Bank of the United States

• By the end of the American Revolutionary War (1775-1783) America’s individual states were deeply indebted, having borrowed heavily to finance the war effort.

• Moreover, inflation had rendered Continentals - the fiat money issued by the Continental Congress to finance the war - worthless.

• So Alexander Hamilton, America’s first Treasury Secretary (1789-1795), sought to get the newly formed country’s finances in order.

• To this end, Hamilton submitted his Report on Public Credit to Congress in January 1790.

• The report is most famous for calling for the federal government to consolidate and assume states’ debts.

• But a less well known part of the plan is its call for the creation of a “sinking fund” which would collect surplus tax revenues and be used to pay off 5% of the government’s outstanding bonds per year.

• Importantly, Hamilton also insisted that the sinking fund’s commissioners be allowed to borrow money and purchase federal government bonds that were trading below their “true value.”

• It was later decided that the vice president, the treasury secretary, the secretary of state, the attorney general, and the chief justice of the Supreme Court would serve as commissioners of the fund.

• As we will see below, this fund would play an integral role in the history of the early American financial system and in responding to America's first financial crisis.

• Hamilton followed up his Report on Public Credit by submitting his Report on a National Bank to Congress in December of 1790.

• The report proposed creating a national bank which would accept deposits, make loans to businesses, collect the government’s tax revenue, and issue notes that circulated as currency and were convertible into gold or silver.

• The bank would issue publicly traded stock, 20% of which would be owned by the national government, with the rest being owned by private investors.

• Private investors who wanted to own shares in the bank would need to pay 75% of the cost of purchasing them in U.S. government bonds and the other 25% in gold and silver.

• By requiring those who wished to purchase shares in the national bank to make 75% of the payment in US federal government bonds, private investors were incentivized to purchase such bonds and thereby finance the government’s debts.

• Hamilton had conceived of the idea for a national bank as early as 1779, over a decade before he was able to advocate for the creation of one as Treasury Secretary in 1790.

• And as early as 1781, Hamilton wrote about the idea of a national bank in a letter to Robert Morris, the U.S. Superintendent of Finance under the Articles of Confederation from 1781-1784.

• In crafting his idea for a national bank, Hamilton was influenced by the charter of the Bank of England and Adam Smith’s Wealth of Nations.

• In 1791 Congress accepted Hamilton’s proposal for a national bank and passed a bill which, if signed by President George Washington, would grant a 20-year charter for the creation of such a bank.

• But James Madison, perhaps the most influential member of Congress at the time, along with Secretary of State Thomas Jefferson and Attorney General Edmund Randolph, all residents of agrarian Virginia who distrusted northern financiers, wanted Washington to veto the bill.

• And Washington remained unsure about the constitutionality of the proposal.

• So he sent Hamilton a letter with comments by Secretary of State Thomas Jefferson on why Washington should veto the bill and gave Hamilton one week to provide his rebuttal.

• Jefferson had argued that the constitution did not explicitly give the federal government the authority to charter a national bank.

• And he argued that the necessary and proper clause of the US constitution could only be applied when the legislation in question was necessary - not merely if Congress deemed it convenient -  to the execution of Congress' explicitly enumerated powers, and therefore, could not be used to suggest that Congress has the implied power to create a national bank.

• Hamilton spent the next week preparing his thoughts and worked through the night of February 22 drafting his rebuttal, which amounted to almost 15,000 words.

• His rebuttal argued for a looser reading of the necessary and proper clause than Jefferson's. He suggested that reading the clause as only being applicable when the legislation in question was absolutely necessary would be debilitating, restraining the government from fulfilling its duties: in a world of uncertainties, how can we know for sure what is absolutely necessary?

• And if we accept a looser reading of the necessary and proper clause as being applicable to anything Congress deems useful in the discharge of its duties, then it is implied that Congress can do things – such as creating a national bank to collect taxes – which it deems to be useful to discharge its explicitly stated powers and obligations under the constitution – such as collecting taxes – even if the constitution doesn’t explicitly state that Congress has the authority to create a national bank.

• Hamilton’s rebuttal managed to convince Washington of the bank’s constitutionality and Washington signed the bill into law, creating the Bank of the United States (1791-1811).

• (Learn more about the necessary and proper clause of the U.S. Constitution and the doctrine of implied powers here.)

• The Bank would operate as the first American institution to perform many of the functions of a modern-day central bank and was a predecessor to today’s Federal Reserve System.

• The Bank of the United States’ 1791 headquarters are pictured below. (Carpenters Hall at 320 Chestnut Street)

• The debate over this bank was such a divisive issue that in a 1792 letter to James Madison, Thomas Jefferson stated that any Virginia banker who cooperated with the national bank was committing high treason and should be executed.

• (You can learn about what actually constitutes treason under U.S. law here.)

• And disagreement over the Bank was one of the core political disagreements – arguably the most important disagreement – that led to the creation of America's first two political parties: the Federalists who argued for a strong federal government and supported the existence of the national bank and the Democratic-Republicans who opposed the existence of a national bank, advocated for a weaker federal government, and argued for the United States to remain an agrarian society rather than one based on business and banking.

• The Bank resembled modern central banks in some important ways.

• It issued banknotes to businesses and individuals who deposited funds at the Bank which could be redeemed for gold and silver. These banknotes then acted paper currency.

• The size and scope of the Bank meant that these banknotes were widely circulated and therefore acted as a sort of national currency.

• Because its banknotes acted as a quasi-national money, the Bank could conduct a rudimentary form of monetary policy: by increasing (decreasing) its lending, it could increase (decrease) the supply of money and decrease (increase) interest rates charged to borrowers.

• Likewise, modern central banks are today tasked with influencing the amount of national currency in circulation and the availability of credit.

• Part of the reason why the Bank’s notes circulated so widely was because, as the government’s fiscal agent, it held the federal government’s revenues as deposits, and therefore, could make more loans.

• But the Bank also differed from modern central banks in several ways: it did not regulate other banks nor set official monetary policy.

• Incidentally, the Bank’s initial public offering and monetary mismanagement would play a role in precipitating America’s first speculative bubble and subsequent financial crisis: the Panic of 1792.

• And Hamilton’s response to this crisis – using the resources of the above mentioned sinking fund to buy up government bonds –  mirrors one of the tools central banks use to fight such crises today: open market operations.

• In 1797, the Bank moved its headquarters into the building pictured below. 

• Given that one of the Bank’s roles was to collect taxes on behalf of the federal government and that most of the federal government’s tax revenue at the time came from customs duties, the Bank made a strategic decision to place branch offices in the nation’s port cities.

• In addition to its headquarters in Philadelphia, at its peak the bank had branches in 8 port cities: New York City, Baltimore, Charleston, Washington D.C., Savannah, New Orleans, Norfolk, and Boston.

• In the interim, America would fight the War of 1812 (1812-1815).

• Financing the war effort required the federal government to issue debt.

• With the Bank of the United States defunct, the government placed the funds it raised by issuing debt with state banks.

• The state banks in turn used these large deposits to issue large quantities of loans and banknotes.

• The result was an increase in the supply of money without a concomitant increase in the production of goods and services, and therefore, inflation.

• But absent a central bank-esque institution with the capacity to rein in lending by state banks, such lending and rising inflation went unchecked.

• Moreover, the absence of a fiscal agent – a role that the Bank of the United States had previously filled –  to collect the government’s revenues, help it issue debt, and pay its bills made managing the massive debts the government incurred during the war more difficult, causing the U.S. government to default on some of its bonds.

• Furthermore, several prominent self-interested businessmen lobbied aggressively for the establishment of a new central bank.

• So in 1816, the U.S. would take a second try at establishing a national bank.

Written By: Aiden Singh Published: July 10, 2020 Sources