The new Constitution gave the national government a dependable source of revenue, but it could have probably met only the government’s current operating costs. It was not going to do very much to deal with the United States’ vast debt, which it had incurred during and after the Revolution, especially debts to the French government and the bankers of Amsterdam.
Time Is of the Essence
The man whom Washington nominated to be the new Secretary of the Treasury was Alexander Hamilton. Washington signed the bill creating the Treasury Department on September 2, 1789, and nominated Hamilton on September 11. Hamilton was at work two days later. The task confronting Hamilton was, to say the least, daunting.
Hamilton was also not going to have much time in which to formulate a response. On September 21, 1789, the House of Representatives directed him to prepare a report on the credit status of the United States and “report the same to this House at its next meeting.” The House then adjourned and set the date for its next session in January—giving Hamilton exactly 110 days to gather all the information he needed to present his recommendations.
This is a transcript from the video series America’s Founding Fathers. Watch it now, on Wondrium.
Hamilton’s Huge Headache
Unhappily, the more Hamilton thumbed through the various loans, notes, IOUs, and unpaid interest, which had accumulated in the Confederation’s hands, the more and more daunting the prospect became. The overall position generally broke down in this fashion.
First, there was foreign debt. The United States owed $10 million in direct loans—approximately half of it to the French government, most of the rest to Dutch bankers, and a smaller sum to the Spanish government. Annual interest on these loans, calculated at between 4%–5%, plus repayment of principal, amounted to approximately $1 million a year, but already the United States was $1.6 million in arrears on interest payments and $1.4 on repayment of principal.
Second, there was the domestic debt. The domestic debt of the United States was in even worse shape than its foreign debt. The Confederation had financed the war, not only by borrowing abroad but, in effect, by borrowing at home by issuing a dismaying variety of bonds, notes, warrants, certificates, and promissory notes for the pay and supply of the Continental Army. Overall, the United States was obligated to repay another $16 million just in principal. Add the interest, which remained unpaid; the total came to a staggering $40 million.
And then, of course, there was the state debt. Under the loose reins of the Confederation, individual states had accumulated their own indebtedness, which tacked another $25 million onto the bill. Against this, Hamilton could expect an overall income from federal tariffs and excise taxes of a little over $4.4 million, and most of that would go to fund current operations.
Learn more about Alexander Hamilton’s reports.
Not Many Options
The possibilities for dealing with this situation were not appetizing. The national government might, well, as one option, simply repudiate the debt as a responsibility of the Confederation, which no longer existed. Or, at least, repudiate the unpaid interest and pay off the principal at whatever the current depreciated market value was.
Or, they might take the path of discrimination, which is to say—pay interest and principal only on notes and debts still held by the original owners, not by second buyers. The third possibility was to pay off the entire national debt by imposing whopping taxes and the sale of public land in the west.
Apologize and Start Over
Repudiation was the simple solution because it simply wiped the slate clean. It was sort of like bankruptcy. You could make apologies to the people who made American independence possible—though, at the same moment, you would actually make fools of them—and then start in 1790 from a baseline of zero indebtedness.
But it also meant that not another lender in either Europe or America would ever agree to loan the American government a single dollar. That meant, for the indefinite future, that the American economy would be cash-poor. American enterprises would be capital-poor. And the whole country would remain what it had been under British rule, an agricultural appendage of Europe.
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United States’ Vast Debt Was Too Much
As Hamilton explained to Washington, Congress must either:
Erect itself into a court of justice, and determine each case upon its own merits, after a full hearing of the allegations and proofs of the parties; or it must proceed upon vague suggestions, loose reports, or at best upon partial and problematical testimony, to condemn in the gross and in the dark, the fairest and most unexceptionable claims, as well as those which may happen to be fraudulent and exceptionable.
Paying off the debt entirely also had the appeal of being simple. But no one in the new government could forget that the kind of taxes necessary to pay off that debt was precisely what had sparked Shays’s Rebellion. And any expectation that the sale of western land would bring in sufficient cash to pay off the debt collided with the need to clear those lands of the Indian tribes who occupied them, and those tribes were not likely to go along quietly.
And none of these solutions did anything toward extinguishing the state debts. So long as those state debts remained outstanding, foreign investors were still going to pull shy of pouring investment capital into American pockets.
Common Questions about the Vast Debt and the New Constitution of the United States
Much of the United States’ vast debt was owed to foreigners. Approximately $5 million to the French government, and another $5 million to Dutch bankers and the Spanish government.
The United States’ vast debt had to be paid for the international community to trust them; otherwise, nobody would lend the country money in the future.
The United States’ vast debt was too much for the country at the time. The only way was to increase taxes which could have led to public unrest.