The West is ensnared in a debt crisis. The US, as everyone knows, came perilously close to defaulting on Aug. 2, and Standard & Poor’s downgraded US debt from “AAA” on Aug. 5. In Europe, the outgoing head of the European Central Bank recommends more centralized fiscal authority in Europe in order to deal with likely defaults by one or more of Greece, Portugal and Spain.
Both Europe and the US can learn a lesson hidden in US history, for, lost in the haze of patriotic veneration of the US’ founders is the fact that they created a new country during — and largely because of — a crippling debt crisis. Today’s crises, one hopes, could be turned into a similar moment of political creativity.
After independence from Britain in 1783, the American states refused to repay their Revolutionary War debts. Some were unable; others were unwilling. The country as a whole operated as a loose confederation that, like the EU today, lacked taxing and other authority. It could not solve its financial problems, and eventually those problems — largely recurring defaults — catalyzed the 1787 Philadelphia convention to create a new United States.
And then, in 1790 and 1791, the US’ first treasury secretary, Alexander Hamilton, resolved the crisis in one of history’s nation-building successes. Hamilton turned the US’ financial wreckage of the 1780s into prosperity and political coherence in the 1790s.
To understand Hamilton’s achievement — and thus to appreciate its significance for our own times — we need to understand the scale of the Revolutionary War debt crisis. Some states lacked the resources to pay. Others tried to pay, but would not levy the taxes needed to do so. Others, like Massachusetts, tried to levy taxes, but its residents refused to pay them.
Indeed, some tax collectors were met with violence. Indebted farmers physically disabled the repayment machinery in many states, most famously in Shay’s Rebellion in Massachusetts.
Even private debt-payment mechanisms via courts didn’t work. James Madison, who would become the US Constitution’s principal author, couldn’t borrow to buy land in frontier Virginia, because lenders lacked confidence that Virginia courts could enforce repayment. George Washington bemoaned that the US was not a “respectable country.” He found Shays Rebellion so worrisome that he came out of his first retirement to preside over the 1787 convention.
Today, the US Constitution’s most noted features are its allocation of power between Congress and the presidency, and its guarantee of individual rights via its first 10 amendments. However, at the time, its key role was as a government-debt-repayment mechanism. The Constitution would create a new national government that could coin stable money, borrow and repay debts, including the states’ defaulted Revolutionary War borrowings.
With the Constitution ratified by 1789, Washington became president and appointed Hamilton — still in his 30s — to head the Treasury. Hamilton had not been a finance person. He was Washington’s chief of staff during the Revolutionary War and a quick study: When it was time to learn battlefield tactics, he read military manuals; when it was time to become a national leader who understood finance, he read finance books.
Yet, it was no accident that two military men were key to making the US a “respectable nation” in financial terms. Both thought that only a fiscally strong US could have the military prowess needed to defend itself from the European powers, whose return to US soil both men expected.