The Bank that Hamilton Built

December 12, 1791, was a red-letter day in the financial history of the young United States. That day a bank unlike any previously seen in America opened for business in Carpenters’ Hall in Philadelphia, then the seat of the federal government. The new bank was a national bank, authorized by Congress to hold $10 million in capital—an astronomical sum at the time—and operate across state borders. And it was a quasi-public institution, owned mostly by businessmen and lawyers motivated by profit, but also intended to serve the public interest by improving the financial standing of the federal government and fostering economic growth.

Businessmen and investors across the nation had anticipated the opening of the Bank of the United States with mounting excitement for almost a year. In July 1791, a public offering of bank stock sold out in less than an hour, setting off frenzied speculation in bank shares. Stockholders had chosen directors hailing from eight states to run the bank. By December, it was ready to begin accepting deposits, making loans, selling U.S. Treasury bonds and issuing paper currency backed by gold and silver coin stored in its vaults. The following year, bank branches would be established in Boston, New York, Baltimore and Charleston, S.C., to facilitate the flow of money and credit to various regions of the country; four more branches would follow by 1805.

The intellectual architect of the bank—known today as the First Bank of the United States—was Alexander Hamilton, the founding father who most profoundly influenced the economic development of this country. As the Republic’s first Treasury secretary, Hamilton championed the idea of a national bank, proposing its establishment to Congress and convincing President George Washington—over the strenuous objections of Thomas Jefferson—that the bank would not violate the Constitution.

The man on the $10 bill, whom biographer Ron Chernow describes as “the clear-eyed apostle of America’s economic future,”¹ believed that the new nation needed a national bank if it was to prosper. After the Revolutionary War, the economy was in tatters: Crushing war debt weighed down the federal government, and a shortage of sound currency and bank credit stifled commercial growth. Hamilton designed the First Bank to help the government get on its financial feet and to galvanize American commerce by providing currency and loans to businesses and individuals. The bank was a vital part of a national financial infrastructure that Hamilton created during his short but prodigious career, the template for today’s monetary economy based on a stable currency and access to credit.

A statesman with a natural genius for economics, Hamilton was far ahead of his contemporaries in perceiving how the country’s fortunes and those of free markets were intertwined, says Thomas M. Humphrey, a former senior economist with the Federal Reserve Bank of Richmond who has written extensively about the history of economic thought. “Hamilton saw a system of sound, secure and resilient financial institutions as being necessary for the real economy to function efficiently,” Humphrey said in a telephone interview. “He also had this vision that America would one day become a huge, thriving economic success around the world, and he thought of these institutions as being necessary to promote that vision.”

The First Bank worked in consort with Hamilton’s other financial reforms—paying off war debt and establishing a stable monetary standard—to put the government’s finances in order and stoke the fires of enterprise at the beginning of the industrial revolution. By aiding in revenue collection, lending to the Treasury and marketing government debt to private investors, the bank served as a financial bulwark for the federal government. And its operations invigorated markets by providing a sizable, trustworthy currency and extending credit to businesses.

Hamilton’s bank was destined not to endure; constitutional challenges and opposition from state banks forced it to close after 20 years of operation. But the institution he created laid the foundation for a second national bank and, almost a century later, for the establishment of the Federal Reserve System. Although the First Bank was not a true central bank—the concept of centralized monetary control didn’t develop until the 20th century—its powers and operational scope presage the Fed’s stabilizing influence on the nation’s money supply.

The economic ideas that sprang from Hamilton’s fertile, industrious mind have informed financial practice and monetary policy in this country for more than two centuries. This article examines how those ideas became manifest in the First Bank of the United States—and transcended the death of the bank and Hamilton himself.

War and peace

The plan for the First Bank wasn’t cut from whole cloth, the product of an individual flash of inspiration or a snuff-fueled brainstorming session in Washington’s cabinet room. Hamilton mulled over the notion of a national bank for more than a decade before making his formal proposal in 1790.

During the Revolutionary War, as an aide-de-camp to General Washington, Hamilton saw firsthand how financial disorder undermined the patriotic cause. Because the Continental Congress had little power to tax, it was forced to finance the war by borrowing and issuing paper money, known as “continentals.” However, without collateral to back them, millions of dollars in this currency had become nearly worthless. Government debt was mounting by the day.

The cure for these ills, Hamilton believed, was a national bank. In a 1779 letter to a congressional delegate, Hamilton described a large banking and trading corporation owned by wealthy individuals, but partly controlled by the government. The institution would invest in war debt, converting deflated continentals into new currency and credit that would promote industry and trade.

Colonel Hamilton was just 24, but versed far beyond his years in matters of political economy. As a teenager, he had received a crash course in international commerce as a clerk for a trading firm on the island of St. Croix in the British West Indies. While studying at King’s College (now Columbia University) in New York and during the war years, Hamilton read extensively on economics and finance, absorbing the mercantilist theories of James Steuart and Malachy Postlethwayt as well as the classical, free-market teachings of Adam Smith and David Hume. “Hamilton was just a genius,” Humphrey says, “and he somehow managed to put it all together, although his style was not completely pro–free market, like the classical economists.”

In 1781, Hamilton again broached the idea of a national bank, outlining his vision in a letter to Robert Morris, superintendent of finance for Congress. The bank would issue pound notes backed in part by real estate, redeem the government’s outstanding paper money obligations and lend to both government and private businesses. Such an institution would furnish the needed capital to win the war and “be a source of national strength and wealth,”² Hamilton wrote. Morris may have incorporated some of Hamilton’s ideas into his plan for the Bank of North America, the first independent bank in the country. (Domestic banks were banned under Colonial rule.) Incorporated in 1781, the Philadelphia bank was conceived as a national bank but devolved into a regional bank focused on private lending.

If a national bank was needed to defeat the British, an even stronger argument for establishing such an institution could be made after the war. The infant nation’s economy was depressed, hobbled by staggering war debt and a scarcity of specie (gold and silver coin) with which to pay taxes and trade goods and services.

Currency was so scarce in some cities that farmers, unable to sell their produce in the market, returned home at the end of the day with full wagons. Besides the Bank of North America, only a handful of state-chartered banks were in operation in the entire country, each issuing its own notes in a limited geographic area. The Constitution outlawed the issue of paper money by state governments.

In 1789, Washington appointed Hamilton his secretary of the Treasury. Finally, Hamilton was in a position to put his long-standing plan for a national bank into action.

A bold proposal

The 34-year-old secretary made his pitch to the first Congress in December 1790, in his Report on a National Bank. Like Hamilton’s three other major reports to Congress, on public credit, the Mint and manufacturing, it was lengthy, meticulously researched and highly persuasive. In his seminal 1910 treatise on the First Bank, banking historian John Thom Holdsworth calls the report “undoubtedly the most informing and illuminating presentation of banking principles and practice known to American literature up to that time.”³

Noting that banks had proven their value to government and business in the world’s leading economies, Hamilton argued in the report that the country needed a national bank to help it shake off its financial malaise and join the company of modern commercial nations. A Bank of the United States would not only enhance the federal government’s creditworthiness by issuing a currency suitable for the payment of taxes, investing in war debt and lending to the Treasury in emergencies, it would also expand the money supply and provide credit to merchants and other businesses to foster trade, both within the country and across the sea.

Hamilton echoed Smith’s The Wealth of Nations in describing banks as “nurseries of national wealth” that transformed the “dead stock” of gold and silver into active and productive capital that rippled through the economy, creating wealth and increasing welfare.⁴ Deposits and stock investments in a national bank would support increased currency circulation, relieving farmers and merchants of the need to resort to barter.

To avoid the inflation caused by the wartime continentals, Hamilton proposed that the bank issue notes redeemable on demand for specie. The bank and all other banks in the country would operate under a mixed-money system, cutting-edge monetary practice in the age of the gold standard. Paper currency issued by the national bank and state-chartered banks would be a close substitute for gold and silver coin in financial transactions; thus the nation’s currency would be stable, anchored to a bimetallic monetary standard, and portable, expediting the transport of funds and speeding circulation.

As in his earlier proposals, Hamilton stressed the importance of a quasi-public structure for the bank. It would serve the national interest, but under the control of private individuals, not government officials. In studying other great banks of issue, such as the Bank of England and Bank of Amsterdam, he had concluded that a national bank must be shielded from political interference: “To attach full confidence to an institution of this nature, it appears to be an essential ingredient in its structure that it shall be under a private not a public direction, under the guidance of individual interest, not of public policy.”⁵

The federal government would be a minority stockholder in the bank, authorized to hold up to one-fifth of its capital and vote for directors. But the remaining $8 million in stock would be held by private investors—merchants, landowners, speculators or anyone else who could pony up the required funds.

One of Hamilton’s primary goals in establishing the bank was financing the country’s war debt, which included the debts of individual states assumed by Congress. His plan for the bank provided for this by requiring that 75 percent of its privately held shares be bought with “government stock”—Treasury bonds paying 6 percent interest. (The balance was to be paid in specie.) Like the Bank of England, which had invested heavily in British government debt, the Bank of the United States would unite the interests of private enterprise in support of public credit. Bank shareholders would profit as the government paid off its debts over time. Meanwhile, the bank’s government debt—as good as gold in Hamilton’s calculus—would serve as collateral for increased currency circulation, stimulating commercial development.

In hindsight, Hamilton’s bold, financially creative proposal was more than a plan for a national bank; it was the springboard for a future U.S. economy based on private capital and the creative use of various forms of bank credit, including government debt.

Fighting words

This grand plan for economic unity and progress under the aegis of a national bank was not universally embraced. Hamilton had to summon all his analytical and rhetorical gifts to overcome the objections of men who received his proposal coolly, if not with disdain. Congressional debates in early 1791 over the constitutionality of the bank had political as well as monetary consequences; Hamilton’s proposal alienated him from founders Jefferson and James Madison, and helped to open a permanent schism in the halls of power.

Many politicians of the period, especially those from the agricultural South, scorned banks as corporate monopolies that profited merchants and financiers, but defrauded farmers and other ordinary people. Jefferson, secretary of state in the Washington administration, saw banks, credit and stock markets subverting his ideal of America as a self-reliant, agrarian utopia with limited industry. Vice President John Adams abjured debt and dismissed bankers as “swindlers and thieves.”⁶ Much of the debate turned on the interpretation of a clause in the Constitution that allows the federal government to enact “all laws which shall be necessary and proper” for the carrying out of explicit powers such as borrowing money and collecting taxes. Jefferson argued in a written opinion to Washington that a national bank may be convenient, but not truly necessary or indispensable for the execution of the government’s enumerated powers. Therefore, Hamilton’s bank was unconstitutional.

James Madison of Virginia, co-author with Hamilton of the Federalist Papers, agreed with Jefferson. He added that a national bank would conflict with state interests under the Constitution by interfering with the right of states to charter and oversee their own banks of issue.

Hamilton and allies, such as Congressman Fisher Ames of Massachusetts, countered that a national bank was indeed necessary for the reasons laid out in the proposal before Congress. If it was necessary, then it was proper under the Constitution and did not pose a conflict with states’ rights. Furthermore, the bank would energize state economies in the agricultural South as well as the mercantile North.

The bitter skirmish between Hamilton’s and Jefferson’s followers over the First Bank was the first clash in what would become an endless war of words in America—partisan politics. Quoting Chief Justice John Marshall, Chernow notes that the dispute led to the emergence of “those distinct and visible parties which in their long and dubious conflict for power have … shaken the United States to their center.”⁷ For the next 30 years, Hamilton’s Federalists vied with Jeffersonians (or Democratic-Republicans) for mastery of the government. Although the parties’ names and constituencies have morphed over the intervening 200 years, the lineage of today’s Republicans and Democrats extends back to these original foes.

After Congress passed a bill adopting Hamilton’s proposal, its fate lay on Washington’s desk; the president had been swayed by Jefferson’s arguments and was considering vetoing the measure. Hamilton defended it in a 15,000-word manifesto that articulated what would come to be known as the implied powers doctrine; that is, the government has the right to employ any means necessary to execute its express powers under the Constitution. In ringing phrases, Hamilton asserted that “every power vested in a government is in its nature sovereign and includes, by force of the term, a right to employ all the means requisite and fairly applicable to the attainment of the ends of such power.”⁸ This doctrine became embedded in constitutional law, giving the federal government broad scope to exercise its authority.

Washington was convinced. On Feb. 25, 1791, he signed the act incorporating the Bank of the United States, clearing the way for the sale of stock (the government borrowed $2 million from money lenders in Amsterdam to purchase its stake) and the start of operations.

The nation’s bank

Little is known about those operations; virtually all the bank’s records were destroyed in the early 1800s. But what evidence exists shows that the bank largely succeeded in accomplishing Hamilton’s aims—jump-starting the economy and building public confidence in the Treasury and financial markets. By virtue of the sheer volume of transactions flowing through its Philadelphia office and regional branches, the bank was by far the single largest financial entity in the country. The economic changes it wrought were pervasive and arguably long-lasting.

By converting war debt into bank stock, the bank relieved the government of that financial burden and sent a message to investors at home and abroad that the United States would honor its debts. (To this day, the Treasury has never defaulted on a bill, note or bond.) In an era when the government could not count on a steady income—there was no income tax; import duties and public land sales made up the bulk of federal revenue—the bank sustained daily operations with short-term loans. By the end of 1795, the Treasury, now led by Hamilton’s successor, Oliver Wolcott, had borrowed a total of $6.2 million from the bank, more than 60 percent of its capital.⁹

A robust currency circulation and lending to other banks and businesses stimulated the economy, leading to increased domestic and foreign trade that generated income and job growth. Unlike paper issued by state banks, the First Bank’s widely circulated notes were accepted by the federal government for the payment of duties. Although the United States would not have a true uniform currency until after the Civil War, “it is certain that the notes of no state bank possessed to anything like the same degree the quality of universality” of the national bank’s notes, Holdsworth writes.¹⁰

In its organization and many of its functions, the First Bank foreshadowed the Federal Reserve System. Like the Fed, the First Bank was quasi-public in nature; as Hamilton intended, it served a public purpose, but independently from the administration and under the direction of private interests. (Nominally, each regional Federal Reserve Bank is owned by its member banks.) Also like the Fed, the First Bank acted as the government’s fiscal agent and held its bank balances. And just as the Fed’s 12-bank network does today, the First Bank’s eight branches extended its influence throughout the country. “I think there are enough parallels, enough elements there that you could say that Hamilton’s bank was the progenitor for at least some functions of the modern Fed,” Humphrey says.

Scholars such as Richard Timberlake Jr., a former economics professor at the University of Georgia, have pointed out that neither Hamilton nor Congress intended the First Bank to control the size of the money stock—a defining function of the Fed and other modern central banks. Nevertheless, Timberlake contends that over the course of several years the bank took on that role, leveraging its large transaction volume and reserve balances to expand or constrain the money supply. To rein in credit, the bank promptly presented the state banknotes that passed through its offices for redemption in specie, reducing the lending capacity of the issuers. To ease credit, the bank lent more to businesses and banks and treated state banknotes with “forbearance.”¹¹ Timberlake sees this activity as an early form of open market operations—resented by many state banks—that acted as a check on inflation.

The parallels with the Federal Reserve go only so far, however. The Fed neither lends to government nor operates as a commercial bank, accepting deposits from and making loans to businesses and individuals. Also, the Fed enforces reserve requirements, examines accounts and exercises other regulatory authority over banks—powers not contemplated by the creators of the First Bank.

Political defeat, economic victory

For all its successes, Hamilton’s bank could not overcome its political liabilities. When its charter came up for renewal in 1811, the Federalists were out of power; the Democratic-Republicans, who had remained hostile to the bank, now held the majority. Renewing Jefferson’s attack of 20 years earlier, they charged that the bank was unconstitutional, a perversion of the necessary-and-proper clause.¹² Hamilton’s enemies had allies at many state banks, whose ranks had swelled to 90 since the First Bank’s founding. Coveting the bank’s federal government deposits, the directors of these banks—along with the representatives of state governments that owned bank stock—lobbied against recharter. The bank’s opponents also accused many of its directors of being Tories or monarchists, noting darkly that British investors held a large amount of its capital.

This time there was no Hamilton to mount a passionate and brilliant defense; Aaron Burr had killed him in a pistol duel seven years earlier. Despite support from President James Madison and Treasury Secretary Albert Gallatin, Congress let the charter expire, and the bank closed its doors on March 3, 1811.

The Hamiltonian model of banking and monetary policy did not die with the First Bank, however. Out of the financial chaos that followed the War of 1812 rose a Second Bank of the United States. This federally chartered, well-capitalized institution was not as well managed as its predecessor, but in time it too exerted central-bank-like influence over the economy. During the war the number of state banks exploded, and they stopped redeeming their notes for specie, contributing to high inflation. Leveraging its large currency reserves, the Second Bank encouraged the redemption of those bank-notes for gold and silver, helping to shrink the money supply and stabilize prices.

The Second Bank’s life was also cut short; irked by its burgeoning monetary and political power, President Andrew Jackson refused to renew its charter, and the bank ceased operations in 1836. But even in the absence of a central bank, the ideas that Hamilton expounded and put into practice endured. In the 19th century, bank lending supported in part by state and federal credit spurred business growth, planting the seeds for the nation’s flowering into an economic power after the Civil War.

After a financial panic in the early 1900s, Congress revived Hamilton’s notion of a centralized, quasi-governmental bank exerting a positive influence on the monetary system and the overall economy. The Federal Reserve Act of 1913 created the system of Reserve Banks that has provided a backstop for commercial banks and shaped monetary conditions ever since.

In ensuring the demise of the First Bank, the Democratic-Republicans may have won their political battle with Hamilton, impugned by Jefferson as “the servile copyist”¹³ of British Prime Minister William Pitt. But history has given economic victory to Hamilton. The economy that developed in this country would not realize the Jeffersonian ideal of yeoman farmers and artisans producing goods from their own resources, unassisted by banks and financial markets. Instead, it would embrace Hamilton’s capitalist vision—sophisticated, multifarious commerce thriving on a sound currency and ready access to credit.

Successive generations of Americans have reaped the rewards of the economic revolution that began with the opening of the First Bank of the United States.

Endnotes

¹ Ron Chernow, Alexander Hamilton. New York: Penguin Books, 2004, p. 344/p>

² Bray Hammond, Banks and Politics in America: From the Revolution to the Civil War. Princeton: Princeton University Press, 1957, p. 47.

³ John Thom Holdsworth and Davis R. Dewey, The First and Second Banks of the United States. Washington, D.C.: Government Printing Office, 1910, p. 13.

⁴ Alexander Hamilton, The Papers of Alexander Hamilton, ed. Harold C. Syrett and Jacob E. Cooke. New York: Columbia University Press, 1961–1987, vol. 7, p. 308. “Report on the Bank,” Dec. 13, 1790.

⁵ Ibid., p. 331.

⁶ Joseph J. Ellis, Passionate Sage: The Character and Legacy of John Adams. New York: W.W. Norton, 1994, p. 161.

⁷ Chernow, p. 351.

⁸ The Papers of Alexander Hamilton, vol. 8, p. 98. “Final Version of an Opinion on the Constitutionality of an Act to Establish a Bank,” Feb. 23, 1791.

⁹ Holdsworth, p. 45.

¹⁰ Ibid., p. 94.

¹¹ Richard H. Timberlake Jr., Monetary Policy in the United States. Chicago: University of Chicago Press, 1993, p. 10.

¹² The constitutionality of a national bank with broad monetary powers would not be affirmed until 1819, in the landmark U.S. Supreme Court case McCulloch v. Maryland. Echoing Hamilton’s assertion of implied powers in 1791, the Court ruled that Congress indeed had the power to incorporate such a bank under the necessary-and-proper clause.

¹³ Letter from Jefferson to James Monroe, May 26, 1795, in Paul Leicester Ford, ed., The Writings of Thomas Jefferson. New York: 1896, VII, 16.