1790, the government was effectively bankrupt. Without tax revenues until late in 1789—after the newly created Treasury Department opened in September of that year, it managed to collect by year end a grand total of $162,200 in custom duties—the U.S. government was in default on almost all of its large domestic debts left over from the Revolution, as well as on most of its foreign debts incurred in the struggle. The new nation lacked a national currency, a national bank, a bank- ing system, and regularly functioning securities markets. It had only a couple of dozen business corporations the states had chartered during the 1780s. The fi nancial revolution of 1790 to 1792 changed all that. In 1793, the government collected almost $4.7 million in tax revenue, more than enough to fund government operations and meet interest payments on the national debt. By 1793, a federally chartered Bank of the United States had opened in Philadelphia with branches in several cities, as had the U.S. Mint, to produce silver and gold coins in the newly defi ned dollar unit of account. Several states had chartered ten more banks to join the fi rst three bank start- ups of the 1780s, one of which operated without a corporate charter until 1791. Richard Sylla is the Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics at New York University, and a research associate of the National Bureau of Economic Research. The author thanks Eric Hilt, Farley Grubb, Douglas Irwin, Naomi Lamoreaux, Hugh Rockoff, Jon Wallis, Thomas Weiss, Robert Wright, other participants in the Founding Choices conference, and two anonymous reviewers for comments and suggestions that he hopes have improved this essay. Some material in the chapter is based upon work supported by the National Science Foundation under Grant no. 0751577, “U.S. Corporate Development, 1801– 1860.” Any opinions, fi ndings, and conclusions expressed in this chapter are those of the author and do not necessarily refl ect the views of the National Science Foundation. 60 Richard Sylla Along with the national bank and its branches, these banks were interacting with one another as a banking system. Forty- four new business corporations, including the banks, received char- ters in 1790 to 1792: more in three years than the total of seven in the entire colonial era and the total of twenty- four in the 1780s. Securities markets in Philadelphia, New York, and Boston priced every business day the $63 mil- lion of restructured domestic U.S. debt that began to appear in late 1790, as well as the $10 million in stock of the Bank of the United States and the stock of state banks and nonbanking corporations.1 These markets had even survived their fi rst bubbles, panics, and crashes in 1791 and 1792 (Sylla, Wright, and Cowen 2009). Financially, by 1793 the United States looked surprisingly modern. In 1789 it was decidedly premodern. Because of the events of 1790 to 1792, from that time forward Americans and most of their historians could assume, correctly, that a modern fi nancial system always existed in their country. But, too often incorrectly, they also assumed there was nothing special, unique, or even good about it. Since modern economies by defi nition have modern fi nancial systems, much of U.S. fi nancial historiography has focused on the unseemly, negative features of these systems. Taxes and public spending are too high. The national debt is too big and ought to be reduced. Large banks are a threat to economic stability and perhaps even the people’s liberties. Banks take too many risks and too often fail. Stock markets are the dens of speculators and thieves, and too often they crash. Business corporations have too many privileges and too much infl uence in American life. These widely trumpeted opinions of our time are nothing new. They have been voiced throughout U.S. history since 1790. But they were not voiced in America before 1790, or in most other countries until long after 1790. The United States was one of the fi rst nations to modernize its fi nances. Only two nations did so earlier—the Dutch Republic (the modern Neth- erlands) about two centuries before the United States, and Great Britain starting perhaps a century earlier. Neither modernized as completely as the United States did by 1800, and neither did it within three years, or even three decades (Rousseau and Sylla 2003, 2005; Sylla 2009). This chapter attempts to answer several questions. How did so much mod- ernizing economic and fi nancial change happen so quickly at the start of U.S. history? What were the specifi c choices made and actions taken during 1790 to 1792 that made it happen? How were they challenged? How were they defended? Did the fi nancial revolution happen as easily as is sometimes assumed from its sheer rapidity? And fi nally, what difference did the fi nancial revolution make for what happened after it occurred? In particular, what was its impact on the growth of the U.S. economy? 1. An additional $12 million of foreign debt raised the total national debt to approximately $75 million as of 1790. Most of the foreign debt was owed to France, for French loans during the War of Independence and arrears of interest on those loans. Financial Foundations 61 2.1 Hatching and Shaping the Plan The origins of the fi nancial revolution of the early 1790s can be traced to the seemingly insurmountable fi nancial difficulties of the last years of the War of Independence. Then, the Confederation Congress saw its paper money become worthless and, having no tax powers, it struggled to fi nd ways to pay its army and its debts (Ferguson 1961). Congress appointed Robert Morris, a wealthy merchant and fi nancier, to be superintendent of fi nance in 1781. Morris managed to fund the decisive Yorktown campaign and victory in October of that year, and to persuade Congress to charter the fi rst American bank, the Bank of North America, shortly thereafter. But Congress failed to enact most other fi nancial reforms Morris recommended, and he resigned in frustration in 1784. Financial difficulties in countries are common, particularly during times of war, and there were lots of such times during the eighteenth century. Financial revolutions, however, are rare. How, then, did the fi nancial difficulties experienced by Americans during the War of Independence lead to a fi nancial revolution a decade later? Subsequent events would reveal that the initial plans for a U.S. fi nancial revolution were hatched in several letters—more accurately essays—on political economy that Alexander Hamilton wrote between late 1779 and early 1781. Hamilton at the time was a lieutenant colonel in the Continental Army and the principal aide de camp to General Washington, the American commander. In his long letters to U.S. leaders, Hamilton demonstrated an unusual understanding of fi nancial history, gained from his recent study of the works of Malachy Postlethwaite, David Hume, Richard Price, Adam Smith, and others (McDonald 1979, 35). The letters indicate that Hamilton knew quite a lot about the successful fi nancial revolutions of the Dutch and the British, and the aborted efforts of John Law in France. From those histories he drew the conclusion that fi nance was the key both to state power and economic growth. Applying his historical understanding to the situation of the United States, he began to formulate plans for what would become the U.S. fi nancial revolution a decade later. In 1789, as the fi rst secretary of the treasury of the new federal government, Hamilton would execute a more refi ned version of a plan he had hatched a decade earlier and then developed during the 1780s. The setting for Hamilton’s letter- essays was the dire situation of the Amer- ican revolutionaries in 1779 to 1781. The war had dragged on for fi ve years. Paper “Continental Currency,” fi rst authorized and issued by Congress in 1775, and then issued to excess by 1778 to 1779, was well on its way to becom- ing worthless by 1780. Taxation, then, was in the hands of the states. To meet the requisitions of Congress, states were supposed to levy wartime taxes payable in Continentals as well as in their own state paper currencies. That would support the values of the paper currencies by making them acceptable as a means of paying taxes and by reducing the amounts outstanding. But 62 Richard Sylla taxes levied and collected by the states were woefully inadequate to the task, so Continental paper dollars depreciated to the point where it took about forty paper dollars to purchase a dollar in hard- money coins by the start of 1780, and about one hundred paper dollars to buy a dollar in specie by the beginning of 1781 (Perkins 1994, 97). Borrowing, an alternative to taxation and money printing as a method of public fi nance, also proved difficult both at home and abroad, in part because ineffective taxation and excessive money printing undermined whatever confi dence lenders might otherwise have had in the revolutionary cause. In his fi rst letter on the dire U.S. fi nancial situation (undated, but thought to have been written between December 1779 and March 1780), Hamil- ton argued that the main solution to the wartime fi