Sylla, Richard (2008) “The Political Economy of Early U.S. Financial Development”, in Political Institutions and Financial Development, ed. Stephen Haber, Douglass C. North and Barry R. Weingast. Stanford: Stanford University Press, 60-91.
In only seven years, from 1788 to 1795, the US underwent a dramatic financial revolution; starting from scratch and swiftly acquiring all the key components of a modern financial infrastructure. By the time the westward expansion and the industrial take-off were ready to swing into action, a strong financial system was there to back them (p.62). But what allowed the US to develop these instruments?
I have a dream (or two)
While the Independence War was still going on the young Alexander Hamilton presented what would later become the backbone of the US financial system. Hamilton planned to use a foreign loan to set up the currency-issuing Bank of the United States (BUS) that would in turn finance the government (p.64). Based on the English Example, the institution would have public securities as part of its capital (p.65).
Hamilton was adamant that future growth and good governance would allow the Republic to float easily its national debt and limit the recourse to foreign funds to the very early stages. A first attempt to acclimatize central banking in the US was initiated in 1781 by Robert Morris (using French capital) but it was not successful (p.66).
Free at last
When Hamilton became secretary of the Treasure in 1789, he quickly endeavoured to implement his plan. In 6 years he managed to import institutions that had taken decades to develop in England and the Netherlands (p.67). The US started with a significant wartime debt to service, further expended by Hamilton’s decision to incorporate to the federal debt, the ones contracted by the individual states (p.68).
But the fiscal apparatus also needed to be created and the government could not levy the $3.6 million required yearly by its creditors before 1792 (p.69). State debts had been assumed by the federal government to avoid that a single default stained the credit of the others as well as to prevent competition for revenue base (p.70). This decision led to the creation of active secondary markets for Treasury bonds (p.71).
A good ol’ rebel
Several politicians opposed Hamilton on the ground that the BUS was nowhere authorized in the constitution. However, Hamilton countered this argument by underlining the fact that the constitution also left explicit power to the lawmakers to create new institutions, the BUS being one of them (p.72). Meanwhile, the bank had become a reliable source of short-term credit for the Treasury and its nationwide branch network eased transfer of government funds wherever it was needed (p.73).
“As in his advocacy of tying tax increases to service and redeem debts to every debt issue, Hamilton comes across as wanting the federal government to avoid the temptations of pursuing time-inconsistent financial policies” (p.74).
Hamilton ambition to develop a bimetallic dollar in order to increase money supply however could not be sustained as the ration failed to remain stable.
Let 1600 flowers blossom
By 1795, the US had 20 incorporated state banks (p.75) and 5 branch offices of the BUS. By 1805, the total had rose to 80! The creation of the central bank seems to have pressured states legislation into accepting more liberally the chartering of new banks (a process of vertical competition seems to be at play here; p.76). However a federal structure as such is not necessarily sufficient to foster banking growth, indeed from 1811 to 1832 the central government had a negative impact on the creation of new institutions (p.77). Despite those setbacks, by 1860, there were 1600 banks in the country.
The decision of the government to assume state debts simplified the securities market and thus increased liquidity (p.79). The initial public offering of the BUS was more controversial as it led to a speculative bubble which burst in the early months of 1792 (p.80). What appeared especially contentious was the fact that the southern gentry saw bonds and shares as artificial property which undermined its monopoly over “real” property (slaves and land; p.82). Unsurprisingly when the slave-owning class acceded to power in 1801, he critics became muted.
“The most distinctively American feature of the early US financial development was the proliferation of corporations” which put the young nation several decade ahead of Europe (p.83). From 1781 to 1790, 28 new business corporations had been chartered in the US, from 1791 to 1800, this figure jumped to 295. Competition between states forced them to emulate each other’s chartering system, while the BUS and the Treasury bonds had created a new “security ownership culture” (p.84).
The BUS had proved useful but also an unwanted competition for the bank-chartering states. The central bank was closed in 1811. Its absence “was sorely felt in the War of 1812, and a second bank was chartered in 1816 (p.85). The second closure of the bank in 1832, led to a long period of financial instability (p.86). Ultimately:
“leaders who understand fiancé and its relationship to growth, and who are also skilled in getting things done politically, may matter as much as political structures in producing good outcomes” (p.87).
Disclaimer: this summary is written by the contributors of the blog and not by the author of the article. Any mistake is Manuel’s fault (and he shall be punished).