America's Fiscal Constitution (11 page)

T
HE
W
AR OF
1812

Voters defeated more than half of the incumbents in the House of Representatives in 1810. Young “war hawks” like Kentucky’s Henry Clay and South Carolina’s John C. Calhoun dominated a new House majority after the election. Congress was not yet willing to raise taxes to build a navy to protect US shipping against British attacks. Ezekiel Bacon of Massachusetts, chairman of the House Ways and Means Committee, observed: “If the people will not bear the necessary taxes, it cannot with propriety be said that they will bear the contemplated war, and the sooner we know it the better.”

Jefferson’s friend Jean-Baptiste Say, the most influential economist at the beginning of the nineteenth century, wrote in his 1803
Treatise on Political Economy
that “the whole skill of government . . . consists in the continual and judicious comparison of the sacrifice about to be incurred, with the expected benefit to the community.”
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The War of 1812 forced federal leaders to weigh carefully the mix of debt and taxation to pay for war. Until the twenty-first century, the federal government would never consider waging a prolonged war without asking for public support in the form of higher taxes to finance it.

When the House finally voted to raise taxes in February 1812, President Madison wrote to Jefferson that the resolve to take “the dose of taxes” showed that people “would not flinch from the contest” with Great Britain.
²³
In March, Congress authorized $11 million in debt, at 6 percent interest, to prepare for combat, though the Senate delayed action on the tax increase.

The ostensible reasons for the War of 1812 seem odd to modern eyes. New England merchants and shippers adamantly opposed a war declared
for the official purpose of protecting their shipping from naval attacks. They were far more willing to endure occasional losses than a potential British trade embargo. Meanwhile, politicians from states in the South and West, which suffered least from maritime attacks, clamored for war. In reality, many residents of those states saw the war to be both a means of defending national honor and a pretext for occupying Canada and taking territory from Native Americans they had identified as British allies. On June 1, 1812, President Madison sent Congress a message detailing America’s grievances against Britain, which included predation on American trade, the kidnapping (“impressment”) of American sailors for service on British vessels, and the alleged support of Native American attacks on Western settlers.

The House—under the leadership of Speaker Henry Clay—voted quickly for war. The Senate passed the declaration of war by a margin of 19 to 13 following an initial tied vote and lengthy debate. From the outset critics labeled the conflict “Mr. Madison’s War” and predicted defeat. The US Navy had five old frigates and none of the large ships of the line that formed the backbone of the Royal Navy. The US Army consisted of only six thousand soldiers—most paid a dollar a day—and assorted state militias. In contrast, Great Britain fielded a quarter of a million professional soldiers and possessed a navy of over a thousand warships. Moreover, Great Britain reacted with anger in response to the American attempt to invade Canada at a time when British forces were fighting Napoleon in Europe.

The divisive war wounded Madison politically. He was barely reelected in 1812, when most of the nation’s merchants supported the rival candidacy of DeWitt Clinton, mayor of the nation’s commercial center, New York City. Madison would have lost without the support of Gallatin’s former constituents in Western Pennsylvania.

Before 1812 the new nation had added significant amounts of debt for only two purposes: to strengthen the Union by assuming state debts from the American Revolution in 1790 and to expand and secure the nation’s borders in 1803. Congress had authorized debt for naval construction in the 1790s, but the political chaos surrounding the Quasi-War made it difficult to treat that action as a lasting precedent. Funding for the War of 1812, however,
did
set a precedent for a third use of debt: financing war.

Creditors were reluctant to lend as much money as Congress sought to borrow. Of the $11 million in bonds authorized by Congress in March 1812, Gallatin managed to sell only $6.2 million, a third to individuals
and the rest to banks.
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Many New England banks, some of the nation’s strongest, refused to buy Treasury debt issued to finance a war they vehemently opposed. In June 1812 Congress authorized the Treasury Department to issue $5 million in notes.

By 1813, with bank credit exhausted, Gallatin asked for help from three of the nation’s wealthiest businessmen. Each of the three—shipping magnate Stephen Girard, fur trader John Jacob Astor, and international financier David Parish—had immigrated to the United States and made fortunes from trade during the preceding decade. They bought some bonds on their own account and resold some bonds to others. On March 24, 1814, Congress authorized a new $25 million loan, which prompted a lively public debate on the nation’s capacity to sustain a debt of that size.
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Opponents of the loan questioned whether the nation could ever repay it, while its supporters argued that the nation’s economy provided a sufficient potential tax base, comprising $2.567 billion in property and an estimated annual national income of $237 million.
²⁶
To facilitate commerce, advocates of the loan estimated that the nation needed currency—in the form of bank notes—totaling no more than $47 million, which would leave about $53 million in remaining bank notes.
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Modern politicians frequently make exaggerated claims along the lines of: “The United States faces a great challenge, perhaps its greatest ever.” When doing so, they ought to consider the situation confronting President Madison in the fall of 1814. By October 1814 Secretary of the Treasury George Campbell reported that the federal government had collected only half the revenue it needed for that year and was $50 million short of future requirements.
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Worse still, the federal government could not find anyone to lend it more money and would soon be unable to pay interest on existing debt. Merchants accepted Treasury notes only at a deep discount, and the government’s gold supply was exhausted. Treasury Secretary Campbell concluded this gloomy report by resigning after only eight months on the job. Secretary of the Navy William Jones advised Alexander Dallas, whom Madison nominated to be the new secretary of the treasury: “Something must be done speedily or we shall have an opportunity of trying the experiment of maintaining an army and navy and carrying on a vigorous war without money.”
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Just weeks earlier, British soldiers had burned down much of official Washington, including the White House and Capitol. President Madison only narrowly escaped after Secretary Monroe rode in from the front lines
near midnight to warn of the British approach. The president, armed with dueling pistols, left town the next morning on a horse he had to borrow when his own mount went lame.

Madison implored Congress to raise taxes in the wake of the occupation. He argued that “in offering their blood Americans give the surest pledge that no other tribute will be withheld.”
³⁰
Congress increased all taxes and began imposing new or higher taxes on luxury goods such as carriages, gold and silver watches, and household furniture. In September Monroe, serving as both secretary of state and secretary of war, borrowed $5 million on behalf of the government on his own signature and credit to supply troops led by General Andrew Jackson.
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Peace prospects seemed slim during that grim autumn of 1814. Gallatin had made little progress after traveling to Europe the preceding year for the purpose of negotiating a peace treaty. He and other American negotiators, including John Quincy Adams, had little bargaining power when British officials eventually agreed to meet with them. America’s attempts to invade Canada had failed, and British troops occupied parts of Massachusetts. President Madison instructed the American delegation to seek peace without a resolution of the issues giving rise to the war.

Time was not on the side of an insolvent United States. Days later Madison received word that British negotiators were demanding part of Maine, control of the Great Lakes, and swaths of territory for their tribal allies in exchange for peace. The weary but determined president worried about domestic opponents of war who threatened to dissolve the Union. Gouverneur Morris, who drafted much of the Constitution, urged a “union of commercial [Northern] states to take care of themselves, leaving the War, its Expense, its Debt” to Madison.
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On October 17, 1814, Massachusetts called for a convention of the New England states to discuss how to end the war, with or without the existing federal government. That same day Alexander Dallas, the capable new secretary of the treasury, told Congress that the United States could incur more debt without increasing taxes.

Like his predecessors Hamilton and Gallatin, Dallas had immigrated to the United States as a young man. He received a fine education in Edinburgh, Scotland, and he and Gallatin had gravitated toward one another early in their careers, when Dallas introduced Gallatin to the woman he later married. Secretary Dallas found that imports—the foundation of the prewar tax system—had shrunk to $13 million in 1814, less than a
tenth of the level in 1807.
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In late 1814 Dallas notified creditors that the United States might default on its debt—the first and last notice in American history of a potential default or a failure to pay interest when due. Dallas recommended a balanced budget consisting of $21 million in tax revenues and spending.
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The effective interest rate on federal debt had already soared to double-digit levels. Bonds could be sold for merely 88 percent of their face value, and even at that discount the federal government had to accept paper notes valued by merchants at 80 percent or so of their face value. A congressional investigation conducted years later concluded that Treasury obligations with the face value of $80 million yielded just $34 million gold dollars during the war.
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Secretary Dallas requested the formation of a new national bank. Jefferson disagreed, arguing that the Treasury Department should continue issuing interest-bearing notes. President Madison sided with Dallas and explained to Jefferson that a bank with private capital at risk could impose greater discipline than a Treasury controlled by the White House. In December 1814, however, Madison vetoed legislation creating a national bank because the bill prohibited the bank from lending to the government.

Delays in communications across the Atlantic forced Madison to speculate about the status of peace negotiations. He did not learn until later that his most trusted negotiator, Gallatin, experienced the peril inherent in federal indebtedness to foreign creditors. Alexander Baring, a banker and member of Parliament, had served for years as the agent for the US government’s payment of European creditors. Before the next installment on the bond from the Louisiana Purchase came due in January 1815, Baring asked Gallatin how he could be expected to “advanc[e] sums for the service of a Government with which we are at war?”
³⁶

Yet, when things looked the worst for the United States in the fall of 1814, Great Britain’s own excessive debt undermined that nation’s will to continue the war. Its debt approached 800 million pounds, or nearly $4 billion—twice the size of British annual national income after a decade of wars with Napoleon and the United States.
³⁷
British bonds, once the most creditworthy in the world, sold at only 55 percent of face value. Parliamentary debate on the war with America centered on its costs and related taxes.

Prime Minister Robert Banks Jenkinson, Earl of Liverpool, sought to end the conflict. In October 1814 the British cabinet asked the nation’s
preeminent military hero—Arthur Wellesley, Duke of Wellington—to consider taking command in America to end the conflict with either decisive victory or negotiation. He declined the post, explaining that he “would have great reluctance in undertaking the command, unless we made a serious effort to obtain peace.”
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Wellington privately urged Gallatin to remain patient. The duke knew, however, that some veteran soldiers from his Spanish campaign, commanded by his brother-in-law General Edward Pakenham, had already sailed to capture New Orleans.

Lord Liverpool, the prime minister, informed his foreign secretary, Lord Castlereagh, that they should “bring the American War to conclusion,” impress the pro-American Russian czar, and “pay serious attention to the state of our finances, and to the difficulties we shall have with the property tax” in Parliament.
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On December 24, 1814, the British and American delegations in Ghent signed a peace treaty, news of which took weeks to travel across the Atlantic. The same day Gallatin noted that Baring Brothers agreed to disburse funds due to satisfy the Dutch bondholders who had financed the Louisiana Purchase.

The War of 1812 was a financial fiasco for the United States and Great Britain. Both nations had to pay exorbitant interest rates and had reached the limit of publicly acceptable taxation. That financial reality was imprinted on the memory of a new generation of American leaders, who would seek a more sustainable system of financing for national security.

Most Americans preferred to remember the Battle of New Orleans rather than the nation’s wartime financial crisis. Ten days before the peace treaty was signed, more than eight thousand British soldiers on sixty ships entered Lake Borgne, a dozen miles from New Orleans. Even after signing the treaty, Lord Liverpool privately expressed to Wellington his hope that “the American war should terminate with a brilliant success on our part.” General Andrew Jackson—who had been abused by British soldiers when he was captured during the Revolutionary War—had a different outcome in mind.