Hamilton on Banks, Paper Money and the First Subprime Bailout

Alexander Hamilton began the tradition of big government conservatism. His followers have included Henry Clay, Abraham Lincoln, Theodore Roosevelt, Nelson Rockefeller and George W. Bush. In today's nomenclature, Hamilton was the first "Republican". In other words, the Republicans have been traditionally the party of inflation, and it was only intermittently, during the century from 1871 to 1971, that the Republicans could claim to support hard money. For the first 25 years of that century, the Democrats too were a hard money party. It was only by default that the Republicans became associated with monetary stability in 1896, and they have always been wobbly supporters. The Benjamin Strong Fed was inflationary, with the approval of the Harding and Coolidge administrations. The deflation of the Hoover administration was a product of Fed policy and had little to do with Hoover. Yet, the segment of Americans who are able to grasp this issue and are anti-inflation mostly remain within the Republican party. perhaps the greatest political betrayal of the late twentieth century was Ronald Reagan's decision to adopt Keynesian (supply side) deficit and expansionist policies despite his mandate from the Reagan Democrats. Both American political parties today descend from Hamiltonian centralizing, banking and rationalizing theories. Those who are skeptical of central economic planning, big government, Keynesian economics and the ability of academics to foresee progress have nowhere to turn. Both parties are marionettes of Wall Street.

Hamilton argued for federalism and centralization of government, a central bank and for banking in general. He was an elitist who believed in the ability of bankers and merchants to make use of artificially created money in the form of bank notes to expand the economy, and this theory provided the fulcrum on which his advocacy of the Bank of the United States pivoted. He argued that bankers can rationally assess risk. He makes the same aarguments that we hear on CNN and read in the New York Times today. The themes that Hamilton emphasized, paper money, central banking, rationality of business strategy, the importance of fractional reserve banking to stimulating the economy and the ability of the business elite to build the economy were paradigms for subsequent Whig, progressive, and New Deal ideologies, of which George W. Bush and Barack Obama are the latest manifestations.

There were two strange turns in the history of the elitist, centralizing ideology. At first, Jefferson and then Jackson reacted to the Federalist-Whig philosophy of Hamilton, Clay (and then Lincoln) by advocating decentralization and hard money. Thus, decentralization and hard money were benign views that represented the values of the workman. The loco focos and workingmen's parties of the 1820s and 1830s reflected the Jacksonian resentment of banks, business monopolies, internal improvements (the profits from which went into the pockets of elite Whig stockholders) and the central bank.

In the Gilded Age, the laissez-faire ideology became associated with the elite. This was a reversal. It occurred because laissez-faire became associated with social Darwinism in the ideas of Spencer and William Graham Sumner. Thus, the Mugwump Republicans carried forward the Republican centralizing and elitist views but adopted the laissez-faire and hard money philosophy of Jefferson and Jackson because it fit the ideas of social Darwinism. This deprived the hard money position of its benign, pro-worker foundation. So by adopting laissez-faire the Republicans weakened the force of its claims and destroyed it. They did this by claiming that only the fittest would benefit from hard money. This opened the door for the Democrats to claim that central banking, the chief elitist tool, was Democratic. Then, Progressivism removed the laissez-faire element from the Gilded Age's rationalizing philosophy, retaining the traditional Hamiltonian claims of rationality of business and banking elites, the importance of a centralized state, the virtue of elite experts, and centralized banking.

In 1790 Hamilton, as the first Secretary of the Treasury, wrote his Report on Public Credit and Second Report for Further Provision Necessary for Establishing Public Credit. He also wrote a report on the Constitutionality of the Bank and Report on Manufactures. The issues in the Report on Public Credit directly concerned the question of centralization and of establishing a central bank. The questions that faced the nation at that point concerned federal assumption of the states' revolutionary war debts and how such assumption would be arranged; and the question of whether the federal government should honor its debts at par, especially because speculators had purchased bonds at steep discounts; and the payment of interest on the outstanding debt. Hamilton argued for stabilizing the nation's credit record and honoring debts.

Hamilton argues for the importance of federal debt to the expansion of the US economy. He argues that a funded debt (which has been converted into bonds and for which there is funding) can expand economic activity because the debt can function as money and because debt will cause real estate prices to appreciate. The notion that inflation can help real estate investors finds legitimacy in Hamilton's report to the first Congress. He writes (p. 6):

"The effect, which the funding of the public debt, on right principles, would have upon landed property, is one of the circumstances attending such an arrangement, which has been least adverted to, though it deserves the most particular attention. The present depreciated state of that species of property is a serious calamity. the value of cultivated lands, in most of the states, has fallen since the revolution from 25 to 50 per cent. In those farthest south the decrease is still more considerable...This decrease in the value of lands, ought, in a great measure, to be attributed to the scarcity of money."

Thus, Hamilton was among the first Americans to recognize the possibility of monetary expansion to transfer wealth to the landed, the stock holder and the wealthy. This theme was to continue throughout American history except for the four post Civil War decades because of the ideology of social Darwinism. Notably, it was in the post Civil War period that the United States made the lion's share of its economic progress, beginning with the abolition of the bank in 1836 through the advent of Progressivism in 1905.

Hamilton's preference for centralization is explicit in Report on Public Credit. It is much better, he argues, for creditors to receive payments from one source than from the several states. If the central government takes responsibility "there can be no competition for resources" and "different states, from local considerations, would in some instances have recourse to different objects, in others to the same objects, in different degrees, for procuring the funds of which they stood in need. It is easy to conceive how this diversity would affect the aggregate revenue of the country....hence the public revenue would not derive the full benefit of those articles from state regulation." Moreover, "if all the public creditors receive their dues from one source, distributed with an equal hand, their interest will be the same. And having the same interests, they will unite in support of the fiscal arrangements of the government; As these, too, can be made with more convenience, where there is no competition: These circumstances combined will insure to the revenue law a more ready and more satisfactory execution."

It was important to Hamilton to establish the national credit and he was certainly concerned with the interests of creditors, whom he saw as furthering national goals. To this end, Hamilton emphasized the importance of repaying the national debt, including interest. In the end there was a slight reduction in interest (see Elkins and McKitrick, The Age of Federalism.) But the nation did not make good on the currency it used to pay for the Revolutionary War, the Continentals. The federal government allowed them to become worthless.

In Second Report on the Further Necessity for Establishing Public Credit, Hamilton argues for a central bank and extols fractional reserve banking. Little has been added since Hamilton.

One passage that caught my eye might be extended to the subprime crisis and every other boom and bust bubble that has occurred since, including the one that occurred in 1790 in New York with respect to speculation in the stock of the First Bank of the United States:

"It may be said that as Bank paper affords a substitute for specie, it serves to counteract that rigorous necessity for the metals...and...it would retard those oeconomical and parsimonious reforms in the manner of living, which the scarcity of money is calculated to produce...

"There is perhaps some truth...but...of a nature rather to form exceptions to the generality of the conclusion, than to overthrow it...a situation in which a too expensive manner of living of a community compared with its means, can stand in need of a corrective, from distress of necessity, is one which perhaps rarely results, but from extraordinary and adventitious causes, such for example, as a national revolution, which unsettles all the established habits of a people, and inflames the appetite for extravagance, but the illusions of an ideal wealth, engendered by the cause. There is good reason to believe that where the laws are wise and well executed, the oeconomy of a people will, in the general course of things, correspond with its means."

Throughout the two reports on credit, Hamilton emphasizes the rational capacity of bankers and merchants and their sound judgment (e.g., "Those who are most commonly creditors of a nation are, generally speaking, enlightened men...", p. 3, Report Relative to Public Credit).

Hamilton argues vigorously for the positive effects of monetary expansion and a central bank. He argues that "Gold and Silver, when hey are employed merely as the instruments of exchange and alienation, have been not improperly denominated dead Stock; but when deposited in Banks, to become the basis of a paper circulation...they then acquire life." By depositing money in a bank, merchants enable others to borrow and "It is a well established fact, that Banks in good credit can circulate a far greater sum than the actual quantum of their capital in Gold and Silver. The extent of the possible excess seems indeterminate; though it has been conjecturally stated at the proportions of two and three to one."

This rousing defense of fractional reserve banking presaged two centuries of booms and busts, the most recent being the multi-trillion dollar transfer of wealth to wealthy bankers from the general economy and an aggressive monetary expansion.

Hamilton's ideas were rejected in the early nineteenth century but subsequently adopted by both political parties in the twentieth. Most progress occurred in the 19th. The twentieth century was one of reaction and decline.

Evolution of Progressivism as Elitist Paradigm

The debate between individualists and social democrats centers on the effects of centralization and the scope of rationality. Social democrats or "progressives" argue for enhanced centralization and the possibility of broad rationality in policy making. The rationality is accomplished through elite experts who claim to have superior, scientific knowledge obtained through university education. Individualists, in contrast, argue for the necessity to coordinate economic activity through decentralized, autonomous producers who are coordinated via price and motivated by private property. The debate between advocates of price versus hyper-rationalistic human planning through a centralized government agency would seem to have been settled in the 1980s. None of the socialist states was able to successfully implement centrally planned economies. Moreover, the tyranny associated with communism confirmed the worst fears of Milton Friedman and others. Yet, as late as 1972, when it had become evident that the Chinese communists had murdered approximately 25 million people, leading advocates of rational planning, John Kenneth Galbraith and Wassily Leontief, argued for the virtues of the Chinese communist system in the pages of the New York Times Magazine. Within a decade the Chinese themselves admitted that their approach to communism had failed, yet this had escaped the expertise of American universities' most famous economists. Now, 20 years after the final failure of Soviet communism, American academics and the Democratic Party continue to argue for state coordination and elitist-conceived solutions to elitist-conceived problems.

The question of centralization and decentralization has a long history in the United States. Its advocates hearken back to the ideas of Steuart and Shaftesbury and Hume, who was an anti-rationalist in epistemology and ethics but a rationalist in economics. Alexander Hamilton adopted the ideas of Hume and aimed to implement the mercantilist model. The Federalists believed that elite business people had exceptional rationality so that they could transform paper money into enhanced real wealth. This idea came from Hume. In turn, the elitist centralizing and hyper-rationalist idea was adopted by the Whigs, Henry Clay and then Abraham Lincoln, and carried forward by the Republicans in the form of advocacy of high tariffs and national banking. Although the Republicans voiced the ideology of laissez faire in the late nineteenth century, their reform impulses, as reflected in the National Banking Act, the Morrill Act, high tariffs, and the Pendleton Act reflected a centralizing interest in rationality. In turn, the early twentieth century Progressives advocated rationality and centralization, and this theme was reenforced by the New Deal.

If one looks at the social origins of the centralizing rationalists in American history there was a transformation in the late nineteenth century. Hamilton and Clay were a Federalist and a Whig who came from modest origins. Hamilton was an orphan who had won the support of businessmen in Nevis who financed his education and Clay was from a frontier middle class background, although he claimed to be poor. This was William Henry Harrison's response to the Jacksonian common man ideology of which Louis Hartz writes and that Abraham Lincoln carried forward.

A shift occurred in the Gilded Age. The Mugwumps did not identify themselves as having come from poor backgrounds. Their interest in rationalization of civil service and contempt for corruption was a reaction to Jacksonian democracy. They were college educated and saw themselves as differentiated from the mass of Americans and immigrants because of their education. They conceptualized themselves as a self conscious elite, and were other-directed. Their opposition to James Blaine in 1884 was group and media derived. It was fashionable. Among the Mugwumps was Theodore Roosevelt. Roosevelt rejected the laissez-faire philosophy of the older Mugwumps and carried forward the view of morality as an elitist obligation. Progressives saw reform as a class-linked moral prerogative. However, Roosevelt also advocated support for big business, centralized authority and the use of rationality as he defined it, for the ends that he defined as moral. The Progressives applied moral skepticism with respect to the natural rights philosophy, but moral dogmatism with respect to their social vision. They were other-directed in that the Progressive vision consisted of ad hoc propositions, news and whim of the elite itself. It claimed to be pragmatic, but refused to permit its dogmas to be falsified. Roosevelt initated a century long claim to superior mental ability of those who advocate the Progressive or liberal dogma.

The claim of superior mental capacity of a superior class follow through Hamilton, Clay and the Mugwumps, into Progressivism and the New Deal. Hamilton and Clay believed with Jefferson that there was a natural aristocracy. Hamilton and Clay both believed that government support for the elite would foster social goals because the elite could best use public wealth. The Mugwumps transformed the claim to superior knowledge from business to control of business via the state. This coincided with the increasing complexity and knowledge required to succeed in business. As technology grew more complex, the centralizing elitist philosophy dispensed with the claim that superior knowledge was needed to found and run business, and transformed into the claim that it was needed to regulate and dominate business.

The Mugwumps were the first group to identify altruistic or moralistic elitist aims. This came about because of their horror at the boss system and what they identified as pathologies of immigration and urbanization--slums and corruption. They sought to rationalize government.

Roosevelt was thus the product of the increasing wealth of American society. Unlike the early nineteenth century Federalists and Whigs, the Progressives made no pretense of humble origins but rather claimed an aristocratic elitism. Jane Addams was a social worker who aimed to altruistically help immigrant poor through a superior social position. Labor was viewed as ineluctably trapped in inferior class status. Class and group differences were viewed as inevitable, with the Progressive leadership expressing the altruism of the elite class. Government support for and rationalization of big business, the good trusts and the Federal Reserve Bank, the Workers' Compensation laws that limited employer liability in the name of altruistic concern for workers expressed the new elitism.

The Republicans' Whiggish Error

In Louis Hartz's Liberal Tradition in America* Hartz argues that all American ideology is ultimately liberal, to include the Progressives and the New Deal. Hartz's book was written right around the same time as William F. Buckley's God and Man at Yale. It would be interesting to hear how Hartz might have updated his argument in light of the predominance of European left wing and New Left ideology in today's universities. It is true that the elements of New Left ideology that seem to carry forward are in large part those that fit democratic liberalism, such as diversity. Nevertheless, it is also true that Americans have been increasingly indoctrinated in anti-liberal and anti-democratic rhetoric, such as support for ill-defined regulatory systems that benefit economic elites; emphasis on credentials developed by universities that economically support the same New Left ideologues; and a monetary system that is supportive of economic elites, to include the major universities, whose endowments have mushroomed under the Republicans, at the expense of the common working man, whose hourly wage has been decimated by the Keynesian economic policies that university professors have advocated since the 1930s.

Hartz's book is brilliant and perhaps it does not receive more attention is because of the increased emphasis on New Left solutions, and perhaps because he did not anticipate increased deference to elites by an American public that has been increasingly educated to do so. However, as a description of the main run of American history, to include the present, the book makes excellent points.

The history of the Whigs suggests why the Republican Party of the millennium has failed to capture the public's imagination. The Republicans cannot be an elitist party, that is, they cannot pander to the wealthy at the expense of the public. If they do the voters will, as they have, reject them. One of a number of turning points was Bill Frist's refusal to carry forward a law that would have limited federal support for states which permit private use eminent domain. Their failure do so in light of the case of New London v. Kelo captured the (in the early 19th century American sense) impulse of the Whigs.

In order to be successful, the Republicans must inspire the public with what Hartz calls the Alger myth. Americans are in large part desirous of economic opportunity. The Democrats have sacrificed the image of opportunity on the altar of special interest group politics and advocacy of wealth transfers to professional interest groups, real estate developers and Wall Street in the name of the poor. The Republicans cannot cloak the substance of their ideology in purely altruistic raiment because then America would have not two but one party, the Democratic. Nor can they, as they have done, adopt the 19th century Whiggish elitism that is contemptuous of the public. Rather, the Republicans must cloak their ideology in the raiment of economic opportunity. An ideology that capitalizes on such opportunity is believable only if it emphasizes and nurtures private property rights of individuals as against the state and special interests. As well, the Republicans must fathom the source of economic opportunity, which is free enterprise, without which entrepreneurs cannot execute new ideas.

Under George Bush and Bill Frist the Republican Party became a Whig Party, a party of economic elitism. The methodology it adopted was Federalist and Whiggish (in the nineteenth century American sense). It maintained and strengthened regulation; it supported central bank monetary expansion; and it sacrificed private property rights in the interest of frivolous, inept and too often corrupt big business, Wall Street and real estate schemes which have helped to bankrupt the nation.

Hamilton believed that there is a class of people, large commercial operators, who are best equipped to guide the economy. He was wrong. As all who have worked in the real world of industry know the best ideas come from the man or woman on the production line, not the executive. One example is that of Ray Kroc, the builder of McDonald's, who did not create most of the chief concepts that made McDonald's successful (with the exception of a strong emphasis on uniformity and quality of execution), from the concept of scientific management of fast food production to Ronald McDonald, to the firm's use of cash flows, to real estate investment in the stores, to the Big Mac to the Filet O Fish, almost all of McDonald's chief ideas came from franchisees or Kroc's employees.

If so, then why have the Republicans chosen to revert to the Hamiltonian fantasy of a big business elite that is able to guide the economy with freshly minted Federal Reserve counterfeit rather than the reality that the development of new ideas depends on entrepreneurs? The Kelo case brought the Republicans' Whiggish error home.

To quote Hartz (pp. 94-5):

"American Whiggery...could have transformed the very liability of the American liberal community into a tremendous asset. For if the American democrat was unconquerable, he was so only because he shared the liberal norm. And this meant two things: one, that he was not a real threat to Whiggery; and two, that Whiggery had much to offer him in the way of feeding his capitalist impulse. Thus what Whiggery should have done, instead of opposing the American democrat, was to ally itself with him...It should have made a big issue out of the unity of American life, the fact that all Americans were bitten with the capitalist ethos which it was trying to foster. It should, in other words, have developed some sort of theory of democratic capitalism which fit the Tocquevillian facts of American life.

"But this, as we know, is precisely what Whiggery failed to do until it saw the light in 1840, and indeed, in any large sense until the post-Civil War days of Horatio Alger and Andrew Carnegie. Over most of its early history, it pursued a thoroughly European policy, and instead of emphasizing what it had in common with the American democrat, it emphasized precisely what it did not have in common with him. Instead of wooing this giant, it chose, quite without any weapons, to fight him. This would be a high species of political heroism were it not associated with such massive empirical blindness. One can admire a man who will not truckle to the mob, even though the mob is sure to beat him, provided there is actually a mob in the first place. But in America there was no mob: the American democrat was as liberal as the Whigs who denounced him. Consequently the suicidal grandeur of Fisher Ames is tinged with a type of stupidity which makes admiration difficult. At best one can find in the Whigs a kind of quixotic pathos....They pursue the usual conservative strategies but are baffled and dumbfounded at every turn..."


*Louis Hartz, The Liberal Tradition in America. New York: Harcourt, Brace and World, 1955.