Thomas Jefferson was proud of his home and architectural masterpiece, Monticello. So proud, in fact, that he placed a bust of himself in the foyer. He was also proud of his life in politics. To remind himself and visitors of his legacy, he placed a statue of his main rival, Alexander Hamilton, across the foyer.
Jefferson and Hamilton are archetypes of one of the most enduring debates in American politics, a debate over the nature of government and the centralization of political power. In many ways, the DNA of what would become the Federal Reserve System was a compromise between the two men’s visions about the proper role of government in the economy.
Hamilton wanted the fledgling new country to grow and become a commercial and military rival to the great powers in Europe. In particular, he was impressed with the Bank of England, which had performed well as the central bank for a growing British Empire since it was established in 1694.
The California Institute of Technology historian John Brewer suggests that Britain’s development from a peripheral player in Europe to one at the center of world affairs owed more to its bankers and bureaucrats than to its generals and soldiers. In his book The Sinews of Power, he wrote, “Victory in battle relied in the first instance upon an adequate supply of men and munitions, which, in turn, depended upon sufficient money and proper organization.” Those commitments were met “thanks to a radical increase in taxation, the development of public deficit finance (a national debt) on an unprecedented scale, and the growth of sizable public administration devoted to organizing the fiscal and military activities of the state.”1
Even though the newly created United States of America was a fledgling nation, Hamilton saw its potential to rival the great powers of Europe. To achieve that, he developed a complex financial plan to help the country grow economically. The plan included establishing tariffs and other taxes for federal revenue, repaying the Revolutionary War debt acquired by the Continental Congress and all the states, chartering a national bank, and creating a national currency.
Jefferson, on the other hand, saw a different economic future for the new republic. He put more faith in an agriculture-based economy of yeoman farmers. He saw the benefits of large cities in terms of the culture and sophistication they engendered, but viewed them as fountains of corruption as well. He also considered industrial growth and the concentration of economic power in institutions such as banks as potential threats to liberty. Banks were particularly problematic for Jefferson since they encouraged speculation rather than making their money from honest labor, and he believed they tended to concentrate power in near monopolies.
These two worldviews collided over Hamilton’s economic plans, which Congress adopted almost in their entirety. Those included the establishment of the Bank of the United States in 1791, which was granted a twenty-year charter. Jefferson opposed the Bank for many reasons, including his fear that it would primarily help the commercial North and concentrate wealth in cities. A bank chartered by the national government that could operate branches in all states would be an unfair competitor to state-chartered banks that operated in one place and received fewer federal advantages. Above all of these objections, however, Jefferson opposed the Bank because he did not think the Constitution gave Congress the power to create one.
The tensions between different visions of the proper role of government were made even more complicated by the competing interests of many different economic factions. For example, those who had capital wanted to see conservative monetary policy to safeguard against inflation, which would lower the value of their financial wealth. On the other side of the coin, those who needed capital to grow their businesses and farms tended to favor more liberal policies that eased access to credit, even at the risk of sparking inflation or a potential unstable banking system. The more established parts of the country — the wealthier cities of New England and the Mid-Atlantic, for example — often were in the former camp. Growing areas to the West and South were frequently in the latter. And each coalition had their political supporters.
These cross-cutting tensions about the role of government and different economic interests were always at odds in the efforts to manage the nation’s finances, leading up to the creation of the Federal Reserve System. Negotiating among all those different interests would have been difficult during times of economic predictability and stable growth, but the nineteenth century was an era of great innovation, explosive growth, and radical changes to society. At the time of the first national bank — the first Bank of the United States — the nation was almost exclusively rural and agricultural. By the time of the Federal Reserve Act of 1913, the country was industrializing rapidly and people were moving to cities in greater numbers. It is against this backdrop of extraordinary change and shifting battle lines among political factions, regional interest, and economic interests that this history must be understood.
Second Bank of the United States, Andrew Jackson, and the Bank War
The first Bank of the United States had a twenty-year charter that expired just before the War of 1812. Disaster was barely averted in that war against Britain, thanks to a few key battlefield wins, but the inability of the federal government to wage war without a bank was made abundantly clear. When the war was going badly, even strong opponents of a central bank, such as Jefferson’s political ally, President James Madison, reluctantly agreed to approve the creation of a second national Bank. Although Madison’s enthusiasm waned when peace with the British seemed near, he ultimately signed the charter for the second Bank of the United States into law in April 1816; it opened for business in Philadelphia in 1817.
In both structure and function, the second Bank was similar to the first Bank of the United States. It was a fiscal agent, holding federal deposits and issuing debt, and it engaged in bank supervision by issuing and redeeming bank notes that were deposited in state-chartered banks. It also operated as a commercial bank by accepting retail deposits and making loans to individuals and businesses through its twenty-five-bank network. Its early leadership had a mixed record, but that changed in 1823, when Nicholas Biddle took the reins. His sound management is credited with contributing to economic growth.
Biddle soon found a foe in Andrew Jackson, who was a follower of the Jefferson line in his views on the role of government. He saw the Bank as too powerful, too insulated from congressional oversight, and too harmful to states’ attempts to manage their local economies. In addition to Jackson’s political objections, he also distrusted banks in general as dishonest players in the economy.
Jackson’s presidential adversary in 1832 was Sen. Henry Clay of Kentucky, who wanted to make an issue of Jackson’s opposition. Clay thought he could rally support for the Bank — and by extension, his campaign — because the institution seemed to be working reasonably well. At his urging, the second Bank’s charter came up for renewal ahead of schedule in 1832. It passed in the House and the Senate but then was stopped as Jackson vetoed it.