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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
But Hamilton grasped it fully. One of the greatest problems of the American economy at the time was a lack of liquid capital, which is to say, capital available for investment. Hamilton wanted to create a well-funded national debt in order to create a larger and more flexible money supply. Banks holding government bonds could issue bank notes backed by them. He knew also that government bonds could serve as collateral for bank loans, multiplying the available capital, and that they would attract still more capital from Europe.
In the 1780s the United States had been a financial basket case. By 1794 it had an outstanding credit rating, and European capital was building our economy.
Hamilton’s reasoning eventually prevailed over Madison’s, although not without a great deal of rhetoric. Hamilton’s father-in-law, Philip Schuyler, a senator from New York, owned more than sixty thousand dollars’ worth of government securities. It was said that listening to the opposition speakers in the Senate made his hair stand “on end as if the Indians had fired at him.” Rhetoric or no, the House rejected Madison’s proposal 36 to 13 and approved Hamilton’s.
The second major part of Hamilton’s program was for the new federal government to assume the debts that the individual states had incurred during the Revolutionary War. Hamilton thought these debts amounted to twenty-five million dollars, but no one really knew for sure. It eventually turned out that only about eighteen million dollars in state bonds remained in circulation.
Again, opinion was sharply divided. Those states, such as Virginia, that had redeemed most of their bonds were adamantly opposed to assumption. Needless to say, those states, like the New England ones, that had not were all in favor of it. So were financial speculators, hoping for a rise to par of bonds they had bought at deep discounts. But land speculators were opposed. Many states allowed public lands to be purchased with state bonds at face value. Any rise in price would increase the cost of land.
Madison and others argued that it was simply unfair for Virginia to have to pay all over again for the debts incurred by other states. “Where, I again demand,” thundered James Jackson of Georgia, “is the justice of compelling a State which has taxed her citizens for the sinking of her debt, to pay another proportion, not of her own, but the debts of other States, which have made no exertions whatever?”
Fisher Ames, a congressman from Massachusetts, argued that since the new Constitution gave to the federal government all revenues from tariffs and customs—the surest source of funds with which to pay interest—the federal government should now assume the debt. “Let the debts follow the funds,” he demanded.
In the middle of April 1790, the House voted down Hamilton’s proposal 31 to 29. Four more times it was voted down, each time by so narrow a margin that Hamilton had hopes of making a deal. He had to do something, for he had tied the funding of the old national debt and the assumption of the state debts into one bill. Many thought that the state debt issue was, in the words of one of Hamilton’s biographers, “a millstone about the neck of the whole system which must finally sink it.”
Hamilton might have abandoned his effort to fund the state debts, but he had still one more reason for extinguishing as much state paper as possible and replacing it with federal bonds. The debts were largely held by the prosperous men of business, commerce, and agriculture—the oligarchs, in other words. These men’s loyalties lay mainly with their respective states and cozy local societies. While they had largely supported the creation of the new Union, Hamilton had no reason to suppose that their support would not quickly fade away if their self-interest dictated it.
He was therefore eager to make it in the self-interest of these men to continue their support of the federal government. If they had a large share of their assets held in federal bonds, they would have powerful incentives for wishing the Union well. And so he was willing to throw a very large bargaining chip onto the table to save his funding and assumption scheme. The new federal government had come into existence in New York City, and Hamilton and nearly every other New Yorker were hoping that the city would become the permanent capital. Hamilton knew perfectly well that every state wanted the capital and that Jefferson and Madison especially wanted the capital located in the rural South, away from the commerce and corruption of the big cities.
Hamilton intercepted Jefferson outside President Washington’s Broadway mansion one day and asked for help on getting his bill through Congress. Jefferson was opposed to the bill. Nonetheless, he offered to meet Hamilton the following night for dinner, with Madison in attendance. There a deal was made. Enough votes would be switched to assure passage of Hamilton’s bill, in return for which Hamilton would see that the capital was located on the muddy and fever-ridden banks of the Potomac River. To assure Pennsylvania’s cooperation, the temporary capital was to be moved to Philadelphia for ten years.