Did Europe just experience its “Hamiltonian Moment”? The reference of course is to America’s first Treasury Secretary, Alexander Hamilton, who consolidated the war debt of the thirteen colonies with the issuance of common debt. German Finance Minister Olaf Scholz described the €750 billion reconstruction package with a historical reference to the former American Treasury secretary. Is Europe moving in the same direction? The European Union has agreed to a coronavirus relief plan based on the issuance of common debt. Is this the completion of the final phase of the “European Experiment” – fiscal and political integration? Or were the European Union’s actions strictly a Covid-19–related initiative likely never to be repeated short of another pandemic? Further, what would be the implications if any for Europe’s sovereign debt market and the euro were the EU pandemic rescue effort to become the permanent policy model?
Over thirty noted observers offer their views in The International Economy’s Symposium of Views.
Europeans Should Learn from Alexander Hamilton’s Mistake
Dr. Josef Braml, Head of the Americas Program, German Council on Foreign Relations (DGAP)
The International Economy, Summer 2020, pp. 23-24
Hamilton, one of the most admired of the U.S. founding fathers, and the founder of the nation’s financial system, was convinced that the communitization of debt – which, he argued, was due to the first War of Independence – would be the “cement” for the new American state. As the collective debt grew during the second war against the British (1812 to 1815), however, this approach caused a very serious moral hazard problem, and created a bursting bubble followed by a severe recession, laying the economic grounds for a future secessionist war.
When individual states expected that their debts would continue to be assumed by the federal government, loans were increasingly taken out and used to finance infrastructure investments. While this stimulus provided jobs and generated short-term economic growth, it created a bubble in the long run.
The states were willing to borrow because they assumed they themselves would not be responsible for repayment. Since creditors also expected the federal government to protect them, they were content with low interest rates. Credit growth in the second half of the 1820s fed a construction boom. When the economic bubble burst in the mid-1830s and financial markets panicked in spring 1837, a recession began that severely affected the young union. The federal government’s ability to provide further loans for the individual states was soon exhausted. By 1842, a third of the 29 U.S. states and territories at that time had gone bankrupt.
The European Union may face a similar challenge – sooner rather than later. Fiscal deficits in Italy and Spain are rising and debt-to-GDP ratios are increasing rapidly – reinforced by a slower-than-anticipated economic recovery from the COVID-19 crisis. The European Central Bank (ECB) will need to make even larger debt purchases from these “southern” countries in the foreseeable future, magnifying a moral hazard problem and pitting the “southern” members against the fiscally conservative “northern” members on the ECB’s Governing Council – and in the European Union.
Hopefully, the EU member states will be able to manage this conflict and maintain social peace in their own countries and in Europe – and learn from history. It is not a stretch to see a link between the economic troubles in 1842 and the Civil War erupting two decades later in the United States. This war was not only about the moral and institutional questions of slavery and “states’ rights,” but also about money. Customs disputes and the intractable debt problem surely contributed to the tensions.
Only in the aftermath of the Civil War, with the United States’ increasing foreign policy roles, were federal powers significantly increased, while still granting individual states some degree of sovereignty and responsibility – not at least in financial matters. Yet every subsequent economic crisis gave the federal government further openings to help the member states – and itself. During the Great Depression in the 1930s, the federal government assumed in the New Deal many competences previously belonging to the states, such as road construction and the development of energy and communication networks. Since then, the federal government has supported the increasingly overwhelmed individual states in their tasks with lavish “grants-in-aid” that come with federal strings attached. This way, the dualism (“dual federalism”) created by the founding fathers was replaced by a “cooperative federalism.”
Europeans have their own historic mistakes to learn from, and unfolding future crises to meet with cooperative federalism. While the creation of the European economic union is the result of lessons learned from two catastrophic European and World Wars, it needs to be finalized with elements of a fiscal and political union in order to manage the tensions and opportunities the COVID-19 world economic crisis will create for Europe.