Origins of the U.S. Financial System

Before the Revolution, British North American colonists generally circulated foreign specie (full-bodied silver and gold coins) rated in local monies of account and paper bills of credit to settle open account balances, but during monetary stringencies they resorted to country pay and other exigencies. Formal financial intermediaries were few, and for the most part urban and nonprofit. During the Revolution, governments financed rebellion by issuing dollar-denominated Continentals and other fiat paper monies. Much more currency was emitted than demanded at the prewar price level, so the paper money depreciated until it became virtually worthless. Americans then reverted to specie, and the rebel governments turned to foreign loans and in 1782 to the nation’s first joint-stock commercial bank, the Bank of North America. Shortly after the Revolution, two more commercial banks appeared in seaport cities, and a few other business corporations formed, but generally entrepreneurs held back, fearful of the continuation of recession and the return of civil war. Only with the passage of the new Constitution and the installment of a new federal government, led by the venerable George Washington and financial reformer Alexander Hamilton, did the investment floodgates open. By 1795, the new nation had a fully formed modern financial system – including strong public finances and debt management, a uniform unit of account, a central bank, a commercial banking system, efficient securities markets, a network of insurance companies, and economic incentives and legal rights to innovate – that drove America’s nineteenth century economic growth and development.