A Brief History of the Principle of National Banking in the United States
May 29, 2020
While Central Banks exist in many other countries, the United States is unique in its successful development of national banking. The purpose of National Banks, developed even before the ratification of the U.S. Constitution, was to marshal the financial resources of the young nation and direct them into investment in infrastructure and industry. They were never intended to be instruments of buying and selling government debt, as was done in Europe and elsewhere.
There have been four periods in United States’ history where the principle of national banking was successfully implemented, as this blog outlined in a post April of this year. Here we provide a more substantial review, with the aim of demonstrating how this principle worked then, and building support for a similar approach today.
1790-91—First Bank of the United States
The creation of the First Bank was developed in the administration of George Washington. Under direction of Congress and with the support of Washington, Treasury Secretary Alexander Hamilton was commissioned to write several reports to Congress. These reports became the touchstones of the economic system of the nation. When Washington became president, the United States was drowning in its enormous revolutionary war debt, owed to states, individuals, and foreign governments. It was not being paid. Hamilton reorganized the debt, had the federal government “assume the states’ debts,” and funded the entirety by new excise taxes and import duties.
In 1791 the Congress created the Bank of the United States, and capitalized it at $10 million, a sum that was greater than all the banks in the country at the time. And it was capitalized in one day! To summarize: Hamilton offered holders of the newly reorganized debt instruments the opportunity to invest in the bank. They could buy shares with ¼ specie (gold, silver, coin, etc.) and ¾ new government bonds. They would be paid a regular interest higher than the interest on their debt, all federally guaranteed. The interest on the newly minted Government debt was paid to the Bank.
The Bank could issue currency notes up to the amount of capital, $10 million, and that played a crucial role in finally funding commerce and infrastructure (internal improvements) in the country. The value of the currency was regulated by the Bank, and its investment in new productivity cemented its strong value. Also the Bank of the United States was the sole depository of all circulating money and taxes in the nation.
Credit from the Bank became the engine of economic growth of the country. Growth was steady, though not at the pace of later such facilities, simply because the nation was starting at “square one.” Nevertheless the results were impressive.
Production of useful materials expanded at a rapid rate. Merchandise exports had quintupled by 1805, with well over $100 million exported. Gross tonnage moving across the oceans in American built vessels doubled. Imports had grown more rapidly.
From 1803 to 1807, an average of 80 patents per year were issued for new inventions, a rate four times greater than from 1790-94. Twenty thousand miles of post roads were built, a nascent manufacturing base was begun, and dams and early canals were constructed. By 1811, when the charter expired, the main issue holding back the continued expansion of the productive economy was a lack of interconnected transportation.
One important measure of the accelerating growth potential was the increase in population. From 1790 to 1805 the population had grown from 3.9 million to 6.3 million, an annual growth rate of 3.2%. In the 2010s the population growth rate was an anemic .7% by comparison.
Also, the Bank turned a profit.
It was chartered for 20 years, but serious opposition from landed aristocrats and their allies prevented the charter from being renewed.
1816–Second Bank of the United States
Following a serious economic downturn due to lack of credit and investment, and the near disaster of the War of 1812, Congress chartered the Second Bank of the United States in 1816. It was capitalized in the same manner as the First Bank, with the investment of Treasuries into the Bank in exchange for shares. The Bank also was created in a period where the economy was larger, and so investment in the Bank from private capital began to grow. Just like its predecessor, the Bank was chartered to carry out the expansion of the economy, not to bail out the government.
The original capital of the Bank was $35 million, of which $7 million was supplied by the government. This was a large amount, as the total money in circulation was $75 million, and annual revenue into the federal government was $25 million.
The Second Bank got off to a rocky start due to mismanagement, but with the ascension of Nicholas Biddle as a Director in 1819 and then President, the Bank made tremendous progress. Under the guidance of Biddle, in collaboration with President John Quincy Adams, a co-thinker of Washington’s and Hamilton’s policies, and Henry Clay as Speaker of the House, the economy rapidly expanded. Biddle came from the Pennsylvania circle of Benjamin Franklin and Matthew Carey, and had been head of the Society of Internal Improvements. Biddle and Carey founded the Franklin Institute in Philadelphia to promote scientific research in aid of industrialization.
Collaboration between the Congress and the Bank flourished, despite a tremendous push back by speculators and opponents of industrial development.
The Bank was directly involved in the development of canals, railroads, roads, the iron and coal industries, and state and local infrastructure projects. The overall standard of living of the nation grew as a result.
Some examples of the investments of the Bank with either states or private capital include:
Railroads —The Bank helped fund (up to 50%) and create over 20 new rail lines across the nation. They included The Buffalo and Niagara Falls, Franklin, New Orleans and Nashville, Philadelphia-Wilmington and Baltimore, Richmond and Petersburg, etc.
Canals —The Bank directly funded (again up to half) 8 canals, including the Brunswick in Georgia, the Illinois and Michigan, the Morris in New Jersey
Coal—The Bank directly funded much of the new coal industry in Pennsylvania
It also financed turnpikes, roads, bridges, and the like. Currency was controlled, the value of the dollar maintained, and credit was directed into infrastructure and industry.
Its Charter was renewed by Congress in 1832 but vetoed by President Andrew Jackson, who proceeded to take U.S. government monies out of its, and return to “hard money.” His actions eventually led to the Panic of 1837 and the downward spiral of the economy.
The Third Bank of the United States—1841
In 1841 the Congress, under the leadership of Clay, passed new legislation chartering a Third Bank of the United States, on the same exact model of the first two. This bill passed both houses, but was vetoed by President Tyler, who was beholden to the southern slaveholders and northern “Wall Street” financiers.
From 1841 until the presidency of Lincoln, the financial system was “deregulated.” Over 7,000 different currencies were put into circulation, and thousands of banks of all shapes and sizes dotted the landscape creating economic chaos, and a collapse of credit.
1862-64–Abraham Lincoln and the Creation of National Banking
Candidate Lincoln, a protégé of Henry Clay, campaigned on a platform including internal improvements and a National Bank. Lincoln personally added the Transcontinental Railroad to the 1860 platform of the Republican Party. As a state legislator in Illinois, Lincoln had been the leading proponent of infrastructure development. The policy of internal improvements, a tariff, and a National Bank had been dubbed the American System by Clay and was the avowed policy of Lincoln and the new Republican Party.
As president, Lincoln had no time to enact a new national bank; he was immediately confronted by the outbreak of the Civil War. By 1862 under the burden of war and rapidly diminishing finances, Lincoln and his collaborators took the principle of National Banking and applied it to the crisis. He moved to centralize control over the nation’s finances and direct credit to infrastructure and industry, to win the Civil War and build the nation.
Congress passed three Legal Tender Acts in 1862 and 1863, which created a uniform circulating currency, known as Greenbacks (the color of the ink on the back of the bills). Their circulation allowed both for payment of taxes and investment in needed industrial and agricultural projects. Lincoln increased the circulation of Greenbacks by 300% during his administration. (Interestingly, it was under Lincoln that Alexander Hamilton’s picture first appeared on U.S. currency.)
In 1863 and 1864 Congress passed the National Banking Acts based on the Hamiltonian model of the Banks of the United States. This created a national system, ending the chaotic reign of state and local banks running amok. Thousands of banks were re-chartered as part of the National Banking system. They were required to buy long-term Treasury bonds and deposit them with the Treasury as security, and the government then issued Greenbacks, backed by Treasury bills, to them to circulate. The Treasuries were funded with taxes and a tariff just like under George Washington and John Quincy Adams.
The legislation also created the Office of the Comptroller of the Currency to regulate this new national system. These acts by Lincoln are the basis of today’s U.S. banking system.
The results of this policy were impressive. Railroad development drove much of the industrial economy. The U.S. erected a massive railway system, which by 1865 extended to 45,000 miles. As the Lincoln policy continued after his death, railroad construction quadrupled to 167,000 miles by 1890, more than all of Europe combined. Railroad development spurred expansion in all the related areas, i.e. bridge construction, tunnels, and raw materials mining. These included iron ore, coal, limestone, etc. Railroads were used for war time troop transit and peacetime transportation. With the railroads came new cities and expanded agriculture. Under Lincoln the Land Grant and Homestead Acts fostered those developments.
Lincoln also began the Transcontinental Railroad, personally, in 1862. He had met with the proponents of the system before the war and became expert in its development. The Golden Spike in Utah can be directly traced to Lincoln and his national banking policy. The northern spur of the railroad, the Union Pacific, was largely built by Union troops who migrated from rail construction during the war to the new lines opening up the west.
The U.S. also built the first modern telecommunication system during the war, the telegraphs. As the Transcontinental Railroad was building west, telegraph lines were being constructed alongside. When the system was connected at Promontory Point, it was reported instantaneously by the new telegraph system.
As a result of Lincoln’s policies, the United States became an agro-industrial powerhouse, the envy of the world. Productivity expanded, as new inventions and new industrial output led to increasing rates of development and a massively growing economy.
1933-1945—the Franklin Roosevelt Administration
The Franklin Roosevelt Administration went back to the models of National Banking, and infrastructure and industrial development of the 19th Century. FDR’s early relatives were business partners and collaborators of Hamilton and George Washington, and numbers of his advisors were also versed in that tradition. Notable among them were Frances Perkins, Henry Wallace, Harry Hopkins, Harold Ickes, and Sen. Robert Wagner.
The New Deal period of 1933-38 witnessed an outbreak of massive government directed programs to attack the Depression. They went by the various alphabet soup titles of CWA (Civil Works Administration), WPA (Works Progress Administration), PWA (Public Works Administration), NRA (National Recovery Act), TVA (Tennessee Valley Authority), CCC (Civilian Conservation Corps) and more. Their purpose was to get people back to work, with federal intervention. But these were not make-work jobs. They were all vectored into either infrastructure development or ancillary services.
WPA alone built over 125,000 new buildings, including schools, public buildings and libraries; 20,000 miles of water mains; 1,000 new or renovated airports; 600,000 miles of urban and rural roads, etc. CCC built 47,000 bridges, and 200 large dams, in addition to the massive reforestation. CWA built 2,000 new levees, 9,000 miles of drainage and irrigation ditches, and 7,000 bridges. PWA built 11,000 miles of streets, 388 new bridges, 384 airports, 2,000 complete waterworks, power plants, dams, and canals.
However, much of the funding for the New Deal infrastructure came from the Reconstruction Finance Corporation (RFC), which had been created by the Hoover administration. The private banks refused to lend to the productive economy until after the outbreak of WWII. Franklin Roosevelt had a bill for an Infrastructure Bank, like that of Hamilton, Adams, et al, but could not get it through the Congress so he used the RFC as a national bank. It was funded through the Treasury, but functioned as a bank. It had revolving fund lending capabilities, was directed to infrastructure and industrial projects only, and had the independence to intervene directly into the physical economy. It became the largest source of credit in the economy. It also became the largest bank by far, and by 1940 was known as “the fourth branch of government.”
During the New Deal, the RFC deployed between $15 and $20 billion into the recovery effort. It gave WPA $1 billion at its founding to start public works projects and another $2 billion loan over time. RFC took over the municipal bonds held by the PWA and sold them on the markets to raise capital for the Public Works projects. The RFC directly helped fund the Hoover Dam, Grand Coulee Dam, Bonneville Dam, and the Mississippi flood control projects.
From 1933-1939, 70% of the new school buildings and 35% of the hospitals were funded by the RFC. The funding was done on the basis of long term 5-20 year loans at very low interest rates, and ultimately virtually all loans were repaid.
The RFC was crucial to reviving housing. It set up the Home Owners Loan Corporation (HOLC) with $200 million for its capital stock, and the HOLC ultimately refinanced 20% of all mortgages. RFC gave the Federal Housing Administration (FHA) $200 million for its capital, and the RFC created the Federal National Mortgage Association (Fannie Mae) to finance mortgages. Fannie Mae became the main purchaser of FHA mortgages.
The RFC also intervened to aid the farm economy, which at that time was the largest sector of the nation, and mired in deep depression. The key agency that supported decent prices for farm commodities was the Commodity Credit Corporation, which was created in 1933. It was entirely funded by the RFC, and allowed farmers to borrow money based on their crops at a much higher price. In 1933, the Commodity Credit Corporation had a lending capability of $1 billion backstopped by the RFC to save the farm sector.
The RFC was involved in many other farm projects, including the Rural Electric Administration. This agency brought electric power to rural America, created the electric cooperatives, and built the power lines. The Rural Electric Administration was almost entirely funded by the RFC.
During the New Deal period, virtually all RFC loans were repaid.
During WWII , the RFC was invaluable. It created numbers of subsidiaries including the Defense Plant Corporation (DPC), Metals Reserve Corporation, Rubber Reserve Corporation (RRC), and Defense Supplies Corporation (DSC).
The RFC loaned over $27 billion during the war. Between 1939 and 1941, when the United States was not at war, but Roosevelt saw the war approaching, there was little ability to get Congress to fund a military build-up. So FDR turned to the RFC, and it undertook the lion’s share of the industrial ramp-up that allowed the U.S. to enter the war with an already-functioning war economy.
The RFC-generated DPC built the entire machine tool industry during this period, spending nearly $2 billion to create an industry that was state of the art, and deploying tools into newly built factories.
DPC was at the center of building a military airplane industry virtually from scratch. It funded the construction of new, assembly line, war plane factories (including the gigantic Willow Run plant in Detroit). It also built most of the engine companies. Fourteen of the 15 engine plants that supplied the modern engines to the planes were funded by DPC.
The Rubber Reserve gathered in all the rubber available during the interwar period, and the DPC and DSC collaborated to build the synthetic rubber industry de novo. They built 51 new plants to furnish synthetic rubber to all areas of the war and civilian economies.
The list goes on. Suffice it to say, without the crucial role of FDR’s National Bank (i.e. the RFC) the ability to wage and win WWII would have been severely crippled or non -existent.
And again, virtually all of the loans generated by the RFC war industries were repaid or written off, and the agency either broke even or turned a profit. All of this was due to the rapid increase in productivity in the entire economy and the generation of real wealth. From 1940-45 Gross Domestic Product increased at over 10% per year, and productivity grew at 3-5% per year, rates that have not been achieved since.
Coalition for a National Infrastructure Bank
P.O. Box 1029
Leesburg, VA 20177
info@nibcoalition.com