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02/19/2013 11:13 AM

Cementing the Union

Early US 'Attractive Precedent for Today's Europe'

By Christian Reiermann

After the War of Independence, the United States looked a lot like the euro zone, with some states crippled by debt. In the end, under a proposal by Alexander Hamilton, the federal government assumed all the debt, securing the country's creditworthiness. A new report argues it could be a good model for Europe.

When German economists ponder how to rescue the euro, they are often inspired by a man who died after a duel 200 years ago. Academics like Hans-Werner Sinn of the Munich-based Ifo Institute for Economic Research, and Wolfgang Franz and his colleagues on the German Council of Economic Experts, have discovered a new role model: the American Alexander Hamilton, the country's first secretary of the treasury, who was shot to death by Vice President Aaron Burr in 1804.

The academics have noticed surprising parallels between the problems of today's euro zone and the United States in its early years. Like the European Union today, in the late 18th century the United States was more of a loose alliance of independent states than a federal body. The economic and political problems were also similar. Some states, like South Carolina and Massachusetts, were groaning under the burden of debts from the War of Independence, but no one wanted to lend them any more money.

Other states, especially Virginia, had cleaned up their finances but were refusing to help their less fortunate partners. The dispute over money threatened to destroy the young union. It was only newly appointed Secretary of State Hamilton, in his mid-30s at the time, who was able to solve the debt crisis and save the United States.

But can the euro zone learn any lessons from the days of early capitalism? Can the thoughts of an independence fighter who acquired his knowledge of economics from books, even be relevant today? Ifo President Sinn believes they can. The early years of the United States are an "attractive precedent for today's Europe," and Hamilton was something of a "hero," concludes a new report by the European Economic Advisory Group (EEAG), which Sinn and his co-authors plan to present next week.

A Bold Plan

Indeed Hamilton, who served as adjutant to General George Washington in the War of Independence, fashioned a bold plan in 1790. He was determined to prevent one or more of the 13 states from defaulting on debt payments, fearing that this would adversely affect the creditworthiness of the young republic.

Hamilton, a lawyer, adhered to a creed in politics and business alike: "Promises must be kept." In his view, this also applied to the repayment of debts. In his private life, however, the father of eight children had trouble keeping his resolution. He was repeatedly interested in women to whom he wasn't married. But his economic plan worked. The federal government assumed all the debts of the individual states and combined them into a fund Hamilton referred to as the debt "sinking fund". He also introduced duties and assessed luxury taxes, on spirits, for example, especially whiskey.

Hamilton used the revenues to repay the war debts, and in doing so he managed to reduce the country's high interest costs to 4 percent. The resulting low interest rates stimulated the economy, and the recovery brought more revenue into the government's coffers. Within a few years, Hamilton was able to eliminate a large portion of the US's mountain of debt.

Sinn and his colleagues believe "that the logic of an internal revenue source also applies to modern Europe." They argue that the EU should receive the revenues from the planned financial transaction tax. But that isn't all. "In the long term, and in analogy to Hamilton's system, a fundamentally reformed fiscal order would be necessary, one that provides for the joint administration of customs revenues or the value-added tax."

A Debt Repayment Pact for Europe?

Hamilton's "sinking fund" prompted the German Council of Economic Experts to envision a "debt repayment pact for Europe." Under the plan, member states would collect portions of their liabilities in a common pot and jointly repay the debt. The economic experts have nothing but effusive praise for the consequences of Hamilton's work. "It contributed to securing the creditworthiness of the United States, creating a large bond market and making it possible to refinance at low interest rates."

It remains questionable whether the leaders in Europe's capitals working to save the euro will want to learn from Hamilton, because his debt fund was ultimately a liability union. The common bonds with which he refinanced old debt are better known today as euro bonds. Both are ideas that trigger allergic reactions in some capitals, especially Berlin. Chancellor Angela Merkel and Finance Minister Wolfgang Schäuble, both members of the center-right Christian Democratic Union (CDU), are only willing to accept such ideas if a political union is installed as a counterweight to the monetary union.

Nevertheless, Hamilton's approach proves that doing it in reverse isn't necessarily doomed to failure. For him, fiscal union and political union were always two sides of one coin. He didn't just see his plan as a struggle against a debt crisis, but also as vehicle to strengthen the cohesion of the former colonies by dismantling a powerful central government. Joint debt reduction and the reestablishment of joint creditworthiness "to cement more closely the union of the States," he said. Hamilton, whose likeness graces the $10 bill to this day, proved to be right. The United States still exists, and US President Barack Obama recently appointed Hamilton's 75th successor.

Translated from the German by Christopher Sultan

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