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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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