Alexander Hamilton must have been worried. In 1790, as Secretary of the Treasury, a troubled economy had become his responsibility. He had a huge federal debt to fund, a banking sector that was distressed, and manufacturing to stimulate.
Hamilton submitted a 3-part report to the Congress for their approval. Focusing on public credit, creating a national bank, and encouraging manufactures, he had a plan for economic independence.
Public credit was crucial. Created by the Revolutionary War, the debt was primarily owed abroad. He had to reassure our European creditors that they would get all of the money that was due them. By funding the war debt, he would establish our good credit, a requisite, he believed for sound finance.
Hamilton understood that economic independence actually related to being dependable within a network of interdependence. The Congress and President Washington followed his lead, implemented his ideas, and the rest is history. The U.S. has never defaulted on a loan.
On this July 4, as we celebrate political and economic independence, let’s applaud Alexander Hamilton, the father of our economy.
The Economic Lesson
Sovereign debt is created when a nation sells bonds. Because banks typically purchase these bonds (governments, households and businesses buy them also), the health of the banking sector can be tied to the bonds that banks own.
An Economic Question: Keeping in mind Greece’s long history of defaulting on its sovereign debt, why would German and French banks want a Greek bailout?
Having just celebrated July 4th, I’ve been thinking about 1776, the American Revolution, and money. At the time, money frequently determined who won and lost wars. When countries ran out of money, they had to stop fighting. Great Britain had sufficient revenue to fight wars because they could collect taxes efficiently and fund a national debt.
By contrast, the credit of a new nation is anything but dependable. Just like you and me, a country establishes good credit by showing it can pay back loans. In 1776, trying to raise money to fight the war, the U.S. had no credit history. The Continental Congress was able to borrow close to $11 million from the French and the Dutch (British enemies) and through domestic bond sales but still it was not enough. As a result, Congress turned on the printing presses.
As Benjamin Franklin said, “This currency as we manage it is a wonderful machine. It performs its Office when we issue it; it pays and clothes Troops, and provides Victuals and Ammunition.” As Franklin later pointed out, though, when too much money is printed it rapidly diminishes in value. From 1775 to 1779, the Continental Congress had issued and then spent close to $250 million. The people who received the $250 million now had lots of dollars to spend. As a result, prices skyrocketed.
The Economic Lesson
An economist would say that the Continental Congress had created demand pull inflation which means that too many dollars are chasing too few goods. Or, in colonial terms, “A wagon-load of money will scarcely purchase a wagon-load of provisions.”