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Economic History IV: Alexander Hamilton, Path Dependency, and the Financial Crisis

 

Today, public opinion concerning the state of the American economy is unstable at best. There are many indicators which would seem to agree with such a conclusion, the foremost being the growing figure displayed by the National Debt Clock in Manhattan, New York City which has surpassed $14 trillion. In order to put this massive number in perspective for us, those responsible for maintaining the clock have divided the $14 trillion plus dollars equally between all U.S. citizens to determine the debt per citizen, which is currently in excess of $45,000.

There are, however, many variables that go into these calculations—to which the public is generally oblivious—variables such as federal tax revenue, federal spending, and money creation to name a few. With the next round of presidential elections in sight and the recent power exchange in the House of Representatives this last November of 2010, we are coming to find that we are a country divided on the question of how to approach the handling of our economy and personal finances from both macro and microeconomic perspectives.  But this is a bipartisan issue, and the best thing that we could do as a nation is become better informed on the groundwork upon which our economy is based.

Path dependence is the idea that one decision in history can impact, and even determine, the future in a very big way. Several examples of path dependent outcomes are the destruction of the steam locomotive industry, the triumphs of Bill Gates over IBM, and more recently, the adoption of DVDs as a medium over their VHS alternative. Path dependence works in the same way even in the more general case of the U.S. economy and the country’s governmental policies. We can trace contemporary issues back to actions of the past to gain a firmer understanding of what the root causes of said issues are, and what the next best step is in addressing them.

“History repeats itself because no one was listening the first time.” – Anonymous

“Those who cannot learn from history are doomed to repeat it.” – George Santayana

As part of the K-12 curriculum in the United States, students learn that the Founding Fathers of the country were the men who signed the Declaration of Independence, took part in the Revolutionary War, and established the U.S. Constitution. Among these men are George Washington, Benjamin Franklin, Thomas Jefferson, and Alexander Hamilton, though the list goes on and on. It is truly a shame that little emphasis is placed on recognizing the individual contributions to the country made by at least the most prominent of men within this group, as there is much value to acquiring such knowledge.

Oftentimes in our education, we focus on the Who, What, When, and Where. We fail, however, to ask ourselves the most vital question: Why? For instance, why does the concept of debt even exist? Why would foreign countries, foreign citizens, and U.S. citizens loan money to the federal government? Why do we even have a central government to which we pay taxes? The greatest and most detrimental mistake we can make is to accept our surroundings as the norm when we really should be questioning the status quo and arriving to creative solutions to circumvent outstanding problems or even simply to improve our current situations. We can link the current financial crisis back to the very establishment of our country.

Few people are privy to the entirety of Alexander Hamilton’s contributions to the country. Not many know, for example, that he and George Washington first became acquainted after Hamilton impressed the rebel generals in the Revolutionary Way with the professionalism of his New York artillery company over several key battles. After accepting the position of aide-de-camp with the rank of Lieutenant Colonel, Hamilton became Washington’s key confidante. Even as he took on increasing amounts of responsibility in his service with the commander-in-chief of the Continental Army, Hamilton began exploring solutions for policy and administration, casting a critical eye on the Second Continental Congress and their limitations as a governing body.

Hamilton’s Federalist groundings came to be during this time. He believed that congress was overly preoccupied with the various state interests to function effectively. His next step of action was to contact Governor George Clinton of New York to express his views on how there was a great need for a strong central government, particularly if the nation hoped to ever become an international power. The contacts which he had established during his time as Washington’s aide-de-camp came to use as he called for changes to the current government.

The financial plan he outlined back in the 18th century—before he even truly held public office—sounds almost eerily familiar. To secure revenue, he recommended securing foreign loans, taxing businesses and farmers. He advocated an economy based on fiat money and creating a national bank which would act in a manner akin to competitive businesses and even explored ways of turning the national debt into an advantage.

After turning down two nominations for positions within the state assembly, Hamilton returned to the public eye after he wrote the charter for, and became a founding member of, the Bank of New York in 1784. Almost two years after signing the constitution, Hamilton was named the nation’s first Secretary of the Treasury. He became, in essence, responsible for steering the country from a crippling debt to a sustainable power capable of funding professional armies, encouraging growth, and achieving purchasing power. Hamilton followed through with several of the ideas which were mentioned before and exacted a tax on imports, or tariffs, as a means of accumulating some wealth and protecting domestic business interests.

Although all of his policymaking during his time as Secretary of State has impacted us today in one way or the other, the credit system he put into play is perhaps the most relevant to our current crisis. Interestingly enough, it was this facet of his fiscal reform package which helped the country become the international superpower it is today. Thanks to Hamilton’s support of a fluid paper currency, as opposed to landed wealth, investors began filling the treasury’s coffers. His vision of private wealth going towards beneficial public uses was being realized. Hamilton remained true to his Federalist ideals as his policies continued to encourage international trade and domestic industrialization, using the British as a model for success.

Most are familiar with the term bonds, but just to cover all of our bases, bonds are “A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate. Bonds are used…to finance a variety of projects and activities” (Investopedia). In 1790, Hamilton submitted a report in support of public credit to Congress in which he stated that the country’s debt would be converted into interest bearing bonds which, after a predetermined amount of time, would mature, luring investors. Clearly, it was vital that the interests of the public creditors were aligned with those of the central government if Hamilton’s system was to work.

Eleven months later, Hamilton submitted a second report to Congress concerning established credit, though this time the central focus was the bank he had proposed. He had pushed for private ownership to prevent the corruption which was prevalent in the Bank of England. The purposes of such a bank, for example, included—but were not limited to—maintaining a uniform currency, lending money and investing in industry and private businesses, loaning money to the government, and acting as a safe store for the nation’s money.

Just when it seemed as if Hamilton had accounted for everything as he forced his agenda through Congress and President Washington, the young nation experienced a crash in 1792. Groups of speculators, with money loaned to them by banks, began to play the market. Their risky, and sometimes foolish and extravagant, practices finally caught up to them when the market crashed, bankrupting the speculators. As the securities began to lose value, Hamilton created the Sinking Fund Commission, which was responsible for purchasing government stocks.

Does this sound familiar? Well it should, because in 2008, Congress authorized the Treasury Department to spend $700 billion through the Emergency Economic Stabilization Act in an attempt to reverse the declining state of the U.S. economy at the time; this number has since been reduced to $475 billion (Bailout ProPublica). And in 2010, the Federal Open Market Committee of the central bank declared that it would buy $600 billion in mortgage-backed securities in an attempt to reverse the declining state of the U.S. economy at the time (MarketWatch).

 
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Posted by on April 5, 2011 in Economic History

 

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Economic History II: The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

The Great Depression, Fiscal Policy, and the Financial Crisis of 2007

Click here to be taken to Part I if you haven’t read the introduction.

To this day, the Great Depression (1929-1939) remains one of the most fascinating periods of study to historians, political scientists, and economists. Despite extensive studies, however, there remains much about this time period which yet eludes us.

This serious drag in the country’s economic performance can be attributed to several events, many of which are interrelated. To begin, there was the Stock Market Crash of 1929—a product of inflated confidence in the market through most of the 1920s—which led to an approximate loss of $40 billion. Incidentally, some of the banks had fallen prey to these very same traps and lost the money they themselves had invested into the stock market. These events led to subsequent bank failures all throughout the country as debtors became unable to repay their debts. Economic growth and recovery were essentially brought to a grinding halt as the surviving banks became more cautious in their lending practices, leading to reduced expenditures and a decreased money supply (Anari, P.676). This was, in essence, a crisis of confidence.

Consumer spending was in decline, which meant there was less demand for goods in general, which led to businesses decreasing factory inputs, spurring the country’s annual unemployment rates to new heights.

When peoples’ standards of living are at stake, they expect their government to step up and take action. It was no secret how the public was dissatisfied with the president, Herbert Hoover’s, performance as the shantytowns were referred to as Hoovervilles and the newspapers used to shelter the homeless from the cold Hoover Blankets.

Hoover’s unsuccessful policies ushered Franklin D. Roosevelt into the office of presidency, a position he would hold on to for 12 years. In contrast with his predecessor, Roosevelt wasted no time in enacting his New Deal Programs. Here are some examples of how his administration tackled the problem of the day:

  1. To counter unemployment:
    1. 1933, Public Works Administration (PWA). Large-scale public works projects. Six billion dollars. Airports, dams, aircraft carriers, schools, hospitals.
    2. 1933, Civilian Conservation Group (CCC). Public works projects.
    3. 1933, Civil Works Administration (CWA). High paying jobs in construction.
  2. To combat the housing crisis:
    1. 1933, Home Owner’s Loan Corporation (HOLC). Services to refinance homes. One million people received long term loans.
    2. 1934, Federal Housing Administration (FHA). Regulated mortgages and housing conditions.
  3. Poverty upon retirement:
    1. 1935, Social Security Act (SSA). Still active. Addresses poverty among retired, wage-earning senior citizens.

The list continues, but you get the point. Essentially, Roosevelt was a president of action and direct intervention and, as a result, his popularity soared. But how successful were his efforts? Did these programs help dig the country out of its dire situation, or can the recovery be attributed to something else? How does this compare to our current financial crisis and can we learn anything from this?

P. 676 Ali Anari

The above graphs indicate exactly how rough the times were. Industrial production hit an all time low due to a combination of decreased demand, money supply shocks, and the rise in unemployment rates (Anari, p.770). As is shown on the graph, the recovery from the Great Depression began around 1934 with the U.S. economy reaching new heights upon the country’s involvement in World War II, when the economy returned to full employment (Romer P.758).

Studies conducted on the recovery, however, suggest that the New Deal was not necessarily the engine of recovery itself, but as something which cleared the way for a natural recovery (Romer P.758). In fact, many postulate that the greatest result of these policies seems to be the resurging strength of the federal government.

So flash forward about 80 years to today’s current financial crisis. Can we link the effects of the aggregate-demand stimulus of the recovery from the Great Depression to the government bailouts in 2007 and the years following?

Definitely.

The Federal Reserve Board invoked the same authority it had invoked in 1932 to aid in the stabilization of firms through monetary aid, which allowed the Fed to rescue AIG through loans, a move which is controversial to this day (Posner, p.1613 and 1629). Through the Emergency Economic Stabilization Act of 2008, the Treasury was granted $700 billion to buy mortgage-related assets along with many additional powers to deal with the crisis (Posner, p.1614).  After the fall of the Lehman Brothers, the government “began pumping liquidity into the system at unprecedented levels” in the hopes of bolstering confidence in the markets (Bartlett, A25). The financial institutions receiving government aid include, but are not limited to, automakers, banks, saving associations, credit unions, insurance companies, etc. (Bartlett, p.1633).

The government did not stop there either. Immediately upon being elected into office, President Obama began working towards securing stimulus money, accomplishing this in early 2009 (NY Times, Economic Stimulus). But has the $819 billion stimulus package requested by President Obama and passed by Congress helped or hurt us? (Yourish, Washington Post). The following is a breakdown of the tax cuts and the program’s intended recipients:

Data from NY Times

Economists have reported that the administration’s actions led to a decrease in taxes for most Americans (NY Times, Economic Stimulus). In early May of 2009, however, it was estimated that the package fell short of the administration’s optimist forecast of unemployment peaking at 8.5% and was estimated to have saved only 150,000 jobs of the promised 600,000—unemployment surpassed 10% at one point but dropped to 9% in January 2011 (Bureau of Labor Statistics). Other benefits include an increase in the rate of home sales, tax cuts to small businesses, and increased infrastructure spending similar to Roosevelt’s plans.

Much like Roosevelt’s New Deal, perceptions of the stimulus package’s effectiveness are wide-ranging and many. It is almost universally agreed, however, that the government’s actions, while not insignificantly increasing the country’s deficit, helped stem some of the worst consequences of the crisis. Economic optimism and activity have increased in recent months but perhaps all that remains now is hoping that Adam Smith’s “Invisible Hand”, the argument that free enterprise and self-interest benefit society when transactions are voluntary to both parties, proves true and that the economy arrives at optimal levels of employment and economic prosperity (Narveson, p.201).

This is not an examination of which political party’s ideologies are correct, but more so an exploration into the effectiveness of policy in times of economic crises. My data is specific to the time period of the Great Depression and our most recent circumstances, so any conclusions I would come to would be moot in the grander scheme of things, but that does not mean that there isn’t much to learn from the subject matter I have brought to light.

 

Sources:

Anari, Ali. “Bank Asset Liquidation and the Propagation of the U.S. Great Depression.” The Wharton Financial Instiutions Center.

Bartlett, Bruce. The New York Times. “How to Get the Money Moving. Dec. 24, 2008.

Narveson, Jan. “The Invisible Hand.” Journal of Business Ethics, Vol. 46, No. 3.

The New York Times. “Economic Stimulus.” Times Topics. Dec 15, 2010.

Posner, Eric A. “Crisis Governance in the Administrative State: 9/11 and the Financial Meltdown of 2008.” The University of Chicago Law Review

Romer, Christina D. “What Ended the Great Depression?” National Bureau of Economic Research, Inc. .

Yourish. The Washington Post.

http://americanhistory.about.com/od/greatdepression/tp/new_deal_programs.htm

 


 
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Posted by on April 2, 2011 in Economic History

 

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