Last Thursday, February 16, 2017, I gave a presentation to the George Mason University History Club entitled “Two Little Known But Defining Moments of Alexander Hamilton’s Career.” Afterward, a number of great questions were asked, including how the Continental currency worked, why Americans were more trusting of Bank currency in 1791 than of the Continental currency earlier, and how Hamilton’s financial measures worked to bring the country out of the depression of the 1780s. My opening remarks to the club are below.
Two Little Known But Defining Moments of Alexander Hamilton’s Career
In recent years, Alexander Hamilton’s role as chief founder of our financial system has increasingly become an object of study and appreciation. Among his most notable accomplishments, Hamilton masterfully provided for America’s seemingly insurmountable revolutionary war debt, while turning the debt into the basis of a strong financial system. Some of his accomplishments as Secretary of the Treasury are becoming well known, as are some of his earlier writings on banking and the need for a strong Congress.
But Hamilton’s writings as a member of the Continental Congress in 1782 and 1783 are rarely noted, even though two of them, co-written with James Madison, directly foreshadow Hamilton’s most famous reports to Congress in 1790 on credit and banking.
Today I’m going to speak to you about these two little known but defining moments of Alexander Hamilton’s career. First, I will provide some background.
Currency and Debt Woes of the Revolutionary War
From 1775-1779, the Continental Congress printed $226 million of Continental currency to pay for the demands of the war. They left it to the states to uphold the value of the bills by collecting them in taxes, thus taking them out of circulation. But the states did not collect sufficient taxes, and the Congress did not issue bonds to absorb the bills. Due to excess currency, lack of confidence in the union, and high prices from the war’s demands, severe depreciation set in and by spring of 1780 the bills were passing at one-fortieth of their face value.
Congress tried to intervene and raise their value by redeeming them at one-fortieth their face value, giving $4.5 million in specie, meaning gold and silver, for $180 million worth of Continental currency. This was essentially a repudiation of their own promises and hurt the credit of the Congress. It was also unsuccessful, and the market value of those remaining continued to decline to one-hundredth their face value by the end of the year. Meanwhile, war demand kept driving up prices and Congress’ debts to Holland, France, and domestic lenders.
After the Articles of Confederation were ratified in March 1781, Congress began formally asking the states to collect taxes for the expenses of the war and deliver them to congress for appropriation. The states provided about 50% of what they were asked for over the next two years. For the rest, the Congress had to borrow, which mainly amounted to Robert Morris, the Superintendent of Finance, borrowing on his own credit. His promissory notes were called long Bobs, or short Bobs, depending on their duration.
The 1781 Import Duty Request
In February 1781, Congress asked for its own power to collect import duties to begin paying its revolutionary war debts, requiring agreement from all the states. By the end of 1781, three states still had not assented to this request. Congress’ debts were mounting, and Morris could barely make interest payments. Finances were in total disarray. Since the Continental currency no longer circulated, there was a shortage of currency with which to pay taxes.
The type of taxes the states were collecting were direct property and poll taxes. These direct taxes became increasingly burdensome as the war went on and output declined. Families lost laborers to the army and went into debt. Specie was scarce and, without the Continental currency, some taxes were collected in goods and direct property. Declining money and credit led to drop in prices.
How to restore paper credit and currency in this situation? A temporary balm was found in the Bank of North America, which began operation in January 1782. It was capitalized from a loan of specie from France and created a dependable and credit worthy currency of bank notes till the end of the war.
Hamilton and the 1782 Address to Rhode Island
In 1782, Alexander Hamilton went to the New York legislature as a tax collector for Robert Morris. While there, the legislature appointed him to serve in the upcoming Continental Congress that November. By that fall, every state had now signed onto the import duty request except Rhode Island. Morris first employed Thomas Paine to defend the requested import tax from Rhode Island’s objections. But it still did not accept. So, in December, the Congress deputized a three-man committee to craft a special message to the state, with two of the members being Hamilton and James Madison.
In some of the language, Hamilton’s hand can clearly be seen. In arguing for import duties they write that while Congress would like to pay creditors the principal–what they actually owe them–the next best thing is to “fund the debt, and render the evidences of it negotiable.” That sentence jumped out at me because this is what Hamilton later writes about as Secretary, to make the debt tradeable, as money. To fund a debt is to securely pledge revenues for payment of interest and eventual payment of principal. But then the following sentence really made clear that here, in 1782, he had already formulated the main polemic of his later report of 1790. He writes:
Besides the advantage to individuals from this arrangement, the active stock of the nation would be increased by the whole amount of the domestic debt, and of course the abilities of the community to contribute to the public wants. The national credit would revive and stand hereafter on a secure basis.
Hamilton is saying that by funding the debt, it will be equal to money and increase the amount of wealth in the economy by that amount. And not only that, but the measure would allow public credit to be a resource in the future.
Hamilton and the 1783 Congressional Tax Plan
What happens? Rhode island still doesn’t budge, plus Virginia bails out. The exercise of the last previous two years asking the states for this Congressional import power fell flat. In response, Robert Morris threatened to resign if Congress couldn’t figure out how to fund the debts. So Congress debates the issue for some time and reaches a compromise plan in April 1783. They still ask for a power to collect taxes, but instead of an indefinite duration for the power to pay the debt, 30 years or more, it is set for 25 years. Also, instead of a broad power to collect duties of any kind the total amount needed, it gave the states the power to choose whatever they want for 50% of the total tax needs to pay the debt, which, of course, would be largely direct taxes.
Hamilton objected to the compromise and was one of three to vote against it. You might think, what’s the difference? It’s the same amount of taxes collected right? And it’s only five years different than before? It’s an issue of definite security. Hamilton had the following to say, in writing to Governor George Clinton of New York about the plan, he wrote:
For want of an adequate security, the evidences of the public debt will not be transferrable for anything like their value—that this not admitting an incorporation of the creditors in the nature of banks will deprive the public of the benefit of an increased circulation, and of course will disable the people from paying the taxes for want of a sufficient medium.
Hamilton is saying that it’s not a simple matter of obtaining taxes to collect money to pay the debt, but the financial system overall has to be kept in mind:
- If you want more taxes collected, you need a sufficient circulation, a stable system of paper credit;
- If you want a stable currency, you need a proper way to capitalize the banks;
- But there is not enough hard money to capitalize them;
- So, you need to turn U.S. debt into something equal to money;
- But you can not have valuable securities unless the debt is funded;
- And you can not fund the debt unless you have an import tax that is broad enough and coextensive in time with the duration of the debt.
Here he is saying this in 1783, 8 years before this system is implemented, with the funding system of 1790 and the Bank of the United States in 1791. It’s also exciting because it shows the conceptual transition from the design of the Bank of North America in 1781 to the design of a new bank in 1791. There wasn’t enough specie in the colonies to serve as bank capital. This had held back the size of the Bank of North America.
Hamilton and Madison’s Explanation
Hamilton’s statement to Governor George Clinton is itself really interesting, but then when you look at the official report of 1783 itself and there are more clear blueprints of Hamilton’s later actions. Though he’s one of three delegates to vote against the 1783 tax for debt request, the Congress selects Hamilton to write a report with Madison to the states explaining why they should agree to the plan. These points drew my attention:
- One, he states again, that by paying the interest it would allow creditors to “transfer their stock at its full value,” for trade purposes.
- Two, that the “capital of the domestic debt” which bore an interest of 6% could be “canceled by other loans” obtained at a lower interest; in other words, they proposed refinancing the whole debt.
- Third, that it would be a big mistake to discriminate amongst the creditors, whether they were Europeans, soldiers, domestic lenders, or those who had bought them from the original holders.
These were all explicit points and elements of Hamilton’s future credit report of 1790. The last is quite interesting since Madison’s central objection to Hamilton’s later report was that it did not discriminate amongst the creditors who were to be paid back.
But the states did not accept the April 1783 tax plan, none in full and not all even in part. When the Constitutional Convention was being held in 1787, New York was still holding out, rejecting congressional import duty power.
The Depression of the 1780s
A deep post-war depression set in in 1784, led by a large negative trade balance and export of specie for imports, along with a credit contraction. The government need for the Bank of North America’s loans crowded out the private sector and merchants that needed loans. Heavy direct taxes became unbearable as farmers had no money and large war debts bankrupted a lot of people. Keep in mind that the taxes collected by the states for congress were only half of what they were collecting from citizens. Tax increases after the war to pay off state debts increased five to ten times.
The dramatic, increasing weight of direct taxation under conditions of depression led to farmer’s revolts, movements and legislation for debt and tax relief, depreciating state currencies and property values, and a further weakening of the Congress. At the same time, Congress went broke. Morris had to begin postponing interest payments on the debt certificates in 1784, leading to the beginning of the decline in their value. The Congress then collected only 20% of what they requested in 1785 and 2% in 1786. In 1787, they would be insolvent and unable to pay the first principal payments due to their foreign creditors.
Hamilton’s 1790 Credit Plan
This situation created a climate for the Constitutional Convention, in which taxation, debt, and currency reform were major issues and motivators. Consequently, in his January 1790, report to Congress on Supporting the Public Credit, Hamilton combined these issues into one package.
His solution was to refinance the debt and turn the debt into a funded debt. Following his plan closely, Congress assumed the debts of the states, amounting to $22 million, adding them to the domestic debt of the Continental Congress of $42 million. They announced that all holders of any old debt certificates bearing 6% interest could turn them in for new U.S. certificates bearing a lower interest, averaging 4%, but with a guaranteed payment of interest from a permanent appropriation from Congress. A vast array of new indirect import duties collected from Congress secured the appropriation. With these assurances, the value of these new funded public debt certificates increased rapidly, rising in value from $15 million to $45 million by the end of 1790, and $60 million the next year.
Congress effectively created a capital resource of $60 million liquid assets for the economy, which could be readily traded for hard money or as a security for which lenders would readily issue credit. As he said in 1782, a new capital and medium of commerce had been created “equal to the whole amount of the domestic debt.” The assumption of state debts and indirect federal taxes freed the states of the biggest part of their state budgets. The estimates are that direct taxes were cut throughout the states by as much as 85% on average.
The Bank of the United States
These measures contributed to wide prosperity. But the factor that ensured the success of the new financial system was the Bank of the United States. With the debt turned into a valuable security, Hamilton urged Congress in December 1790 to authorize private parties to incorporate their claims of newly funded debt into a Bank, as he had first recommended in April 1783. Holders of the certificates could turn them into to buy shares of the capital stock of the bank, provided they included one dollar of hard coin for every three in debt.
The Bank provided a medium of taxation, increased circulation, discounted U.S. securities and bills of exchange, created a payment system in notes and deposit credit, allowed merchants to pay duties on credit and the government to pay its debts in bank notes and deposit credit instead of specie, and amplified the value of government deposits in loans among other actions.
Hamilton’s two initiatives, creating a funded debt and establishing a sound banking system based upon it, pulled the economy out of the long depression of the 1780s and created the basis for a strong financial system.
For more on the above, the reader is encouraged to get a copy of my book, The Challenge of Credit Supply: American Problems and Solutions 1650-1950, five chapters of which detail the major developments in finance and banking from the beginning of the revolutionary war to the end of the Washington Administration.