Debt Created the United States of America: Hamilton, The Constitution, National Debt and the World's Greatest Economy

Debt created the United States of America.

It was very expensive to go to war against the greatest empire in the world and newly independent colonialists ended the war with about $80 million of debt, representing roughly 40% of the $200 million total GDP at that time.

It was not just the magnitude of this debt. Before the constitution was created and approved, there wasn’t a national government. There were thirteen states but they were not united. The army was going to force congress to pay soldiers back wages after the war and this was the closest our nation has ever come to a coup. (Washington was able to head off this mutiny simply because he was, well, Washington.) In 1783, interest payments on bonds had been suspended and there was no good way to make interest payments. Again, states were real but – at this point – the federal government was fiction that still needed a constitution to become real. Fictional entities generally don’t pay their bills. The first treaty after independence was between Connecticut and Massachusetts settling a border dispute, as if they were France and Italy.

The historian James Beard made a very persuasive argument that the constitution that created the United States of America was driven by bond holders who wanted a national government that could honor its debt. Debt they held.

Collecting revenue and paying the national debt was one of the acts that made the Constitution real, that created the United States.

Hamilton was keen to honor the face value of all this debt. During the Revolution, various Americans bought bonds to help to finance the war. Some surely did it in the hopes of gain. Some did it as a show of support for this aspiring government. By the time the founding fathers were establishing this new democracy, though, most of the debt had been devalued to about 10 to 20% of its face value. Nobody really expected that it would be paid back fully.

Hamilton, though, thought that by honoring the debt he could do a variety of things – chief among them creating a financial system to encourage investing and early manufacturing and he saw the credibility of this new government as key to its credit and financial system. He pushed for valuing the debt at face value, bringing the value of existing bonds from 10 to 20% of their face value to 100%. He saw how debt could literally become a foundation for a modern economy.

Who voted for the new constitution that would create a federal government? And national taxation that would allow this new country to pay back its debt? Bond holders. Only 42% of the Senators who did not hold bonds voted to approve this new constitution. By contrast, 80% of the Senators who held bonds voted for the constitution, voted to create these United States. This vote – that literally established the United States – was biased by those who had the most to gain financially from creating a United States. Because a key part of this new constitution was the ability to tax and spend at a national level. This increased the value of bonds, making them worth 5 to 10X as much as they had been.

During the war, it was states that incurred the debt. The United States did not exist. One of the chief reasons for creating a new nation rather than simply leaving the states independent of one another was to consolidate the debt that states could not repay.

The Senators who helped to create Hamilton’s financial system that was embedded in the constitution made a great deal of money voting for it. But so did the country, creating a financial system that is now the most influential in the world.

Hamilton saw debt as a foundation for a great financial system, borrowing from the British model. In this he was very much aligned with George Washington. The Bank of England had been founded in 1694 and was to become the model for most central banks, a catalyst for the industrial revolution. Curiously, George Washington remained a stockholder in the Bank of England throughout the American War of Independence. Unsurprisingly, Washington approved the first Bank of the United States.

In Hamilton’s mind, taxes, debt, banking and industry were all of a piece. Taxation could finance interest payments on the debt. The debt could be used to create bank stock, something against which banks could issue banknotes and those banknotes could be used to finance industrial stocks, creating a manufacturing economy. Hamilton was one of the few founding fathers who really understood banking and finance, how debt itself could be a valuable asset.

Hamilton’s vision was merited. The US has never defaulted on its debt - has always honored the full face value of its bonds - and is the largest, most dynamic economy in the world and in history. (Russia, by contrast, has always defaulted before any 30-year bond has been paid back and even today about 20% of its population has no indoor plumbing.) And while Hamilton died before he could see it, the US did surpass the UK as the greatest industrial power in the world. And except for one year in its long history, the US government has always held debt since. And continued to prosper.

The United States since its founding has held debt. Honored that debt. And prospered. Just like it was designed to do from the moment our founding fathers first created and approved the constitution that first created this nation.