Monday, August 1, 2011

Life and Debt in the US

Randall Stephens

Has the United States ever defaulted on its debt? Yes. It did so in 1790 and in 1933 as well. Both cases are quite different from the current situation in D.C. (More on that below.)

The second of those had to do with the repayment of gold obligations. When "President Roosevelt and the Congress decided that it was a good idea to depreciate the currency in the economic crisis of the time," writes Alex J. Pollock, "they also decided not to honor their unambiguous obligation to pay in gold."

Arthur Schlesinger dealt with the matter in his Coming of the New Deal, 1933-35. The administration, wrote Schlesinger, aimed to break loose from foreign economic entanglements. Here's Schlesinger:

From the viewpoint of classical theory, Roosevelt's decision to abandon the international gold standard was, indeed, a wanton step. When Britain had left gold in 19S1, it had at least done so because the pressure on its gold reserves left it no alternative. But, despite Roosevelt's professed fears about a raid on American gold by Dutch banking interests, United States gold stocks were, in fact, capable of meeting normal foreign demands. The presidential decision seemed therefore to have a more sinister implication. It meant that American monetary policy was no longer to be the quasi-automatic function of an international gold standard; that it was to become instead the instrument of conscious national purpose. More than that, the step involved the repudiation of obligations to pay in gold long written into the "gold clause" of public and private contracts--an act which damaged all creditors who had hoped to make a killing out of the increase in the value of the dollar (203).

Long before, in 1790, the United States defaulted on its international and domestic obligations. The first government of the new nation enacted the Funding Act of 1790, which allowed Alexander Hamilton, secretary of the treasury, to take on the war debts of individual states. It was intended, in part, to create confidence in the new government. Altogether it amounted to $21.5 million dollars of assumed debt. According to John Carney over at CNBC: "Prior to the passage of the Funding Act, much of the debt was expected to default. It traded at deep discounts to face value. Once the act was passed, the value of the debt skyrocketed—because bondholders were sure they would be repaid by the new federal government. In fact, quite a lot of money was made by people who bought the state debt in anticipation of the Funding Act or with early notice that it had passed. Even at the time of the Founding, traders were profiting from informational asymmetries." That positive outcome had to do with the fact that the federal government was not itself in debt, but was only assuming state debt. That's why, says Carney, "the bonds rallied after the passage of the act."

Some weeks ago historian Julian Zelizer reflected on the political troubles that make the current economic crisis different. "There was a time when Congress worked differently," he observes. "During the committee era, which lasted from the 1910s through 1970s, bipartisan dealmakers were the kings of Capitol Hill. Legislating was seen as an art, and producing policy was the objective." Zelizer, writing on July 5th, hoped for a return to the deal making of recent history. That didn't happen, but a deal has been struck, nonetheless. Zelizer fittingly concludes: "But the fact that we have another example of what should be a routine decision turning into high-stakes gamesmanship should be a stark reminder that we need Congress to work better than this."

5 comments:

M M Bennetts said...

Among the more egregrious of Congress's defaultings was that perpetrated against Pierre Augustin Beaumarchais, the French playwright, as detailed in Maurice Lever's multi-volume biography of him.

Over the course of 1776-77, Beaumarchais had fitted out trading vessels, organised vast loans from the French crown, and sunk most of his own fortune into provisioning the Continental Congress, its army and peoples.

A contract signed on 18 May 1778 by members of Congress's commercial committee recognised that they owed Beaumarchais 5 million livres. Subsequently, Beaumarchais' company continued to furnish the US with arms and supplies worth 24 million livres. Over the course of the next several years, the American government and Hamilton in particular wiggled and squiggled and debated and quibbled, then declared Beaumarchais was only owed a sum of 2.28 million francs. Though even then, they did not pay.

Successive French governments and Beaumarchais' heirs would press for payment during the 36 years that followed Beaumarchais' death in 1799.

However, despite Hamilton's report that 2.28 million were owed, Congress offered to pay only 800,000 livres--less than a third--and without penalty for late payment and not immediately. And that was their final offer, though their delay and refusal to pay had almost certainly bankrupted Beaumarchais and exacerbated the severity of the financial cataclysm which jump-started the French Revolution.

It's an incident that few histories of the Founding Fathers chose to recall. Mainly, I suspect, because it's so oleaginous and venal. Or perhaps just plain caddish.

Randall said...

M M, That's a fascinating episode. I wonder if there are other cases like it over the decades/centuries?

David Carlton said...

Randall,

Clicking through the link, I note that Carney actually questions whether 1790 can actually be described as a "default." Rogoff and Reinhardt describe it as such, but that's a rather eccentric characterization of what Hamilton was about, to say the least.

Jeff Vanke said...

Wasn't a main point of the Constitutional convention to avoid looming default by increasing central government power? Don't tell today's Tea Partiers that about our Founders!

Rebecca said...

Than you for this information about the Funding Act of 1790. The history book we were using left many gaps in information, but I got the distinct impression there was insider trading going on, even way, way back at the beginning of our government.