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A More Perfect Union, Built on Shared Debt
As Americans pause this Fourth of July to reflect on their independence, it’s worth casting a thought across the Atlantic. One story from America’s founding era, in particular, keeps reminding us of modern-day Europe.
Recall that during and after the American Revolution, public spending soared. Without the power to directly tax, the Continental Congress had to print and borrow money to meet its obligations.
Printing bills of credit led to inflation: From 1779 to 1781, prices increased nearly 10-fold. By 1790, the nation’s total outstanding debt had soared to $77.1 million, or roughly 40 percent of economic output.
Civic administration was a mess. Foreign governments held America’s IOUs -- and its leaders -- increasingly in disdain. Congress was hopelessly ineffectual. Secession was in the air.
Then, in 1788, the U.S. Constitution was ratified, giving Congress the power to tax. And beginning in 1790, Alexander Hamilton, the nation’s first Treasury secretary, proposed a series of solutions to tame the fiscal chaos.
He suggested funding the national debt by buying back previously issued (and now devalued) government securities at full value, using new bonds backed by credible tariff revenue. More controversially, he proposed that the federal government assume the debt burden of the states, which amounted to about a third of the nation’s total.
James Madison, Hamilton’s chief congressional adversary, was wary of both ideas. Offering face value for government debt would privilege speculators over the war veterans who had sold their devalued securities at pennies on the dollar. Assuming debts would not only force states that had paid off their obligations to bail out those that hadn’t, it would lead to encroaching federal dominion.
Madison was advancing the views of many Southerners, who feared they would soon be under the thumb of a distant and unaccountable power.
Many considered the debate over assumption itself a threat to the republic. But a bargain was haltingly reached: Congress would approve Hamilton’s funding and assumption proposal, and, to appease Madison and other skittish Southerners, the nation would eventually move its capital from New York City to a new site on the Potomac River.
It worked. The economy prospered under the deal, exports surged, and U.S. debt was brought under control. As a result, it was soon in great demand: By 1794, the U.S. had a credit rating equal to or better than any European country.
Admittedly, the analogy is inexact, but the discord in the early days of the American republic and today’s European debt crisis have some revealing similarities. In both the U.S. of 1790 and the euro area of today, provident states opposed bailing out profligate ones. States accustomed to sovereignty resented an intrusive new power. Anxious voters clamored for a clean break rather than a tighter union.
Yet, in both cases, the real choice was between deeper consolidation and catastrophe for all involved.
We’ve argued that there remains only one long-term solution to Europe’s interminable woes, and that’s a far tighter union, one that includes a fiscal authority with the power to oversee national taxing and spending plans, the issuance of bonds jointly guaranteed by all member states, and a political union to grant it legitimacy. Only with all the union’s states collectively dedicated to backing banks and sovereign debt will investors return to Europe with confidence.
Last week, European leaders took a promising step when they agreed in principle to allow the continent’s permanent bailout fund to directly recapitalize teetering banks, after establishing a banking union overseen by a supranational supervisor.
Voters haven’t exactly embraced this course. That’s why euro-area leaders must now convince them that it’s necessary: However distasteful, a closer union will avoid a chaotic break and years of turmoil. It will create a large new market in euro bonds to attract investors. And it will, ideally, begin to create a deeper European unity.
As Hamilton correctly predicted in 1781, “A national debt, if it is not excessive, will be to us a national blessing. It will be a powerful cement to our union.”
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