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The Founding Wizard
Two hundred years ago the United States was a weakling republic prostrate beneath a ruinous national debt. Then Alexander Hamilton worked the miracle of fiscal imagination that made America a healthy young economic giant. How did he do it?
July/august 1990 | Volume 41, Issue 5
On January 14, 1790, Hamilton submitted his first “Report on the Public Credit,” which called for redeeming the old national debt on generous terms and issuing new bonds to pay for it, backed by the revenue from the tariff. The plan became public knowledge in New York City immediately, but news of it spread only slowly, via horseback and sailing vessel, to the rest of the country. New York speculators moved at once to take advantage of the situation. They bought as many of the old bonds as they could, raising the price from 20 to 25 percent of par to about 40 to 45 percent.
There was an immediate outcry that these speculators should not be allowed to profit at the expense of those who had patriotically taken the bonds at par and then sold them for much less in despair or from necessity. James Jackson, a member of the House of Representatives from the sparsely settled frontier state of Georgia, was horrified by the avaricious city folk. “Since this report has been read in this House,” he said in Congress, “a spirit of havoc, speculation, and ruin, has arisen, and been cherished by people who had an access to the information the report contained. … Three vessels, sir, have sailed within a fortnight from this port [New York], freighted for speculation; they are intended to purchase up the State and other securities in the hands of the uninformed, though honest citizens of North Carolina, South Carolina, and Georgia. My soul rises indignant.”
One of the greatest weaknesses in the American economy was a lack of capital. Hamilton insisted on a well-funded national debt to overcome this.
Elias Boudinot of New Jersey, wealthy and heavily involved in speculation himself, demurred. “I … should be sorry,” he said in reply, “if, on this occasion, the House should decide that speculations in the funds are violations of either the moral or political law. … [I agree] with [the] gentlemen, that the spirit of speculation had now risen to an alarming height; but the only way to prevent its future effect, is to give the public funds a degree of stability as soon as possible.” This, undoubtedly, was Hamilton’s view as well.
James Madison, as congressman from Virginia, led the attempt to undercut the speculators. He proposed that the current holders of the old bonds be paid only the present market value and that the original bondholders be paid the difference. There were two weighty objections to this plan.
The first was one of simple practicality. Identifying the original bondholders would have been a nightmare, in many cases entirely impossible. Fraud would have been rampant.
The second objection was one of justice. If an original bondholder had sold his bonds, “are we to disown the act of the party himself?” asked Boudinot. “Are we to say, we will not be bound by your transfer, we will not treat with your representative, but insist on resettlement with you alone?”
Further, to have accepted Madison’s scheme would have greatly impaired any future free market in United States government securities and thus greatly restricted the ability of the new government to borrow in the future. The reason was simple. If the government of the moment could decide, on its own, to whom it owed past debts, any government in the future would have a precedent to do the same. Politics would control the situation, and politics is always uncertain. There is nothing that markets hate more than uncertainty, and they weigh the value of stocks and bonds accordingly.
Hamilton, deeply versed in the ways of getting and spending, was well aware of this truth. Madison, a landowner and an intellectual, was not. Hamilton, in his report, had been adamant. “[Madison’s plan] renders property in the funds less valuable, consequently induces lenders to demand a higher premium for what they lend, and produces every other inconvenience of a bad state of public credit.” Hamilton was eager to establish the ability of the United States government to borrow when necessary. He was also anxious to establish a well-funded and secure national debt.
The concept of a national debt is not an ancient one. Until the end of the seventeenth century, debts were incurred by sovereigns personally, and money was borrowed from bankers on an ad hoc basis. Only with the creation of the Bank of England did government debt, paying a regular rate of interest and transferable in a free market, come into being. No other major country followed the British example for quite a while, a fact that in no small way contributed to Britain’s rise to the status of a great power in the eighteenth century. Britain’s ability to marshal its wealth for military and economic purposes effectively allowed it to play the pivotal role in European politics throughout the century.
By 1790 the British national debt amounted to the then-staggering sum of £272 million. But despite this huge debt—indeed, in many ways because of it—the British economy was the richest, per capita, and the most productive in the world. Yet there were still many people who failed to grasp the power of a national debt, properly funded and serviced, to bring prosperity to a national economy. John Adams, hardly stupid, was one. “Every dollar of a bank bill that is issued beyond the quantity of gold and silver in the vaults,” he wrote, “represents nothing, and is therefore a cheat upon somebody.”