Hamilton's 1790 Report on Public Credit and what honest borrowing requires

Picture a young Treasury Secretary walking into a Congress that owes money to everyone: to foreign governments that lent during the war, to soldiers who were paid in paper, to farmers who sold supplies on a promise. The paper is trading at a fraction of its face value, speculators are quietly buying it up, and the new government has no credit to speak of. The young man's answer is not to default, not to haircut, and not to wait. It is to pay.

That, in outline, is the First Report on the Public Credit, which Alexander Hamilton delivered to the House of Representatives in January 1790. It is one of the great state papers of the American founding, and it is a better guide to honest borrowing than anything produced by the budget offices that came after. Let me read it with you.

The situation Hamilton inherited

The Revolution had been financed on credit. The Continental Congress had no power to tax, so it borrowed abroad, mostly from France and the Netherlands, borrowed at home by selling certificates to citizens and paying soldiers and suppliers in paper, and printed money until the phrase "not worth a Continental" entered the language. The states had also borrowed and had their own war debts. By 1789 the debts were large, the paper was cheap and the credit of the new national government was untested.

The Constitution had settled one question in principle. Article VI, Clause 1 provides: "All Debts contracted and Engagements entered into, before the Adoption of this Constitution, shall be as valid against the United States under this Constitution, as under the Confederation." The new government inherited the old government's obligations, and said so in the supreme law. What it did not settle was how those debts were to be paid, and to whom, and in what amount. The House asked Hamilton, the Secretary of the Treasury, to prepare a plan. He delivered it on January 9, 1790, and the House took it up in the following days.

What the report proposed

The report is long and technical, but its core fits on a card. It had four recommendations.

One: funding at par. The United States should honour its debts in full, at face value, with interest. A certificate promising a hundred dollars should be worth a hundred dollars, whatever the holder had paid for it. This was the center of the plan and the part that most shocked the people who read it. The paper was trading far below its face value, and Hamilton wanted to redeem it at the full promised amount.

Two: the foreign debt in full. Debts to France, to the Dutch bankers and to other foreign lenders were to be paid exactly as agreed. Hamilton saw no argument for any other course. A country that cheated the lenders who had saved it would be shut out of the world's credit markets for a generation.

Three: assumption of the state debts. The national government should take over the debts the states had incurred in fighting the war, on the theory that it was a common cause and should be a common burden. Assumption would also bind the creditors of each state to the success of the national government.

Four: a means of paying it off. The report did not propose to borrow and let the debt lie. It proposed revenues, chiefly from duties on imports and on the tonnage of ships, with an excise on distilled spirits following soon after, to be set aside to pay the interest, and a plan to retire the principal over time. That is the part I want to dwell on, because it is the part modern Washington has dropped.

I should say what the report did not do. It did not say that a national debt is a blessing without limit. Hamilton made the argument elsewhere, in earlier private letters, that a debt kept within bounds and honoured promptly could serve as an instrument of credit and a tie that bound creditors to the government. What he insisted on in the report was a condition: the debt, once created, had to come with a method of extinguishing it. I am paraphrasing here because I will not trust my memory of a quotation in a document of this importance; read the report in the National Archives' Founders Online collection and find the passage on the creation of debt and the means of extinguishment for yourself.

The sinking fund

The idea of a sinking fund is simple. A government sets aside a stream of revenue to buy down its debt in a regular, automatic way, so that the debt shrinks without needing a fresh decision each year. It is the public version of a mortgage payment: an amount put aside in advance for the principal.

Hamilton proposed devoting certain revenues to this purpose and Congress created a sinking fund with commissioners to manage it, first in 1790 and again with a supplementary act in 1792. The details evolved, and the original arrangement was criticised and adjusted over the years. But the principle was fixed in the first years of the republic: borrowing carries a repayment plan. And the plan worked. The debt of the 1790s was serviced on time, American bonds were in demand in Europe, and the country that had begun the decade with credit in tatters ended it with credit that foreigners trusted.

The principle held for a long time. The debt was reduced under Jefferson, who valued its retirement and, with his Treasury Secretary, Albert Gallatin, set out to pay it down. And in January 1835, under Andrew Jackson, the United States paid off its national debt, the only time that has happened. The Founders' generation believed that borrowing was a bridge, to be crossed and left behind.

The Compromise of 1790

Hamilton's plan did not pass easily. The funding of the federal debt had a majority. The assumption of state debts did not. Southern states that had already paid much of their war debts resented being asked to help pay the debts of the others, and the proposal stalled in the House.

What broke the logjam was a bargain. In the summer of 1790, in a famous dinner arranged by Thomas Jefferson that brought together Hamilton and James Madison, a deal was struck: enough votes would be found for assumption, and in return the new national capital would be located on the Potomac, in the South. The Residence Act, setting the capital's location, and the Funding Act of August 1790, which provided for the debt, passed in the same summer. The story is sometimes told as a cheap piece of horse-trading. It is also a case of the legislature doing what the Founders expected it to do: giving up something on each side to produce a result that neither could have gotten alone. The dinner has become legend, and I will say that the details of what was said at the table come from the later recollections of Jefferson, so treat them with appropriate care.

Madison's objection

Here the history gets more interesting, because the loudest opposition to Hamilton's plan came from his friend and co-author of the Federalist, James Madison.

Madison's objection was not to paying the debt. It was to paying it to the wrong people, in the wrong way. In the years since the war, many of the original holders of government paper, soldiers and farmers, had sold their certificates at steep discounts, in some cases for a fraction of face value, to speculators who bought them cheaply. If the government paid the full face value to the current holders, the speculators would collect enormous profits, while the soldiers who had actually served got nothing. Madison proposed a discrimination: pay the original holders the difference, and pay the current holders something less.

It is a serious moral objection, and Hamilton's answer is a serious one too. A government that starts distinguishing between holders of its paper, he argued, has made the paper less valuable to everyone, because no buyer can be certain he will be paid. A promise is only worth something if it is kept as written. The administrative difficulty of tracing every certificate through every sale was also enormous, and the effort to do so would have delayed the plan and risked its failure. Congress rejected Madison's proposal. The conservative who looks at this exchange should take from it both the principle and the cost: a government that honours its debts at par will sometimes reward people we do not admire, and a government that picks and chooses among its creditors will pay for it in the price of every loan it takes for a century.

The steelman: "Hamilton built a banker's republic"

The best case against Hamilton's program, as its opponents made it, ran like this. One, funding at par enriched speculators at the expense of the original holders. Two, assumption rewarded states that had borrowed freely and penalized those that had paid their way. Three, a permanent public debt created a permanent class of creditors with a stake in a powerful central government, and so tended to bend the republic toward finance and away from the farmers and planters. Four, it set a precedent that the national government could take on whatever obligations it pleased.

I take the first and third points seriously, because Jefferson and Madison saw something real. A great public debt does create a constituency, and it does tie interests to the government. And yet the plan's defenders had the better of the argument on the question that mattered most in 1790. The government had borrowed, and the people who lent had trusted it. An honest government pays its debts, and a young republic that wished to be taken seriously in the world could not afford to be anything else. The answer to Madison's moral point is not that the speculators deserved their profit. It is that the alternative was a default by degrees, and default destroys credit.

Hamilton's standard against Washington's habit

Here is why the report belongs in a debate about the debt today. Hamilton's program carried three conditions that stand against the modern pattern.

First, the debt was tied to a specific, finite event. It was a war debt, and the plan was to pay it. Modern deficits are not tied to any single event. They are structural, built into programs that spend more than they take in year after year, and no plan to retire them accompanies them. For the arithmetic of what that costs, see do the arithmetic on $40 trillion and the interest bill it carries.

Second, the debt was matched by dedicated revenue. Hamilton did not ask Congress to authorize borrowing and hope for the best. He identified the taxes that would pay the interest. Today, the Treasury borrows to cover the shortfall and the interest is paid out of the general budget, which means out of more borrowing; the myths that make this comfortable are catalogued in Seven myths about the national debt that Washington finds convenient. Even the statutory limit on that borrowing, which began as a convenience, as I explain in the debt ceiling began in 1917 to make borrowing easier, not harder, has become a ritual with no plan attached.

Third, the debt was meant to be extinguished. This is the most important difference. In the 1790s, honest borrowing meant a plan to repay. Today, the working assumption in Washington is that the debt will be rolled over forever, and that the only question is the ratio to the economy. A debt that is never meant to be repaid is not a debt in Hamilton's sense. It is a permanent claim on the next generation.

None of this requires us to agree with Hamilton about everything. Conservatives have long debated his views on a national bank, on manufactures and on the reach of federal power, and I explore one of them in Hamilton's Report on Manufactures and the conservative case for tariffs. But on the narrow question of what honest borrowing requires, he is right: you owe the money, you pay it at par, and you say how.

What the Constitution adds

Article I, Section 8, Clause 1 gives Congress the power "To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States." Notice the order. The power to tax is stated for the purpose of paying the debts. A government that borrows without a plan to pay is using a power the Constitution granted with a purpose attached, and failing to carry out the purpose.

Article I, Section 9, Clause 7 requires that "a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time." The Founders wanted the people to see the books. You can read the Constitution at the Constitution page and the founders' own words at the founders page.

The case in brief

1. Hamilton's January 1790 report proposed funding the Revolution's debts at par, paying the foreign debt in full and assuming the state debts, and it tied each to dedicated revenue.
2. Article VI, Clause 1 had already made the old debts valid against the new government, and the plan made that promise real.
3. The sinking fund and the dedicated duties reflected one principle: borrowing must come with a means of paying it off.
4. Madison's objection over speculators was serious, but Hamilton's answer was that a government that picks among its creditors destroys its credit, and Congress agreed.
5. Modern Washington has dropped the plan to repay, and the honest standard is Hamilton's: a debt without a means of extinguishment is not honest borrowing.

What you can do: read the report's section on the sinking fund at the National Archives' Founders Online site, then write to your representative asking what repayment plan, if any, comes with the next major spending bill.