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In this week’s Grumpy Economist Weekly Rant, John Cochrane revisits Alexander Hamilton’s approach to the large public debt left by the Revolutionary War. Rather than repudiate the debt or inflate it away, Hamilton argued that the new United States should honor its contracts and repay creditors according to their terms—even at substantial short-term cost—to establish the country’s financial reputation and preserve its ability to borrow in the future.
Cochrane argues that Hamilton also understood the danger of allowing debt to grow without a plan for repayment. Federal assumption of state debts required the federal government to have the taxing authority to service them, while creditors themselves created a political constituency for sound public finances. Hamilton’s enduring principle was simple: new debt should always come with the means to repay it.
Read: “Pay Your Debts: John H. Cochrane on Alexander Hamilton” on the Freedom Frequency Substack
Transcript
Hi. I’m John Cochrane, senior fellow here at the Hoover Institution, and welcome to my Grumpy Economist Weekly Rant.
Today, I’m going to rant, or rather speak in praise of Alexander Hamilton. I was asked to write a short article on one founder for Hoover’s Freedom Frequency Substack, and as a recovering finance professor and a student of government debt, I naturally chose Alexander Hamilton.
Hamilton faced a situation that rings a bit like today. The US had a large debt after the Revolutionary War. How should the United States pay off that debt? Or would it do so, or should it do so?
Governments are always tempted to repudiate or inflate away their debts. New and financially strapped governments are especially tempted. And in economics, a just-this-once debt repudiation is, in fact, a very efficient tax. It’s also the worst tax when people don’t believe it will be just this once.
So Hamilton went all the way in the other way. He bought reputation at a large cost. The United States will repay the debt. It will stand by its promises. Doing so will be expensive, but it will give the United States standing in the world, including the ability to borrow on good terms in the future.
Unlike many of our politicians, Hamilton was thinking decades in the future.
Now, what about debt that was bought by a speculator from a poor revolutionary soldier in need? Well, but maybe the seller just didn’t have faith in the United States, and the speculator was the patriot taking on a big financial risk and helping the government by propping up the bond market.
Trying to distinguish the moral worth of creditors is a fraught business. Advice politicians might heed today, and Hamilton recognized, was hopeless.
Hamilton emphasizes the obligation of contract. This nation honors its contracts and does not rewrite the terms after the fact, even when it’s really hard.
“It disagreed,” wrote Hamilton, “on all hands that part of the debt which has been contracted abroad ought to be provided for according to the precise terms of the contracts relating to it.”
Would today’s Congress prioritize repaying foreigners? Does it feel the nation’s honor is at stake in repaying its debts? We seem to rip up a lot of contracts these days with little concern for our honor.
It would be wise to listen to Hamilton. In the debt ceiling controversies, for example, I wish Hamilton’s successors as Treasury secretary would declare that the United States pays principal and interest on its debt ahead of anything else. They do not do so.
Famously, Hamilton understood that the federal assumption of the state debts meant that the federal government must have the authority to raise taxes to repay that debt. Also, the assumption would create a class of bondholders interested in sound federal finances.
Hamilton wrote, “If all the public creditors receive their dues from one source, their interest will be the same. They will unite in support of the fiscal arrangements of the government.”
We’ll see if bondholders remain powerful enough to ensure sound finances and debt repayment from our own government. Current political thought disdains the political influence of wealthy security holders. Hamilton saw its benefits.
Now, Hamilton was no fool. He understood that debt can be dangerous. He, meaning Hamilton, is far from acceding to the position that public debts are public benefits, a position inviting to prodigality and liable to dangerous abuse.
Well, today’s debt doesn’t matter. We owe it to ourselves. Don’t worry about debt. And fellow travelers have a long pedigree inviting our current prodigality and dangerous abuse.
Hamilton wrote that he wishes to see it incorporated as a fundamental maxim in the system of public credit of the United States, that the creation of debt should always be accompanied with the means of extinguishment, or, in our words, repayment.
“This he regards as the true secret for rendering public credit immortal. And he presumes that it is difficult to conceive a situation in which there may not be an adherence to that maxim.”
Well, dear Alexander Hamilton, just wait 250 years, if you can keep it. A remark by another of my favorite founders may well apply to our financial as well as to our political future.
Thanks for listening. And if you enjoyed my Weekly Rant, please click to subscribe.
John H. Cochrane is the Rose-Marie and Jack Anderson Senior Fellow of the Hoover Institution at Stanford University. An economist specializing in financial economics and macroeconomics, he is the author of The Fiscal Theory of the Price Level. He also authors a popular Substack called The Grumpy Economist.