Fri, Aug 12, 2011 - Page 9 News List

A page from the past: Learning from the US’ first debt crisis

What the US and Europe need now are leaders who have the authority and willingness to turn the current debt crisis into a moment of political creativity

By Mark Roe

But getting the dollars to repay the debt was not easy. There were no entitlements to cut or government funds to redirect. Hamilton knew that the wrong kind of taxes would weaken the already-fragile economy. He focused taxation on imports and nonessential goods, like whiskey.

Hamilton also needed Congress to approve the federal government’s assumption of the states’ debts, which at first seemed unlikely. Some states, like Virginia, had already paid much of their debt, and others saw their debt as having become a financial game for New York speculators. As a result, many states feared federal assumption would mean that their taxes would go to pay northern speculators or to retire the debt of big borrowers, like Massachusetts.

Virginia and several other southern states that owed little or had repaid what they owed voted against Hamilton’s first assumption bill and defeated it. They were expected to be adamant — an outcome that could well have brought about the young country’s demise.

Thomas Jefferson and Madison, the southern leaders, opposed Hamilton’s assumption plan, and Madison was critical in blocking it in Congress. But then the three met for dinner and cut a deal. Jefferson and Madison did not want the country’s capital to be in the north, and Hamilton reluctantly agreed to support moving it to an area carved out of Virginia or Maryland. They, in turn, would secure the votes for the federal government to assume and repay the states’ defaulted debts.

A responsible fiscal state emerged from that grand compromise. Despite the enormous cost — more than half of the fledgling government’s expenditures in early years went to debt service — the economy shook off the 1780s depression and entered a growth boom.

Hamilton’s task was both easier and harder than ours is today. It was easier, because there were few choices: No income tax rates to adjust or entitlements to cut. And it was harder because the US was an unknown entity, and there was little reason for confidence in the American non-nation.

Today’s trajectory is the reverse of that of the 1780s and 1790s. It is hard today for the US (and, until recently, the world) to imagine a US default, because there has been no strong reason to fear one since the 1790s.

Americans today know what must be done: some combination of entitlement cuts and tax increases. Europeans, too, know a new balance that needs to be struck. However, until Europe and the US find leaders with the authority and willingness to repeat a modern version of the deal-making example set by Hamilton, Jefferson and Madison 200 years ago, their debt problems will continue to weaken their national foundations.

Mark Roe is a professor at Harvard Law School.


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