What Europe Can Learn From Alexander Hamilton

He was born out of wedlock, stained his reputation with an extra-marital affair and was mortally wounded in a duel.

Trbfoto / Getty Images/Brand X Ten dollar bill, with Alexander Hamilton

In between, U.S. Founding Father Alexander Hamilton, the first Treasury Secretary, laid the foundations of a modern financial system by establishing a national bank, securities markets and the mint.

Crucially, the soldier turned political philosopher also knitted his young country together by having the federal government assume state debts incurred during the American Revolution in return for being granted expanded fiscal powers.

In short, some say, the visionary ideas of this architect of fiscal federalism are exactly what a divided euro zone needs to extract itself from a deep debt mess that threatens the very survival of Europe's single currency.

"As I see it, Europe is at an Alexander Hamilton moment, but there's no Alexander Hamilton in sight," Paul Volcker, a former chairman of the Federal Reserve , the U.S. central bank, told a recent conference in The Hague.

Teasing out conclusions for one continent from the history of another is fraught with risk.

For a start, the 27 countries of the European Union will—presumably—never form a unitary state like the United States.

But the evolution of America's system of fiscal governance that Hamilton started offers valuable insights for the euro zone, especially as it squares up to the possibility of a default by one of its members, Greece.

"The fact that states encountered major debt crises and defaulted, yet the union managed to overcome them intact, points to relevant lessons for European policymakers in the current turmoil," write Randall Henning and Martin Kessler, researchers at the Petersen Institute for International Economics in Washington.

Hamilton And Euro Bonds

For instance, the controversy over Hamilton's 1790 proposal that the federal government should take responsibility for state debt is mirrored in today's debate over whether to mutualize euro zone debt, perhaps by issuing common bonds.

Wim Boonstra, chief economist of Dutch lender Rabobank, is convinced that Hamilton, were he alive, would be a strong advocate of such a step.

"Without a euro bond scheme, the problems we face will return because the fragmented markets are an invitation for speculators," said Boonstra, who published a proposal for the common funding of the budget deficits of members of the putative monetary union as far back as 1991.

But just as Germany and other northern euro-zone creditors today oppose a bailout of distressed debtors such as Greece, citing moral hazard, Hamilton's opponents objected that his plan was unfair to some states and would reward speculators.

They also saw he was immensely strengthening the federal government - in today's EU context, heading down the road to political union at the expense of national governments.

"The contemporary debate over monetary union in Europe appears polite compared to the ferocity with which Hamilton's plan was debated in Congress," Henning and Kessler write in an essay co-published with Bruegel, a Brussels think tank.

Moral hazard did indeed endure until Congress in the 1840s rejected petitions to assume the debts of a number of states that had spent recklessly on railroads and canals.

The no-bailout principle quickly led states to pass balanced-budget provisions.

These find an echo in the constitutional 'debt brakes' that are a main pillar of plans to put the euro zone on a more solid footing. But a big difference is that they were adopted spontaneously, not imposed by the center or by Germany as a disciplinary mechanism.

"The episode of the 1840s...underscores the importance of crisis as a driver of institutional change, which is reflected in the contemporary European experience," according to Henning and Kessler.