Financial University lecture, Moscow25.10.10

“Alexander Hamilton and the US Financial

Revolution of the 1790s

Richard Sylla, New York University

Financial Revolution

What is it? Emergence, in a brief period of history, of a modern financial system with:

• Stable public finances and public debt management• Stable Currency/Money• A good banking system• An effective central bank• Efficient securities markets• Business corporations—financial & non-financial—

authorized by governments and with shareholders and managers

Historical Financial Revolutions

Which countries in modern history had financial revolutions?

• Successful cases:– Dutch Republic, 1550-1620– England, 1688-1740s– USA, 1789-1795– Japan, 1870s-1880s

• Aborted case: – France, 1715-1720 (John Law)

Who was Hamilton? (1)

• Born 1757 (or 1755) on island of Nevis in West Indies

• Illegitimate child; orphaned in 1768• Showed high intelligence, and was sent to

American mainland for education in 1772• King’s College (now Columbia University) in

New York, 1773• Revolutionary (anti-British rule)

pamphleteer, 1774-1775

Who was Hamilton? (2)

• Captain, New York Artillery Co., 1775-77

• Lt. Colonel, Continental Army, and principal aid de camp to Gen. Washington, 1777-1781

• Lawyer, New York, 1782-1804

• Member of Confederation Congress and New York legislature, 1780

• Founder, Bank of New York, 1784

Who was Hamilton? (3)

• Annapolis Convention delegate, 1786• Philadelphia Constitutional Convention

delegate, 1787• Principal author of Federalist Papers, 1787-

88• Washington, first president of US under

Constitution, 1789-97, appoints Hamilton Secretary of the Treasury (finance minister), 1789. Serves from 1789 to 1795.

The US Financial Revolution

• The US financial revolution of the early 1790s gives the new federal government strong public finances and debt management, and also jump starts the modern growth and development of the US economy.

Real GDP Per Capita in the United States, 1790-2006

$100

$1,000

$10,000

$100,000

1790

1798

1806

1814

1822

1830

1838

1846

1854

1862

1870

1878

1886

1894

1902

1910

1918

1926

1934

1942

1950

1958

1966

1974

1982

1990

1998

2006

Year

2000

US

D

US Growth Rates per year, 1790-2009

1790-1860 1860-1920 1920-2009

Real GDP 4.40% 3.61% 3.36%

Real GDP/Capita 1.30% 1.52% 2.13%

Population 3.02% 2.05% 1.20%

Finance and Economic Growth

• The USA grew at modern rates virtually from its start as a nation, from 1790 on

• Modernization of the US financial system—the financial revolution of the early 1790s—was a crucial input to growth

• The US financial revolution was conceived and executed mainly by Hamilton

US Financial System, 1788 and 1795

1788 1795

PUBLIC FINANCES, National

Bankrupt Thriving

MONEY Fiat state paper, foreign coins

Convertible US $

BANKS 3, no system 20 state, 5 BUS branches, system

CENTRAL BANK No Yes, with 5 branches

SECURITIES MKTS Trivial, sporadic Several cities, organized

CORPORATIONS Few Many more

The US Financial Revolution, 1789-95

• Stable public finances and debt management• Stable money• An effective central bank• A functioning banking system• Active securities markets• Growing numbers of corporations, financial and non-

financial

Before 1789, the US had none of these. By 1795, perhaps even by 1792, it had all of them.

Public Finance and Debt Management

• Establishing Public Credit—Hamilton’s January 1790 Report to Congress

--Fund all debts at par value (these were about 40% of GDP then), but at reduced interest rate

--No discrimination between ‘original’ and ‘present’ owners--Assume state debts--Commence interest on US debts in 1791, and assumed

state debts in 1792

Problem: Government revenues far from adequate to deliver on the promises

Solution: Using deft financial management, borrow from domestic banks and foreign lenders to meet obligations until tax revenues become adequate

US Government loan receipts used for domestic expenses and foreign debt service, 1789-1793

Q/HY/Y Loans Loans, %

revs

Loans, %

revs + loans

HY12/89 171.6b 106% 51%

Q3/90 50.0b Q6/90 25.0b Q9/90

Q12/90 Y1790 75.0b 5% 4%

HY6/91 Q9/91 361.4?

Q12/91 Y1791 361.4 14% 12%

Q3/92 405.9f Q6/92 140.0f

200.0B

Q9/92 200B Q12/92 156.6b

Y1792 1,102.5 30% 23%

Q3/93 680.7f Q6/93 200B

HY12/93 516.6f 400B

Y1793 1,797.3 39% 28%

Foreign Loans of the US Government, 1777-1803

Source Amount in $ Issue Year(s) Redemption Year(s) France, Farmers General

181,500 1777 1778-79, mostly 1793

France 3,267,000 1778-1782 1791-1795 Spain 174,017 1781-1782 1792-1793 France 1,815,000 1781-1782 1792-1795 France 1,089,000 1783 1795 Holland, 1782 2,000,000 1782-1786 1793-1797 Holland, 1784 800,000 1784 1801-1807 Holland, 1787 400,000 1787-1788 1798-1802 Holland, 1788 400,000 1789 1799-1803 Holland, 1790 1,200,000 1790-1791 1800-1804 Holland, Mar. 1791 1,000,000 1791 1802-1805 Holland, Sept. 1791 2,400,000 1791 1802-1805 Antwerp, 1791 820,000 1791-1792 1803-1805 Holland, Dec. 1791 1,200,000 1791-1792 1803-1807 Holland, 1792 1,180,000 1792-1793 1803-1807 Holland, 1793 400,000 1793 1803 Holland, 1794 1,200,000 1794 1805-1809 Louisiana 6% 11,250,000 1804 1812-1824

Report on the Bank, December 1790

• Hamilton’s plan for the Bank of the United States (1)

--Limited liability corporation, privately managed, with capital of $10 million divided into 25,000 transferable shares with par value of $400 each

--US government to take 5,000 shares (20%), paying for them with a loan from the Bank, to be repaid in installments over ten years

--Private investors offered 80% of shares, one-fourth payable in specie and three-fourths payable in the new US 6% bonds issued as part of the plan to restore public credit

Report on the Bank

• Hamilton’s plan for the Bank of the United States (2)

--BUS to have 25 directors, one to be president

--’Prudent mean’ voting rights—no shareholder to have more than 30 votes, regardless of no. of shares owned

--BUS bills and notes receivable in all payments to US

--Branch offices of ‘discount and deposit’ can be established throughout the US

--BUS to report to Secretary of Treasury as often as weekly, and Secretary has right to inspect BUS books

Hamilton’s Report on the Mint, January 1791

• Hamilton defines a new US dollar as the monetary base: ‘the unit in the coins of the United States ought to correspond with 24 Grains and ¾ of a Grain of pure Gold and with 271. Grains and ¼ of a Grain of pure silver, each answering to a dollar in the money of account.’

• Recommends various coins be minted, including ten dollar gold coins, one dollar silver and gold coins, ‘disme or tenth’ dollar coins, and a copper ‘Cent or Hundreth’ of a dollar.

• Congress enacts the plan a year later, but US Mint develops slowly, so foreign coins with dollar ratings are used for decades.

• A US dollar currency union among American states is established in the 1790s, two centuries before the euro. Monetary unification.

• Banks money—notes and deposits—are convertible into dollar base. US banking system expands rapidly after 1790.

Hamilton’s

US State-Chartered Banks: Numbers and Authorized Capital, by Region and Total, 1790-1835

(Capital in millions of dollars)

Region New Engl

Mid-Atl South West US

Year

No. Cap. No. Cap. No. Cap. No. Cap. No. Cap.

1790 1 0.8 2 2.3 3 3.1

1795 11 4.1 9 9.4 20 13.5

1800 17 5.5 11 11.9 28 17.4

1805 45 13.2 19 21.7 6 3.5 1 0.5 71 38.9

1810 52 15.5 32 29.4 13 9.1 5 2.2 102 56.2

1815 71 24.5 107 67.1 22 17.2 12 6.4 212 115.2

1820 97 28.3 125 74.4 25 28.6 80 28.4 327 159.6

1825 159 42.2 122 71.2 32 33.3 17 9.4 330 156.6

1830 186 48.8 140 73.8 35 37.3 20 10.5 381 170.4

1835 285 71.5 189 90.2 63 111.6 47 35.0 584 308.4

Compare and Contrast• Canada did not have chartered bank until 1817. It had 6 banks in 1830 and

16 in 1840.• Mexico did not have a chartered bank until 1863. It had 8 banks in 1883

and 46 in 1911.• In England, until 1825 all banks apart from the Bank of England had to be

unlimited-liability partnerships with no more than six partners. By 1825 the US had 330 state banking corporations and a central bank with 25 branches carrying on interstate banking.

• England, France, and Germany did not offer general incorporation to banks and other business until the latter half of the 19th century. By that time the US had thousands of corporations.

• The US had 80 banks and branches by 1805, 600 by 1835, 1,600 by 1860, and 25,000 by 1910. In 1913, the US had at least 30% of the total bank deposits of the entire world, and at least 36% of commercial bank deposits--far more than any other country.

Table 3. Corporations Chartered in USA, 1607-1800

Securities Markets: City Listings in 1811

Growth of the New York Securities Market, 1797-1832

Foreign Investment and Capital Flows to the US Emerging Market

• One of Hamilton’s main reasons for establishing a modern financial system in the US is that it would attract foreign investment and capital flows

• The new financial system did exactly that• The US economy and financial system have

continued to attract foreign investment and capital flows, with some fits and starts, for more than two centuries

A crucial US advantage: modern finance from the start

• The US westward expansion depended on finance: e.g., the Louisiana Purchase, lands sold on credit

• The US transportation revolution depended on finance: e.g. turnpike and bridge companies, the Erie and other canals, the railroads

• The US industrial revolution depended on finance: e.g., textile manufacturers raised equity capital by selling stock, and obtained working capital via bank loans

• Rapid industrial growth began with the establishment of a modern financial system in the 1790s

Growth of US Industrial Production, 1790-1913(percent per year in the new Davis index)

1790-1913 5.2

1790-1802 5.3

1802-1815 3.9

1815-1833 5.3

1833-1860 6.0

1860-1913 5.0

The US Case: Part II

• The US financial revolution of the early 1790s, and the jump start it gave to economic growth and development

• A threat to financial modernization that was handled successfully: Wall Street’s first crash in 1792

• Comparing the US and UK financial systems in the early 19th century: Who had the better system?

Threats to the Financial Revolution

• Today we know that the Federalists’ financial revolution was a success.

• But it could have failed at a number of points.• An instructive example is the securities market

panic of 1792 when the US national debt lost 25% of its value in two weeks.

• Hamilton saved the day by modern central-bank-like interventions, which are just now coming into historical focus.

Panic of 1792 threatens to undo the US financial revolution, as had happened earlier in France and almost happened earlier in England:

The collapse of the Mississippi Bubble of 1720 actually undid John Law’s plans for a French financial revolution.

The collapse of the South Sea Bubble of 1720 in Great Britain threatened that country’s financial revolution, but modern finance survived there in a weakened form.

Why you probably never heard of the US panic of 1792:

• Interventions executed and orchestrated by public agents, chiefly Alexander Hamilton, Secretary of the Treasury, ended the financial crisis with no damage to the US economy.

• There was political fallout, as Federalist (pro-business, pro strong central government) and Republican (pro-agriculture, pro states’ right devolution) political parties formed. The politics of Jefferson vs. Hamilton overshadowed the successful weathering of the financial crisis in most subsequent historical accounts.

1792: Bubble, collapse, panic

--Fueled by increases in bank credit and a speculative cabal, securities prices rose rapidly early in 1792 [see securities price charts—next slide].

--Prices crashed in March, after banks stepped on the brakes and the cabal collapsed in default. Panic selling drove US 6s in New York from 126 on March 5 to 95 on March 20, a drop of 25% in two weeks.

--Hamilton intervened on a number of fronts.

U.S. Sixes, Boston, New York, and Philadelphia

60.00

70.00

80.00

90.00

100.00

110.00

120.00

130.00

1790

.103

1

1790

.112

7

1790

.122

2

1791

.010

8

1791

.020

0

1791

.022

6

1791

.033

0

1791

.042

0

1791

.051

8

1791

.060

8

1791

.070

0

1791

.072

7

1791

.081

6

1791

.082

5

1791

.090

5

1791

.091

6

1791

.092

7

1791

.101

5

1791

.110

1

1791

.111

1

1791

.112

2

1791

.120

0

1791

.121

3

1791

.122

8

1792

.011

8

1792

.020

8

1792

.022

5

1792

.030

6

1792

.031

5

1792

.032

7

1792

.041

0

1792

.051

2

1792

.060

9

1792

.070

7

1792

.073

1

1792

.081

8

1792

.091

9

1792

.101

3

1792

.110

7

1792

.113

0

1792

.122

2

Date

Bid

Pri

ce (

Per

cen

t o

f P

ar)

Boston New York Philadelphia

Causes of the 1792 Bubble

• The traditional story: Speculative cabal of Wm. Duer and others to corner market for US 6s.

• A more recent extension of the story: Rapid credit expansion by the new Bank of the United States, opened Dec. 1791, followed by credit contraction as it lost reserves.

Bank of the United States, Dec. 1791 to Mar. 1792

Date/BUS data

Discounts Notes and deposits

Specie reserves

Dec. 29, 1791

$0.96 mill. $1.10 mill. $0.706 mill.

Jan. 31, 1792

$2.68 mill. $2.17 mill. $0.510 mill.

Mar. 9, 1792

$2.05 mill. $2.06 mill. $0.244 mill.

1792: Hamilton’s crisis management tactics (1) Open Market Purchases

• Directs open-market purchases of 1-2% of US debt outstanding.

• Meredith, Treasurer of US, purchases $133K par value of US debt for $92K cash in Philadelphia, Mar. 21-Apr. 25, 1792.

• Seton, cashier of Bank of New York, purchases $192K par value for $151K cash in New York, Apr. 2-17, 1792.

1792: Hamilton’s crisis management tactics (2) Induces banks to extend credit

• Directs banks in major cities to grant credit to merchants having US tax payments falling due—two examples:

• “The merchants of New York have to pay considerable sums in duties in this and the next Month. You may boldly accommodate them under an assurance that the money shall in no event be drawn out of your hands in less than three Months, unless perfectly agreeable to you.” Hamilton to Seton of B of NY, Mar. 19, 1792.

• “Considerable sums of duties have become due, or are to fall due, in Baltimore, in the course of the present month…. I have determined to inform you that, if you should incline to make discounts for the importers, to enable them to pay the duties which have become due or which shall fall due on or before the 15th day of April, I will leave a sum of money equal thereto in your hands, for sixty days after the dates of the notes.” Hamilton to the Bank of Maryland, Mar. 29, 1792.

1792: Hamilton’s crisis management tactics (3) Arranges cooperative agreements among banks and securities dealers.

• Directs Bank of New York to grant credit to securities dealers collateralized by US debt securities at prices Hamilton names, and at a penalty rate of interest, with promise—in case the B of NY got stuck with the collateral, to repurchase the collateral at the prices he had named:

“Let deposits of stock be received to an amount not exceeding a million—Six per Cents at par, three per Cents at 10 shillings on the pound, and deferred at 12 shillings—Let credits be passed on your books in favor of the Depositors for the amounts, according to those values, transferable at the Bank as in the case of deposits at the Bank of Amsterdam…. Let the terms of the deposit be that the Depositors may withdraw their Stock at any time paying in specie the sums credited whenever the Credits have been transferred—with a right to the Bank after six months to sell the Stock and pay them the overplus. Let the Bank engage at the end of six months to pay the amount of these Credits in Gold or Silver; for the undertaking of which let them receive a compensation in Interest at the rate of 7 per Centum per annum.

“I take it for granted in the prevailing disposition of your City, transfers of these Credits under the promise of the Bank to pay in Specie at the end of six months would operate as Cash in mutual payments between Individuals—while the Bank would be perfectly safe from the danger of a run & undoubtedly safe eventually.

“To render the operation more perfectly safe to the Bank, I will engage at the expiration of six months to take off your hands at the rate specified to amount of 500,000 Dollars—in case the parties should not redeem & there should be no adequate demand. Which however is not supposeable.”

Hamilton to Seton, Mar. 22, 1792

Bagehot’s rules, 1873, independently formulated by Alexander Hamilton in 1792

• “The end is to stay the panic; and the advances should, if possible, stay the panic. And for this purpose, there are two rules:--First. That these loans should only be made at a very high rate of interest….

• Secondly. That at this rate these advances should be made on all good banking securities, and as largely as the public ask for them…. If it is known that the Bank of England is freely advancing on what in ordinary times is reckoned as a good security—on what is then commonly pledged and easily convertible—the alarm of the solvent merchants and bankers will be stayed.”

Walter Bagehot, Lombard Street (1873)

Was Hamilton’s Bagehot-like plan of March 22, 1792, implemented? Yes.

• “The Dealers last Night had a meeting & appointed a Committee, to confer with the Directors of the two Banks. The propositions which they are to hold out I hear in general is to offer, funded debt, at your price as pledges for their discounts--& they are to sign an Agreement to bind themselves not to draw any Specie from the Banks, on account of the discounts which they shall obtain and giving checks to each other, if anyone shall part with the Check—except to those, who engage by the agreement, not to draw out Specie, he shall be deemed infamous… &... no one of the signers of the agreement will deal with him.”

Philip Livingston, New York, to Hamilton, Philadelphia, March 27, 1792.

1792: Hamilton’s crisis management tactics (4) Induces banks to cooperate

• Directs US Treasury and banks not to draw on other banks’ reserves—examples:

• “…I have explicitly directed the Treasurer to forbear drawing on the Bank of New York, without special direction from me. And my intention is to leave you in possession of all the money you may have or may receive ‘till I am assured the present storm is effectually weathered.”

Hamilton to Seton, Jan. 24, 1792.

• “I request that you will not draw out from the Bank of N America any further sum without a previous communication from me.”

Hamilton to John Kean, cashier of Bank of the United States, Philadelphia, Mar. 28, 1792.

1792: Hamilton’s crisis management tactics (5) Releases reassuring news

• Publicizes new loan from Dutch bankers to US at 4%:

• “Private…. I have just received a Letter from Mr. Short, our Minister Resident date Amsterdam 28th December, by which he informs me that he has effected a loan for Three Millions of Florins [$1.2 million] at 4 P Cent Interest on account of the United States. This may be announced; and as in the present moment of suspicion some minds may be disposed to consider the thing as a mere expedient to support the Stocks, I pledge my honor for its exact truth.

…Is the Treasury of Great Britain comparatively in so good a state? Is the Nation comparatively so equal to its debt? Why then is there so much depression? I shall be answered—the immediate necessity for Money. But if the Banks are forbearing as to the necessity of paying up—cannot the parties give each other mutual credit and avoid so great a press?”

Hamilton to Seton, Mar. 25, 1792 [Before Hamilton learned that his Mar. 22 plan was being implemented in New York]

Dutch loans served two purposes in 1792

• Publicizing the loan of 3 million florins, or $1.2 million, was a tactic for calming panicked markets in Mar. and Apr. 1792

• As in 1791, Dutch loans financed the open market operations of Mar. and Apr. 1792:

“The whole sum successively received on account of Amsterdam bills, subsequent to the 1st of March, and prior to July, 1792, was $235,412.33. The amount of the moneys invested in purchases between those periods was $242,688. 31.”

Hamilton reporting to the House of Representatives,

February 13, 1793.

Summary and an extension

• Together, the interventions Hamilton orchestrated ended the Panic of 1792 by May, after which securities markets recovered. There were numerous bankruptcies in New York City and fewer elsewhere. But there was little economic damage. The US economy had been growing at modern rates of 1.4% per capita per year from the time the new government appeared in 1789, and that growth continued through the 1790s and after.

• In May 1792, 24 dealers in securities met under a buttonwood tree in Wall Street and founded the NYSE, a better trading system. Ten of the 24 had sold securities to Hamilton’s agents during the open market purchase program of March and April, and probably had participated in the plan for bank-dealer cooperation in a crisis as unveiled in Hamilton’s March 22nd letter.

Hamilton, Central Banking Theory, and Greenspan/Bernanke

• There are parallels of what Hamilton did in 1792 and what Greenspan did more recently:

• 1987 stock market crash

• Russian/LTCM crisis of 1998

• Late ’90s bubble and 2000-2002 crash

• 9/11/2001 terrorist attacks

• 2007-2009 credit crisis

After the panic of 1792, US financial system grows rapidly

• Economic historians often say that Britain had the most developed financial system and was the financial leader of the 19th C.

• But that was not true in the 1790-1830 period, when the USA developed a more advanced financial system and grew economically far more rapidly than Britain.

• After 1830 Britain improved its financial system, and the USA weakened its system.

The US Case: Part III

• The US financial revolution of the early 1790s, and the jump start it gave to economic growth and development

• A threat to financial modernization that was handled successfully: Wall Street’s first crash in 1792

• Comparing the US and UK financial systems in the early 19th century: Who had the better system?

Comparing UK and US levels, 1830

» UK US • PF: Nat. Debt $3,830 m. $80 m.• Money stock $643 m.,M3 $129 m.,M2• Cent. Bank assets $166.1 m. $68.4 m.• Banking capital $70-80 m. $154 m.

(E&W is $55m)• Secs. Mkts.-co. listings 206 216 • Corps./ Jt. Stk. Cos. 250-300 1,100-1,200

Comparing populations, 1830

• UK 23.3 m.

• England & Wales 13.8 m.

• US 12.9 m.

• US Northeast 6.1 m.

Centers of two empires—UK/England & Wales, and US Northeast (to scale)

Per capita comparisons, 1830, in $

» UK US E&W US Northeast

• Pub. Debt/ cap. $161 6-7• Money stock/cap. 27 10• Cent. Bank assets/cap. 6.97 5.30 6.97 8.41• Fin. crises, 1790-1830 6 2• Bank assets/cap. 19 27.30 24 43 • Annual bank

failure rate/1000 18 5

. SM: listed cos./mill. 8.7 16.7 14.9 32

. Corps./Jt stk cos./mill. 13 93 22 180

After 1825-1835

• UK got better—1707 BoE monopoly ended, 1720 Bubble Act repealed, Jt stk banks come to England, unltd. cos. by registration (1844) and ltd. (1857), banks consolidate with extensive branch systems

• US got worse—BUS recharter vetoed (1832), unit banking becomes entrenched

• UK orientation is international, US is domestic

But…by 1830, the winner is…

• UK US• Public finance, debt mgmt. X• Money tied• Central banking X• Banking system X• Securities markets X• Corporations X

• Financial system overall X

From 1790 to 1830…

• US grew faster than the UK, by 0.8 to 1%/yr• US had fewer financial crises, 2 vs. 6• US bank failure rate was lower than that of England and Wales, 5

vs. 18• Admittedly, UK was at war more of time, 1793-1815, than US• US Northeast had more bank assets/capita than England and

Wales, $43 vs. $24• US Northeast had more co. securities listings/mill.pop. than England

and Wales, 32 vs. 15• US Northeast has many more corps/mill.pop. than England and

Wales, 180 vs. 22• US Northeast, comparable in size to UK, in 1830 arguably was the

most financially developed large region in the world. Why?

Foundation of US expansion: The financial revolution planned and executed by Alexander Hamilton as Secretary of the Treasury in the years

1789-1795

1788 1795

Public finances, national Bankrupt Thriving, debt is serviced

Money Fiat state paper, US dollarforeign coins

Central bank No Yes, with 5 branches---------------------------------------------------------------------------------------------------------------------------------

Banks 3, isolated 20 state + 5 BUS branches

Securities markets Trivial, sporadic Organized, active in several cities

Corporations Few Many more

“The 100 most influential Americans of all time”, in an Atlantic magazine poll of historians, Dec. 2006. Top ten:

• Abraham Lincoln• George Washington• Thomas Jefferson• Franklin Delano Roosevelt

• Alexander Hamilton: ‘Soldier, banker, and political scientist, he set in motion an agrarian nation’s transformation into an industrial power’

• Benjamin Franklin• John Marshall• Martin Luther King, Jr.• Thomas Edison• Woodrow Wilson