Lecture

Learning Objective II:

Discuss Hamilton's report on Public Credit.

The first issue that Hamilton tackled as Washington's SECRETARY OF THE TREASURYconcerned the problem of PUBLIC CREDIT. Governments at all levels had taken on so much debt during the Revolution. The commitment to pay them back was not taken very seriously. By the late 1780s, the value of such public securities had plunged to a small fraction of their face value. In other words, state IOU's — the money borrowed to finance the Revolution — were viewed as nearly worthless.

Hamilton issued a bold proposal. The federal government should pay off all CONFEDERATION (state) debts at full value. Such action would dramatically enhance the legitimacy of the new central government. To raise money to pay off the debts, Hamilton would issue new SECURITIES bonds). Investors who had purchased these public securities could make enormous profits when the time came for the United States to pay off these new debts.

The unsettled state of the nation's finances presented the new government with a staggering challenge. In September 1.789,t he House of Representatives Asked Hamilton for suggestions.

Hamilton responded with three reports within two

years:

(1) on public credit,

(2) a proposed national bank, and

(3) manufacturing and trade guidelines.

Hamilton's Report on Public Credit contained two major recommendations

addressed FUNDING and ASSUMPTION. FIRST, under his plan for FUNDING the new federal government would fund its foreign and domestic obligations at full face value.

According to Hamilton, America must have credit for industrial development, commercial activity, and the operations of government. Her future credit would depend on how she met her present obligations. The United States debt, foreign and domestic,

"was the price of liberty, The faith of America has been repeatedly pledged for it.... Among ourselves, the most enlightened friends of good government are those whose expectations [of prompt payment] are the highest. To justify and preserve their confidence; to answer the calls of justice; to restore landed property to its due value; to furnish new resources, both to agriculture and commerce; to cement more closely the Union of the States; to add to their security against foreign attack; to establish public order on the basis of an upright and liberal policy; these are the great and invaluable ends to be secured by a proper and adequate provision, at the present period, for the support of public credit."

The first part of Hamilton’s plan involved federal “assumption” of state debts, which were mostly left over from the Revolutionary War. The federal government would assume responsibility for the states’ unpaid debts, which totaled about $25 million. Second, Hamilton wanted Congress to create a bank—a Bank of the United States.

The goal of these proposals was to link federal power and the country’s economic vitality. Under the assumption proposal, the states’ creditors (people who owned state bonds or promissory notes) would turn their old notes in to the Treasury and receive new federal notes of the same face value. Hamilton foresaw that these bonds would circulate like money, acting as “an engine of business, and instrument of industry and commerce.” This part of his plan, however, was controversial for two reasons.

First, many taxpayers objected to paying the full face value on old notes, which had fallen in market value. Often the current holders had purchased them from the original creditors for pennies on the dollar. To pay them at full face value, therefore, would mean rewarding speculators at taxpayer expense. Hamilton countered that government debts must be honored in full, or else citizens would lose all trust in the government. Second, many southerners objected that they had already paid their outstanding state debts, so federal assumption would mean forcing them to pay again for the debts of New Englanders. Nevertheless, President Washington and Congress both accepted Hamilton’s argument. By the end of 1794, 98 percent of the country’s domestic debt had been converted into new federal bonds.

Everyone agreed the foreign debt of $l1.7 million owed mostly to the Netherlands, Spain and France should be paid at par. Consequently; almost overnight Hamilton's fiscal feat had established the public credit. As a result the Treasury was able to secure needed funds in the Netherlands on terms more favorable than any other borrowing nation.

However, many people objected to paying the $42.4 million at par which the government borrowed under the Articles of Confederation from the American people during the war. The opposition was led by Jefferson and Madison who were upset when urban speculators rushed to rural areas where they purchased loan certificates from unsuspecting citizens at bargain prices. It was estimated that, of the nation's domestic obligation, about 20,000 people owed a majority, only 20 of whom were the original creditors. Hamilton's program allowed all current holders of loan certificates, no matter how they obtained them, to exchange the old certificates for new government bonds bearing 6% interest.

Madison was concerned about the citizens and soldiers who, because of financial hardship, were compelled to sell their certificates at rock bottom prices. Why should wealthy speculators now profit from their hardship? Also to many back-country farmers, making money without physical labor appeared immoral, un-republican, and, certainly, un-American. Too many records had been lost since the Revolutionary War for the Treasury Department to identify all the original holders.

The RESULT:

In February 1790 Congress soundly defeated Madison's proposal to pay "...the highest price (to the speculators) which has prevailed in the market and the remaining funds would go to the original purchasers." Also, nearly half the members of the House of Representatives, 29 of the 64, owned Continental securities, many through purchase. The debate and organized opposition between the urban commercial class and the agricultural rural class over the domestic debt began the solidification of the two interest groups that would be the foundation of our two party system.

Next, under his ASSUMPTION program, Hamilton urged the federal government to pay all remaining state debts. Hamilton argued the state debts were a proper national obligation, for they had been incurred in the war for independence.

Hamilton believed federal assumption of state debts would chain the states more tightly to the "federal chariot." It was hoped that the maneuver would shift the attachment of wealthy creditors from the states to the federal government. Getting the wealthy to THINK nationally was a crucial link in Hamilton's political strategy to strengthen the central government. Hamilton also reasoned that the federal government's assumption of the states' $21.5 million debt would significantly reduce the power of the individual states to shape national economic policy and thus create a

strong federal government.

Assumption unleashed great criticism from states like Virginia which had already paid its revolutionary war debts, and Hamilton's program seemed to reward certain states like Massachusetts for failing to put their finances in order. Virginia had levied high taxes

to pay its debts and now its citizens would have to pay the debts of other states as well... mostly for the benefit of northem speculators. 

The debate over financing the federal debt would help polarize the southern agricultural interest against that of the northern commercial interest which would help lead to the two party system. To win support for his controversial plan, Hamilton made a deal with the large, powerful congressional delegation from Virginia. He agreed to support the transfer of the national capital from Philadelphia, its temporary home, to to a new federal district across the Potomac River from Virginia.

Continue on to LO III