We usually don’t think of the U.S. as a monetary union, but early in its history it essentially was. Unlike the crisis-wracked euro zone, the dollar zone survived its first few decades without a major crisis, providing the fragile young republic with a period of relative stability during which it began to congeal culturally, economically, politically and militarily.
European policy makers hoped that the euro would serve as the unifying and integrating force of the European Union much as, they believed, the dollar had for the early U.S. What the Europeans failed to appreciate was that early America’s real glue was not its dollar union but its fiscal one.
The EU today and the U.S. in the last quarter of the 18th century are not so different, really. Like many Europeans today, most early Americans saw themselves as citizens of their state of birth first and of the wider union second. For them, the U.S. was a compact between sovereign states. General Robert E. Lee joined the Confederacy because he wanted to protect his homeland, which he considered to be Virginia.
The flow of human capital between the states was legally open but in fact limited by cultural considerations. Ethnically and linguistically, early America was diverse but also insular. Most folk preferred to stay with their own, be they Dutch, Forest Finns, Germans, free blacks, Welsh, Scots, Scotch-Irish or one of four flavors of English, each with their own distinctive dialect and religious, marital and childrearing customs. Even movement to the frontier didn’t become vigorous until roads were built and military victories against the natives were won.
An early U.S. bond, signed by George Washington, for $185.98 of assumed debt, dated Jan. 17, 1792.
Source: Museum of American Finance, NYC.
Similarly, financial capital flowed across state lines in only limited quantities at first. People could lawfully lend money to individuals or businesses in other states, but few did so for fear of being expropriated. Unsurprisingly, interest rates varied from state to state and region to region. Corporations, which proliferated at a prodigious rate after ratification of the Constitution, couldn’t yet operate across state lines without prior legislative approval. (Even the right of the two federally chartered central banks to branch across state lines was questioned.)
The early nation was so fractured that the U.S. Armed Forces relied heavily on state militias until after the War of 1812. So what kept the new nation together?
First-rate economic statesmanship, not a shared unit of account. In the early 1790s, Treasury Secretary Alexander Hamilton defined the dollar in terms of gold and silver, but more significantly he established the taxes and institutions (collection system, central bank) that made it possible for the national government to service its own debts and those of the states. Assumption of state debts, as it was called, was positioned not as a bailout but rather as a way of ensuring that each state shouldered the burden of the Revolutionary War equally. Just as importantly, assumption made bondholders beholden to the national government, cementing the union together as Hamilton predicted it would.
The U.S. Constitution effectively prevented state governments from endangering the monetary union by prohibiting them from issuing money or making anything other than gold or silver a legal tender. The Constitution didn’t enjoin the states from incurring debt but — with the exception of assuming war burdens — the early national government refused all responsibility for state debts.
State governments refrained from large-scale borrowing until the transportation infrastructure boom of the 1820s and ’30s. Several defaulted when the economy turned sour in the late 1830s and early ’40s, but Washington policy makers refused to come to their aid. (A few states repudiated their debts, but most restructured by mimicking New York’s “stop and tax” program and making constitutional restrictions on deficit financing. To this day, many states try to restrict their own borrowing, some more successfully than others.) The U.S. government also declined to pay the debts of the rebel states after the Civil War and enshrined its decision in Section 4 of the Constitution’s 14th Amendment.
By leaving state debts to the states, the national government protected itself, the dollar union and the residents of fiscally sound states from the depredations of profligate or rapacious ones (like Rhode Island, which was so willing to benefit at the expense of other states that it was referred to as Rogue Island). What kept the tender young republic together during its formative decades, then, was not a shared unit of account called the dollar but a shared sense of fairness. Debts incurred in the defense of all were shared by all. Debts undertaken to build a state canal or to thwart federal law were not.
(Robert E. Wright is the Nef Family Chair of Political Economy at Augustana College in South Dakota and the author of 14 books, including “One Nation Under Debt: Hamilton, Jefferson, and the History of What We Owe.”)