Financial History Issue 121 (Spring 2017) - Page 29

the difference? Would not the same dollar amount of taxes be collected? And what difference does five years make? The issue was one of having definite security. In addition to other objections, Hamilton had the following to say when writing to New York Governor George Clinton about the plan later that May: For want of an adequate security [a certain source of funds], the evi- dences of the public debt will not be transferrable for anything like their value — that this not admitting an incorporation of the creditors in the nature of banks [allowing them to use bonds as capital for bank stock] will deprive the public of the benefit of an increased circulation, and of course will disable the people from paying the taxes for want of a sufficient medium. Hamilton’s statement is remarkable. It was not a simple matter of obtaining taxes to collect money to pay the debt, but the financial system overall had to be kept in mind: To collect more taxes required a suf- ficient circulation and stable system of paper credit; a stable currency required a proper way to capitalize banks. But there was not enough specie to capitalize banks; therefore, the government needed to turn US debt into valuable securities equal to money. The latter was not possible unless the debt was funded, requiring an import duty that was broad enough, dependable and coextensive in time with the duration of the debt. The quote from Hamilton is also excit- ing because it shows the point of concep- tual transition from the 1781 design of the Bank of North America to the 1791 Bank of the United States and other state banks in the 1790s: the specie basis of the former limited its capital size, while the design of the latter recognized the importance of government securities for banking capital and reserve assets. Though he voted against it, Congress tasked Hamilton in April to co-write an explanation of the plan to the states with Madison and Oliver Ellsworth. More ele- ments of his 1790 credit plan can be found in the following points of their argument: • That providing for paying the inter- est on the debt would enable creditors (buyers of the government debt and receivers of debt certificates for pay- ment) to “transfer their stock at its full value,” for trade purposes; • That the “capital of the domestic debt,” which bore an interest of 6% could be “canceled by other loans” obtained at a lower interest; in other words, they proposed refinancing the debt for a bet- ter rate. • That it would be a mistake to discrimi- nate amongst the creditors, whether they were French or Dutch, soldiers, domestic lenders or those who had purchased the debt certificates from the original creditors. All three of these were explicit points of Hamilton’s future credit report of 1790. The last is quite interesting since Madison became the chief opponent in Congress of Hamilton’s 1790 plan, objecting that it did not discriminate amongst the creditors to be paid back. The April 1783 tax plan never went into operation because the states did not all approve it; New York was still objecting to congressional taxation power in 1787. The Depression of the 1780s In 1784, a deep post-war depression set in. It was caused in part by a large negative trade balance that caused merchants to withdraw specie from the Bank of North America to pay for imports. Other fac- tors included speculative trading, credit contraction, interest rate hikes, lack of war demand, government crowding out of Bank of North America credit due to war debts and Britain closing its ports to American ships in the West Indies. Increases in direct taxes by the states after the war to pay off state debts increased five to 10 times. These taxes became unbearable as farmers had little specie. The dramatic, increasing weight of direct taxation under conditions of depression led to farmers’ revolts, movements and legislation for debt and tax relief, depreciating state cur- rencies and reduced property values. Congress went broke. Morris had to begin postponing interest payments on the debt in 1784, marking the beginning of their steady decline in value. The Con- gress then collected only 20% of what it requested in 1785 and only 2% in 1786. In 1787, it would be insolvent and unable to pay the first principal payments due to their foreign creditors. Hamilton’s 1790 Credit Plan This situation created the climate for the Constitutional Convention, for which taxation, debt and currency reform were major motivators. Consequently, in his January 1790 report to Congress on Sup- porting the Public Credit, Hamilton, then Treasury Secretary, combined these issues into one package. Hamilton devised his plan at a time when the debts of the Congress, both for- eign and domestic, were unpayable with existing revenues, as were the debts of the state governments. Debt certificates were trading for a small fraction of their original value. As he had first explained in 1782–1783, Hamilton’s solution was to refi- nance and fund the debt. This was made possible by his pledge that the government would pay all debts to all creditors at face value. » continued on page 39  |  Spring 2017  |  FINANCIAL HISTORY  27