Happy (almost) Independence Day!
We all know the Fourth of July as the date upon which the Founders signed the Declaration of Independence, the official beginning of the United States of America.[1]
History books emphasize the surprising fact that a ragtag band of British colonies gained independence from the British Empire – one of the most powerful empires in the world.
But, in some ways, the military victory of the Revolutionary War was only a first step in the American Revolution.
Below, we’ll talk about why the formation of the First National Bank of the United States arguably constituted America’s second revolution, how the bank affected peoples’ wealth in hidden ways, and how you might take steps to prevent similar future outcomes. We discuss inflation – click here for a copy of our book, Politicians Spend, We Pay.
America begins to repeat its mistakes
In 1783, the American colonists had defeated the British militarily, but they had numerous decisions to make and problems to solve before the new nation could function properly.
Money had been a key motivator for the start of the Revolutionary War. The colonists’ famous cry, “No taxation without representation!” emerged as the British tried to tax colonists to pay off Britain’s own war debts from the Seven Years’ War (also known as the French and Indian War).
But in the aftermath of the Revolutionary War, the American leaders began doing the same thing that the British had done – impose heavy tax burdens on citizens.
Why did taxes in America become so high?
During the American Revolution, the Continental Congress created a new fiat currency – the Continental Dollar – and inflated it so much that the Continental Dollar no longer possessed any value. (For more detail on this, see our post on Inflation and Independence.)
The Revolutionary War had required a huge expenditure of money and goods, and the Continental Congress had to figure out how to pay back its debtors. The Federal Government owed about $65 million in debt to its own people. (The $12 million of foreign debt was dealt with separately.)
Broadly speaking, there are four ways that a government can raise money: 1) Taxation, 2) Inflation, 3) Borrowing, and 4) Outright seizure of goods (also known as theft). Given their experience during the Revolutionary War, the Founders were wary of inflation. They had already borrowed a lot of money. So they attempted taxation.
Failed attempts to solve the problem through taxation
During the Revolutionary War, the Continental Congress had relied largely on inflation to finance the conflict.
During the aftermath of the war, Congress relied heavily on taxation – but this strategy triggered discontent, including Shays’ Rebellion.
Shays’ Rebellion of 1786 and 1787 was a protest against high taxes. Led by a farmer, Daniel Shays, the group (largely composed of Massachusetts farmers) gathered in front of a courthouse to block proceedings which attempted to impose higher taxes and punish debtors.[2] Many of Shays’ followers included former soldiers in the Continental Army, who had never received payment for their services, and thus were unable to pay the high taxes demanded of them. Massachusetts, in some cases, attempted to seize the property of these men, prompting them to protest.[3]
The Whiskey Rebellion was another example of the use of taxation to attempt to raise back the money that had been spent on the war. Although one reason for the American Revolution had been to avoid excise taxes such those mandated by the Sugar Act and Stamp Act, the government passed an excise tax on whiskey in 1791. Farmers who relied on whiskey production to make a living felt unfairly targeted, and many small farmers were almost put out of business by the tax. So they refused to pay, and protested by setting fire to the tax collector’s house. General George Washington himself arrived with an army to put down the rebellion.[4]
The Continental Congress had to do something to pay down its debt and keep the people happy. Taxes just weren’t working.
The war over the First Bank of the United States: The Secret Second Revolution
Alexander Hamilton came up with a plan to monetize the Federal debt.
He proposed, among other things, the creation of a Central Bank.
Alexander Hamilton and James Madison became enmeshed in a political battle regarding the question: Should the United States establish a Central Bank?
We call this the ‘Secret Second Revolution’ because the debate about the Central Bank, while integral to our economy today, is not often spoken about or discussed. In that sense, it is “secret.” And it’s a “revolution” because establishing such a strong link between the Federal Government and the Central Bank, arguably, betrayed the principal of “no taxation without representation.”
You see, the National Bank, once established, caused inflation, and inflation is a hidden tax on the consumers who don’t benefit from such inflation.
Understanding the past and how the typical person’s wealth was destroyed in the past can help us think about how to protect our wealth in the future.
Arguments for and against the National Bank
Hamilton argued that the establishment of a Central Bank would be necessary for the “public good”, and that the Bank would enable the government to have more ability to finance necessary government expenditures. (For example, Shays’ Rebellion had been put down by a state, rather than a federal, militia. In the minds of many, this suggested that the Federal Government needed to fund an army to protect the new nation, rather than rely on state armies.)
He also argued that the creation of a National Bank would “increase the amount of active capital” in the country, and “stimulate investment.” (Similar arguments for growth of the money supply would be used in the 20th century by economist John Maynard Keynes, who argued that an increase in the availability of currency would lead to spending, and asserted that spending fuels economic growth.)
Hamilton’s financial plan for the US included monetization of the debt, which meant that government debt would essentially be considered not a liability, but an asset. Government debt, in fact, would be used to purchase bank-notes from the National Bank of the United States.
Madison argued that such a system would not benefit all people equally, and that it was an over-reach of government power.
However, Hamilton ended up winning the debate, and the National Bank was established in 1791.
Consequences of the First Bank of the United States
The formation of a National Bank included a key consequence which likely hurt the average American: inflation.
Monetization of the American government’s debt essentially turned that debt into money. Turning debt into money sounds like magic, but it’s not. In economics, there’s no free lunch – and someone had to pay for government debt to become an asset, rather than a liability.
When government debt started being treated like money, this effectively increased the amount of money in the economy. For those familiar with the idea that an increase in the money supply leads to an increase in the price level, the connection is clear: monetization of the debt led to inflation. (For more explanation of this, request a copy of our book, Politicians Spend, We Pay, here.)
Although Hamilton was aware of inflation and took pains to prevent it, inflation still occurred in the aftermath of the National Bank’s establishment. Between 1790 and 1796, the wholesale price of commodities rose over 8% (annual compound annual growth rate), from 90 to 146.
This inflation almost certainly impoverished the average person.
Implications of the National Bank today: Know how to protect your clients’ wealth
In the midst of political turmoil or an upcoming election, it can be important to understand how to protect your families’ and your clients’ wealth. Not only is it important to be educated about history (understanding the past can help us understand the future), but it’s important to know what options exist today to help protect your assets.
One of Sterling’s key solutions to wealth protection is a Tax Exempt Trust. Tax Exempt Trusts can help your clients avoid capital gains tax on sale of appreciated assets. For more information regarding Tax Exempt Trusts, request an Advisor Guide here. Or email Connor at [email protected] or Katherine at [email protected] . Or call 703 437 9720.
[1] The final text of the Declaration of Independence, read in Congress on July 4, 1776, begins, “The declaration of the thirteen united States of America: When in the course of human events…” Source: https://www.archives.gov/founding-docs/declaration-transcript. On September 9, 1776, the Continental Congress officially stated that the colonies should no longer be referred to as “united colonies” in any official documents, but rather as “United States.” Source: https://constitutioncenter.org/blog/today-the-name-united-states-of-america-becomes-offici
[2]Oddly, mainstream American history curricula (such as the AP US History exam) and websites (such as https://www.mountvernon.org/library/digitalhistory/digital-encyclopedia/article/shays-rebellion/#:~:text=A%20violent%20insurrection%20in%20the,of%20the%20American%20Revolutionary%20War) refer to Shays’ Rebellion as a ‘violent insurrection.’ However, as far as I can tell, it was not Shays and his followers who fired the first shots. Rather, General Benjamin Lincoln of the Massachusetts state militia fired ‘warning shots’ at Shays and his men because the army general ‘anticipated’ that Shays and his men would storm a federal armory.
[3]https://constitutioncenter.org/blog/on-this-day-shays-rebellion-starts-in-massachusetts#:~:text=Daniel%20Shays%2C%20a%20former%20Continental,wartime%20debt%20and%20high%20taxes
[4]https://www.mountvernon.org/library/digitalhistory/digital-encyclopedia/article/whiskey-rebellion/
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