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The budget is the state stripped of ideological pretensions.1 So when the European Union, a confederation, sets out to control the budgets of its member governments, what is being discussed is not just debt, but the question of who will be sovereign. The fiscal debates are thus a constitutional debate, as my American Enterprise Institute colleague Michael Greve has recently discussed, with particular attention to Alexander Hamilton and Federalist No.15.2
“Oh, for an Alexander Hamilton to save Europe!” from its sovereign debt and banking crises, a Financial Times op-ed exclaims; but how does Hamilton’s thought apply to Europe?3
Summarizing Hamilton, Greve writes, “You may want a league or alliance among independent states. Or you may want a government that governs you directly, as individuals, citizens, and taxpayers. What you cannot want is the ‘political monster’ of a ‘government over governments.’” But the European Union “is quintessentially a government over governments.”4 So was the United States under the Articles of Confederation. Can the former manage its fiscal crisis when the latter could not?
Hamilton asserted “the imbecility” of the Articles of Confederation government. Among the elements of its “national humiliation,” he included “debts to foreigners and our own citizens … without any proper or satisfactory provision for their discharge.”5 Hello, Europe.
The issue of whether confederations can endure successfully was instructively explored and debated during the American Constitutional Convention, of which Hamilton was, of course, a part. James Madison, for example, discussed “the History and fate of the several Confederacies modern as well as Ancient, demonstrating some radical vice in their structure.”6 Elbridge Gerry observed that “Confederations are a mongrel kind of government.”7
The European Union ‘is quintessentially a government over governments.’ So was the United States under the Articles of Confederation. Can the former manage its fiscal crisis when the latter could not?
Madison was blunt: “We are vague in our Expressions—we speak of the sovereignty of the States—they are not sovereign.” He continued, “There is a regular gradation from the lowest Corporation, such as the incorporation of mechanicks, to the most perfect. The last is the true and only Sovereignty—the states are not in that high degree Sovereign—they are Corporations with power of Bye Laws.”8
Hamilton jumped in: “Nations are equal when independent—it is as reasonable that States should enter into a League departing from the Equality of States, as that men should enter into the Social Compact and agree to depart from the natural Equality of man.” He concluded, “It is said the States will be destroyed and therefore the people will be slaves—the consequence is not true. The people are free, at the expense of a mere ideal and artificial being.”9
In other words, this means that the states—or, for example, in Europe’s case, Finland or France or Spain—are merely theoretical and artificial. How would that play in various European countries?
Gunning Bedford of Delaware contended that “there was no middle way between a perfect consolidation and a mere confederacy of the States. The first is out of the question, and in the latter they must continue if not perfectly, yet equally sovereign.”
Taking up the reality of the will to power, Bedford continued: “If political societies possess ambition, avarice, and all the other passions which render them formidable to each other, ought we not to view them in this light here? Will not the same motives operate in America [or Europe] as elsewhere? If any gentleman doubts it, let him look at the votes. Have they not been dictated by interest, by ambition? Are not the large States evidently seeking to aggrandize themselves at the expense of the small?”10
In these thoughts, from a defender of the small states, we hear exactly the same note as in December 2011 in Poland: “In Warsaw, thousands of protesters marched through the capital, shouting their opposition to the EU rescue plan … waving red and white Polish flags and chanting, ‘We want sovereignty, not the euro.’”11 It is the same note that today fears German hegemony seized through finance.
Should Europe want a true central government with compulsion and therefore force, or should it stick to a confederation without real authority?
As Bedford was pointing out, what makes the debates in and about the management of confederations so difficult is a fundamental proposition, so simple and obvious, but easy to forget amid the ideological pretensions involved. This is: Government = Compulsion = Force. Should Europe want a true central government with compulsion and therefore force, or should it stick to a confederation without real authority?
A mark of a confederation is a statement like this recent one by French President Nicolas Sarkozy: “Greece is a sovereign nation and must enact the promises it’s made.”12 This is a non sequitur. To be sovereign means precisely that you can break promises if you decide to, and tough luck to the promisee.
So, as Greve observes, when faced with a case like Greece, “A government over governments presents a nasty enforcement problem.” Or as Hamilton put it, “It is essential to the idea of a law, that it be attended with … punishment for disobedience.” The Europeans now intend to impose punishment on governments which, since they do not have enough money, violate the confederation’s budget deficit rules by charging them still more money. But when push comes to shove, where is the force to do the pushing and shoving of compulsion?
Hamilton argued that you can have either compulsion by force (“arms”) or compulsion by courts (“the magistracy”). But the authority of courts and magistrates itself necessarily rests on force. So really, it comes down to force. Whether force is commanded by the central body or not determines whether the central government can compel obedience or not. Force is evidently easier to apply against individuals than against other sovereign governments.
In the United States, the compulsion of the central government’s force versus the sovereignty of the states was not settled until 1865 by Lincoln, nearly fourscore years after Hamilton was writing Federalist No. 15. Indeed, we can say that it was not fully settled until 1957 by Eisenhower.
A confederacy does not have the force to compel obedience to its rules. But do the actions of a confederacy have to be “imbecilic”? They certainly are sometimes.
The confederation came up with the rule that banks investing in European government debt would for such investments have zero required capital, which can only make sense if owning this debt has no risk whatsoever.
Let’s consider, for example, a key factor in creating the European fiscal crisis: the way the EU implemented the Basel international risk-based capital requirements for banks. The implementation reflects the political logic of a confederation. In this case, the confederation came up with the rule that banks investing in European government debt would for such investments have zero required capital. This can only make sense if owning this debt has no risk whatsoever.
The notion that any debt instrument could be riskless is wrong in general. But in particular, considering that there have been 250 defaults on sovereign debt from 1800 to the present day, the proposition that sovereign debt is riskless can accurately be labeled as “imbecilic.” It was especially disastrous because the Basel rules encouraged debt to flow into the weak hands of highly leveraged banks, whose own indebtedness compounds the problem. It simultaneously encouraged bigger deficits and borrowing by the freely spending governments.
Of course, after the fact the big mistake has been realized. “I don’t think anyone is zero risk [correct],” said the head of the European Parliament’s Economic and Monetary Affairs Committee. “We should dispense with the concept … using this terminology turns us into idiots.”13 “Idiots” or “imbecilic”—the same judgment two centuries apart.
Since it will not have a Hamiltonian central government, Europe cannot carry out a repetition of Hamilton’s celebrated assumption of state debts—in which the new United States Treasury paid par for debts which were trading at 25 cents or so on the dollar. Such a transaction is beyond the power of any confederation. It is impossible to imagine that the United States under the Articles of Confederation would have, or could have, carried out this famous debt assumption.
Thus, some of the accumulated debt of member governments of the European confederation will not be paid. It will be “restructured” in various ways with losses to creditors, as is in the process of happening with the Greek government’s debt and has historically happened over and over again with government debt.
Europe’s debt, bailout efforts, budget deficits, and endless negotiations will continue to exhibit the internal stresses and contradictions of a government over governments. Europe’s Hamilton will not arrive.
Alex J. Pollock is a resident fellow at the American Enterprise Institute. He was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004.
1. To paraphrase the striking insight of Rudolph Goldscheid in 1917, cited in Richard Swedberg, Joseph A. Schumpeter—The Economics and Sociology of Capitalism, 1991, p. 48.
2. “The EU Misses Hamilton’s Moment,” National Review, December 13, 2011.
3. Ronald McKinnon, Financial Times, December 19, 2011.
4. Ellipses in quotes not shown.
5. Federalist No. 15, “The Insufficiency of the Present Confederation to Preserve the Union.”
6. The Records of the Federal Convention of 1787, 1937, Vol. I, p. 485.
7. Ibid., p. 474.
8. Ibid., p. 477.
10. Ibid., pp. 490-1.
11. “Poland Protesters Blast EU Plan,” Wall Street Journal, December 14, 2011.
12. “EU Nears Greek Confrontation as Portugal Poses Looming Risk,” Bloomberg, January 31, 2012.
13. “Bank-Caapital Rule on Sovereign Debt Targeted by EU Lawmakers,” Bloomberg, January 23, 2012.
Image by Rob Green / Bergman Group
Alexander Hamilton asserted ‘the imbecility’ of the United States under the Articles of Confederation. There are lessons for Europe today.
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