The new makers of modern.., p.34
The New Makers of Modern Strategy, page 34
Convinced, Washington signed the bank bill into law on February 25, 1791, and the Bank of the United States was duly chartered for twenty years—until 1811. Interestingly, Jefferson, the great proponent of a limited federal government, did not hesitate to employ Hamilton’s system of public debt to make the Louisiana Purchase. Jefferson even used many of Hamilton’s arguments favoring implied powers to defend his own power to make the purchase, as he did again when he decided to wreck the American economy by forcing the Embargo Act through Congress in 1807. Madison, however, had the last word on the First Bank of the United States, when, as president, he allowed its charter to expire in 1811. Therefore, the bank no longer existed when the War of 1812 erupted. The war ushered in a period of unregulated currency expansion, made a shambles of the public debt, and did so much damage to the nation’s economy that Madison was forced to reverse his position and approve legislation creating the Second Bank of the United States in 1816.
The Second Bank of the United States was effectively destroyed by the enmity of President Andrew Jackson, who undertook what became known as the “Bank War.” The contest began in 1832, when Congress, led by Jackson’s political rival Henry Clay, pushed through an extension to the bank’s charter. Jackson vetoed the bill, and, after his reelection, he removed all US deposits from the Bank of the United States and spread the funds over ninety-one state-chartered banks. Congress censured him for this unilateral act but did not reverse it. For all practical purposes Jackson’s removal of funds killed the bank, although its current charter still had four years to run.
The bank’s demise led directly to the Panic of 1837, as state banks immediately began printing their own currency and overextending themselves with loans. The resulting depression lasted seven painful years, until the California Gold Rush vastly increased the amount of specie in circulation. But without a national bank, ready to act as a lender of last resort, the United States jumped from economic crisis to economic crisis for the next seventy-five years, including the Long Depression of 1873. It was not until the great Banking Crisis of 1907—ended when J. P. Morgan coordinated a financial rescue of the financial system—that there was, once again, substantial public support for a new central lender of last resort, capable of pumping liquidity into the banking system in any amount required. Thus, in 1913, the United States created the Federal Reserve System—the modern incarnation of Hamilton’s bank. Unfortunately, the Federal Reserve was not ready in time to help finance World War I. Moreover, by mistakenly contracting the money supply in 1929, when it should have been expanding it, the Federal Reserve worsened the impact of the Great Depression. It did, however, come into its own at the start of World War II, when Federal Reserve President Marriner Eccles announced he would throw the entire power of the Federal Reserve behind the war effort and guaranteed that there would be enough money to pay for the total mobilization of the country for a war of any duration. As US Secretary of War Stimson said after the war:
The one thing upon which the whole country was agreed was that the services must have enough money. At no time in the whole period of the emergency did I ever have to worry about funds; the appropriations from Congress were always prompt and generous. The pinch came in getting money turned into weapons.25
V
When Hamilton took office in 1789, the US Treasury was nearly empty. His great achievement was to give the United States a modern financial system that, within six years, ensured there were sufficient funds to pay government expenses, as well the interest on a debt of approximately $80 million. Hamilton also left the United States with an established mint issuing a new dollar currency in gold and silver, as well as a stable paper money system based on banknotes backed by specie and government debt obligations. This was all managed through the Bank of the United States, which stabilized the financial system sufficiently for states to charter twenty new banking corporations in less than half a decade. Finally, by combining all of these elements, Hamilton made it possible to create regularly functioning financial markets. Rudimentary financial markets had existed in the United States prior to Hamilton’s modernization of the country’s finances, but they were erratic. In the year after the formation of the Bank of the United States there were active markets in government securities and corporate stocks in Boston, New York, and Philadelphia in continuous operation.
Economist Frederic Mishkin explained the importance of Hamilton’s creation:
Why is finance so important to economic growth? The answer is that the financial system is like the brain of the economy: it is a coordinating mechanism that allocates capital to building factories, houses and roads. If capital goes to the wrong uses or does not flow at all, the economy will operate inefficiently, and economic growth will be very low. No work ethic can compensate for a misallocation of capital. Working hard will not make a country rich because hard-working workers will not be productive unless they work with the right amount of capital. Brain is more important than brawn, and similarly an efficient financial system is more important than hard work to an economy’s success.26
Robert Sylla further informed us that the United States grew at unprecedented rate because Alexander Hamilton provided it with a fully developed brain.27 Despite many changes and adaptions over the past 200 years, the essentials of what Hamilton created remain with us, and its impact on strategy in peace and war remains immense.
Before the financial revolution, states were always bankrupted long before they ran out of productive capacity or manpower. The financial revolution reversed this historical truism in ways strategists and policymakers are still having trouble adjusting to. For example, before the onset of World War I, many Britons voiced considerable trepidation over German war reserves stored in gold within Spandau Fortress. By hording French reparations—₤70 million in gold—after the Franco-Prussian War to defray the costs of a future war, Germany robbed itself of the opportunity to use this specie to underwrite a further expansion of its economy. Their thinking on specie was, in fact, no different than that of Persian rulers, who had stored vast hordes of silver and gold for Alexander the Great to pillage. As World War I approached, British Chancellor of the Exchequer Lloyd George was asked about this massive gold reserve. His response: “A mighty sum, but England will raise the last million.”28 Lloyd George had clearly absorbed the lessons of the financial revolution, even if few others had. It was a remarkable testament to his faith in Britain’s capacity to finance a prolonged conflict, as well as proof that his government realized that its ability to increase its public debt was now the determining factor in war.29
In 1914, however, few could envision the colossal sums of cash that industrial warfare consumed. For instance, the much-feared Spandau gold reserves proved insufficient to cover even a single month’s war expenses. Economists who did estimate the cost of modern warfare were convinced that no state could finance a war for more than six months. Even the great economist, Milton Keynes, believed Britain, despite being the financial center of the world, could not cover the cost of a single year of total war. Clearly, even the best economists could no longer comprehend how the coupling of the financial and industrial revolutions had impacted the overall wealth of modern societies as well as their governments’ ability to draw upon that wealth. Nations that could raise and sustain the largest amount of public debt now had a decisive advantage in war, as they were literally tapping into the wealth of future generations to fight a current conflict.
While every major European state was pushed to the brink of financial disaster during the Great War, only Russia collapsed. Still, the other major participants—Germany, France, and Great Britain—all discovered that they ran out of industrial capacity long before they ran out of financial wherewithal. It was only when Britain could no longer finance the purchase of American war production that national bankruptcy threatened. That possibility disappeared when America entered the war and opened its financial spigots to full blast. A similar pattern was repeated in World War II, where states hit their industrial and manpower limits long before they were bankrupted. Famously, Britain went to the financial edge, but that was, once again, caused by the need to buy American production after their own industries were tapped out. In this case, America’s Lend Lease program removed the financial stranglehold.
But it was America’s entry into the war that changed the global fiscal picture. Through Lend Lease, America financed a huge percentage of the war materiel employed by its allies, while also financing its own massive mobilization and executing operations in multiple theaters. This was brought about by the remarkable cooperation between the US Treasury and the Federal Reserve. Treasury would issue the debt and the Federal Reserve would ensure that its member banks would purchase whatever the American public did not. The Federal Reserve, employing methods similar to what we now call “quantitative easing,” sopped-up any debt the markets could not absorb. Any detailed discussion of the inner workings of this process is beyond the scope of this essay. But, for all practical purposes, America during World War II discovered how to tap into Cicero’s “endless streams of money.”
VI
Paul Kennedy, in his masterpiece The Rise and Fall of Great Powers, noted that victory in long-drawn out great-power wars has “repeatedly gone to the side with the most flourishing production base.”30 As this essay makes clear, it is not the size of the production base that counts; it is the efficiency with which a state can muster its financial resources that decides conflicts. Paul Kennedy also popularized the term “imperial overstretch,” claiming that “that the sum total of the United States’ [sic] global interests and obligations is nowadays far larger than the country’s power to defend them all simultaneously.”31 Kennedy clearly identified the problem, but he misidentified the state. The US economy, thanks to Hamilton’s gift to the nation, could have maintained its Cold War spending for generations. It was the Soviet Union that buckled under the economic and financial strain of the competition.
Yet at the start of the twenty-first century, strategists and policymakers must wonder if the United States and much of the world is not facing a problem of “entitlement overstretch.” Hamilton, who called the national debt a “national blessing,” in the same breath warned that this was only true “if it [was] not excessive.” Hamilton envisioned the public debt as proof against a crisis. Today, we are conducting a great experiment to see if debt can be continuously expanded at wartime levels during peacetime. When the United States entered World War II, its debt was under forty percent of the GDP. The country finished the war with a debt-to-GDP ratio of 118 percent. We exceeded that level in 2020, and we, along with the rest of the world, continue to pile on more debt. The strategic question is, can a nation already pushing a debt-to-GDP ratio approximating 150 percent sustain the amount of new debt required to engage in a prolonged great state competition or conflict? In other words, at what point does the system Hamilton bequeathed to us break? The answer is unknowable as we are now in unchartered financial waters.
1. From George Washington to Robert Morris, August 27, 1781, Founders Online, National Archives, https://founders.archives.gov/documents/Washington/99-01-02-06802. [This is an Early Access document from The Papers of George Washington. It is not an authoritative final version.]
2. “From George Washington to Joseph Reed, 28 May 1780,” Founders Online, National Archives, https://founders.archives.gov/documents/Washington/03-26-02-0150. [Original source: The Papers of George Washington, Revolutionary War Series, Volume 26, 13 May–4 July 1780, Benjamin L. Huggins and Adrina Garbooshian–Huggins, eds. (Charlottesville, VA: University of Virginia Press, 2018), 220–25.]
3. Joseph Plumb Martin, Yankee Doodle Boy (New York, NY: Holiday House, 1995), 155.
4. M. Tullius Cicero, The Orations of Marcus Tullius Cicero, trans. C. D. Yonge (London, 1903), 95. This quote may be an adaptation of the original, “First of all the sinews of war is money in abundance.”
5. “From Alexander Hamilton to———, [December–March 1779–1780],” Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-02-02-0559-0002. [Original source: The Papers of Alexander Hamilton, Volume 2, 1779–1781, Harold C. Syrett, ed. (New York, NY: Columbia University Press, 1961), 236–51.].
6. Emphasis added. Alexander Hamilton to James Duane, September 3, 1780, Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-02-02-0838, originally found in Syrett, ed., Papers of Alexander Hamilton, Volume 2, 400–18.
7. Hamilton to Robert Morris, April 30, 1781, Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-02-02-1167, originally found in Syrett, ed., Papers of Alexander Hamilton, Volume 2, 604–35.
8. Hamilton to Morris, April 30, 1781.
9. Hamilton to Morris, April 30, 1781.
10. For copies of each of these six essays see Syrett, ed., Papers of Alexander Hamilton, Volume 2, 649–74.
11. Report Relative to a Provision for the Support of Public Credit, January 9,`1790, Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-06-02-0076-0002-0001. [Original source: The Papers of Alexander Hamilton, Volume 6, December 1789 – August 1790, Harold C. Syrett, ed. (New York, NY: Columbia University Press, 1962), 65–110.]
12. Louis Johnston and Samuel H. Williamson, What Was the U.S. GDP Then?, MeasuringWorth 2022, https://www.measuringworth.com/datasets/usgdp/.
13. Richard Sylla, “Financial Foundations: Public Credit, the National Bank, and Securities Markets,” in Founding Choices: American Economic Policy in the 1790s, Douglas A. Irwin and Richard Sylla, eds. (Chicago, IL: University of Chicago Press, 2011), 59.
14. “Report Relative to a Provision for the Support of Public Credit.”
15. “Report Relative to a Provision for the Support of Public Credit.” Emphasis in original.
16. George Washington to Joseph Reed, May 28, 1780, Founders Online, National Archives, https://founders.archives.gov/documents/Washington/03-26-02-0150. [Original source: The Papers of George Washington, Revolutionary War Series, Volume 26, 13 May–4 July 1780, Benjamin L. Huggins and Adrina Garbooshian-Huggins, eds. (Charlottesville, VA: University of Virginia Press, 2018), 220–25.]
17. Paul Schmelzing, Eight Centuries of Global Real Rates, R-G, and The “Suprasecular Decline,” 1311–2018 (London: Bank of England, January 2020).
18. Mauricio Drelichman and Hans-Joachim Voth, Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (Princeton, NJ: Princeton University Press, 2014), 280.
19. P.G.M. Dickson, The Financial Revolution in England: A Study in the Development of Public Credit, 1688–1756 (New York, NY: Macmillan, 1967), 9.
20. Dickson, The Financial Revolution in England, 457.
21. John Brewer, The Sinews of Power: War, Money, and the English State 1688–1783 (Boston, MA: Harvard University Press, 1990), xiv. Emphasis in original.
22. “Final Version of the Second Report on the Further Provision Necessary for Establishing Public Credit (Report on a National Bank),” December 13, 1790, Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-07-02-0229-0003. [Original source: The Papers of Alexander Hamilton, Volume 7, September 1790 – January 1791, Harold C. Syrett, ed. (New York, NY: Columbia University Press, 1963), 305–42.]
23. “Final Version of the Second Report on the Further Provision Necessary for Establishing Public Credit (Report on a National Bank).”
24. “Final Version of an Opinion on the Constitutionality of an Act to Establish a Bank,” February 23, 1791,” Founders Online, National Archives, https://founders.archives.gov/documents/Hamilton/01-08-02-0060-0003. [Original source: The Papers of Alexander Hamilton, Volume 8, February 1791 – July 1791, Harold C. Syrett, ed. (New York, NY: Columbia University Press, 1965), 97–134.]
25. Henry Stimson, On Active Service in Peace and War (New York, NY: Harper & Bros., 1971), 352.
26. Frederic S. Mishkin, “Is Financial Globalization Beneficial?” NBER Working Paper 11891 (December 2005). Emphasis added.
27. Richard Sylla, “Comparing the UK and US Financial Systems, 1790–1830,” in The Origins and Development of Financial Markets and Institutions: From Seventeenth Century to the Present Jeremy Atack and Larry Neal, eds. (Cambridge: Cambridge University Press, 2009), 214.
28. B. M. Anderson, Effects of the War on Money, Credit and Banking (Washington, DC: Carnegie Endowment for International Peace, 1919), 6. The Germans began storing additional gold in the Reichsbank in 1912, but ceased collecting reserves at about $360 million when they apparently considered they had enough to finance a major war. In reality, it was enough to pay for (at best) a single month of heavy fighting in 1915. See also J. Laughlin, Credit of Nations: A Study of the European War (New York, NY: Charles Scribner’s Sons, 1918), 202–5.
