Alexander Hamilton’s role as chief founder of our financial system has become an object of study and appreciation in recent years.  Among his most notable accomplishments, Hamilton masterfully dealt with the problem of America’s seemingly insurmountable revolutionary war debt, while turning that debt into the basis of a strong financial system.  Many of Hamilton’s achievements as Secretary of the Treasury are becoming well known, as is the fact that Hamilton had already developed many of the elements of his financial program carried out as Secretary during the early 1780s.  But among these early writings, Hamilton’s important addresses as a member of the Continental Congress in 1782 and 1783 are rarely noted, even though some of them clearly foreshadow his most consequential reports to Congress in 1790 on credit and banking.1

In a Congressional report addressed to Rhode Island on taxation in 1782, Hamilton made what could be his first explicit statement describing the intended effect of his later plan in 1790 to create a funded debt (a debt with revenues securely pledged for regular payment of interest and eventual payment of principal).  Next, in a message to the states written in April of 1783, he put forward a blueprint of what would become his credit report of 1790.  In addition, his commentary upon the latter spells out how his funded debt plan would work together with his banking plan, implemented with the chartering of the Bank of the United States in 1791.  

Before reviewing these Continental Congress reports, some essential background will be useful. Later, I will describe how Hamilton’s early thoughts in 1782-1783 evolved into his reports as Treasury Secretary.

Currency and Debt Woes of the Revolutionary War

The Continental Congress printed $226 million of Continental currency from 1775-1779 to pay for the demands of the war.  They left it to the states to uphold the value of the bills by accepting them for tax payments and taking them out of circulation.  But the states did not collect enough taxes, and the Congress did not issue bonds that could have been purchased with the bills and made them a sound investment.  Due to excess currency, lack of confidence in the union, and high prices of goods, severe depreciation set in; by the spring of 1780, the bills were passing at one-fortieth their face value.

Congress tried to intervene and stop the currency from depreciating by redeeming $180 million worth of bills at market value in specie (money in coin), i.e. for $4.5 million specie. The action–paying $4.5 million for $180 million of bills–was essentially a repudiation of their own promises and damaged Congress’ credit; it was also unsuccessful, and the market value of currency remaining in circulation 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, domestic lenders, and soldiers.  In February 1781, in response to the growing crisis, Congress asked the states for the power to collect import duties to begin paying its revolutionary war debts, but this required agreement from all the states.  

Additionally, in accord with the Articles of Confederation, ratified in March 1781, Congress began annually requesting the states collect and fulfill quotas of the sums needed to pay ongoing wartime expenses.  The taxes the states collected were almost entirely direct taxes (property and poll taxes), which became increasingly burdensome as the war went on.  Output declined and families lost laborers to the army and went into debt.  Making matters worse, since the Continental currency no longer circulated and specie was scarce, there was a shortage of currency with which to pay taxes; many taxes were paid in goods. The compliance rate on these congressional quotas from the states was roughly 50% in 1781 and 1782.  For the rest, the Congress had to borrow, which largely amounted to Robert Morris, the Superintendent of Finance, writing promissory notes on his own credit.  

By the end of 1781, three states still had not assented to the import duty request. Congress’ debts were mounting and Morris could barely make interest payments in specie on the debts already owed.

How to restore paper credit and currency in this situation?  A temporary balm was found in the Bank of North America, capitalized with a loan of specie from France.  It began operation in January 1782 and created a dependable and credit worthy currency of bank notes through to the end of the war.2

Hamilton and the 1782 Address to Rhode Island

Every state had signed onto the import duty request except Rhode Island by the fall of 1782.  After an unsuccessful attempt by Thomas Paine to overcome Rhode Island’s objections,  the Congress deputized a three-man committee to craft a special message to the state in December. The three were James Madison, Alexander Hamilton, and Thomas Fitzsimmons.

Hamilton’s hand can be clearly seen in much of the language.  In arguing for import duties they write that while Congress would like to pay creditors the principal of the debt, the next best thing is to “fund the debt, and render the evidences of it negotiable”; that is, to make the debt tradable as money.  That statement stands out because it is what Hamilton later writes as Secretary in 1790.  Then, the following sentence makes it entirely clear that Hamilton had already formulated the main polemic of his first famous report of 1790 in 1782.  He wrote:

Besides the advantage to individuals from this arrangement, the active stock [liquid assets] 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 [pay taxes]. The national credit would revive and stand hereafter on a secure basis.  

Funding the debt would increase the liquid assets in the economy by the amount of the debt, Hamilton said, and it would allow public borrowing to be a resource in the future.  He added, that “This was another object of the proposed duty,” a statement which shows he had in mind a much more integrated system of finance than simply collecting import duties to pay off a war debt.  He would soon elaborate.

Hamilton and the 1783 Congressional Tax Plan

What happened? Rhode island still did not budge and agree to import duties to finance the Federal authority, and Virginia rescinded its previous agreement. The exercise of the previous two years asking the states for an import duty power fell flat.  In response, Robert Morris threatened to resign if Congress could not figure out how to fund the debts.  Congress debated the issue for some time and reached a compromise plan in April 1783.

Congress still asked for the power to collect taxes, but instead of an indefinite duration for the power to pay the debt, 30 years or more, they requested 25 years.  Also, instead of a broad power to collect duties on all goods to reach the total amount, the plan gave the states the power to choose whatever they wanted for 50% of the total. Hamilton objected to the compromise and was one of three delegates to vote against it.  One might wonder, what is the difference?  Would not the same dollar amount of taxes be collected?  And what difference does five years make?

The issue was one of having definite security.  In addition to other objections, Hamilton had the following to say when writing to New York Governor George Clinton about the plan later that May:

For want of an adequate security [a certain source of funds], 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 [allowing them to use bonds as capital for bank stock] 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’s statement is remarkable. It was not a simple matter of obtaining taxes to collect money to pay the debt, but the financial system overall had to be kept in mind: To collect more taxes required a sufficient circulation and stable system of paper credit; a stable currency required a proper way to capitalize banks.  But there was not enough specie to capitalize banks; therefore, the government needed to turn U.S. debt into valuable securities equal to money.  The latter was not possible unless the debt was funded, requiring an import duty that was broad enough, dependable, and coextensive in time with the duration of the debt.

The quote from Hamilton is also exciting because it shows the point of conceptual transition from the 1781 design of the Bank of North America to the 1791 Bank of the United States and other state banks in the 1790s: the specie basis of the former limited its capital size, while the design of the latter recognized the importance of government securities for banking capital and reserve assets.     

Though he voted against it, Congress tasked Hamilton in April to co-write an explanation of the plan to the states with Madison and Oliver Ellsworth.  More elements of his 1790 credit plan can be found in the following points of their argument:

  • That providing for paying the interest on the debt would enable creditors (buyers of the government debt and receivers of debt certificates for payment) to “transfer their stock at its full value,” for trade purposes;  
  • 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 debt for a better rate.
  • That it would be a mistake to discriminate amongst the creditors, whether they were French or Dutch, soldiers, domestic lenders, or those who had purchased the debt certificates from the original creditors.

All three of these were explicit points of Hamilton’s future credit report of 1790.  The last is quite interesting since Madison became the chief opponent in Congress of Hamilton’s 1790 plan, objecting that it did not discriminate amongst the creditors to be paid back.  

The April 1783 tax plan never went into operation because the states did not all approve it; New York was still objecting to congressional taxation power in 1787.

The Depression of the 1780s

In 1784, a deep post-war depression set in.  It was caused in part by a large negative trade balance that caused merchants to withdraw specie from the Bank of North America to pay for imports.  Other factors included speculative trading, credit contraction, interest rate hikes, lack of war demand, government crowding out of Bank of North America credit due to war debts, and Britain closing its ports to American ships in the West Indies.  

Increases in direct taxes by the states after the war to pay off state debts increased five to ten times.  These taxes became unbearable as farmers had little specie.  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 reduced property values.

Congress went broke.  Morris had to begin postponing interest payments on the debt in 1784, marking the beginning of their steady decline in value.  The Congress then collected only 20% of what it requested in 1785 and only 2% in 1786.  In 1787, it would be insolvent and unable to pay the first principal payments due to their foreign creditors.

Hamilton’s 1790 Credit Plan

This situation created the climate for the Constitutional Convention, for which taxation, debt, and currency reform were major motivators.  Consequently, in his January 1790 report to Congress on Supporting the Public Credit, Hamilton, then Treasury Secretary, combined these issues into one package.  

Hamilton devised his plan at a time when the debts of the Congress, both foreign and domestic, were unpayable with existing revenues, as were the debts of the state governments.  Debt certificates were trading for a small fraction of their original value.  As he had first explained in 1782-1783, Hamilton’s solution was to refinance and fund the debt.  This was made possible by his pledge that the government would pay all debts to all creditors at face value.

The federal government would assume the debts of the states, amounting to $22 million, and add them to the domestic debt of $42 million.  It would then inform holders of any old debt certificates bearing 6% interest that they could turn them in for new U.S. certificates bearing a lower interest, averaging 4%, but having a guaranteed payment from a permanent pledge of revenues from Congress.3  

Where were the revenues to come from? The Constitution had empowered Congress to create a tax system that could provide sufficient revenues without unduly burdening the public. Hamilton’s report called for more efficient, indirect consumption taxes using federally levied and collected import duties and excises to replace direct state taxation.  Once Congress passed the report in three Acts from August 4-August 12, 1790, with these assured and pledged revenues for payment of interest, the value of the new funded public debt certificates increased rapidly, rising in value from $15 million to $45 million by the end of 1790.  

Congress effectively created a capital resource of liquid assets for the economy equal to the rising value of the debt, which traders would purchase with specie and bank notes and for which lenders would readily issue credit.  As Hamilton said in 1782, a new capital and medium of commerce “equal to the whole amount of the domestic debt” could be created with the proper commitments in place.  

The assumption of state debts freed the states of the biggest part of their state budgets. Direct taxes were cut throughout the states by as much as 85% on average between 1785-1795.

The Bank of the United States

Hamilton’s funding system of 1790, foretold almost a decade earlier, contributed to wide prosperity.  But the factor that ensured the success of the new financial system was the Bank of the United States.  In December 1790, Hamilton urged Congress to authorize private parties to put their assets in the form newly funded debt into a Bank.  Holders of the new government debt certificates, he said, could turn them into to buy shares of the capital stock of the bank, as long as they included one dollar of specie for every three in debt.  

The Bank provided a stable and sufficient currency to meet taxation needs, 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 domestic debts in banknotes and deposit credit instead of specie, accelerated agriculture and industry with its credit, and amplified the value of government deposits in loans.  In the 1790s also, many state banks rose into place to facilitate growth.

Trade and commerce rapidly expanded with the credit supply from the developing banking system.  For example, the value of U.S. exports doubled between 1790-1795, dramatically increasing tariff revenues for the Treasury. And the total tonnage of U.S. ships entering U.S. ports with cargo increased by 63%.  

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, established the credibility of America’s finances, and created the basis for a strong financial system.  Hamilton’s early statements while serving in the Continental Congress provide important hints at how he came to these financial initiatives.    

This article draws from Chapters 3-7 of the author’s book, The Challenge of Credit Supply: American Problems and Solutions 1650-1950. For further detail on the period and events described, the reader is encouraged to obtain a copy on Amazon or Vernon Press.

 

  1. January 9, 1790, “Report Relative to a Provision for the Support of Public Credit,” and his December 13, 1790, “Second Report on the Further Provision Necessary for Establishing Public Credit (Report on a National Bank).”
  2. Hamilton had engaged with Morris and others about bank plans from 1779-1781.
  3. Hamilton also instructed Congress to take out a new loan for the amount of the foreign debt, $12 million, to pay interest in arrears and pay off the principal in installments. Duties secured the interest payments on the new loan.