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Alexander Hamilton: America's Financial FounderDick Fox February 12, 2007 (© 2007)The most influential man in the founding of our country was never elected to the United States Congress, was never President or Vice President, and was never on the Supreme Court. It could even be argued that without his leadership the United States of America would never have existed. Yet, he is perhaps the least known of all of the Founding Fathers. Some may know that Alexander Hamilton’s likeness is on the $10 bill. Revolutionary War historians might know that he was on General Washington’s personal staff and that he led the first assault in the decisive battle of Yorktown. Constitutional scholars would know that he was the primary author of the Federalist Papers and political historians would know that he led the Federalist Party in New York. Adventurously romantic souls would know that he was the first member the President’s Cabinet to be embroiled in a sex scandal and forced to resign, and that he was killed by Aaron Burr, the Vice President of the United States, in a duel of honor. But by far his most lasting impact on the fledgling new nation was his five short years as the first Secretary of the Treasury. The School of Hard Knocks Alexander Hamilton was born on the island of Nevis in the West Indies, the illegitimate son of a failed businessman and a fugitive woman, fleeing from her abusive husband. His father moved the family to Saint Croix when Alexander was still a child, but then abandoned Alexander, his brother, and his mother to find their own way as he sought his fortune on other islands. To support her small family his mother opened a general store where Alexander, not yet an adolescent, kept the store’s books. But fate can be cruel. Alexander and his mother contracted fevers, and after days of delirium his mother died. Alexander did recover, but over the following year, her abusive first husband compounded his mother’s tragic death by vindictively working through the courts to have Alexander and his brother declared illegitimate. In the end all of their mother’s property was awarded to her first son, who was living in South Carolina with his own family. Alexander and his older brother, both young teenagers with nothing more than the clothes on their backs, found themselves under the charge of distant family members. A wealthy American businessman, Nicholas Cruger, who had been a supplier of goods for Alexander’s mother, opened the largest import/export business on the island, and hired Alexander to keep his books. Alexander quickly proved himself to be a business prodigy dealing with ships captains and sailors three times his age, with pirates, smugglers and customs agents. He created, and balanced budgets, ordered and received inventory, and purchased and sold goods. By the age of 16 he was totally running Cruger’s operation on Saint Croix, and earning a healthy profit for his employer. Cruger and several of the other men on the island, who recognized Hamilton’s genius, donated goods and money to secure his passage to New York so he could begin his formal education. After a life threatening fire at sea his ship struggled into Boston Harbor at the height of the revolutionary fervor, only a few months before the Boston Tea Party. In Boston Hamilton wandered the city for a week waiting for a stagecoach to take him to New York. In New York he entered Kings College, an Anglican school and Tory stronghold, but Hamilton’s loyalties were with those seeking liberty, so when word reached New York of the battle of Breed’s Hill, he and his fellow students began drilling with the local militias. On March 14, 1776 he was assigned command as captain of an artillery and cannon company where he joined the Continental Army in preparing the defense of the city from British attack. Washington and the Continental Army suffered a devastating defeat in New York and survived only through a miraculous retreat across the river under the cover of a foggy night, but during the battle and the retreat Washington had been impressed by the diligence and leadership of the 22-year-old Hamilton. On June 20, 1777 Washington selected him to serve on his personal staff.1 Hamilton had a gift for writing that had been revealed early in his life when, as a boy, he was first published in the Royal Danish American Gazette, a newspaper that circulated throughout the West Indies. Then in New York as a student he became the primary defender of liberty in anonymous letters and articles to the newspapers. His gift for writing thrust him into the role of Washington’s personal secretary and involved him in every decision concerning the administration of the war. It also exposed him to the difficulties of convincing Congress to honor its financial commitments to the war effort. Washington developed such respect for his ability to make decisions that Hamilton was allowed to issue orders under the General’s signature without consultation. But Washington and Hamilton were never personally close and engaged in a constant war of wills.2 Hamilton, who was neither awed by Washington’s presence nor intimidated by his power, wanted to be in the heat of the battle with the fighting men on the front lines, but Washington considered him invaluable in planning and executing the war. Shortly before the battle of Yorktown their conflict came to a head. Washington sent Hamilton on an errand, but while he was gone had an immediate need to consult him. When Hamilton returned Washington, standing at the top of the stairs, chastised him in front of the other officers. Hamilton felt the criticism unfair so he resigned from Washington’s staff. Washington later sent an apology, which Hamilton accepted, but he still refused to return to Washington’s staff choosing instead to remain with the troops.3 While at King’s College Hamilton had studied the greatest political philosophers, Lock, Montesquieu, Hobbes, and Hume and the great legal scholars Blackstone, Grotius and von Pufendorf. During the war he not only wrote most of Washington’s official correspondence, but he corresponded personally with the most important people in the administration of the government. In 1780, while still involved with the war, Hamilton wrote a lengthy letter to James Duane criticizing the Articles of Confederation that created a government much like that of the modern United Nations. After the war he returned to New York to practice law, but he continued his correspondence with the national leaders and continued his criticism of the Articles. He was watching the nation crumble into a mixture of small nation-states constantly in disputes over trade. In 1786 the state of Virginia called a conference at Annapolis to discuss the trade problems. Hamilton was one of six delegates selected4 from New York to the Annapolis conference. It was at this conference that, with the help of James Madison, he drafted an appeal to the states to convene a Constitutional Convention. His old college friend, Robert Troup, later wrote that Hamilton was only interested in “a commercial convention … as a stepping stone to a general convention to form a general constitution.”5 The delegates agreed the issue of trade was a symptom of a larger problem and voted for Hamilton’s petition to convene a convention to amend the Articles of Confederation. Hamilton was selected as a member of the New York delegation to the Constitutional Convention primarily because of his prominence at Annapolis. New York Governor George Clinton opposed the convention fearing that a strong federal government would weaken the individual states and the power of their governors. Since he controlled the political power in New York, all delegates, with the exception of Hamilton, supported his opposition to a new constitution. At the convention Hamilton allied himself with James Madison and the Virginia delegation, but was uncharacteristically quiet during the proceedings. His only significant speech was late in the session when he presented his own plan for a new government. The Convention was successful in drafting a new constitution and in spite of vehement opposition it was ratified by the states. George Washington, elected the first President, knew that repairing the financial condition of the nation was his most pressing responsibility. The constitution made no provision for a cabinet, but Washington, drawing on his wartime experience, knew the importance of a personal staff. In April 1789, on his way to his inauguration, he stopped in Philadelphia to pay a personal visit to Robert Morris. During the war Congress had selected Morris as superintendent of finance, and he had drawn from his own personal fortune to pay salaries and compensate Washington’s spies. Morris had only recently reentered the private business world so when Washington offered him the position of Secretary of the Treasury he declined for personal reasons. “But, my dear General,” he replied to Washington, “you will be no loser by my declining the secretaryship of the treasury, for I can recommend to you a far cleverer fellow than I am for your minister of finance in the person of your former aide-de-camp, Colonel Hamilton.”6 Washington, surprised, stated that he had never talked national finances with Hamilton. Morris then told Washington about his correspondence with Hamilton during the war and that at age 23 while still on Washington’s staff, Hamilton had sent Morris a 31 page plan for a national bank which Morris immediately introduced to congress to charter America’s first commercial bank, the First National Bank of North America.
On April 22, 1789 Washington met with a delegation from the House of Representatives, the Senate, and his prospective cabinet members in the New Jersey home of Representative Elias Boudinot. Hamilton emphasized the urgency of creating the Treasury Department. If it was not quickly organized the government would lose $300,000 in duty to be imposed on the fleets arriving in the spring. He noted that this was the bulk of the federal budget projected for the year.7 On May 19, 1789 Boudinot introduced a bill to create a department of finance. The bill generated lengthy debate over the summer because some in Congress feared one man controlling the treasury could threaten the entire government, but the bill was passed and on September 2, 1789 Washington signed it into law. Nine days later, on Friday, September 11, Washington formally nominated Hamilton as Secretary of the Treasury and the same day the Senate confirmed the nomination. The very next day after his appointment, Saturday, he arranged a $50,000 loan from the Bank of New York, then working all day Sunday he prepared another request that was submitted to the Bank of North America, in Philadelphia.8 Hamilton, only 34 years of age, wasted no time in his new position approaching his responsibility as Treasury Secretary with the same energy and passion he had lived his entire life. The Financial Condition of the United States Hamilton faced a monumental challenge as the first Treasury Secretary. For almost fifteen years the economy and resources of the central government had been alternately neglected and mismanaged to the point of near total collapse. Congress faced the daunting task of financing the war with Great Britain, so on May 10, 1775, meeting in secret session, a plan was agree to, but not until June 22, the day news arrived of the battle on Breed’s Hill, was it actually resolved to emit bills of credit not to exceed “2,000,000 Spanish milled dollars.” On paper the financing scheme appeared sound. The bills were to be issued by congress in exchange for supplies and services to be used in the war effort, and then the bearer would surrender them to pay taxes levied by the states. In this manner the states would shoulder the financial burden of the war. But plans on paper are often much different than actual results. Two major flaws quickly became apparent with the plan. First, there was no enforcement of the mechanism for the redemption of the bills, if the states did not levy the taxes necessary to retire the bills. Secondly, there was no restraint on the issuance of new bills or on the states issuing their own bills to pay for their own war debts. With federal bills and state bills in competition and neither being retired, the value of the bills began to decline. Alarmed, the states took legal action. In 1776 and again in 1777 the New England states approved price controls on the exchange value of the bills, but the result was a sever shortages of goods and a dislocation of labor, and there was no pause in the decline in value. The controls were soon rescinded. By early 1778 the ratio of the Continental to gold had fallen to 4:1 and a frustrated Continental Congress intervened by passing a law stating that wages and prices were “not to exceed 20 fold the levels of 1774.” By November 1789 the ratio had careened to 45:1 and, recognizing the abysmal failure of the wage and price controls, a defeated Congress allowed the controls to expire in February 1780. By May of 1781 the Continental had crashed at 1,000:1 in some places and circulation virtually ceased.9 Fortunately, in late 1781 the Continental Army defeated the British at Yorktown and the surrender of Cornwallis began to bring the fighting to an end. The nearly bankrupt nation had won its independence. The end of fighting was only the beginning of the struggle of the new country, faced with a worthless currency and dismal credit rating. John Witherspoon, President of the College of New Jersey, later Princeton, and a signer of the Declaration of Independence, described it well: “For two or three years we constantly saw and were informed of creditors running away from their debtors, and the debtors pursuing them in triumph, and paying them without mercy.” 10 In all of this chaos during the war John Adams, Thomas Jefferson, and Benjamin Franklin had been traveling Europe in an effort to borrow money to support the small Continental Army’s fight against the most powerful military in the world. While the war raged some countries wished to create problems for Great Britain by supporting the United States, but the end of the war ended this justification for aid. A treaty was signed with Great Britain in 1783 formally ending the war, but it did not end the fighting as the English violated the treaty and skirmishes continued along the western frontier. The individual states, swamped under their own great wave of debt, refused to pay the federal taxes and levies making it nearly impossible for the national government to meet its debt obligations; the weak and ineffective Articles of Confederation had proven totally useless. Hamilton's Solution Immediately after his confirmation Congress assigned Hamilton an unprecedented task, one that has been left undone for 15 years. He was ordered to prepare a report on the public credit, and to present it to the congress in three months. Hamilton set to the task and almost totally by his own efforts and his own hand completed and submitted the Report on the Public Credit to congress on January 9, 1790. During the war Hamilton had used his free time to study both government organization and government finance. He knew that few, if any, of the members of congress understood national finance so his report not only reported the status of the public credit, but was a primer on national finance and a blueprint for legislation to cure the national economic ills. Hamilton, never shy, began the report, not with details of the contemporary financial conditions, but rather striking at the source of the problem, the reputation of the government. “For when the credit of a country is in any degree questionable it never fails to give an extravagant premium in one shape or another, upon all the loans it has occasion to make. Nor does the evil end here; the same disadvantage must be sustained upon whatever is to be bought on terms of future payment.”11 Then, continuing to emphasize the importance of reputation, he addressed the primary argument of necessity. “Every breech of the public engagements, whether from choice or necessity, is in different degrees hurtful to public credit.”12 Hamilton then rhetorically asked and answered the obvious question. “If the maintenance of public credit, then, be truly so important … by what means is it to be effected? The ready answer … is, by good faith, by a punctual performance of contracts.”13 Obviously Hamilton had correctly identified the problem, but his opening remarks were anything but politically correct. Most of the members of the current congress had also been members of the congress under the Articles of Confederation, and some were directly involved in managing the national finances. Criticism of the current situation as stemming from a moral problem was a direct challenge to many members of this sitting congress. But Hamilton’s blow to their honor was small compared to his recommended solution. His first suggestion met with little opposition, because it was necessary to repair the national reputation and to secure a place in the nations of the world. The congress could understand the necessity. “…that part of the debt which has been contracted abroad, and is denominated the foreign debt, ought to be provided for, according to the precise terms of the contracts relating to it…. [This] is agreed on all hands….”14 But the members of congress looked on the domestic debt as an extension of taxation. They essentially forced the holders of domestic debt, soldiers, merchants, and others who had sacrificed for the war effort, to shoulder even more of the burden. But Hamilton understood that the reputation of the nation was also determined by how it honored its domestic commitments and so he placed the challenge right at the feet of the members of congress. “It is to be regretted that there is not the same unanimity of sentiment on this part, as on the other.”15 Hamilton rejected anything short of full redemption of all debt, because anything less “… is inconsistent with justice … a breech of contract; in violation of the rights of a fair purchaser.”16 But not only were all debts to be assumed, they were to be paid at specie value and with interest where applicable including the useless continental money. “And let all sums of the Continental money now in the treasuries of the respective states … be credited at specie value.”17 To most this seems like an honest, common sense approach, but Hamilton’s report was like a thunderclap in the city of New York. New York City had been the home of the Continental Congress since 1785, but it was also the financial center of the country. When word of Hamilton’s proposal was leaked to the financial district, it spread like wildfire. Speculators were posted throughout the states prepared to buy government paper, and one Connecticut congressman was reported to have hired two ships to head south to buy as much government debt as possible. Later documents showed that even Hamilton’s assistant, William Duer, created a syndicate with financier William Bingham to buy backcountry securities.18 Government paper in general had been selling for $0.10 on the dollar in distressed areas, but as news of Hamilton’s report slipped out speculators began to offer three to four times the normal rate. When southern legislators learned of the speculators attempts to profit from Hamilton’s proposal, a cry went up from members of congress appalled that speculators would take advantage of the poor holders of government debt. They leveled their attacks directly at Hamilton, and attempted to change his plan by having the original holders of the debt compensated. Though Hamilton had addressed this argument in the report, his plan faced powerful opposition, significantly from Madison and Jefferson. But what was lost in the debate was the fact that Hamilton’s plan had produced immediate results. Virtually overnight the current value of government debt began to recover. Hamilton and Money Hamilton, unlike most others, had a much deeper understanding of the national debt. He understood that restoring faith in the national finances would do much more than simply facilitate the nation’s ability to borrow, and what he saw was “less obvious, though not less true.” “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 stock19 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.”20 With this understanding Hamilton knew it was critical that he win his battle with the southern legislators. If they succeeded it would be a critical defeat to the acceptance of government bills as money. If government bills of credit were restricted in exchange from one person to another person they would not function as money. “… notice the effect … upon two persons, who may be supposed two years ago to have purchased, each, securities at three shillings in the pound and one of them to retain those bought by him, till the discrimination should take place; the other have parted with those bought by him within a month past at nine shillings. The former, who had had most confidence in the government, would in his case only receive at the rate of three shillings and the interest while the latter, who had less confidence would receive for what cost him the same money at the rate of nine shillings and his representative, standing in his place, would be entitled to a like rate. But we must not confuse Hamilton’s understanding of debt as money to be a recommendation to issue fiat money. In his Report on the National Bank presented to congress December 13, 1790, he states clearly: “… the 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.”22 Then continuing to make the distinction he stated: “Among other material differences between a paper currency, issued by the mere authority of Government, and one issued by a Bank, payable in coin, is this – That in the first case, there is no standard to which an appeal can be made, as to the quantity which will only satisfy, or which will surcharge the circulation; in the last, that standard results from the demand. If more should be issued, than is necessary, it will return upon the bank. Its emissions, as elsewhere intimated must always be in a compound ratio to the fund and to the demand: whence it is evident, that there is a limitation in the nature of the thing: while the discretion of the government is the only measure of the extent of the emissions, by its own authority.”23 But from 1775 through 1779, when the Continental ceased trading, the aggregate amount issued had increased from the initial $2,000,000 offering to $242,000,000. Why would Hamilton want to increase the existing supply of money? Wasn’t this exactly the action that doomed the Continental? Returning to the Report on Public Credit we can see that Hamilton had a complete understanding of money and of the real reason the Continental failed. “But these good effects of a public debt are only to be looked for when, but being well funded, it has acquired an adequate and stable value. Till then, it has rather a contrary tendency. The fluctuation and insecurity incident to it in an unfunded state render it a mere commodity, and a precarious one. As such, being only an object of occasional and particular speculation, all the money applied to it is so much diverted from the more useful channels of circulation in fact, one serious inconvenience of an unfunded debt is, that it contributes to the scarcity of money.”24 The nation faced not a glut of money because of the Continental, but a shortage of money due to its failure. Hamilton's Words Today When Hamilton informed President Washington on December 1, 1794 of his intention to resign he had served as Secretary of the Treasury only slightly more than 5 years, but during that time he had taken the nation’s credit from the lowest rating in Europe to one of the highest. In 1789 no nation would willingly loan additional funds to the United States but in 1794 United States bonds were selling in Europe for 10% over par. Tallyrand wrote that the bonds of the United States were “safe and free from reverses. They have been funded in such a sound manner and the property of this country is growing so rapidly that there can be no doubt of their solvency.”25 Hamilton did work an economic miracle in his time as Treasury Secretary but do his lessons apply today? It should be instructive that our problems today are so reflective of the problems Hamilton confronted. The Federal Reserve Bank of St. Louis Review26 featured two panel discussions with various economists, including current Federal Reserve Chairman Ben Bernanke, addressing the question, What have we learned since 1979? referring to the time since the Great Inflation of the 1970s. It was noted again and again in various presentations that the loss of value of the currency, inflation, was the enemy at the monetary gate. But behind this concern with inflation we could hear the echo of Hamilton’s words as each presentation called for restoring the credit of our nation, honoring financial commitments, and repairing the national reputation. Hamilton understood money in ways that escape even the highly educated economists of our day. Money is only as good as the confidence placed in it to facilitate indirect exchange, what Hamilton called the “security of transfer”. He understood that when government debt is not properly funded the bills lose the confidence of the economic participants and their value as money declines. He also understood that the loss of value of the Continental was due to a loss of confidence and that a restoration of confidence would restore the value. This necessity of confidence in a currency was not lost on the participants in the 2005 Saint Louis Review discussion. There was constant discussion of “inflation expectation” and other euphemisms in discussions of the loss of confidence as a primary contributor to the Great Inflation, but not one presentation showed the boldness of Alexander Hamilton to recommended restoring faith in government paper by redeeming “at specie value.” When Richard Nixon severed the only remaining connection of funding of the dollar in 1973, the result was immediate and, for those who understood such as Robert Mundell, totally expected. But lost in economic history is that the Great Inflation of the 1970s rivaled the infamous inflation of the Continental in the 1770s. Both the dollar and the Continental experienced a 20:1 decline against gold in less than a decade, and there can be little doubt that had it not been for the massive deflation engineered by Paul Volker in the early 1980s the dollar would have suffered the same fate as the Continental. So have Volker and his successors been successful in curbing the decline in the dollar? Volker did reverse the decline to 10:1, but we must understand that the huge destruction of wealth caused by the Great Inflation is lost forever. Now 25 years after Volker’s drastic action we have grown to accept a 15 to 20-fold depreciation in the value of the dollar to gold as normal. Today our citizens expect the value of the dollar to decline every year and the government systematically implements COLA adjusts to correct for inflation. So how much wealth is lost through institutionalized inflation? No one knows, but the precarious state of our unfunded monetary system should concern us all. Could our fiat currency sustain a serious monetary shock? Should we be concerned that the conditions in our world today are closer to those of 1789, when Hamilton stepped up as Treasury Secretary, than to those of 1795, when Hamilton formally presented his resignation to congress? If we had the genius of Alexander Hamilton with us today would he be pleased with our nation’s financial condition, with the condition of our nation’s credit? There is little doubt that the brash, blunt Alexander Hamilton, never concerned with political correctness, would give today’s Congress, Treasury, and Federal Reserve the same advice he gave congress in 1789: Restore confidence in the credit of the nation “by good faith, by a punctual performance of contracts” and “let all sums … be credited at specie value.”
***** Dick Fox can be reached via e-mail at: rpfox@worldnet.att.net. |