November 12, 2012

WHEN WE HAD A REAL DEBT PROBLEM:

Mr. Hamilton's Growth Strategy (THOMAS K. McCRAW, 11/11/12, NY Times)

The face value of federal and state debts was about $74 million, including $12 million owed to Dutch banks. Federal income for 1790 amounted to just $1.6 million -- a debt-to-income ratio of 46 to 1. (Today that same ratio is about 6.5 to 1.)

Hamilton first paid off the foreign debt by rolling it over through new loans from abroad. Determined to establish the nation's creditworthiness and avoid default, he then consolidated the remaining debts at their par, or face, value, which was higher than their market value -- a move opposed by Thomas Jefferson and James Madison, who said it would reward speculators.

Meanwhile, he temporarily ignored Jefferson and Madison's idea of repaying the principal of the domestic debt. Instead, he persuaded Congress to authorize new bonds to replace existing obligations, while reducing the interest rate to 4 percent from 6 percent. He then announced that all interest would be paid in gold, and that receipts from import duties would be earmarked for these payments -- reasoning that bondholders would rather get 4 percent in gold than 6 percent of nothing.

Hamilton then established the Bank of the United States as a private, profit-making institution. Shares in the bank soon rose, and it would eventually have branches in all major cities -- at a time when only three small banks existed in the entire country, and when Jefferson and other founders opposed the very existence of banks. The bank, together with funding of the debt, vastly increased liquidity in the country, much as the Federal Reserve chairman, Ben S. Bernanke, has tried to do today. [...]

By 1794, four years after his plan went into effect, the federal debt had increased a bit, but revenues had risen more than threefold. The debt-to-income ratio had shrunk to 15 to 1 from 46 to 1; by 1800, it was 8 to 1.
Posted by at November 12, 2012 5:25 AM
  
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