Alexander Hamilton and the Origin of the Fed

Published by EH.Net (June 2020)

Jack Rasmus, Alexander Hamilton and the Origin of the Fed. Lanham, MD: Lexington Books, 2019. v + 139 pp. $85 (hardcover), ISBN: 978-1-4985-8284-1.

Reviewed for EH.Net by David Cowen, Museum of American Finance.

In Alexander Hamilton and the Origins of the Fed, Jack Rasmus of St. Mary’s College traces and analyzes the roots of American central banking. The book consists of eleven detailed chapters that outline the story of U.S. banking development. He starts with Hamilton’s creation of the First Bank of the United States (BUS1), the subsequent chartering of Second Bank of the United States (BUS2), an in-depth survey of the period 1836-1913 without a national bank, followed by the creation of the Federal Reserve System. He concludes by looking at the current Federal Reserve and comparing it to the BUS1 in order to answer the question of whether the Federal Reserve is the “Third Bank of the United States.” This is a phrase that is not in the book, but is one I first heard as a student of Richard Sylla.

The setup to that question can be found in the first several chapters, which describe how Hamilton’s central banking vision was crucial for early U.S. economic growth. The author retraces Hamilton’s youth and early ideas on banking, as well as his military service, the Constitutional Convention, his appointment as the nation’s first Secretary of the Treasury, the creation of the BUS1, and the subsequent battle to get the legislation passed. One of Rasmus’s analogies that resonates is his comparison of the U.S. Constitution to the Bible: “One can find a particular passage or reference to justify one’s interpretation, and other passages to justify the opposite” (p. 31).

Many others — including Bray Hammond, Fritz Redlich, Edwin Perkins, James Wettereau, Benjamin Klebaner, Robert Wright, Richard Sylla, and this author — have looked at the BUS1 and concluded that the national bank performed many tasks associated with a modern central bank. All, including Rasmus, give the BUS1 high marks as the government’s fiscal agent. Rasmus looks at Hamilton’s unique hybrid 80%/20% private-public partnership and, on the one hand, concludes that there was independence for the bankers. However, he states that the Treasury Department made “considerable interference” in its operations (p. 36). Reconciling this “considerable interference” with his notion that there was independence is not an easy tightrope to walk. This theme continues throughout the book and is nicely framed as a two-sided question, “Independence from whom? … Interference in carrying out central banking functions by private banker interests? Or interference from government politicians” (p. 66).

After reading and analyzing hundreds of letters about the bank, it seems to me that during this period the Treasury was the central banker and the BUS1 the central bank. It is best described as a principal-agent relationship; however, it is clear the principal held the upper hand. For instance, when Treasury Secretary Albert Gallatin was in office, he allayed Thomas Jefferson’s fears about the BUS1: “Whenever they shall appear to be really dangerous, [the Bank is] completely in our power and may be crushed.”

While aptly describing the bigger themes surrounding the BUS1 creation, Rasmus makes several errors. He correctly states that Hamilton’s first act was to raise money for the newborn country through bank loans from the Bank of New York. However, he mistakenly labels the other bank, the Bank of North America, as the “National Bank of Philadelphia” and says that the total loan amount was $100 million when the borrowings were a tenth of one percent of that amount (p. 19). Also needing correction is that the “bonds issued” by the BUS1 to its investors would be paid at 4% (p. 21). It was the equity stock of the bank that paid the dividends, as the BUS1 did not issue bonds. To state that the “federal government put up $2 million in gold” is correct in terms of amount, but the reality is that the government did not have $2 million in gold to invest (p. 25). Rather, the federal government infused the funds to the national bank through a complex transaction via loans from Amsterdam, but immediately borrowed that amount and more. Rasmus does note that within a few years BUS1 loans to the government had tripled, peaking at $6 million or about 60% of its capital, before the BUS1 directors became nervous and asked for repayment. The government commenced selling its shares to repay the loans.

Because banks proliferated and the money supply grew, Rasmus states that as far as control of that supply is concerned, the “BUS1 clearly receives an ‘F’ in terms of performance during its twenty-year charter period” (p. 34). This failing grade contradicts Thomas Willing, the bank’s long-standing president, who wrote that BUS1 was the “great regulating wheel of all the Commercial Banks [and] … never overtraded, neither was it possible for any other institution to do so and preserve its credit for a day.” Bolstering the Willing case was William Gouge, certainly no friend of bank note issuance, who wrote in 1842 that the BUS1 “was perhaps as well managed as a paper money Bank could be.”

The book is detailed in describing nineteenth century banking in the intervening years between the BUS2 and the creation of the Federal Reserve. Major financial crises are on display — 1837, 1857, 1873, 1884, 1890, 1893 — culminating with the 1907 panic that led to the creation of the Fed. These episodes include explanations of a “full-blown financial crisis versus a banking panic” (p. 81). Themes recur, for instance how fractional reserve banking is a “great boon,” but at the same time a “fundamental weakness,” and the constant pushback and resistance to centralized banking powers in U.S. history (p. 5).

Rasmus brings the book together in a nice concluding chapter analyzing where the Fed and Hamilton’s BUS1 have similarities, differences, or an incomplete scorecard. The verdict: “In many respects the 1913 Fed was an implementation of Hamilton’s vision. It was very much a Hamiltonian central bank” (p. 121). However, Rasmus sees two great failures in the lack of effective bank supervision and a weak lender of last resort, the latter evidenced by many bank failures, particularly in the 1930s. Nonetheless, Rasmus’s book suggests that the Federal Reserve is indeed the Third Bank of the United States.

In a postscript, Rasmus criticizes central banks and the Fed for the massive stimulation in the wake of the 2008-09 financial crisis, believing it has “not been very effective” (p. 125). Earlier in the book, he posed the question of whether the Fed would be able to “evolve further” to handle a future crisis (p. 10). That answer is currently upon us, as the U.S. grapples with the coronavirus, quarantine, economic shut down and reopening, and social unrest. With the Fed balance sheet growing from $4.5 trillion to $7 trillion in a matter of months in 2020, and likely more financial stimulus on the way, we may expect that Jack Rasmus will have some forthcoming opinions on evolving central banking.

David Cowen is President/CEO of the Museum of American Finance. He is the co-author (with Richard Sylla) of Alexander Hamilton on Finance, Credit, and Debt (Columbia University Press, 2018) and (with Robert Wright) of Financial Founding Fathers: The Men Who Made America Rich (University of Chicago Press, 2006). He is author of The Origins and Economic Impact of the First Bank of the United States, 1791-1797 (Garland Publishing, 2000).

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