Friday, December 24, 2010

If you only read one really long economics lecture this holiday...

Delong, again:

Alexander Hamilton and the Origins of the National Debt: Back in the early 1790s, the national debt was close to 40% of annual GDP. It was close to 40% because the first Treasury Secretary, Alexander Hamilton, thought it was a good idea to make it close to 40%. He convinced congress to let him go to the states and say:

You know all that money you spent winning us our independence from Britain by raising armies during the Revolutionary War? The federal government is going to pay you back for all of that. We in the federal government are going to assume your Revolutionary War debts, and pay off all the bonds you issued at full face value.

Alexander Hamilton did this for three reasons. One was he had a bunch of friends who were financiers in New York. Once they got wind of how he was thinking they had the opportunity to buy up pieces of the debt from the merchants, the soldiers, and the others to whom the government owed money--to say:

You don't think New Jersey will ever pay off that piece of paper, do you? I'm willing to gamble that they will eventually pay something--how about you trade it to me for 40 cents? You get the cash, I take the risk, it is a good deal for both of us.

Then Alexander Hamilton announces his debt assumption plan. New York financiers who understand how Hamilton thinks make an awful lot of money. And they are grateful.

That, however, was only a minor reason.

One major reason was that Alexander Hamilton saw that the United States was then a relatively small country in a world dominated by two super powers, Britain and France. Both Britain and France had ocean-spanning ambitions and blue water navies. Hamilton thought it likely that we would at some time in the future get into a big war with either Britain or France. And he wanted to make sure that if we did get into a big war that the federal government would be able to borrow money in order to fight it effectively. Moreover, even if we did not get into a big war a U.S. federal government that could not borrow--that had no debt capacity--would be weak. Both France and Britain would both notice that we were weak, and they would steal our stuff, press our sailors and make them man their navies, et cetera et cetera. Thus Hamilton thought it was important for the federal government to start its existence by building up its debt capacity. And what better way to convince investors that the federal government would pay off its debts in the future than for it to pay off the debts of the United States incurred during the Revolutionary War--even or perhaps especially if those debts had not been incurred by the current federal government?

The most important reason, however, was that Alexander Hamilton was Secretary of the Treasury in a country where the rich were at best uneasy about the revolution and independence. Of America's upper class as it stood in 1775, full half of them were gone: had fled to Britain or Canada during the Revolutionary War. Those who remained remembered that back before 1775 the British monarch had protected property, that the British army and navy had protected them against deprivations of all kinds, that it was quite clear who the police worked for. Now you have a republic with a much broader electorate. Might politicians run on a platform of soaking the rich and redistributing wealth to the poor? Thus the rich people were nervous--and at least thinking about how maybe it would be good if the British came back and ruled again.

This was where Alexander Hamilton had his good idea. Suppose, he thought, he could set things up so that the rich owned a lot of U.S. government bonds. Then if the British returned--well, the British were not going to pay off the Revolutionary War debt of the United States of America under any circumstances. Having a national debt was a way to bind the United States rich to the country--giving them a stake in the new republic's survival. And by large it worked: the national debt was a national blessing.

Definitely worth reading the whole thing.

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