What Hamilton Got Right on Debt

From a woodcut that the artist Charles Turzak created in the late 1930s. We gratefully acknowledge the estate of the artist for permission to feature this image.

By J. French Hill

This article appears in the Summer 2024 issue of the Coolidge Review. Request a free copy of the print issue.

During my time at the Treasury Department, my sunny office on the south side of the building looked out over Alexander Hamilton’s statue. At my office desk then, as now, was an engraving of Hamilton in his famous pose leaning against the artillery rampart at Yorktown.

As someone who loves finance, I majored in economics at Vanderbilt University. During my high school and college holidays, I worked at my father and grandfather’s public finance and investment firm and at one of our locally owned commercial banks. At thirty-two, I became a deputy assistant secretary of Hamilton’s creation—the Treasury. By comparison, Hamilton became America’s first treasury secretary at thirty-five.

Hamilton was a classic example of an extraordinary mind who complied with Malcolm Gladwell’s famous “10,000 hours” in his mastery of trade and finance. While just a boy on the island of St. Croix, under the stewardship of merchant ­Nicholas Cruger, Hamilton learned the intricacies of trade, foreign exchange, the value of sound money, and how to structure short- and long-term obligations.

Through his position at the Constitutional Convention and as a lead author of The Federalist Papers, Hamilton played a vital role in creating our constitutional Republic. With the Constitution ratified, the United States needed a modern financial system. Crafting such a system was no mean task. In the preceding hundreds of years, only two countries had done so successfully: the Dutch and the English.

And the United States would need to attempt the task without its principal financial officer from the Revolution and the Confederation, Robert Morris. The new president, George Washington, asked Morris to serve as the first treasury secretary. Morris demurred. Instead, he urged Washington to appoint Hamilton.

On January 8, 1790, in the Senate chamber of New York City’s Federal Hall, President Washington delivered the inaugural State of the Union address. The previous year, the House of Representatives had resolved that “an adequate provision for the support of the public credit is a matter of high importance to the national honor and prosperity.” The president said, “In this sentiment I entirely concur.”

Washington concluded the address by telling the members of Congress, “The welfare of our country is the great object to which our cares and efforts ought to be directed, and I shall derive great ­satisfaction from a cooperation with you in the pleasing though arduous task of insuring to our fellow citizens the blessings which they have a right to expect from a free, efficient, and equal government.”

But the Washington administration would soon find it difficult to achieve such ­cooperation.

Credit in Shambles

The House of Representatives had asked the new treasury secretary to provide a report on public credit. Hamilton delivered it the day after Washington’s message to Congress.

In the First Report on Public Credit, Secretary Hamilton showed that the accumulated debts of the new Republic, both foreign and domestic, as well as the debts of the individual colonies, amounted to nearly $80 million. He considered this debt “the price of liberty.” Hamilton argued that it should all become a federal obligation. Restructuring the debts properly, he said, would restore credit available on favorable terms and supply capital to support growth. At the time, the credit of the United States was in shambles—literally, “not worth a Continental.”

Hamilton recommended that the federal government fully repay the $11.7 million in foreign debt as well as the $40 million the new Republic owed to its own citizens. During the debates on the Constitution, Hamilton and the Virginian James Madison had been on the same page about the need to consolidate debts. In fact, Article VI of the Constitution provides, “All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be valid against the United States under this Constitution, as under the Confederation.”

But in the winter of 1790, Madison stunned Hamilton when he opposed the proposal to exchange at par value the $40 million in domestic debt and assume all the debts of the states. Madison, now representing Virginia in Congress, noted that many of the original holders of the debt had, out of necessity, sold their bonds at a discount years earlier. Thus, exchanging them at par would reward “speculators.” Madison also objected to the assumption of the $25 million in state debts. He argued that it was fundamentally unfair for Virginians to be taxed to pay back state debts when Virginia had already been fiscally responsible and paid its debts.

This issue lay at the heart of the debate that grinded away from the cold of January to the heat of the summer in 1790. In February, the House passed, over Madison’s objection, Hamilton’s exchange plan for the existing domestic debt. But in the spring, the House voted down—five different times—Hamilton’s proposal to roll up the individual state debts. The issue came to an impasse.

The Compromise of 1790 marked an essential step in the formation of the Republic.

A fateful dinner

In June, the new secretary of state, Thomas Jefferson, was on his way to a meeting with President Washington when he ran into Hamilton on the street. Jefferson described Hamilton as looking “sombre, haggard, and dejected beyond description,” even “uncouth and neglected.” As Jefferson told the tale, ­Hamilton said that “we should make common cause in supporting one another.” Jefferson, who had just returned from five years in France as U.S. ambassador, protested that he “had been so long absent” that he had “lost a familiarity” with the country’s affairs. But he believed that he could spur a “friendly discussion” between Hamilton and Madison that might lead to “some conciliation of views.”

Despite suffering from terrible migraines, Jefferson invited Madison and Hamilton to his home for a working dinner. During that fateful meal at 57 Maiden Lane, they discussed not only Hamilton’s debt plan but also another issue vexing Congress: where to locate the new national capital. Among sixteen proposed locations, the leading candidates appeared to be Annapolis, Baltimore, Carlisle, Frederick, Germantown, New York, Philadelphia, the Potomac River, the Susquehanna River, and Trenton. As the historian Joseph J. Ellis noted, most observers viewed a Pennsylvania location as the most likely choice, given the state’s central location.

A solution began to take shape at the dinner. Hamilton would obtain the necessary House votes for consolidation of state debts; Madison and the southern states would receive favorable treatment on the final debt settlement; and the permanent U.S. capital would be located on the Potomac River, after ten years in Philadelphia. Building the new capital on the Potomac had long been George Washington’s ­objective.

This Compromise of 1790 marked one of the essential steps along the path from Revolution to the formation of the most amazing Republic in history.

A Masterful Debt Plan

Hamilton’s genius becomes evident when you examine his First Report on Public Credit as well as the other financial building blocks he laid.

In the report, Hamilton calculated the Republic’s total debt at $54,124,064. The accumulated war and confederation debt of the states added another $25 million, he estimated. Economists believe that this nearly $80 million in total debt accounted for approximately 40 percent of the early Republic’s gross domestic product. Prior to the ratification of the Constitution and the formation of the new federal government, the confederation was effectively bankrupt, with no ability to raise tax revenue to keep foreign or domestic creditors ­current.

The total debt figures looked ­daunting, but Hamilton recognized that the immediate question centered on whether the United States could service the debt. That is, could debt holders reliably receive interest income, thus securing the nation’s public credit?

The treasury secretary recommended that the interest on the foreign debt be paid in full. The foreign debt was owed mostly to France. America could never have won the Revolution without the funding, arms, and uniforms that France supplied, or without the intervention of the French navy. Thanks to John Adams, the Dutch also advanced funds. And the ­Spanish provided gunpowder from their Caribbean territories. Dutch bankers arranged a ­rollover of the American foreign debt. By 1795, that rollover had been completed.

Meanwhile, Hamilton masterfully restructured the domestic debt, significantly reducing the annual debt service. According to Hamilton’s plan, debt holders would “voluntarily agree to have the full value of their debts funded by a new loan at a reduced rate of interest amounting essentially to 4 percent instead of the original 6 percent,” explains economist Richard Sylla. The loan “took the form of three new securities”: a 6 percent bond, a 3 percent bond, and a 6 percent bond with interest deferred for ten years. ­Public creditors would receive “a package of the three yielding 4 ­percent interest in exchange for the old debt.”

The plan worked. By the end of 1794, 98 percent of the total domestic debt had been exchanged—voluntarily—for the new securities.

Just four years after the Compromise of 1790, the United States possessed the highest credit rating in the world.

A National Blessing

A key question remained: how to pay nearly $4 million per year in government expenses, plus the restructured debt service? Congress authorized tariffs and some excise taxes. But Hamilton resolved the issue by laying the financial foundation of the new Republic.

In December 1790, he submitted to Congress his plan for the formation of a national bank and for functioning securities markets. The bank could be a creditor to the U.S. government in case of ­reve­nue shortfalls, and it could make loans to entrepreneurs and businesspeople. Securities markets would help the United States sell debt securities, and help businesses raise equity and debt capital.

From the beginning, Hamilton’s bank proposal created legal challenges. Many of the Founders had concerns: Congressman Madison, Secretary Jefferson, and Attorney General Edmund Jennings Randolph believed that the Constitution did not authorize such a bank. Hamilton countered this charge by crafting the doctrine of implied powers in the Constitution.

Ultimately, Hamilton’s argument carried the day. President Washington signed the bank bill into law in 1791. The bank quickly proved its strategic value in loaning money to the United States during shortfalls in tariff revenues.

Thus, just four years after the Compromise of 1790, the United States possessed the highest credit rating in the world. Its securities were liquid and traded freely. Hamilton and Robert Morris’s dream of a free Republic with a sound source of financing had come true.

Hamilton had brought to reality a vision he had outlined in a letter to Morris in 1781: “A national debt if it is not excessive will be to us a national blessing.”

Beyond his genius, Hamilton shone because he didn’t squander his opportunities. Treasury secretaries today too often let opportunities pass by.

J. French Hill represents the Second District of Arkansas in the U.S. House of ­Representatives.