The federal government had fallen woefully in arrears in paying off the enormous debt—$54 million in national and $25 million in state obligations—amassed to fight the Revolutionary War. It would have been tempting for the young nation to repudiate this burden, but as a matter of policy and morality, Washington and Hamilton thought nations should honor their debts if they aspired to full membership in the community of nations. “With respect to the payment of British debts,” Washington had written before becoming president, “I would fain hope . . . that the good sense of this country will never suffer a violation of a public treaty, nor pass acts of injustice to individuals. Honesty in states, as well as in individuals, will ever be found the soundest policy.”6 If Washington gave Hamilton something close to carte blanche on fiscal matters, it was because they essentially agreed on the steps needed to tame America’s staggering debt. But he had also set up a policy-making apparatus in which major decisions had to cross his desk for approval, so he was confident that he could control the sometimes-brash Hamilton.

Hamilton’s audacious report argued that, to restore fiscal sanity, the government did not have to retire the debt at once. All it had to do was devise a mechanism to convince people that, by setting aside revenues at predictable intervals, it would faithfully retire it in future years. Such a well-funded debt, Hamilton argued, would be a “national blessing” inasmuch as it would provide investment capital and an elastic national currency.7 The report foresaw a medley of taxes, from import duties to excise taxes on distilled spirits, to pay off existing debt and to service a new foreign loan. With its new taxes and its funded debt, Hamilton’s program was bound to dredge up unwelcome memories of the British ministry.

In his report, Hamilton championed several controversial measures. Some original holders of the wartime promissory notes, including many Continental Army veterans, had sold them after the war at a tiny fraction of their face value, believing that they would never be repaid in full. Hamilton planned to redeem them at face value and wanted current holders of the paper, even if they were speculators, to reap the rewards of the steep price appreciation that would follow enactment of his program. Only by doing this, he thought, could he establish the principle that owners of securities were entitled to all future profits and losses. Without such a policy, the United States could never establish thriving securities markets. Hamilton was also persuaded that, since the debt had been raised to finance a national war, the federal government should assume responsibility for the states’ debts as well. Such an act of “assumption” would have extraordinarily potent political effects, for holders of state debt would transfer their loyalty to the new central government, binding the country together. It would also reinforce the federal government’s claim to future tax revenues in any controversies with the states. Peerless in crafting policies embedded with a secret political agenda, Hamilton knew how to dovetail one program with another in a way that made them all difficult to undo.

Until the publication of Hamilton’s report, James Madison had been Washington’s most confidential adviser. That began to erode on February 11, 1790, when Madison rose in the House and, in a surprising volte-face, denounced the idea that speculators should benefit from Hamilton’s program. It was a stunning shot across the bow of the administration. Madison favored a policy of so-called discrimination—that original holders of the debt, mostly former soldiers, should share in the windfall as the price of government paper soared. Many Americans found it hard to see speculators rewarded instead of veterans, and Madison’s speech tapped a powerful vein of discontent. Speculation in government debt, Madison affirmed, was “wrong, radically and morally and politically wrong.”8 As a Virginia congressman and budding advocate of states’ rights, Madison was moving away from the continental perspective that had united him with Hamilton when they co-authored The Federalist. For Madison, the funded debt and the expanding ranks of Treasury employees were far too reminiscent of the British model. Feeling betrayed by Madison, Hamilton argued that his former comrade’s discrimination proposal was simply unworkable. To track down the original holders of securities and parcel out their shares of the profits would be a bureaucratic nightmare. He also considered speculation to be an inescapable, if unsavory, aspect of functioning financial markets.

As the hero of the old soldiers, Washington confronted a ticklish dilemma, and Madison later attested that the president’s mind was “strongly exercised” by the debate. 9 On the one hand, Washington sympathized with veterans who had unloaded their IOUs to “unfeeling, avaricious speculators.”10 At the same time, he had warned his men at the end of the war not to part with these certificates, telling them bluntly in general orders in May 1783: “The General thinks it necessary to caution the soldiers against the foolish practice . . . of disposing of their notes and securities of pay at a very great discount, when it is evident the speculators on those securities must hereafter obtain the full payment of their nominal value.”11 Washington’s words had been prophetic. Because Congress had ordered Hamilton’s report, Washington did not want to overstep his bounds by lobbying for it, and he remained cagey in discussing it. To David Stuart, he wrote circumspectly, “Mr Madison, on the question of discrimination, was actuated, I am persuaded, by the purest motives and most heartfelt conviction. But the subject was delicate and perhaps had better not have been stirred.”12

While Washington introduced no ringing opinion during the debate, his silence was tantamount to approval of the Hamiltonian system. At this point he was still a sacred figure in American politics, making Hamilton a convenient lightning rod for protests. It was also expedient for Washington to allow Hamilton to engage in the rough-and-tumble of political bargaining, while he himself held fast to the ceremonial trappings of the presidency. Taken aback by Madison’s defection and the vehement schism provoked by the public credit report, Washington was especially disheartened that the country had split along geographic lines, placing him at odds with the South. He wrote privately that if the northern states moved “in a solid phalanx” and the southern states were “less tenacious of their interest,” then the latter had only themselves to blame.13

The debate over the Hamiltonian program opened a rift between Washington and his Virginia associates that only widened through the years. Reflecting their bias in favor of landed wealth and against paper assets, members of the chronically indebted gentry recoiled in horror at the northern financial revolution ushered in by Hamilton. The tobacco market had fallen into a deep slump, making these pinched Virginia planters ripe for tirades against northern speculators, who seemed to profit from easy winnings. Also, Virginia had already paid much of its debt and therefore opposed a federal takeover of state debt, which would reward irresponsible states that had repudiated their loans. Things went so far that in some Virginia circles Washington was regarded as almost a traitor to his class. When David Stuart reported that spring on extreme hostility in Virginia toward the new government, Washington grew distressed. “Your description of the public mind in Virginia gives me pain,” he replied. “It seems to be more irritable, sour, and discontented than . . . it is in any other state in the Union.”14 On February 22 Madison’s proposal to discriminate in favor of original holders of government debt was roundly defeated in the House, 36-13. In a preview of problems to come for Washington, 9 of the 13 negative votes came from his home state of Virginia.