The national debt was one of the most contentious issues in the politics of the early United States. The debates that swirled around how to pay the national debt helped to provide the rationale for the writing and RATIEIcation of the Constitution and contributed to the development of political parties in the 1790s and early 1800s. The debt also remains one of the most difficult subjects to understand. Indeed, few people—perhaps not even Alexander Hamilton—ever fully comprehended all of the intricacies and complications of the debt that had emerged from the Revolutionary War (1775-83). However, Hamilton’s policies successfully transformed the debt from a public liability to a civic asset. In the process, the debt became a driving force behind the creation of the United States and crucial to the molding of a national identity.
By the mid-18th century several European states had long become accustomed to some form of national debt. Both Great Britain and France depended upon debt as a means to pay for their repeated wars with each other. Armed conflict fought on a global scale had become too expensive to sustain on a pay-as-you-go basis. Debt allowed a country to spread out the cost of a war over many years, including years of peace. The two nations, however, took their debt in different directions. The British government had greater flexibility in raising taxes, encouraged an active capital market in London, and formed an intimate relationship with the Bank of England that allowed for quick infusions of cash. The French government was more antiquated and cumbersome, had a less well-developed capital market, and did not have an equivalent institution to the Bank of England. In the closing decades of the 18th century Great Britain continued to draw on its capital resources while the French Crown experienced a bankruptcy that contributed to the outbreak of the French Revolution (1789-99).
British Americans were not only aware of the national debt in Great Britain but also had a more direct experience with government debt within each colony. The victory in the French and Indian War (1754-63) had been funded with deficit spending on both sides of the Atlantic Ocean. Parliament increased its own national debt and reimbursed the colonists for about 40 percent of the ?2.5 million spent by the colonial governments. Most of the colonies paid for their share of the fighting with fiat currency; they printed money that could be used to pay taxes in the future. This type of funding constituted a form of debt since the intention was to eventually retire all of the paper money in circulation. The New England colonies, including Massachusetts, which had some of the heaviest expenditures during the conflict, were prohibited from printing money by the Currency Act of 1751 and therefore issued interestbearing treasury notes, which were a more direct form of state debt. Whether the colony used fiat currency or treasury notes, during the 1760s and into the 1770s almost all of the colonies were successful in retiring their debt.
When the Revolutionary War broke out, the Second Continental Congress, building on the colonial experience, turned to fiat currency as a means to pay for the conflict. The idea was for the Continental currency to be used for supplies and the army and then have the notes circulate until they were paid in taxes. Once returned to the government through taxation, the money would either be recirculated or, when no longer needed, retired and taken out of circulation. From this perspective it was acceptable for the Continental dollars to be a little inflationary, since a decrease in their value would make it cheaper for the money to be redeemed. However, Continental money soon became highly inflationary, creating problems for the government of the United States and for the people who held on to Continental dollars. After printing about $25 million dollars in 1776 the value of the currency began to slide. With $76 million more Continentals placed in circulation in 1777 and 1778, the ratio of paper money to specie fell to 5:1. In 1779 the value of the printed money began a free fall so that, by the end of 1780, the ratio had become 100:1 and soon thereafter the Continental was all but worthless. In 1781 the government suspended issuing further notes. From 1775 to 1781 the Continental Congress had authorized $227.8 million to be printed and netted about $47 million in specie value.
Fiat currency did not work for the Continental Congress because the war became more expensive than expected and because the revolutionaries used a variety of different and conflicting methods to raise money. The individual states printed their own fiat currency. Since under the Articles of Coneederation Congress did not have the power to tax directly, the states were supposed to impose taxes payable in Continental money and then return that money to the national government. However, most states preferred to take care of their own currency first and therefore did not always meet the requisitions imposed by Congress. State currencies, too, became inflationary, creating a maze of shifting values that made it difficult for anyone to know what their money was worth. Throughout the war the states printed $210 million in money, which had a specie value of $6 million.
If the existence of multiple fiat currencies was not complicated enough, there were other ways the national and state governments paid for the war. Local militias and committees, as well as the Continental army, issued impressment certificates to pay for goods and services. Really nothing more than formal IOUs, these certificates could be used for taxes, although they were usually redeemed at less than face value. In addition, as head of the treasury Robert Morris suspended payment of the army in 1781 and later issued $11 million in interest-bearing certificates to soldiers in lieu of back pay. Both levels of government also floated loans, although the national government did so on a grander scale in the domestic and international market: Individuals within the United States loaned the Continental Congress about $11 million; foreign countries, especially France and the Netherlands, loaned another $12 million.
The situation became even more complex during the 1780s. Morris suspended all interest on the domestic debt in 1782. With interest added each year, the debt grew. To help deal with the expanding debt, the national government issued indents on the loan certificates held by individuals, which were paper payments for the interest on the debt that also accrued interest. Simultaneously, the states actually began to retire some of the Continental currency through taxation; in the early 1780s, about $119 million in bills was collected, which had a specie value of $3 million. States also started to work off their individual debt, and by the end of the 1780s, some states had begun to assume the interest payments on the national debt.
The Continental Congress was most concerned with maintaining its credit overseas. Even though it suspended interest payments on the French debt in 1786, Congress did everything it could to service the Dutch debt. The capital market in Amsterdam was absolutely essential to the reputation of the United States. To maintain that position, the United States continued to borrow money from Dutch investors, who amazingly continued to provide loans, even if it was to just pay off the interest on the money that had already been borrowed.
Also during the 1780s many of the various forms of debt were traded in an open market. Most of the military certificates exchanged hands as did many of the impressment certificates, sometimes for as little as 10 to 15 cents on the dollar. Although it may seem as if the original holders of such certificates received a bad deal, that judgment is based on hindsight and does not take into account the risk any purchaser took, nor the years of delay before the government was willing to pay out on the debt. One scholar has calculated that had the original holder turned around and invested the specie he received for the certificate, his returns were not that far from the delayed return of the purchaser. Of course, such calculations overlook the fact that many of the original holders sold their certificates because of poverty and quickly spent what they had been paid, nor does it fully take into account the multiple times notes were traded—sometimes for a profit and sometimes for a loss.
The nationalists of the 1780s who wanted to strengthen the central government hoped that a more powerful United States would more effectively deal with the debt. But they did not do so simply, as Charles Beard believed, to ensure profit on their speculation in government securities. Instead, they saw a symbiotic relationship between their nationalism and the debt. As Alexander Hamilton explained as early as 1781: “A national debt, if not excessive, will be to us a national blessing. It will be a powerful cement of our union.” In other words, creating a stronger union was not the means to the end of paying the national debt; instead, the national debt would be the means to the end of a stronger United States. The men who gathered at the Constitutional Convention included in their draft work two provisions directly related to the national debt: First, they guaranteed that the new government would stand behind all financial obligations made by the previous government, and second, they provided Congress with the power to tax.
After ratification of the Constitution and the election of a new national government, it was left to Hamilton as secretary of treasury to disentangle the complicated web of financial instruments that comprised the national debt and develop a program to guarantee that the debt would become the “cement of our union.” In his Report on Puhlic Credit of January 9, 1790, Hamilton embraced the national debt as a positive force and not, as many in the 1780s had believed, a burden. Hamilton argued for the full funding of the debt, that is, he wanted to honor all financial obligations at their full face value regardless of the current market price. He also pushed for the assumption of the state debts. Although this assumption would increase the debt, by shifting the obligation to the federal government more creditors would be tied to Congress and would support a powerful central government that would be able to sustain the debt.
Hamilton, however, had no intention of paying off the debt. He merely wanted the United States to pay the interest on the debt. Built into his program was a regulation limiting final repayment of the debt to 2 percent a year. Hamilton believed that a continued debt would create a capital market in government securities similar to the one that existed in England that the United States could tap into in emergen-cies—such as a war. In other words, the debt would guarantee the independence of the republic by ensuring that there would always be eager domestic investors with liquid assets held in government securities that could facilitate financing of the government through any crisis.
Hamilton set up both full funding and the assumption of state debts to obtain advantageous interest rates, significant profits for the holders of government securities, and low taxes for the citizens of the United States. The total debt included: $40 million held by the national government ($27 million in original debt and $13 million in interest); $12 million in foreign debt ($8.4 million to France and $3.6 million to the Netherlands); and $18.2 million in assumed state debts. Hamilton left the terms of the foreign loans the same and kept borrowing from the Dutch to pay the interest and even, at first, to sustain his overall financial program. He fully funded the national debt but drove down the interest rate by exchanging outstanding notes for new federal securities, paying 6 percent interest on two-thirds of the notes and delaying payment of that interest on one-third until 1800. He also limited the interest on the outstanding arrears, including the indents issued during the 1780s in lieu of interest, to only 3 percent interest. For the assumed state debts he came up with an even more complicated formula: Six percent interest would be paid on four-ninths of the total immediately; 3 percent interest on three-ninths immediately; and 6 percent on the remaining two-ninths after 1800. Taken together, the payment program lowered the effective interest rate on government bonds to between 4 and 6 percent, the same rate given on the international market to only the strongest governments. Investors eagerly seized upon the program since by 1790 few of them had paid par for the notes and their effective rate of return was much higher than the face yield. Moreover, they were now guaranteed a return through the government’s power to tax. An investment that had been a gamble before the United States Constitution now became a sure thing.
The financial program also lowered the tax burden. Most of the cost of the program would be carried by an impost duty of 5 percent. Such a tax was invisible since it was paid at the time of importation and would be carried by the most affluent consumers—those people most likely to benefit from the financial program itself. There was also an excise tax imposed on alcoholic beverages. Hamilton wanted this tax more to establish the principle of the federal government’s right to impose domestic tax than for the $500,000 in revenue it was expected to generate. The total taxes would generate about $5 million a year, which Hamilton hoped could pay the interest on the debt and carry the government’s expenses.
State taxes could be reduced since most states were now relieved of the burden of their debt. Although Hamilton set a $4 million ceiling on the amount assumed from any one state, by the mid-1790s the rest of the state debts were all but wiped out by a final accounting of the expenses from the Revolutionary War. In an effort to clarify the level of state debt, the Continental Congress in 1786 organized a special settlement claims commission to calculate how much each state spent on the war and how much they should have spent based on a per capita basis. The national government under the Constitution continued this work and came to a final accounting in 1794 when the settlement claims commission determined that the 13 states had spent a combined $114.4 million on the Revolutionary War. After subtracting the portion of the state debts assumed by the national government under the Hamiltonian program, and counting the amount of money each state had already paid back, the commission used a zero-sum formula and concluded that six debtor states owed seven creditor states $3.5 million. The national government then issued bonds to be paid the creditor states while the debtor states were supposed to pay the national government the difference. The result was that the seven creditor states, and three other states where the balance was nearly even, had almost no debt. Combined, the federal and state taxes were thus reduced to an extremely low 2 percent of the total national income.
Hamilton’s efforts concerning the national debt drew opposition and contributed to the organization of the Democratic-Republican Party. Thomas Jeeeerson did not accept the idea that debt could be a good thing and thought that each generation should be responsible for the their own expenditures. He also viewed the creation of a market for capital—something that Hamilton believed strengthened the republic—as an anathema. Whereas Hamilton believed that all men were dependent and that a republican government was best served when the people relied upon that government, Jefferson believed that a republic could be comprised only of independent men divorced from ephemeral forms of wealth such as stocks and bonds.
Regardless of party differences, the United States continued to have a national debt, which persisted as “a powerful cement of our union” throughout the 1790s and early 1800s. With the Federalist Party in control of the national government during the 1790s, Hamilton’s policies predominated. The national debt hovered persistently around $80 million even though Hamilton encouraged the creation of a small sinking fund to shrink the debt modestly. Once Jefferson took office, however, he and his treasury secretary, Albert Gallatin, reversed government policies and began to erase the national debt, which dwindled to about $45 million by 1811. That debt would have even become smaller without the $15 million expended for the Louisiana Purchase and the dramatic decline in revenues during the embargo OE 1807. The War of 1812 (1812-14), however, reversed the downward trend of the national debt, which ballooned to $127.3 million by the end of 1815.
Further reading: E. James Ferguson, The Power of the Purse: A History of American Public Finance, 1776-1790 (Chapel Hill: University of North Carolina Press, 1961); Edward J. Perkins, American Public Finance and Financial Services, 1799-1815 (Columbus: Ohio State University Press, 1994).
World History
