America's Fiscal Constitution (7 page)

On June 19, 1790, Hamilton encountered Jefferson on the street outside the president’s office and complained that gridlock over state debts threatened the Union. Jefferson listened to the “somber, haggard and dejected” Hamilton and responded by inviting him to “a friendly conversation” with Madison over dinner at his house on Maiden Lane in New York, then a city of about thirty thousand people.
³⁸
Jefferson was well practiced in the French custom of negotiations over a multicourse meal with wine.

Jefferson’s hospitality diffused tensions between his two guests, both of whom respected their host, who was several years older and had earned an international reputation by virtue of his authorship of the Declaration of Independence and various writings on North America’s natural history.

While drinking wine and dining with friends, the reserved Jefferson could become charming, humorous, informal, and provocative. Jefferson preferred to converse rather than argue because he had observed that words
could rarely change an opinion already formed. Years later as president, he would scandalize the European diplomatic corps, who were accustomed to strict court protocol, by hosting dinners in casual dress at tables without seating plans.

It is likely that Jefferson began the evening on a personal note. Madison was a close and trusted friend, and the host must have asked Hamilton about his wife, Eliza, whose sister Jefferson, a widower, had fallen in love with in Paris during his years as minister to France.

Madison and Hamilton each appreciated how difficult it would be for the other to compromise on the issue of state debts. Madison was in a position to be reminded by his former political opponent, Monroe, that the congressman had once assured Virginians that the Constitution imposed no obligation to pay state debts. Hamilton, on the other hand, would have to explain the loss of New York as the temporary capital to his wealthy father-in-law, who had raised funds to pay for federal offices there.

The issue of state debt seemed far more important to Hamilton than did the location of the capital. Just ten days earlier, at a meeting with Pennsylvania senator Robert Morris on a foggy morning at the southern tip of Manhattan, Hamilton had offered to support a temporary capital in Morris’s preferred location of Philadelphia as long as Morris delivered the votes necessary for the federal government to assume state debts. But Morris could not overcome the opposition of Virginia’s House delegation to the assumption of state debts. To do so might require Jefferson’s influence with Virginians such as James Monroe and members of the powerful Lee family.

Jefferson had already anticipated that a deal with Virginians on the capital might engender opposition from Pennsylvanians. Shortly before his dinner with Madison and Hamilton, Jefferson met with Morris to float the idea of a temporary capital in Philadelphia.

Madison himself shared Hamilton’s concerns that the issue of state debts had to be resolved in order to avoid impediments to tax collection in Massachusetts. Just days before his dinner with Jefferson and Hamilton, Madison had written to Monroe with alarm about the “prophetic menaces” of debtor states.
³⁹

Jefferson’s dinner meeting served his desired purpose. The three resolved to locate the new, permanent capital on the Potomac, close to Washington’s plantation home, with a temporary capital in Philadelphia. Jefferson would help bolster support for the federal assumption of state
debts, while Hamilton would work with Morris to bring Pennsylvania on board and mollify disappointed New Yorkers. After the dinner, Jefferson wrote to Monroe, who had once served as his law clerk, to explain “the necessity of yielding for this time to the cries of the creditors in certain parts of the union, for the sake of union, and to save us from the greatest of all calamities, the total extinction of our credit in Europe.”
⁴⁰

Jefferson wrote to his brother-in-law that the failure to assume state debts could interfere with “the funding of the debt altogether, which would be tantamount to a dissolution of the government.”
⁴¹
In July Congress approved the location of the new capital on the Potomac, where it would move after ten years in Philadelphia. President Washington would use the home of the status-conscious Morris as his official mansion. Morris himself, who unsuccessfully speculated in land development within the boundaries of the new capital, would spend three years of the Washington administration housed nearby, at the Prune Street jail, for nonpayment of debts.

In August Congress passed the Funding Act, which authorized the assumption of state debts and raised the estimated federal debt to $75.4 million.
⁴²
Once freed of debt, many states slashed their property taxes. This assumption of debt was the first of many occasions on which the states would demand the federal government shoulder various financial responsibilities while at the same time protesting the related intrusion of federal authority.

Of the $52 million in obligations directly inherited from the Confederation, $40.3 million was owed to American citizens, amounting to $27.3 million in principal and $13 million in accumulated interest. The balance, $11.7 million, was owed to foreigners, principally in the Netherlands, Spain, and France. The Funding Act gave priority to payment of interest owed abroad, in order to preserve the nation’s international credit. It also gave interest payments priority over all federal expenditures except for an annual sum of $600,000 earmarked for general administration, including tax collection.
⁴³

Hamilton then refinanced, at a lower average interest rate, the principal amount of all domestic debt and accrued interest. Hamilton expected to be able to pay interest but not retire principal for the foreseeable future.

The total debt after the assumption of state debts imposed a great burden on the young nation, whose economy in 1790 produced goods and services with an estimated value of $200 million and which had a
population of 807,094 free white males and eight million acres of cultivated land trading at little more than $2 per acre.
⁴⁴
Much of the population lived outside the cash economy.

In February 1792, after Hamilton’s refinancing, Treasury debt bearing the highest interest rate sold for $1 for every dollar of face value, a sharp rise from its value of 45 cents per dollar two years earlier. Many merchants considered that appreciation to be a remarkable achievement. Both Hamilton’s supporters and critics compared US debt to the familiar benchmark of British sovereign debt. Even Great Britain at times would receive less than a pound sterling for every pound of face value of its standard bonds, known as “consols.” Hamilton’s detractors were aware that those consols were often purchased by the English landed gentry, who treated them as a perpetual annuity financed by taxes.

Stable pricing of federal debt in relation to gold coins helped provide liquidity. To understand the importance of federal paper notes worth their “face value,” consider today’s ten dollar bill, on which Hamilton’s picture appears. Creditors and vendors accept it in payment for $10 owed, without the need to negotiate its “real value.” Hamilton wanted US Treasury notes, or notes from a bank with Treasury notes in reserve, to serve as a national standard of value and thereby facilitate trade within the new nation.

Even when the United States began circulating its own coins, the quantity of these coins was insufficient to serve the needs for “hand-to-hand” money and bank reserves. Gold and silver tended to be drained abroad, since the United States typically imported goods of greater value than it exported.
⁴⁵
Federal debt obligations backed by federal taxing power served as an alternative standard of commercial value. That value depended, of course, on the creditors’ confidence that federal revenues would be available to pay debt service. After the destruction of finances in other developed nations following World War II, US debt became—as Hamilton could only dream—the worldwide standard of commercial value.

D
EBT AND
P
OLITICAL
O
PPOSITION

The spirit of cooperation at Jefferson’s 1790 dinner did not last long. The following year, during the third and final session of the First Congress, Hamilton pushed through legislation chartering a national bank, the Bank of the United States. Private investors supplied 80 percent of the bank’s
original funding. The new Bank of the United States assumed responsibility for handling the deposits and disbursements of the US government.

Scholars often revisit the bank controversy in order to discern the origins of the nation’s competing political doctrines. However, Hamilton’s defense of the bank was grounded less in ideology than in his practical need for help in collecting taxes at distant ports and disbursing payments to scattered vendors and creditors. The overworked Hamilton had few competent staff members and only a crude accounting system.

Hamilton also understood, as has virtually every secretary of the treasury since, that properly regulated banks could support short-term federal borrowing. The government’s cash flow inevitably fluctuates over the course of a budget year, and the revenues of a new tax system were especially difficult to predict. Bank credit could smooth the cash flow and assist when revenues fell short of estimates. Not even a handful of the nation’s wealthiest citizens had much gold to lend during the nation’s first dozen years, so the Bank of the United States provided a vehicle for pooling funds from a large number of investors and depositors. Moreover, Hamilton believed that oversight by a broad group of investors might reduce the risk of political influence over the bank’s credit decisions.

Jefferson and Madison’s intense opposition to the bank likewise rested on a practical objection to monopoly. English law treated chartered corporations as having the exclusive or monopoly right to engage in a defined line of business.
⁴⁶
In fact, it was not until 1837 that the Supreme Court decided, by only a slim majority, that a state could legally charter more than one corporation for a particular purpose. Jefferson and Madison’s opposition to the bank also reflected their antipathy toward the concentration of power in a financial institution controlled by the executive branch and a group of wealthy private investors that included more than thirty members of Congress.

The bank controversy initiated more than a century of national debate concerning the responsibility for functions now described as “central banking.” The Constitution gave Congress the power “to coin money [and] regulate the value thereof” but did not specify
who
ultimately would make decisions on the supply of money and credit or
how
enough would be supplied to accommodate the reasonable public and commercial credit needs without inflation. Jefferson sought to limit private influence over these decisions, while Hamilton wanted to curb future interference by elected officials
who might lack the competence, discipline, integrity, and access to private capital required to effectively manage the nation’s banks and currency. This essential debate over central banking continued until an agreement was reached between the Treasury Department and the Federal Reserve in 1951.

By 1792 Jefferson and Madison had organized like-minded political leaders in opposition to the bank and some of Hamilton’s other initiatives. They began referring to their anti-Hamilton coalition as one of two “parties,” and, like modern partisans, they stereotyped their opponents as an elitist minority. In a letter to Madison, Jefferson offered one description of the party alignment:

On one side, 1. the fashionable circles of Phila, N. York, Boston, & Charleston (natural aristocrats), 2. merchants trading on British capitals, 3. paper [money] men. . . . On the other side are 1. merchants trading on their own capitals, 2. Irish merchants, 3. tradesmen, mechanics, farmers, & every other possible description of our citizens.
⁴⁷

Madison was even less generous. He described the opposition as being “partial to the opulent” and as “having debauched themselves into a persuasion that mankind are incapable of governing themselves.”
⁴⁸

Jefferson and Madison called their group “republicans.” Like-minded citizens in various cities gathered as “democratic” clubs or societies. Their opponents often called them antifederalists or Jacobins. For the next forty years, the party operated as a coalition without an official organization, platform, or name.

Though the written Constitution did not explicitly refer to political parties, eventually a party system would become part of the nation’s unwritten constitution and an accepted means of expressing political opposition. This prospect did not sit well with President Washington, for reasons often misunderstood. Washington was a superb politician who listened to public opinion and paid attention to details affecting his public image. For example, he designed his frequent walks in New York to help cultivate his identity as a man of the people. Yet he also knew how to set himself apart; he chose to ride on horses whose white color he enhanced with powders he specially prescribed. Washington felt that federal elected officials derived their authority based on a direct relationship with voters or the electors who chose them. Accordingly, he suspected that parties might undermine
the direct accountability of elected officials to voters, their ultimate source of authority.

Though Washington’s views on parties did not ultimately prevail, his crucial decisions about executive power did set precedents incorporated in the nation’s unwritten constitution. Washington believed that federal appointees should be loyal to the president and his policies. The written Constitution did not state whether the president could discharge senior appointees who had been confirmed by the Senate, especially for differences with the president arising from policy or politics rather than competence in executing the law. Paradoxically, Washington’s idea that presidential appointees should adhere to an administration program served to accelerate partisan groupings that could be used to identify people sharing common policy preferences.