Financial University lecture, Moscow 25.10.10

1. Financial University lecture, Moscow25.10.10 “Alexander Hamilton and the US Financial Revolution of the 1790s Richard Sylla, New York University

2. 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

3. 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)

4. 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

5. 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

6. 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.

8. 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.

10. 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%

11. 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

12. US Financial System, 1788 and 1795

13. 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.

14. 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

17. 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

18. 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

19. 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.

20. Hamilton’s

21. US State-Chartered Banks: Numbers and Authorized Capital, by Region and Total, 1790-1835(Capital in millions of dollars)

22. 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.

23. Table 3. Corporations Chartered in USA, 1607-1800

26. Securities Markets: City Listings in 1811

27. Growth of the New York Securities Market, 1797-1832

31. 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

34. 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

36. 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

37. 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?

38. 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.

39. 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.

40. 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.

41. 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.

43. 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.

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

45. 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.

46. 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.

47. 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:

48. “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

49. 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)

50. 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.