One nation overdrawn
Lessons for Europe from America’s history
IN THE frantic race to save the euro, many Europeans have sought inspiration from the United States, perhaps the most successful monetary union in history. Germany’s council of economic experts has proposed a debt redemption pact modelled on the American federal government’s assumption of state debts in 1790. To European federalists, America demonstrates that monetary union cannot survive without fiscal union. And proponents of a European lender of last resort to insulate sovereigns from liquidity crises note how America can still borrow at 2% thanks to a deep and liquid government bond market backstopped by the Federal Reserve.
Look more carefully, however, and the American example is more complicated. Fiscal and currency union did indeed kick-start America’s early economic development. But fiscal and monetary frameworks were so rudimentary that they contributed little to nation-building.
America began life as a fiscal basket-case. The federal and state governments were deeply in arrears on loans taken out to finance their war for independence from Britain; federal debt traded at 50 cents on the dollar, state debt for 20 cents or less. Alexander Hamilton, the first Treasury secretary, considered it vital to America’s economic health to re-establish faith in the national credit. He proposed in 1790 that the federal government assume the states’ war debts and then arrange a new schedule of payments and interest to refinance all of the republic’s unpaid bills. Holders of the restructured bonds would be encouraged to exchange them for capital in a new central bank that would issue a uniform currency to unify the states’ financial systems.
Foreshadowing the rifts within Europe today, Hamilton’s plan was deeply divisive. Virginia and other southern states that had paid off their debts resented being asked to pay taxes to bail out the others. Hamilton at one point feared for the future of the union if his plan did not pass: Our credit will burst and vanish; and the States separate, to take care every one of itself.