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America's First Debt Crisis
CAMBRIDGE "â?? The West is ensnared in a debt crisis. The United States, as everyone knows, came perilously close to defaulting on August 2, and Standard & Poor's downgraded US debt from AAA on August 5. In Europe, the outgoing head of the European Central Bank recommends more centralized fiscal authority in Europe in order to deal with likely defaults by one or more of Greece, Portugal, and Spain.
Both Europe and America can learn a lesson hidden in American history, for, lost in the haze of patriotic veneration of America's founders is the fact that they created a new country during "â?? and largely because of "â?? a crippling debt crisis. Today's crises, one hopes, could be turned into a similar moment of political creativity.
After independence from Britain in 1783, America's states refused to repay their Revolutionary War debts. Some were unable; others were unwilling. The country as a whole operated as a loose confederation that, like the European Union today, lacked taxing and other authority. It could not solve its financial problems, and eventually those problems "â?? largely recurring defaults "â?? catalyzed the 1787 Philadelphia convention to create a new United States.
And then, in 1790-1791, Alexander Hamilton, America's first treasury secretary, resolved the crisis in one of history's nation-building successes. Hamilton turned America's financial wreckage of the 1780's into prosperity and political coherence in the 1790's.
To understand Hamilton's achievement "â?? and thus to appreciate its significance for our own times "â?? we need to understand the scale of the Revolutionary War debt crisis. Some states lacked the resources to pay. Others tried to pay but would not levy the taxes needed to do so. Others, like Massachusetts, tried to levy taxes, but its citizens refused to pay them.
Indeed, some tax collectors were met with violence. Indebted farmers physically disabled the repayment machinery in many states, most famously in Shay's Rebellion in Massachusetts.
Even private debt-payment mechanisms via courts didn't work. James Madison, who would become the Constitution's principal author, couldn't borrow to buy land in frontier Virginia, because lenders lacked confidence that Virginia courts could enforce repayment. George Washington bemoaned that America was not a "respectable country."? He found Shays Rebellion so worrisome that he came out of his first retirement to preside over the 1787 convention.
Today, the US Constitution's most noted features are its allocation of power between Congress and the presidency, and its guarantee of individual rights via its first ten amendments. But, at the time, its key role was as a government-debt-repayment mechanism. The Constitution would create a new national government that could coin stable money, borrow, and repay debts, including the states' defaulted Revolutionary War borrowings.
With the Constitution ratified by 1789, Washington became President and appointed Hamilton "â?? still in his thirties "â?? to head the Treasury. Hamilton had not been a finance person. He was Washington's Chief of Staff during the Revolutionary War and a quick study: when it was time to learn battlefield tactics, he read military manuals; when it was time to become a national leader who understood finance, he read finance books.
Yet, it was no accident that two military men were key to making the US a "respectable nation"? in financial terms. Both thought that only a fiscally strong US could have the military prowess needed to defend itself from the European powers, whose return to American soil both men expected.
But getting the dollars to repay the debt was not easy. There were no entitlements to cut or government funds to re-direct. Hamilton knew that the wrong kind of taxes would weaken the already-fragile economy. He focused taxation on imports and nonessential goods, like whiskey.
And Hamilton needed Congress to approve the federal government's assumption of the states' debts, which at first seemed unlikely. Some states, like Virginia, had already paid much of their debt, and others saw their debt as having become a financial game for New York speculators. As a result, many states feared federal assumption would mean that their taxes would go to pay northern speculators or to retire the debt of big borrowers, like Massachusetts.
Virginia and several other southern states that owed little or had repaid what they owed voted against Hamilton's first assumption bill and defeated it. They were expected to be adamant "â?? an outcome that could well have brought about the young country's demise.
Jefferson and Madison, the southern leaders, opposed Hamilton's assumption plan, and Madison was critical in blocking it in Congress. But then the three met for dinner and cut a deal. Jefferson and Madison did not want the country's capital to be in the north, and Hamilton reluctantly agreed to support moving it to an area carved out of Virginia or Maryland. They, in turn, would secure the votes for the federal government to assume and repay the states' defaulted debts.
A responsible fiscal state emerged from that grand compromise. Despite the enormous cost "â?? more than half of the fledgling government's expenditures in early years went to debt service "â?? the economy shook off the 1780's depression and entered a growth boom.
Hamilton's task was both easier and harder than ours is today. It was easier, because there were few choices: no income-tax rates to adjust or entitlements to cut. And it was harder, because the US was an unknown entity, and there was little reason for confidence in the American non-nation.
Today's trajectory is the reverse of that of the 1780's and 1790's. It is hard today for America (and, until recently, the world) to imagine a US default, because there has been no strong reason to fear one since the 1790's.
Americans today know what must be done: some combination of entitlement cuts and tax increases. Europeans, too, know a new balance that needs to be struck. But, until Europe and the US find leaders with the authority and willingness to repeat a modern version of the deal-making example set by Hamilton, Jefferson, and Madison 200 years ago, their debt problems will continue to weaken their national foundations.
Mark Roe is a professor at Harvard Law School.
Copyright: Project Syndicate, 2011. www.project-syndicate.org
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Username Password New registration Forgotten password RalphMus 07:56 08 Aug 11Mark Roe in his final paragraph makes the classic blunder that everyone who has not studied economics makes. He thinks that a government debt can be compared to the debt of a micro economic entity like a household or firm. When a micro economic entity wants to reduce its debt, it has to raise income or reduce spending. Every taxi driver and street sweeper knows that. Government is a macro economic entity and is entirely different.
If public spending is cut (or taxes are raised), that cuts demand, which raises unemployment, which means the automatic stabilisers kick in, which raises public spending. In fact Victoria Chick and Anne Pettifor of London University recently did a study which confirmed that when public spending is cut, public spending rises! Yes you read that right: when public spending is cut, public spending rises.
http://www.debtonation.org/wp-content/uploads/2010/06/Fiscal-Consolidation1.pdf
Cutting the debt is in fact easily done. It can be done by a combination of tax increases and QE â?? not a combination of tax increases and public spending cuts. The reasons for this are set out here:
http://www.positivemoney.org.uk/2011/05/let%E2%80%99s-print-money-and-buy-back-national-debts/
dltanev 10:55 08 Aug 11Nice history lecture - sadly, it is sublimely irrelevant, if not ridiculous. It saddens me to contemplate that this might be the level of economics thought at Harvard these days. It is absurd to even compare the debt issues that confronted 18th century USA - a country with a newly established financial system, based on commodity money (silver/gold),and the USA of the 21 century - a country which is the sovereign monopolist issuer of its own fiat currency. The whole article is such a complete mess, that I somehow preffer to think of it as a deliberate deception, or an attempt to push some Tea Party ideological agenda. thinly veiled as economic, rather than sheer ignorance.
The author unsurprisingly makes two glaring, fundamental mistakes by, firstly, equating the financial systems of a country using commodity money with that of a country using fiat money, and secondly, equating the debt of a household, which is a USER of currency, with the debt of a sovereign government, ISSUER of its own currency.I refuse to believe that a Harvard professor might honestly be unable to differetiate between these, whatever his political bias.
Unlike the 18th century US, the US of 2011 cannot possibly face a liquidity crisis, let alone dafault. Unlike the 18th century, the US does not need to issue debt, or collect taxes in order to spend, although it might SEEM otherwise. The 21st century US government is NOT REVENUE CONSTRAINED. It issues its own fiat money and cannot run out of the money it alone issues.The only form of "defeult"nowadays could be a self-imposed, political one. The ""debt" of the US in reality DOES NOT FINANCE ANY SPENDING. The debt of the US is just a tool to drain reserves from the banking system and thus set the overnight interest rates at the prefferred levels. It also provides an easy way for the private sector to save earning interest.The USA can service and repay ANY amount of debt, at any time, indefinitey without ever running into any problem. The author's ideas are only be applicable to a financial system based on commodity money, such as the gold standard. One cannot and must not apply the same logic and principles with regards to a fiat money system - that is utter nonsense!
rginnh 02:22 09 Aug 11Just another expert from Harvard trying to justify Keynesian Economic Spending on Steroids. After 2 and a half years, it is a contuation of the same blather. Less than a Trillion, I gave these folks some time. At a Trillion, doubts set in. Approaching two Trillion, I think it time to conclude the scheme is a failure.
How much failure is to be allowed before people just say NO MAS. NO MAS Harvard University, NO MAS.
ravikunjurs 09:56 09 Aug 11The USA needs Hamilton-like reforms immediately. And, it must tax a wide range of imports including OIL! This would be a clear sustainable way to get back into shape. Taxing imports would encourage import substitution of a wide range of products and services, which is the key driver to develop city regions, which in turn are the driving force of an economy.
RalphMus 05:00 10 Aug 11I agree with Dltanevâ??s remarks above about the poor quality of economics thinking at Harvard. However Dlaneyâ??s reasons are questionable: one cannot form opinions about economics at a university on the basis of something said by a historian at the same university.
My reason for concern about economics at Harvard is the boring nonsense we get from two Harvard economists: Kenneth Rogoff and Martin Feldstein. Of course these two are household names which means they are guaranteed space in publications which are more interested in filling up column inches than publicising anything interesting or novel. Maybe these two produced some bright ideas when they were younger. The biggest contribution they can now make is to keep quiet.
rginnh 01:35 11 Aug 11True Story?
An Entrepreneur sitting on a pile of cash is pondering whether to jump into the innovation fray once more. He goes to a new shop down the road. A Combo Soothsayer/Keynesian Shop (the economy). The Soothsayer tells him he will create this terrific product beyond his dreams. However, because he has to work 7 days a week 10-12 hour days he will turn heavily into drinking. His wife being fed up will throw him out of the house and file for Divorce.
She gets 50% of the Assets, large child support and alimony payments. Obama Representatives show up and tell him he needs to share his wealth and that his tax bill is due at 70%. The Combo Soothsayer/Keynesian shows up explaining he has to pay for all the Keynesian spending. The Combo Soothsayer/Keynesian whips out this University Study to justify the 70% tax rate. The Professor who wrote the study received a Nobel Prize even before its printing and publication, so it must be accurate.
The Entrepreneur without blinking an eye goes home, kisses his wife and children telling them how much he loves them. They buy a dusty old camper and happily drive away never to be seen again.
Mysteriously, an email picture of the Hammurabi Code that is in the Louvre is sent to all members of the Soothsayer/Keynesian Klub.
AUTHOR INFO Mark Roe Mark Roe is a professor at Harvard Law School. MOST READ MOST RECOMMENDED MOST COMMENTED The Second Great Contraction Kenneth Rogoff The Eurozone's Last Stand Nouriel Roubini Debt and Delusion Robert J. Shiller A Contagion of Bad Ideas Joseph E. Stiglitz Read China's Lips Stephen S. Roach A New World Architecture George Soros America's Political Class Struggle Jeffrey D. Sachs Did the Poor Cause the Crisis? Simon Johnson No Time for a Trade War Joseph E. Stiglitz Avatar and Empire Naomi Wolf The Future of Economic Growth Dani Rodrik The Second Great Contraction Kenneth Rogoff The Tea Party's Modest Proposal Simon Johnson A Contagion of Bad Ideas Joseph E. Stiglitz The Manufacturing Imperative Dani Rodrik ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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Mark Roe in his final paragraph makes the classic blunder that everyone who has not studied economics makes. He thinks that a government debt can be compared to the debt of a micro economic entity like a household or firm. When a micro economic entity wants to reduce its debt, it has to raise income or reduce spending. Every taxi driver and street sweeper knows that. Government is a macro economic entity and is entirely different.
If public spending is cut (or taxes are raised), that cuts demand, which raises unemployment, which means the automatic stabilisers kick in, which raises public spending. In fact Victoria Chick and Anne Pettifor of London University recently did a study which confirmed that when public spending is cut, public spending rises! Yes you read that right: when public spending is cut, public spending rises.
http://www.debtonation.org/wp-content/uploads/2010/06/Fiscal-Consolidation1.pdf
Cutting the debt is in fact easily done. It can be done by a combination of tax increases and QE â?? not a combination of tax increases and public spending cuts. The reasons for this are set out here:
http://www.positivemoney.org.uk/2011/05/let%E2%80%99s-print-money-and-buy-back-national-debts/
Nice history lecture - sadly, it is sublimely irrelevant, if not ridiculous. It saddens me to contemplate that this might be the level of economics thought at Harvard these days. It is absurd to even compare the debt issues that confronted 18th century USA - a country with a newly established financial system, based on commodity money (silver/gold),and the USA of the 21 century - a country which is the sovereign monopolist issuer of its own fiat currency. The whole article is such a complete mess, that I somehow preffer to think of it as a deliberate deception, or an attempt to push some Tea Party ideological agenda. thinly veiled as economic, rather than sheer ignorance.
The author unsurprisingly makes two glaring, fundamental mistakes by, firstly, equating the financial systems of a country using commodity money with that of a country using fiat money, and secondly, equating the debt of a household, which is a USER of currency, with the debt of a sovereign government, ISSUER of its own currency.I refuse to believe that a Harvard professor might honestly be unable to differetiate between these, whatever his political bias.
Unlike the 18th century US, the US of 2011 cannot possibly face a liquidity crisis, let alone dafault. Unlike the 18th century, the US does not need to issue debt, or collect taxes in order to spend, although it might SEEM otherwise. The 21st century US government is NOT REVENUE CONSTRAINED. It issues its own fiat money and cannot run out of the money it alone issues.The only form of "defeult"nowadays could be a self-imposed, political one. The ""debt" of the US in reality DOES NOT FINANCE ANY SPENDING. The debt of the US is just a tool to drain reserves from the banking system and thus set the overnight interest rates at the prefferred levels. It also provides an easy way for the private sector to save earning interest.The USA can service and repay ANY amount of debt, at any time, indefinitey without ever running into any problem. The author's ideas are only be applicable to a financial system based on commodity money, such as the gold standard. One cannot and must not apply the same logic and principles with regards to a fiat money system - that is utter nonsense!
Just another expert from Harvard trying to justify Keynesian Economic Spending on Steroids. After 2 and a half years, it is a contuation of the same blather. Less than a Trillion, I gave these folks some time. At a Trillion, doubts set in. Approaching two Trillion, I think it time to conclude the scheme is a failure.
How much failure is to be allowed before people just say NO MAS. NO MAS Harvard University, NO MAS.
The USA needs Hamilton-like reforms immediately. And, it must tax a wide range of imports including OIL! This would be a clear sustainable way to get back into shape. Taxing imports would encourage import substitution of a wide range of products and services, which is the key driver to develop city regions, which in turn are the driving force of an economy.
I agree with Dltanevâ??s remarks above about the poor quality of economics thinking at Harvard. However Dlaneyâ??s reasons are questionable: one cannot form opinions about economics at a university on the basis of something said by a historian at the same university.
My reason for concern about economics at Harvard is the boring nonsense we get from two Harvard economists: Kenneth Rogoff and Martin Feldstein. Of course these two are household names which means they are guaranteed space in publications which are more interested in filling up column inches than publicising anything interesting or novel. Maybe these two produced some bright ideas when they were younger. The biggest contribution they can now make is to keep quiet.
True Story?
An Entrepreneur sitting on a pile of cash is pondering whether to jump into the innovation fray once more. He goes to a new shop down the road. A Combo Soothsayer/Keynesian Shop (the economy). The Soothsayer tells him he will create this terrific product beyond his dreams. However, because he has to work 7 days a week 10-12 hour days he will turn heavily into drinking. His wife being fed up will throw him out of the house and file for Divorce.
She gets 50% of the Assets, large child support and alimony payments. Obama Representatives show up and tell him he needs to share his wealth and that his tax bill is due at 70%. The Combo Soothsayer/Keynesian shows up explaining he has to pay for all the Keynesian spending. The Combo Soothsayer/Keynesian whips out this University Study to justify the 70% tax rate. The Professor who wrote the study received a Nobel Prize even before its printing and publication, so it must be accurate.
The Entrepreneur without blinking an eye goes home, kisses his wife and children telling them how much he loves them. They buy a dusty old camper and happily drive away never to be seen again.
Mysteriously, an email picture of the Hammurabi Code that is in the Louvre is sent to all members of the Soothsayer/Keynesian Klub.
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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