Hamilton Hairstyles | AEP

We often hear that if the US government defaults on its debt, it would be unprecedented. But one treasury secretary in our history actually structured a federal debt default. Who was that? Hint: There is a popular musical on Broadway with the same name. That’s right, it was Alexander Hamilton.

Hamilton became Secretary of the Treasury in 1789. He faced a difficult situation: loans, both foreign and domestic, including government debt, covered almost a third of the cost of the Revolutionary War. Although interest on Dutch loans was still paid in specie (gold and silver), the Continental Congress, from May 1782, resorted to paying interest on its domestic loans mainly through so-called “indentations”, which were essentially paper IOUs. After 1789, even with the new government’s taxing powers, there was no way to pay the entire debt directly and in full. Instead, new securities were offered to creditors, on which interest could be paid in specie. The Hamilton Report recommended that Congress fully finance the $11.7 million foreign debt, and Congress did so by authorizing new Dutch loans. But for the $65.4 million domestic debt (including interest arrears and alleged state war debts), Hamilton concluded that the originally promised 6 percent interest rate was more than the government could afford. Therefore, he proposed to Congress several different schemes for lowering this rate.

Ultimately, Congress passed a plan to offer two-thirds of the principal to holders of domestic debt securities paying 6% per annum. The securities had no fixed maturity, effectively making them look like perpetual British consoles. These 6 percent consoles had a built-in call option that allowed the Treasury to buy them back for no more than 8 percent of their value. initial face value per year, including interest and principal. If the Treasury repeatedly exercised the call option over time, it made the consoles look like today’s fixed-rate mortgages (except for the possibility for mortgage holders to pay off all their debt early). For the remaining third of the debt, the creditors received the so-called deferred consoles, paying the same 6 percent interest rate, but starting in 1801, ten years later. This was the result of Hamilton’s desire to lower the effective interest rate below 6 percent to an overall average of just above 4 percent. Interest receivables were treated separately and repaid with consoles paying only 3 percent per annum.

The bottom line is that domestic debt financing involved a haircut that, in all but name, was a partial default. Using a discount rate of 6 percent, we calculated that someone who traded $100 of wartime Continental Congress debt, with one-third of that debt funded by deferred 6 percent consoles, received assets with a present value of only $82. At the same discount rate, the present value of $100 3 percent consoles was $50. Moreover, Hamilton and Congress did not even consider the idea of ​​paying additional interest on arrears. And the supposed government debts had an even tighter haircut in principal and interest; the present value of $100 of this debt has been reduced to $59. Some Revolutionary War debt holders, especially in New England, were outraged by the loss of the full 6 percent on all new securities. Of course, prior to the refinancing, wartime debt securities traded well below their face value.

You might think that this story is irrelevant to the current situation because 14th The amendment to the US Constitution was not ratified until July 9, 1868. Section 4 of that amendment reads, in part: “The validity of the public debt of the United States as authorized by law, including debts for the payment of pensions and awards for services to suppress an insurrection or insurrection, shall not be questioned.” But Title VI of the Constitution already dealt with the general question of the federal debt. Specifically, it states: “All debts and obligations entered into prior to the enactment of this Constitution have the same effect against the United States under this Constitution as under the Confederation.” So Hamilton’s haircuts seem quite appropriate in today’s controversy.

Whatever you think about the wisdom of Hamilton’s moves, our point is simple and categorical: the US government has failed in the past.

David R. Henderson

David R. Henderson

David R. Henderson is a senior fellow at the American Institute for Economic Research.

He is also a fellow at the Hoover Institution at Stanford University and a professor emeritus of economics at the Naval Graduate School. Concise Encyclopedia of Economics.

Previously, David was Senior Health Policy Economist for President Reagan’s Council of Economic Advisers.

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Geoffrey Rogers Hummel

Geoffrey Rogers Hummel

Jeffrey Rogers Hummel is a professor in the Department of Economics at San Jose State University who has taught both history and economics. He is the author Freeing Slaves, Enslaving Free Men: A History of the American Civil War (the second edition of which was published in November 2013). He received his Ph.D. in History at the University of Texas at Austin.

Professor Hummel was the William C. Bark National Fellow at Stanford University’s Hoover Institution, Director of Publications at the Independent Institute, and US Army Tank Platoon Leader.

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