Monday, July 9, 2012

Alexander Hamilton is no Guide for Europe (part 2)

Last post I mentioned how fiscal unification in Europe would lead to tensions between member states as disagreements over taxation, spending, regulation, labor policy, ect. inevitably arose. But more to the point, the circumstances under which Hamilton proposed Federal assumption of the state's debt beres little resemblance to the present situation in Europe.

Lets investigate why. Alexander Hamilton made his proposal in First Report on the Public Credit in order to create a system that would build the credit record of the new country. By proving the Federal government could borrow and repay international and domestic creditors, future borrowing would be possible on better terms for both the government and private borrowers. The debt burden at the time (equivalent to about $4.1 trillion in todays dollars) which the United States had no problem servicing at an interest rate of 4%.

Contrast these circumstances with those faced by Europe. All the European nations have long and established credit histories (some of which are good, some bad, all of which the bond market considers). They've got nothing to prove. Their issue is not to demonstrate their capacity to service debt at face value, but to services a nominal stock of debt that has become unsustainable given the decrease in NGDP growth (and hence nominal government revenues) since 2008. So basically the European periphery + France (I have no doubt Britain will opt out) can cede fiscal independence to Germany in a pact that will lead to tensions and pan-national resentments, or the ECB can do it's job.

Your move Draghi.

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