Sunday, October 30, 2011

Banking on Hamilton 1

Open up your wallet. If you have a ten dollar bill in there, pull it out. Take a look at the face of the guy on the front. That's Alexander Hamilton, America's first Secretary of the Treasury and the father of our banking system. A bit has changed over the years but his mark has been indelibly left upon our economic structure: the first national bank, the role of government in finance, and the powers of financial institutions rest heavily upon his founding philosophy and tenacity to get his policies through.

The brief life of Alexander Hamilton can be read something like this: Alexander Hamilton was born in the Caribbean, fought in the American Revolution, proposed a strong (by early American standards) federal government, created the precursors for most of our modern economic institutions, and fought so furiously with his political opponents that he was eventually shot and killed by Aaron Burr in a duel. He was a man with strong opinions and a well-read background.

Modern Americans can thank Mr. Hamilton for a great many of our political views which we hold today. The idea of a national government that gives states some authority but maintains standing armies, levies taxes, and takes on large programs was Mr. Hamilton. The protection of American industry through tax breaks, levies, tariffs and other economic mechanisms can be called his. Even how members of the cabinet address Congress originated with him.

But his lasting achievement was in how he shaped our banking system. He proposed the mint, argued strongly for a central bank, and shaped how our markets ran. He got his way in the establishment of the first national bank, the creation of the Federalist party, and the establishment of the US Mint. Although the bank, which was partially owned by the government, was disbanded when Congress failed to renew its terms in 1811, it set precedent for the second national bank, and eventually the Federal Reserve.

Banks in America are quite hard to pin down. Jackson was vehemently against the second national bank on the grounds that it was a corrupt institution owned by foreigners who were trying to influence elections. So strong was his opposition that this is known as the Bank War. Jackson saw the private ownership of the very powerful, nationally funded bank as a monopoly with interests against the popular will (sounds familiar). He opted for state banks collectively known as 'pet banks.' These banks decentralized the system and took power away from Jackson's meddling foreigners but created a very unstable situation wherein many pet banks eventually failed. This is probably because Jackson, for all of his high handed rhetoric about fairness and populist justice, awarded federal investments to political allies as part of the 'spoils system' (remember that term from US History?). Anyways, this unstable system of uncontrolled and financially unsound series of banks without adequate regulation but plenty of government funds led, it has been argued, to the Panic of 1837.

This was America's second depression. Not the Great one, but just a regular one. Basically, the banks were not required to abide by many principles considered necessary to our banking system today. Banks weren't required to have a minimum percentage of physical cash in their vaults at any time to back up their loans and bank notes. In modern times the number is 10%. Because banks weren't keeping cash in reserve, they could loan out larger and larger sums on riskier and riskier investments (sounds familiar again); basically inflating currency until the bank notes didn't have much real value. Realizing this, banks changed policy and stopped accepting cash, requiring gold or silver as a deflationary measure. Well, that did deflate currency, but more in the manner of popping the bubble than drawing down pressure. Suddenly things like mortgages on houses couldn't be paid for because the property was worthless and average Americans were left with worthless bank notes (the coincidence is thick in this history). Martin Van Buren, newly elected president of 1837, refused to get involved reasoning (I bet you can guess) that the markets would even themselves out and government had no place intervening. Hamilton would have set him straight on this point, but he had already been shot in the abdomen by Aaron Burr—the founding father famous only for shooting another founding father in the gut.

Unemployment rose. A lot. And banks collapsed by the hundreds. To really drive home some striking coincidences I'd like to quote Edward M. Shephard, writer of The Life of Martin Van Buren: “They believed that Van Buren could with a few strokes of his pen repair, if he pleased, those blunders, and restore commercial confidence and prosperity. The panic of 1837 became, and has very largely remained, the subject of political and partisan differences, which obscure its real phenomena and causes.” And so it was a system of unregulated speculation, free of partisan politics that nearly crippled the nation of America. Burr wasn't very good at economics, but he wasn't solely responsible for the resulting depression.