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The legal framework by which paper money and coins came to be accepted for use in private transactions and international trade was established in the 18th century by George Washington and Alexander Hamilton.

When President Washington brought together his cabinet for its first meeting on November 26, 1791, Alexander Hamilton put forward what is now universally accepted as the American law for money and public credit. The central bank shall be the depository for the government’s collection of taxes and the customer of first and last resort for the government’s sales of its debt. The paper currency issued by the central bank, along with secondary coinage, shall be defined by the law as legal tender.

In his presentation, Hamilton added a condition that is no longer considered necessary: To avoid the inflation and corruption caused by war spending, the central bank promises to redeem its bank notes on demand for coins. Hamilton offered the example of the Bank of England as evidence of the wisdom of such a plan. Through central-reserve banking, both the country and the government’s needs for capital would be answered, as they had been in the United Kingdom. Using foreign and domestic coins held as a reserve, the Bank of the United States would be able to put into circulation the amount of legal tender that the country needed. (Hamilton did not formally offer the now standard description of the money multiplier; but he hardly needed to. As users of merchant and state-chartered and private banks’ bills of exchange, Americans were already thoroughly familiar with paper as payment.)

After listening carefully and requesting position papers from each member of his cabinet, Washington said “yes” to Hamilton’s idea of a nationally-chartered bank, but “no” to everything else. As Hamilton hoped, the wealthy, both at home and abroad, would invest a portion of their money savings in the national debt. Investors would accept American federal debt as “safe” investments because its interest was reliably paid in the international money of gold. The Bank of the United States would accept the federal government’s deposits of its tax collections. The Bank would issue its own notes and bills of exchange.

But neither the Congress nor the Bank would issue paper legal tender. The national bank’s responsibility would be to maintain the country’s ability to meet its foreign exchange obligations. It would not be gathering up the nation’s savings and making them available to Congress to pay for public improvements. It would not even be allowed to lend against real estate. At the same time, the states had independent authority to issue charters for banks within their range of their own sovereignties. Those state-chartered and private banks would be able to issue bank notes in even the smallest denominations. (This was in stark contrast to the Bank of England, whose notes specifically excluded anything we might consider to be “small change”.) As Marcello De Cecco observed, Washington’s rejection of conventional central banking and acceptance, for the states, of the Scottish model of “free” banking, was establishing a unique financial system. The United States was allowing independent banks to be established almost at will, without a central government overseer. Each town would have a bank that could issue notes to its borrowers without first getting the approval of a central bank.