THE FIRST BANK OF THE USA – A NECESSARY EVIL?

FT Alphaville has run a series of stories in recent weeks that compared the problems in the EMU to that of the early USA.  It turns out that there was a great deal of logic to the idea of a bank of the USA – the “monster” that Alexander Hamilton built in the late 1700s.  The same bank that created so much angst between small government and big government Americans actually solidified our union and ultimately played a vital role in helping create a functioning US economy.  There was a real genius behind Hamilton’s creation (via FT Alphaville):

“Basically, northern US states had issued debt to fight the war against the British, but quickly went bust in a recession after. Fiscally-correct southern states refused to bail them out. (Yeah, geographically upside-down but very familiar, isn’t it?) Northern bonds collapsed in price in the meantime, directly affecting members of the public who had bought them at face value.

It was getting to one side of the other seceding or even the Union crashing towards disorderly default, when Hamilton rocked in and came up with a plan. A debt assumption plan — the First Report on Public Credit — which effectively restructured state bonds as the price for fiscal union and ultimately, the USA’s status as the world’s safest sovereign credit. If you’ve ever read the Federalist Papers (really, who hasn’t?) you’ll know Hamilton had long seen a robust public debt as the anchor for a strong economy.

The federal government would assume the debt and issue bonds to cover them, but would only pay off interest, not the outstanding principal. It’s possible to argue whether this was really a sovereign default, we suppose, but FT Alphaville reckons that if there had been ye olde credit default swaps at the time, they would have triggered.”

They’ve written a follow-up post here.  For those who aren’t up to snuff on their history of the first Bank of the USA, enotes has a quick cheat sheet:

“Alexander Hamilton, secretary of the treasury during the 1790s, had observed the instability of his fledgling republic during the 1780s, when it still operated under the Articles of Confederation. The new nation’s finances and politics then seemed in disarray. Shortly after the government established by the U.S. Constitution began working in 1789, Hamilton devised an economic plan intended to bring stability and prosperity to America’s finances.

The Bank of the United States became a central feature of Hamilton’s scheme. He expected that a national financial institution such as the Bank would centralize and manage the nation’s currency and credit. The Bank would hold government monies and issue notes that could be used to pay debts to the state. It would also extend loans to stimulate manufacturing and economic growth. Additionally, Hamilton hoped that government could forge an alliance with the country’s wealthy elite, and indeed the Bank’s early subscribers were virtually all speculators and businessmen. The Bank played a vital role in the flourishing, commercialized society that Hamilton and the Federalist Party envisioned, and in 1791 Congress officially chartered it for a period of twenty years (1 Stat. 191).”

Now, it’s difficult to find raw economic data from that period, but the USA was clearly suffering from many of the same problems that we see in Europe today except that it was even more loosely organized.  What the USA needed was not only a common currency, but a fiscal transfer system whereby a supranational entity could manage the finances of the entire union without the mess of state liquidity issues every few years due to trade and imbalances within the union.  This was the only way to make the union fully functional.  The Bank of the USA was a necessary evil in order to make the union work from an economic perspective.  And boy has it worked!  In just 235 short years this union grew to become the largest economy in the entire world.