A thought about economic policy in the early United States

My history book club met last night to discuss John Steele Gordon's book, Empire of Wealth: The Epic History of American Economic Power. We all agreed it was a good read, the result of great skill by the author in presenting economic ideas accessibly. The book traces the history of the United States through the lens of an economist. It makes the point that technological innovations have been extremely important in American growth. I also found it to provide a very good explanation of how the differences in agricultural resources between the southern and northern colonies of what became the United States led to social and economic patterns in their societies (which later led to the Civil War and the postbellum differences between northern and southern states).

One thing that came out in the discussion was the difficulty faced by Washington and his Treasury Secretary in economic policy in the first government after the Constitution went into effect. We think of economic policy as being balanced between fiscal policy managed collaboratively by the executive and legislative branches of government, and monetary policy involving the central bank (or in our case, the Federal Reserve system).

The impact of government fiscal policy on the economy is a function of the size of the government relative to the overall size of the economy. Two hundred years ago, the federal government was tiny, limited by the conceptions of its founders and managers, by the willingness of the individual states to be governed by the central government, and by the limited taxing ability of the time. Thus there was little that could be done to improve the economy using fiscal policy, even if the leaders of the time had understood macro economic policy as we do.

The federal government did not print money at the time (not until the Civil War, when it started printing "greenbacks"). Rather, individual banks printed their own forms of money. Alexander Hamilton argued successfully that there should be a national bank which had the ability among other things to regulate the state and local banks. This gave the national bank the ability to influence the money supply, and thus to begin monetary policy.

The national bank was privately owned, and thus like the Federal Reserve insulated from the direct control of the government. Andrew Jackson, much later when he was president, hated the first national bank and managed to put it out of existence. Jon Meachem in his book American Lion: Andrew Jackson in the White House argues that Jackson's antagonism to the bank was due to the fact that its owners, who opposed his pro-poor policies, used the power of the bank politically, especially to support opponent politicians through favorable financing.


We noted however, that there was likely to be considerable inflationary pressure as many independent and unregulated banks issued currency, and that the regulation of the national bank could reduce this inflationary pressure by limiting the amount of money printed by the banks it was regulating. The wealthy owners of the national bank would have been likely to favor less inflationary policies than would the populist president, Jackson.

Gordon describes well in his book the similar issue later in history. The United States after the Civil War issued both gold and silver currency. In both cases the coins actually contained metals with the value the coin represented. Gold discoveries lagged silver discoveries, and consequently a lot more silver coinage could be and was minted later in the century than gold currency. The gold standard used by the government thus limited the growth of the money supply. Going off the gold standard would have been more inflationary. Thus William Jennings Bryan in his famous Cross of Gold speech led democratic forces seeking that the government abandon the gold standard, while the more conservative forces in the country successfully defended that standard until well into the 20th century.

Alexander Hamilton is credited with both the creation of the national bank and with the decision to have the federal government assume state debts from the Revolutionary War and pay them through revenue raised by taxing power independent from the states. These policies were raised in two crucially important policy papers, both discussed by Gordon in his book.

Hamilton, also wrote a third major policy paper recommending a federal government policy to promote manufactures. Gordon does not discuss that paper, nor did Richard Brookhiser in his book Alexander Hamilton, American (another good book enjoyed by our book club). I found that paper to be equally remarkable, recommending many policies that were later implemented, and indeed are still relevant today.

Hamilton of course was from New York, and the split between the southern states emphasis on plantation agriculture versus the northern states emphasis on manufacturing was already evident in the late 18th century. Still, it is manufacturing that made the American economy great in the late 19th and the 20th centuries, and Hamilton deserves great credit for his efforts to get the federal government to help create the conditions that supported that industrialization.