Alexander Hamilton’s Eurozone Tour

Specifically, for European states groaning under unbearable debt burdens, Hamilton’s negotiation in 1790 of the new federal government’s assumption of the states’ large debts looks like a tempting model. Indeed, after Thomas Sargent won the Nobel Prize in Economics last year, he cited it as a precedent in his acceptance speech.

Hamilton argued – against James Madison and Thomas Jefferson – that the debts accumulated by the states during the War of Independence should be assumed by the federation. There were two sides to his case, one practical, the other philosophical.

Initially, the most appealing argument for his plan was that it would provide greater security to creditors, and thus reduce interest rates, from the 6% at which the states financed their debt to 4%. Hamilton emphasized the importance of a commitment to sound finance as a prerequisite to public economy. “When the credit of a country is in any degree questionable,” he argued, “it never fails to give an extravagant premium upon all the loans it has occasion to make.”

While that logic certainly appeals to Europeans today, Hamilton insisted on a stronger reason for pursuing sound finance than merely the pursuit of expediency. There is, he maintained, “an intimate connection between public virtue and public happiness.” That virtue consisted in honoring commitments, and it would build solidarity in the new political community of the United States. Indeed, public virtue made federal finance what he called “the powerful cement of our union.”

The condition for success in the American case was that the US raised its own revenue, with federally administered customs houses initially providing the bulk of its receipts. The logic of a need for specific revenue applies also in modern Europe, where a reformed fiscal system might include common administration of value-added tax (with the additional benefit of eliminating a considerable amount of cross-border fraud).

In the American case, however, unity carried a price: a ceiling was imposed on Virginia’s exposure to the common debt. Only this inducement to the most powerful state in the union persuaded Madison to drop his opposition to the proposal. That compromise (which also led to the US capital’s relocation to the District of Columbia, on the border of Virginia and Maryland) may serve as a precedent for limiting Germany’s liabilities if Eurobonds, or some other debt-mutualization scheme, are introduced.

The US experiment in federalized finance was not immediately successful. Two important components of Hamilton’s financial architecture were not realized, or were realized imperfectly. He proposed a model of joint-stock banking on a national scale, which ran into immediate opposition (curiously, his proposal was much more influential in Canada). Second, opponents eventually blocked his proposal for a national central bank. The charter of the First Bank of the United States was allowed to lapse in 1811; a generation later, in 1836, President Andrew Jackson successfully opposed the charter of the Second Bank of the United States.

Nor did the Hamiltonian scheme of federal finance guarantee a peaceful commonwealth. In fact, the fiscal union proved to be explosive rather than adhesive. As international capital markets developed in the early nineteenth century, state governments borrowed on a large scale, quickly turning them from creditors into debtors. A wave of state defaults followed in the late 1830’s.

A generation later, in the 1860’s, the Civil War between northern and southern states resulted in large part from a dispute about the character of financial burdens – at least from the South’s perspective. Abraham Lincoln’s original proposal to end the immoral practice of slavery by compensating slave owners for manumission was unacceptably expensive, so the Union, according to the slave-holding Confederacy, was determined to expropriate the South.

The federal assumption of states’ debts by itself could not guarantee political order. The Civil War revealed the centrality of a common foundation of morality to Hamilton’s approach to debt and public finance. As a result, his approach foundered on the differences between the different states’ conception of morality.

Europeans today have latched onto the practical side of Hamilton’s argument – that is, the idea that debt mutualization might be a means to cheaper credit; but they have worked out neither the political institutions, nor the shared public virtue, that Hamilton deemed crucial. The extended and politicized debate about debt restructuring has made a Hamiltonian solution more difficult, because the credit of the countries that would be party to it has become questionable.

An obvious starting point for a Hamiltonian Europe would be to set some standard limit for federalized national debt – perhaps the tarnished threshold of 60% of GDP that was mandated (without adequate enforcement) by the Maastricht convergence criteria, or perhaps a lower limit. Debt exceeding that amount would be left to the responsibility of the member states.

Collective burden-sharing is in the long run the only non-catastrophic way out of Europe’s current crisis, but that requires a substantially greater degree of political accountability and control on a European level. The lesson to be learned from Hamilton and the US is that the necessary institutions will not function without a greater degree of moral consensus as well.

Project Syndicate