The History of the U.S. Financial System
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Bibliographic details
- Authors: VITOR GASPAR, DAVID AMAGLOBELI
- Published: March 1, 2018
Historic meeting and political deal
- On June 20, 1790, James Madison and Alexander Hamilton met at Thomas Jefferson’s home on Maiden Lane, New York, and struck a deal: Madison agreed to have the US federal government take over the states’ Revolutionary War debt; Hamilton agreed to support moving the nation’s capital to the banks of the Potomac River.
- The episode illustrates that public finance reform is fundamentally political and that political negotiation can enable institutional transformation.
- Jefferson’s later reflection (September 1792) on the episode: “When I embarked in government, it was with a determination to intermeddle not at all with the legislature & as little as possible with my co-departments. The first and only instance of variance from the former part of my resolution, I was duped by the Secretary of the Treasury and made a tool for forwarding his schemes, not then sufficiently understood by me; and of all the errors of my political life, this has occasioned me the deepest regret.”
Early fiscal consolidation and institutional building (1789–1792)
- Timeline highlights:
- April 8, 1789: Madison introduced the First Tariff Act.
- August 1, 1789: The First Tariff Act became law.
- September 1789: The Treasury Department was created.
- By 1792: The new administration had restructured wartime debt, built federal tax capacity, laid foundations of public credit, created a national bank, and promoted financial market development.
- Revenue structure and collection:
- Tariffs provided a stable source of revenue and contributed about 90 percent of the total federal revenue.
- Fiscal condition and debt:
- Hamilton estimated the stock of public debt at $79 million (roughly 40 percent of GDP), of which $54 million was owed by the federal government and $25 million by the states.
- Debt service costs alone exceeded tax revenues prior to debt reforms.
Hamilton’s pragmatic program and five core areas
- Hamilton’s three landmark reports:
- Public credit (January 1790)
- A national bank (December 1790)
- Manufactures (December 1791)
- The reports collectively addressed five core areas:
- Taxation
- Public credit
- Financial markets and organizations
- Financial stability and crisis management
- Trade policy
- Hamilton’s inspiration: a state model like Britain’s post–Glorious Revolution (1688–89) capable of mobilizing resources for war and economic competition, and actively engaged in economic and financial development.
Debt-conversion proposal and contentious issues
- Hamilton proposed offering domestic creditors the choice of swapping existing government notes for new debt to:
- Reduce the interest rate from 6 percent to 4 percent, saving about one-third of domestic interest costs.
- Offer call protection limiting the government’s ability to redeem the debt early if market interest rates declined.
- Political controversies:
- The swap at face value created windfall gains for speculators who had purchased original securities at small fractions of face value, sometimes as little as 20 percent.
- Debate over federal assumption of states’ debt: Hamilton argued state debts were incurred for the common good (the War of Independence) and therefore appropriate for federal assumption.
- Market reaction:
- Credibility was gained rapidly after passage of Hamilton’s proposals; in 1791 prices rose above par before falling again during the financial crisis of 1792.
Liquid markets, federal power, and the location of the capital
- Hamilton aimed to:
- Ensure creditors’ allegiance to the federal government.
- Foster deep and liquid markets for Treasury securities.
- Shape the structure of government through the structure of public finances (concentrating taxation capacity at the federal level).
- Political bargaining over the capital:
- By June 1790, Congress had not yet decided to assume states’ debt; the House passed Hamilton’s funding bill on June 2, 1790, but without the debt-assumption provision.
- A compromise at the June 20, 1790 dinner led to Congress’s passage in July 1790 of the Residence and Assumption bills in quick succession.
Political consequences and the emergence of party politics
- The policy confrontations revealed fundamental differences between two camps:
- Federalist Party (Hamilton and John Adams): advocated a strong federal government.
- Democratic-Republican Party (Jefferson and Madison): favored decentralized government with limited federal powers.
- In 1792, Madison and Jefferson organized their party to rival the Federalist party, marking the beginning of professional, competitive party politics in the United States.
- The narrative emphasizes that fiscal policy, finance, and politics are inextricably intertwined; debts, taxes, and state capacity shaped the political system.
Key statistics and exact figures
- Dates and events:
- June 20, 1790: Madison–Hamilton–Jefferson dinner on Maiden Lane.
- April 8, 1789: Madison introduced the First Tariff Act.
- August 1, 1789: First Tariff Act became law.
- September 1789: Treasury Department created.
- January 1790: Hamilton’s report on public credit.
- December 1790: Hamilton’s report on a national bank.
- December 1791: Hamilton’s report on manufactures.
- June 2, 1790: House passed Hamilton’s funding bill (without debt-assumption provision).
- July 1790: Congress passed the Residence and Assumption bills.
- 1791: Prices rose above par.
- 1792: Financial crisis and Madison/Jefferson party organization; by 1792 administration had restructured wartime debt and built institutions.
- September 1792: Jefferson’s letter to President Washington reflecting regret.
- Fiscal and financial figures:
- Tariffs contributed about 90 percent of federal revenue.
- Stock of public debt estimated at $79 million (roughly 40 percent of GDP): $54 million federal, $25 million state.
- Interest reduction target: from 6 percent to 4 percent (saving about one-third of domestic interest costs).
- Speculators sometimes purchased original securities at as little as 20 percent of face value.
VITOR GASPAR, Special Advisor to the Managing Director (until the end of the month of November); DAVID AMAGLOBELI, deputy division chief in the IMF’s Fiscal Affairs Department.
Content in this bundle
- Política fiscal ● Ejercicio de equilibrio ● Finanzas y Desarrollo ● Marzo de 2018
- Budget et politique
- The History of the U.S. Financial System - IMF F&D Magazine
- Политика и финансы – Финансы и развитие – март 2018 года
- 财政政治 - <金融与发展>, 2018年3月号·第55卷·第1期, 国际货币基金组织季刊