Towards Modern Public Finance

The American War with Mexico, 1846-1848

James W Cummings

• Publisher: Routledge
• Year: 2015
• Print ISBN: 9781138663787
• eBook ISBN: 9781317313953
• Edition: 1
• Topic: Economía
• Subtopic: Teoría económica

Addresses the financing of the American-Mexican War of 1846-48. This study argues that the successful financing of the American-Mexican War had a long-term beneficial effect on American financial institutions and markets.

1 Financial and Economic Background

By 1846 the United States possessed a rich history of war financing and economic development reaching back over two hundred years. Both successful innovation and abject failure crowned the efforts of the colonists and early Americans to develop a financial system capable of funding public endeavours and private enterprise. In the beginning, colonial governments relied on sources as varied as paper money, taxes paid in kind, tobacco warehouse receipts and loans from local merchants to finance military campaigns. Lessons were learned, forgotten and relearned. One lesson absorbed early by colonial officials was that current means (taxes) were insufficient for the massive outlays required by warfare and, further, likely to be rejected by the populace as too burdensome. Like European states they turned to various schemes of borrowing. The provincial officials also observed that some methods used to finance military efforts were admirably suited as economic stimulants during periods of slow trade. The financial and economic environment in which the Mexican–American War was financed was shaped by past experimentation and evolution. This chapter is devoted to placing the process in a historical context.¹

During the colonial period the British Americans funded their military efforts against the French and their Native American allies largely with bills of credit issued by the provincial governments. Massachusetts pioneered this method in 1690 and, as warfare became more extensive and expensive in the eighteenth century, one colony after another found it necessary to follow the Bay colony’s example. The paper money, the first in the British Empire, passed as currency alongside the gold and silver coins then in circulation. The value of the bills, other than faith and trust, lay in the provision making them receivable for provincial taxes and other public dues.²

As the eighteenth century advanced the wartime expediency became a technique to stimulate trade by increasing the money supply and by financing agricultural expansion. In a raw and developing country like North America, capital, if it does not exist or cannot be imported, must be created. The colonial governments loaned capital to merchants and farmers in the form of paper money and accepted mortgages and other debt obligations as collateral. As long as the bills remained in circulation the governments stood to reap a tidy profit as they exchanged non-interest-bearing instruments for interest-bearing obliga-tions.³

The huge emission of paper money for war, commerce and agriculture led to a steady depreciation of the currency that accelerated in the 1740s, particularly in New England. The colonists were learning what Alexander Hamilton was to stress half a century later. Hamilton believed that ‘the creation of debt should always be accompanied with the means of extinguishment’.⁴ Without adequate assurance to creditors and note holders, debt depreciates and rampant inflation permeates the economy. Eventually, Massachusetts’s currency fell to one-twelfth its face value in silver. Fortunately, a parliamentary reimbursement of military expenditures allowed the colony to redeem its paper money at that reduced rate in 1749.⁵

The monetary depreciation suffered by the colonies eventually forced the British Parliament to abandon its policy of benign neglect and take action. The impetus for change came from British merchants in the American trade who were being paid, or feared payment, in the depreciated currencies. The sting in the colonial legislation lay in the provisions requiring acceptance of the bills as payment for all public and private debts. The Currency Act of 1751 restricted new issues to a life of two years and eliminated the legal tender provision in private transactions. Initially the law only applied to the four New England colonies, but in 1764 it was extended to the remainder. Despite Parliament’s concern it is estimated that paper money made up 50 to 60 per cent of the $12 million in currency circulating at the time of the Revolution.⁶

Who controlled the currency and the economy became a very divisive issue during the 1760s and early 1770s. As the American economy became larger and more self-sufficient the greater the resentment against parliamentary control grew. The colonials, in particular, wanted to control the money supply. They repeatedly made their demands known. For example, in 1764, in what Michael Kammen regards as New York’s opening salvo of the Revolution, the legislature petitioned the King and Parliament for four policy changes, among which was the repeal of the Currency Act of 1764. Robert Wright points out that those policies favouring the home market in Britain tended to force up colonial interest rates and decrease profits and asset values. In the end, economic problems, ideology and political concerns led to rupture and war.⁷

As delegates to the Second Continental Congress assembled in Philadelphia in May 1775 the supreme crisis of early America broke. The Congress constituted what passed as a national government but possessed little real power and only limited resources. The delegates inherited a war already in its early stages and an army of militiamen surrounding Boston. Whether the conflict ended in peaceful negotiations or was fought to the bitter end this army needed supplies, pay and munitions. To the bitter end proved to be the case. The Revolutionary War’s scope, intensity and financial demands were unprecedented and at times failure loomed.⁸

The lack of the power to tax gravely handicapped Congress’s ability to prosecute the war. Without this capacity the simplest recourse was to follow colonial precedent and issue paper money redeemable by the States. On 22 June 1775 Congress authorized the emission of bills of credit with a face value of 2 million in Spanish milled dollars. The notes ranged in value from $1 to $20 and bore the imprint of the Continental Congress. Military expenses quickly consumed the first $2 million and it became necessary to make further emissions. During the first five years of war, paper money constituted the main source of funding. A total of $200 million was outstanding by early 1780. Over-emission and inflation reduced the value of a dollar to 1.5 cents in silver.⁹

Congress also attempted to sell long-term bonds directly to the public. For this purpose a loan office was established in each state to collect the proceeds, issue the certificates and pay the interest. The public found the 4 and 6 per cent loan office certificates with interest payable in continentals unappetizing. In spite of this the loan offices continued to issue certificates through 1781. Of the $67 million issued most went to army contractors who preferred them to paper money. They did have one advantage that became important in the future. The Continental Congress and the government of the Confederation acknowledged their legal liability to the holders at the specie value (not face value) of the obligation at the time of issue. This reduced the liability from $67 million to $11 million.¹⁰

After 1779 and the collapse of the currency, America’s ability to resist depended on two funding sources. First, the army increasingly maintained itself by requisitioning supplies and services and ‘paying’ with certificates drawn on the quartermaster and commissary departments. Because of the poverty of the continental and state governments it proved difficult for the person supplying the goods and services to obtain reimbursement. Second, Great Britain’s traditional enemies supplied loans and subsidies. Benjamin Franklin managed to negotiate loans totalling 34 million livres from the French crown and a further million from the Farmers General. In 1782 John Adams secured 5 million guilders in Amsterdam. This loan, the first of many in Holland, was the Americans’ initial exposure to loan contracting by investment bankers.¹¹

As the war neared its end the Continental Congress did take one step that held great portents for American finance. In May 1781, it chartered the country’s first bank, the Bank of North America. The government supplied $254,000 of the $400,000 in capital and deposited $462,812 in silver obtained from the French. From this firm base the bank initiated the outstanding feature of nineteenth-century American banking, the issuance of specie-backed bank notes. Since the bank stood ready to redeem its notes in coin on demand the notes circulated at par (face value). The bank assisted the government in paying its bills and with short-term loans. It quickly became profitable and doubled its capital.¹²

The Revolutionary War’s cost in specie exceeded $110 million and probably approached $135 million. Despite the importance of foreign subsidies and loans the citizenry of the thirteen states bore the main burden. This fell, not in the shape of equitable taxation, but through the depreciation of the paper currency. Soldiers and suppliers who retained the promises to pay constituted the real losers. In addition to repudiating the continentals, the Continental Congress wrote down the other debts to what it deemed their specie value at the time of issuance. At war’s end the national government recognized a domestic debt of $27 million consisting of $11 million in loan office certificates, $11 million in paymaster notes issued upon demobilization of the army, over $1 million in quartermaster certificates and $3.7 million in final settlement certificates for the remaining sums owed the public. Around $80 million dollars for supplies and payroll simply disappeared.¹³ Not all patriots agreed with Benjamin Franklin’s assertion that

this depreciation though in some circumstances inconvenient, has had the general good and great effect of operating as a tax, and perhaps the most equal of all taxes, since it depreciated in the hands of the holders of money, and thereby taxed them in proportion to the sums they have and the time they held it, which generally is in proportion to men’s wealth.¹⁴

In spite of their chaotic and confused nature the mass of paper emissions allowed the nation to maintain the war and survive until victory was achieved. Americans emerged from the conflict with their independence and a deep distrust of paper money that plagued the body politic until the election of 1896 and the creation of the Federal Reserve System in 1913.¹⁵

Funding the residue of Revolutionary War debt after adoption of the Constitution in 1788 represents one of the most important moments in American historiography. Historian Richard Sylla believes that in addressing the disaster that represented the fiscal landscape of American public finance Alexander Hamilton and his Federalist allies initiated a financial revolution.¹⁶ Robert Wright argues that Hamilton’s efforts led to the emergence of ‘a modern financial sector that laid the basis for America’s ultimate political unification and economic development’.¹⁷ According to Ron Chernow, Hamilton’s latest biographer, Hamilton really sought to use the government’s fiscal machinery to implement his vision of the new nation’s future as a commercial and industrial power.¹⁸

What happened in the early 1790s to bring about this financial miracle? First, the Constitution gave the new federal government the all-important taxing power. Congress quickly placed duties on selected imports and an excise tax on distilled spirits. With a secure source of income Hamilton managed to fund the Revolutionary War debt. He only funded the legally recognized amounts and made no attempt to resurrect the continentals or other obligations previously written down or off. To assist the government he secured legislation creating a national bank and a mint.

To Hamilton the debt represented a great opportunity. He urged funding because he believed ‘a national debt, if it is not excessive will be a national blessing. It will be a powerful cement to our nation. It will also create a necessity to keep up taxation to a degree which without being oppressive will be a spur to indus-try.’¹⁹ Using fiscal policy and public finance Hamilton proposed the creation of a powerful commercial, financial and manufacturing nation that contradicted the limited government and agrarian society envisioned by Thomas Jefferson. The benefits Hamilton cited from funding the debt included securing the support of the influential debt holders, an improved credit standing that allowed borrowing in time of war on reasonable terms and increased respect abroad.²⁰

Hamilton proposed to fund $65 million in depreciated domestic debt by exchanging this mass of paper for new government bonds. The debt consisted of Congress’s legal obligation of $27 million, $13 million in accrued interest, $4 million in interest on the unpaid interest (indents) and an estimated $21 million incurred by the states (assumption) for war expenses. Bonds of 6 per cent were exchanged for two-thirds of Congress’s debt and two-thirds (final amount $18 million) assumed from the states. Deferred 6 per cent bonds (interest payable after 1800) went for the remaining one-third of Congress’s obligation and two-ninths of the states’ obligation. The interest, remaining state debts and various odds and ends, including a small amount of continentals at 2 cents on the dollar, were funded with 3 per cent bonds. In the end the Treasury issued $30 million in 6 per cent bonds, $14.7 million in deferred and $19.7 million at 3 per cent. The bonds were callable at the government’s pleasure.²¹

What Hamilton really created was $50 to $60 million in capital for the expansion of trade, financial institutions, agriculture and manufacturing. According to Stuart Bruchey, Hamilton forced the public to increase the nation’s pool of savings through taxation and then used the revenue to create capital by restoring the value of the debt obligations. The new bonds represented solid, liquid assets that could be sold, used as collateral for loans or exported abroad in lieu of specie. Along with the restored public credit and additional capital came renewed commercial and economic confidence. Hamilton also successfully argued that the current holders of the old debt should reap the benefits from any price rise. Ron Chernow believes this attitude established the moral and legal basis for American security trading. This principal, the free trade of securities with the buyer assuming all rights to profits and loss, to Chernow, laid the foundation for America’s future financial prominence.²²

In addition to funding a national debt the Federalists created a powerful new bank headquartered in Philadelphia. Its advocates advertised its major usefulness as a source of short-term loans for the government, paying its expenses, storing its surplus and being a fount of strength during war time. In the broader economic sense the bank represented another $10 million in capital to finance commerce and other enterprises. Its bank notes and power allowed some control over the three state chartered banks existing in 1791 and later over the ninety-seven others that opened between 1791 and 1811.²³

The new bonds and bank stock became the mainstays on the embryonic securities markets in Philadelphia, New York and Boston. Robert Wright sees in Hamilton’s acts the key pillars of a modern financial system – a negotiable public debt, a secondary sec...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Contents
• List of Tables
• Introduction
• 1 Financial and Economic Background
• 2 Ideology, Revenue and Financial System
• 3 The Loan of 1846
• 4 The Loan of 1847
• 5 Mexico's Finances
• 6 Making War Pay: The Mexican Assessments
• 7 The Independent Treasury at War
• 8 The Loan of 1848
• 9 Mexican Indemnity and Bounty Land
• Conclusion
• Notes
• Works Cited
• Index