Europe’s ‘Hamilton Moment’ Is a Flop. That’s Fine.

 Federalizing debt was what united the states, but don't expect the same effect from a European Recovery Fund.

Does the EU have a shot? Photographer: Theo Wargo/Getty Images

Does the EU have a shot? Photographer: Theo Wargo/Getty Images


Europe is boring. That is a great achievement.

Throughout the 20th century, Europe mass-produced history, most of it disastrous. The two most destructive wars in history began in Europe over obscure questions such as the governance of Bosnia-Herzegovina and the ownership of Gdansk (now in Poland, then the “free city” of Danzig). The most dangerous location in the Cold War was not Cuba but Berlin. If World War III had broken out, Europe would have been its principal battlefield. And let’s not forget that the most dangerous ideologies of the modern age — communism and fascism — were both of European origin.

So the fact that this weekend’s news is of a meeting in Brussels of 27 European leaders to discuss a bond-financed scheme to aid recovery from the Covid-19 pandemic, while not terribly exciting, is really a cause for congratulation. Even if the meeting’s inconclusive.

The fact that, despite an initial wobble between Feb. 26 and March 14, the European nations didn’t revert to sauve qui peut — every man for himself — as the novel coronavirus SARS-CoV-2 swept through northern Italy is another reason to be cheerful. And the fact that, in most European countries, right-wing populists have declined in popularity in 2020 is a huge relief for the continent’s political centrists.

Americans have reason to be grateful for European stability. The European Union is the biggest market for U.S. exports. Despite widespread fears of a crisis of globalization, cross-border flows of capital between the U.S. and the EU remain substantial. Until this year, European cities such as Paris and Florence were among Americans’ favorite overseas destinations.

Europeans like to give the EU credit for the fact Europe is no longer the world’s number one battlefield, but Americans understand that it has been the North Atlantic Treaty Organization and the presence of U.S. troops that have really kept the peace. They are rightly proud of that achievement.

Yet, at the same time, Americans don’t really understand Europe. President Donald Trump’s view is not mainstream, to be sure. “We’re in tremendous economic competition, including Europe, which has never treated us well,” he said at a press conference last week. “The European Union was formed in order to take advantage of the United States … I know that, and they know I know that, but other presidents had no idea.”

Most Americans also have no such idea. They are just happy that young Americans have not had to die in droves over Europe’s quarrels as they did in 1918 and 1942-45. And if Trump was alluding to the issue of NATO burden-sharing, U.S. presidents since Richard Nixon have been complaining that Europeans don’t pay their fair share.

The American elite misunderstands Europe in a different way. The working assumption has long been that the EU is essentially a first draft of a United States of Europe. They therefore interpret European politics by analogy, as the Chicago-born, Oxford-based political philosopher Larry Siedentop did in his 2001 book "Democracy in Europe." The American Republic, he wrote, “provides the crucial point of reference for the attempt to create a European federal state today. Any evaluation of the prospects of that enterprise should begin with American federalism.”

The latest example of this misconception is the claim that in contemplating an ambitious 750 billion euro European Recovery Fund this weekend, Europe’s leaders are having their very own "Hamilton Moment."

The deal, wrote the economist Anatole Kaletsky when it was first proposed by German Chancellor Angela Merkel and French President Emmanuel Macron in May, “might one day be remembered as the European Union’s ‘Hamiltonian moment,’ comparable to the 1790 agreement between Alexander Hamilton and Thomas Jefferson on public borrowing, which helped to turn the United States, a confederation with little central government, into a genuine political federation.”

“What is required is a policy leap guided by the Hamiltonian experiences at the birth of the American republic,” argued Pierpaolo Barbieri and Shahin Vallee in Foreign Affairs. That means “a common budgetary authority with democratic legitimacy … a truer, historically informed federal framework, not a patched-up union.”

The Hamilton Moment idea has caught on more because of the popularity of Lin-Manuel Miranda’s musical than because commentators have a deep knowledge of what exactly Hamilton achieved as the first U.S. Treasury secretary. “We need to handle our financial situation,” declares Miranda’s Hamilton. “Are we a nation of states? What’s the state of our nation?”

To give Miranda his due, he does a far better job of translating the early financial history of the republic into rap verse than I had any reason to expect when I went to see the show in 2016:

    THOMAS JEFFERSON

     But Hamilton forgets

     his plan would have the government assume state’s debts.

     Now, place your bets as to who that benefits:

     the very seat of government where Hamilton sits …

     HAMILTON

     If we assume the debts, the union gets

     A new line of credit, a financial diuretic.

     How do you not get it? If we’re aggressive and competitive

     The union gets a boost. You'd rather give it a sedative?

Still, it’s worth reverting to Ron Chernow’s biography, on which Miranda's musical was largely based, as well as to the leading historian of early American finance, Richard Sylla, to get the details right.

Hamilton himself was a serious student of financial history, and had drawn the correct conclusion that the U.S., heavily indebted after winning its War of Independence, needed to “restore public credit” by establishing a consolidated public debt, consisting mostly of long-dated bonds, on the British model.

At this point in its history, the U.S. was not much better off financially than a banana republic. Total liabilities were $54 million in national debt, coupled with $25 million in state debt. Around $12 million of the total was owed to foreigners, mainly the French government and Dutch investors. The face value of the debt was equivalent to around 40% of estimated gross domestic product. But so uncertain was the new republic’s future that by 1789 American bonds were trading as low as 15 cents on the dollar. (Think Argentina, except Argentine bonds are currently trading at close to 50 cents on the dollar.)

In his seminal Report on Public Credit of January 1790, Hamilton proposed that “an assumption of the debts of the particular states by the union and a like provision for them as for those of the union will be a measure of sound policy and substantial justice.” In other words, the bonds issued by the states would become part of a restructured federal debt.

The terms Hamilton envisaged for domestic bondholders were less attractive than for foreign creditors, who were paid in full, but the outcome was a win both for speculators who’d bought at the lows and the creditworthiness of the U.S. government.

Fans of the musical will remember that the only way Hamilton could get his debt plan through Congress was by agreeing — in “The Room Where It Happens” — to the proposal of Jefferson and James Madison that the future capital of the U.S. should be on the Potomac River, not the Hudson. (“The immigrant emerges with unprecedented financial power … The Virginians emerge with the nation’s capital.”)

To New York investors, Hamilton looked like a genius. Bonds that had traded at 15 cents on the dollar in 1789 reached par in 1791, and 120% of par in early 1792, just before the first American bond-market crash knocked 20 per cent off the price in the space of two months. (In May 1792, when the New York State government enacted a law to end speculation in the streets, brokers agreed to meet under a buttonwood tree in Wall Street — the birthplace of the New York Stock Exchange.)

But there was much more to Hamilton’s grand design than just a debt consolidation. He always saw the collection of significant federal tax revenue as a necessary corollary. In Federalist 30, he had described the power of taxation as “an indispensable ingredient in every constitution.” Without it, under the Articles of Confederation, the U.S. government had “gradually dwindled into a state of decay, approaching nearly to annihilation.”

It was equally important in Hamilton’s eyes to establish a sinking fund to earmark revenues for debt repayment, a Bank of the United States modeled on the Bank of England, and a new U.S. dollar based on a bimetallic (gold and silver) standard — to say nothing of his ambitious plans for the economic development of the North American continent.

In the South, and particularly to his political rivals, Hamilton looked like a villain. The debt deal appeared to benefit some states more than others. It seemed to replicate the British financial system, notoriously a vehicle for political corruption as well as imperial power. And the new excise tax was so unpopular that it precipitated an armed insurgency, the Whiskey Rebellion of 1791-94.

It’s no exaggeration to say, as Chernow does, that the origins of the American two-party system lie in the controversy over Hamilton’s debt restructuring, even if the original political schism was between Republicans and Federalists.

Now that we’ve got the U.S. history straight, we can see just how little of it applies to Europe today. First and foremost, there is not even the glimmer of a chance that the debts of the 27 member states will be consolidated or even slightly “mutualized.” The highest of these (that of Greece) stood at 177% of GDP on the eve of the Covid-19 pandemic, with Italy at 135% and Portugal at 118%. Put differently, Italy accounted for 22.2% of all EU-27 debt, more than France (22%) and Germany (19%). And the European Recovery Fund does very little to solve the problem of Italian debt sustainability.

Continental Divide
EU members' debt-to-GDP ratios, 4th quarter 2019


Source: Eurostat

​Second, whereas the charter of Hamilton’s Bank of the United States expired in 1811 and a second version was destroyed by Andrew Jackson — leaving the U.S. without a central bank until the Federal Reserve Act of 1913 — the European Central Bank came into existence more than 20 years ago, long before serious thought was given to the question of member states’ debts. Some of us predicted at the time that a monetary union without a fiscal union would inevitably lead to a crisis. We were right.

Third, Hamilton’s ultimate ambition was to propel American economic growth. But that is one thing that has been in short supply since the creation of the European Monetary Union. The latest International Monetary Fund projections for EU growth this year are grim: the euro area is projected to contract by -10.2%, compared with -8.0% for the U.S. The Organization for Economic Cooperation and Development’s projections are similar. The EU may have brought Covid-19 under control more rapidly than the U.S., but it simply cannot match the scale of U.S. monetary and fiscal relief measures. For example, there are already grumbles from Bundesbank president Jens Weidmann about the scale of ECB purchases of Italian bonds. This year the Fed’s balance sheet has grown roughly twice as much as the ECB’s has.


 

​Fourth, it is a near certainty that every step the EU takes to expand its tax base will be fiercely resisted, and not only by the so-called “frugal four” (Austria, Denmark, the Netherlands and Sweden), the countries least enthusiastic about the European Recovery Fund.

Fifth, the populists are not losing everywhere. Just look at which countries will be among the principal beneficiaries of the recovery fund, if it is approved. Hungary, whose prime minister, Viktor Orban, is the bete noire of West European liberals, will receive gross support equivalent to 10.4% of GDP. Poland, where the Law and Justice Party’s Andrzej Duda was re-elected president last weekend, could receive 12.2% of GDP. This is remarkable, considering how few deaths from Covid-19 these two countries have suffered.

Meanwhile, the popularity of the EU in Italy continues to decline. It is not helped by the lingering memory that, when things were really bad in early March, France and Germany each ordered a national export ban for protective medical equipment. The right-wing populist Lega may be losing supporters, but it is losing them to the even more right-wing Fratelli d’Italia. The pandemic has made the immigration issue go away. But it will be back.

It has been a delusion not only of Americans but also of the most ardent pro-Europeans that the ultimate destination of the EU is to be the USE. In reality, as the British historian Alan Milward argued three decades ago in "The European Rescue of the Nation-State," and as Princeton’s Andrew Moravcsik showed in 1998's "The Choice for Europe," the primary driver of European integration has always been the self-interest of the nation-states. For that reason, moves in the direction of federalism nearly always backfire.

Alexander Hamilton had a talent for making enemies, but he never did anything as foolish as the European leaders on whose watch Brexit was approved four years ago. The equivalent disaster in the 1790s would have been if Virginians had voted for “Vexit” from the U.S. (They finally did, of course, in 1861.)

It is still astonishing to me, as someone who opposed Brexit, that the continental Europeans — in particular Merkel and her then-finance minister, Wolfgang Schaeuble — so underestimated the probability of a "Leave" vote in 2016 that they offered British Prime Minister David Cameron next to no concessions on the key issue of free movement of people.

They may console themselves that Britain’s departure makes the path down the federalist road easier, as the U.K. was always the most vocal opponent of steps toward “ever-closer union.” Yet the damage to the European project of losing one of the top seven economies in the world, one of the key members of Anglosphere’s Five Eyes intelligence network, and one of the top two international financial centers, is incalculable.

This is not to predict an imminent collapse of the EU, another erroneous notion that is popular among Wall Street types, who — like nearly all the leading American economists — were convinced the euro area would collapse at the time of the 2012 Greek debt crisis. When Merkel refers to Europe as a “community of fate” and when Macron calls the European Recovery Fund decision a “moment of truth,” they are being as sincere as elected politicians ever are.

The EU will last much longer than its critics expect. I expect that it will continue to exist long after populist governments have established a veto position on the Council of Ministers, and long after the inevitable Italian debt crisis. There is a historical precedent for such a shadowy afterlife, but it is not that of the U.S. It is the Holy Roman Empire, which had long been moribund when Napoleon finally swept it away in 1806.

That was just two years after Aaron Burr mortally wounded Alexander Hamilton at Weehawken, New Jersey. The difference is that there is no musical about the Holy Roman Empire, just as there will be no rap version of the European Recovery Fund negotiations. They are, let’s face it, too boring.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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