The Funding Act and the Final Settlement

It had not been paid. The words lay on the page in front of Henry Knox, and they meant something different now than they had meant seven years before. He sat in a tavern on Market Street in Philadelphia, two papers spread before him on a table stained with wine rings and candle wax. One was his original certificate, the final settlement paper issued to him at the war’s end, creased and softened from years of being carried in a coat pocket, then folded into a desk, then unfolded again. The other was a freshly printed broadside containing Alexander Hamilton’s Report on Public Credit, delivered to Congress nine days earlier and now circulating through the city in copies that passed from hand to hand like currency itself.

Knox read the numbers. Hamilton proposed that the federal government assume the state debts contracted during the war and fund the national debt at full face value. The certificates—the very paper Knox held in his hand, the paper that had been worth twelve or fifteen shillings on the pound when he had needed cash and could find no better buyer—would be redeemed at par. Not at the market price. Not at the discounted rate that speculators had paid to officers desperate to feed their families. At full face value, with interest dating from the beginning.

He calculated. The arithmetic was not difficult, but the conclusion it pointed toward was. If Hamilton’s plan passed, the certificate he had sold years ago for a fraction of its worth would become, in someone else’s hands, a claim on the federal treasury for its full amount. The buyer would collect the difference. The officer who had borne the hardship would have traded away the reward.

Knox was Secretary of War now. He had been given the post by President Washington, who remembered him from the war, from the crossing of the Delaware, from the guns he had hauled over the mountains to Boston. He was not a desperate man selling paper to buy bread. But he remembered what it had been to wait for payment that never came. He remembered Newburgh.

The tavern noise rose around him. Merchants talked of shipments and insurance rates. A group of former officers at the next table argued about the assumption bill, their voices carrying the particular intensity of men who understood what was at stake because they had lived without it. Knox folded the broadside and put it in his coat. He left the certificate on the table for a moment, looking at it. Then he picked it up and put it away.

Outside, Philadelphia was busy with the business of a new government. The first Congress had convened in March 1789. After the passage of the Tariff of 1789, various other plans were considered to address the debt issues during the first session of Congress, but none were able to generate widespread support. The old certificates still traded at discounts. The old promises still sat unredeemed. The war had been over for six years, and the army that had won it had still not been paid what it was owed.

Hamilton had been waiting for this moment. As Secretary of the Treasury, confirmed by the Senate in September 1789, he had spent the autumn and winter preparing his report. He understood the debt not as a burden but as an instrument. What mattered was not merely paying it off but managing it, funding it, transforming it into a binding tie between the new federal government and the wealthy creditors who would then have a stake in its survival. The certificates scattered across the country, held by former soldiers and officers and the speculators who had bought them, represented a constituency. Hamilton intended to make that constituency a pillar of the new national state.

On January 9, 1790, he submitted his Report on Public Credit to the House of Representatives. The document ran to more than fifty pages. He projected that the federal government’s annual income would be $2.8 million. Drawing on the ideas of Robert Morris and others, Hamilton proposed the most ambitious economic plan ever advanced by an American, calling for federal assumption of state debts and funding of the national debt at par. The total exceeded $77 million—$54 million in federal obligations, including the foreign debt, and roughly $25 million in state debts incurred during the war.

The numbers were staggering. The political calculations embedded in them were more staggering still. Hamilton proposed to pay not the original recipients of the certificates but the current holders. The distinction mattered. Many original holders—soldiers, officers, suppliers—had sold their paper years ago, when its value had collapsed and they had needed immediate cash. Speculators had bought that paper at deep discounts, sometimes for as little as ten or fifteen cents on the dollar. Under Hamilton’s plan, those speculators would receive full face value plus interest. The original holders would receive nothing beyond what they had already been paid by the buyers.

The proposal ignited a firestorm. James Madison rose in the House to oppose it. He did not object to funding the debt. He objected to the transfer of wealth from the soldiers who had earned it to the financiers who had speculated on it. On February 11, 1790, Madison delivered a speech that lasted more than two hours. He proposed an alternative: discriminate between original holders and current holders, paying the former the highest market value the certificates had ever reached and the latter the price they had paid plus a reasonable profit. It was, he argued, a matter of justice. The certificates had been issued to men who had risked their lives. Those men had sold them under duress, not by choice. To reward the buyers at the expense of the sellers was to reward exploitation.

The House debated Madison’s proposal for days. The arguments cut deeper than finance. They touched the question of who the government served and who it ought to protect. Former officers wrote letters. Veterans’ groups organized. The Society of the Cincinnati found itself drawn into the fight. Some members had kept their certificates and stood to benefit from Hamilton’s plan. Others had sold theirs and watched the paper pass into the hands of merchants and bankers who had never fired a shot.

The debate exposed a fault line that had been present since Newburgh. The officers had been promised payment. They had been promised pensions. They had been promised, in the darkest days of 1783, that their country would not forget what they had done. The nationalist politicians who had encouraged their anger, who had whispered that Congress must be forced to act, had used that promise as a lever. Now the promise was being kept—or rather, it was being paid. But the payment would go, in many cases, to men who had never worn a uniform.

Hamilton defended his plan on grounds of practicality. Discriminating between original and current holders would be administratively impossible. The certificates had changed hands many times. Records were incomplete. The market had already priced in the expectation of some form of federal funding; to alter the terms now would disrupt commerce and undermine confidence. More fundamentally, Hamilton argued that the government’s obligation was to the bearer of the paper, not to its original recipient. The certificate was a contract. To question who held it was to question the very nature of contractual obligation. The government had promised to pay. It would pay whoever presented the claim.

The House voted on Madison’s discrimination proposal on February 22, 1790. It failed, 36 to 13. The margin was not close. The representatives had decided that the government’s credit was more important than the soldiers’ original claim. The certificates would be funded at par for their current holders.

But assumption of the state debts remained contested. The southern states, which had paid off more of their war debts, objected to assuming the burdens of the northern states, which had not. Virginia in particular chafed at the prospect of subsidizing Massachusetts and Pennsylvania. The debate dragged on through the spring, blocking not just the funding bill but the question of where the permanent capital would be located. Northern states wanted it in Pennsylvania or New Jersey. Southern states wanted it on the Potomac. The two issues became linked, each side holding leverage over the other.

By June 1790, the deadlock had become total. Hamilton’s funding plan could not pass without support for assumption. The assumption could not pass without southern votes. The capital question could not be resolved without northern concessions. The first Congress, which was supposed to establish the new government’s foundations, found itself paralyzed by the same sectional divisions that had crippled the old Congress under the Articles of Confederation.

Then, in late June, Hamilton approached Madison and the Secretary of State. The three men met outside New York, at the Secretary of State’s lodging on Maiden Lane. Over dinner, interested parties could discuss a “mutual accommodation.” The deal subsequently struck, known as the Compromise of 1790, cleared the way for passage, in July 1790, of the Residence Act. The act transferred the federal capital to Philadelphia for ten years, while a permanent capital would be established on the Potomac River. In exchange, southern representatives allowed assumption of the state debts to pass.

The bargain was not recorded in any official document. The Secretary of State later expressed regret about it, believing he had been manipulated. Madison was caught between his principles and his region’s interests. Hamilton had gotten what he wanted: a funded national debt, assumption of state obligations, and a financial system that would bind wealthy creditors to the federal government. The circle that had been drawn at Newburgh was now closed. The crisis that had been engineered—or at least encouraged—by nationalist politicians seven years before had produced the stronger government they had sought. That government was now acting to pay the debt they had used as a lever.

The Funding Act passed the House on August 4, 1790, by a vote of 49 to 23. The Senate had already approved it. President Washington signed it four days later. The law provided for the issuance of new federal securities to replace the old certificates. Holders of the final settlement certificates, the promissory notes, the various paper issued by the Continental Army and the states, could exchange them for federal bonds paying 6 percent interest, with deferred portions paying 3 percent. The debt would be serviced by revenue from import duties and, beginning in 1791, from an excise tax on whiskey.

That whiskey excise was one of the principal sources of revenue Hamilton prevailed upon Congress to approve. In his first Tariff Bill in January 1790, Hamilton had proposed to raise the three million dollars needed to pay for government operating expenses and interest on domestic debt. The tariff alone was insufficient. Despite additional import duties imposed by the Tariff of 1790, a substantial federal deficit remained—chiefly due to the federal assumption of state revolution-related debts under the Funding Act. By December 1790, Hamilton believed import duties had reached their practical limit. The excise on distilled spirits was his solution. It would prove controversial in ways that echoed the old sectional tensions, particularly in western Pennsylvania where farmers distilled whiskey because transporting grain over the mountains was impractical. But that controversy belonged to the future. In the summer and fall of 1790, the immediate question was how the funding system would work.

The Treasury began the process of exchanging certificates for bonds. Holders presented their paper at designated offices. Clerks recorded the amounts, verified authenticity, and issued new securities. The old certificates, the ones that officers had carried in their pockets and sold at discounts and used as collateral for loans, were canceled and filed away. The new bonds, backed by the full faith and credit of the United States, entered circulation.

For those who had held on, the payoff was substantial. A certificate that had traded at fifteen cents on the dollar became worth its full face value plus accumulated interest. Officers who had weathered the years of waiting, who had refused to sell when the price was low, who had trusted that somehow the government would make good, received a windfall. They were paid. The promise was honored.

But many had not held on. The records of the Treasury tell the story in aggregate, but the human reality was scattered across thousands of individual choices made under pressure. A captain in Massachusetts who had sold his certificate in 1785 to buy seed for his farm. A lieutenant in Pennsylvania who had traded his paper for store credit when his children needed shoes. A quartermaster’s clerk in Virginia who had taken whatever he could get because his wife was sick and the doctor would not wait for Congress to act. These men had made rational decisions given their circumstances. They had been forced to discount the future because the present would not wait.

The speculators who had bought their paper made rational decisions too. They had taken a risk. The certificates might have remained worthless. The government might have defaulted or repudiated. The new Constitution might have failed to produce a functioning fiscal system. Those who purchased final settlement certificates at steep discounts were betting that something would change—that the country would find a way to pay its debts. Hamilton’s plan was the payoff for their bet.

The transfer of benefit from original holders to current holders was, in the end, a wealth transfer from those who had served to those who had speculated. It was not total. Some officers had kept their certificates. Some speculators had lost money on other bets. But the pattern was clear enough to generate lasting resentment. Madison had seen it. The House had voted anyway. The practical demands of establishing federal credit had outweighed the abstract demands of compensating the original creditors.

Knox watched the process from his position as Secretary of War. He saw the petitions that arrived from veterans who had sold their certificates and now pleaded for some form of relief. He saw the certificates themselves, the creased paper with its faded ink, presented by men who still remembered what they had been promised. He could do nothing for them. The law was the law. The certificates had been sold. The claim had transferred. The government would pay the bearer.

The irony was not lost on him. At Newburgh, the officers had been worked on by men who wanted to use their grievance to force a stronger government. They had been told that Congress would not pay because Congress could not pay, because the Articles of Confederation gave Congress no power to tax and no power to compel the states to contribute. The solution, the nationalist argument ran, was a government with real power—power to raise revenue, power to pay its debts, power to honor its obligations. That government now existed. It was paying its debts. It was honoring its obligations. The mechanism worked.

But the men who had provided the grievance, who had supplied the pressure, who had made the threat credible enough to force the constitutional transformation, were in many cases not the beneficiaries of the resolution. They had sold their stake in the outcome before the outcome arrived. The crisis they had helped create had been resolved, but the resolution came too late for those who had been forced to liquidate in the meantime.

Hamilton understood this. His report had addressed the question of discrimination and dismissed it. The justice of the original claim, he argued, could not override the practical necessity of establishing credit on firm foundations. The government needed to pay its debts to function. Who held the debt was, from the perspective of the Treasury, irrelevant. What mattered was that the debt be funded, that the interest be paid, that the credit of the United States be established in the markets of the world.

The Funding Act accomplished that. By the end of 1791, the exchange of certificates for bonds was largely complete. The old paper money, the continental currency that had been worth nothing, was gone. The new federal securities traded at par, sometimes above par. European investors began to take an interest in American debt. The credit of the United States, which had been ruinous under the Articles, became sound under the Constitution.

The transformation was real. The federal government could now borrow. It could service its obligations. It could raise the revenue to pay for what it spent. The taxing power that the nationalists had sought, the power that the Newburgh crisis had helped force into existence, was now being exercised. Import duties flowed into the Treasury. The whiskey excise would follow. The debt would be paid.

But the payment came at a cost that exceeded the numbers on the ledger. The officers who had marched with Washington, who had wintered at Valley Forge, who had held the line at Monmouth and stormed the redoubts at Yorktown, received, in many cases, a fraction of what they had been promised. Not because the government defaulted, but because they could not wait for it to make good. The years of nonpayment under the Articles had forced them to sell. The funding under the Constitution rewarded those who had bought.

This was not an accident. It was not an unforeseen consequence. Hamilton had designed the system this way. He wanted the debt held by wealthy creditors who would support the federal government because their fortunes depended on its survival. The original holders—farmers, shopkeepers, former soldiers—were too scattered, too poor, too disorganized to form a reliable constituency. The speculators who bought their certificates were concentrated in cities, connected to commercial networks, capable of political organization. By paying the current holders, Hamilton was creating the constituency he needed.

The officers had served their purpose. Their grievance had been used to force the constitutional change. Their certificates had been transferred to men who would become the financial pillars of the new order. The crisis that had threatened to become a mutiny had been transmuted into a system of credit. The Debt Theater that had begun at Newburgh had reached its final act. The script called for payment. The payment was made. But the actors who had opened the show were, in many cases, no longer on the stage.

Knox saw this clearly. He had been at Newburgh. He had watched Washington enter the meeting and turn the room with a letter and a pair of spectacles. He had seen how close the army had come to something darker. He had also seen how the threat of that darkness had been used by men who wanted a stronger government and were willing to push the army to the brink to get it. Now he watched those men—Hamilton, certainly, though Hamilton had not been at Newburgh himself—collect the winnings from a gamble that others had helped make possible.

There was nothing to be done about it. The past could not be renegotiated. The certificates could not be reassigned. The officers who had sold had sold, and the buyers who had bought would be paid. The Funding Act was law. The Treasury was open. The government was functioning as the nationalists had intended.

Knox put his certificate away. He had kept his, in the end. He had been lucky. His position, his connections, his appointment as Secretary of War had given him the income to wait. Not every officer had been so fortunate. Not every former soldier had been able to hold on through the years of nonpayment until the payment finally came.

The tavern was emptying. The afternoon light was fading. Outside, Philadelphia was building the new capital, the temporary capital that would house the federal government for the next decade while the permanent city rose on the Potomac. The deal that had made it possible—the dinner on Maiden Lane, the exchange of votes for location—had been struck by men who understood that politics was the art of mutual accommodation. The officers who had fought the war had been accommodated too. They had been paid. But they had not all been the ones to receive the payment.

The ledger closed. The debt was funded. The crisis that had begun at Newburgh, seven years before, had reached its resolution. The government that the nationalists had wanted, the taxing power they had sought, the fiscal system they had dreamed of—all now existed. The price had been paid in certificates redeemed and interest funded. The price had also been paid in the transfer of wealth from those who had earned the certificates to those who had bought them.

The human cost ran deeper than the financial accounting. Men who had trusted their country had been forced, by years of nonpayment, to sell their trust at a discount. Men who had risked their lives had been forced, by the grinding pressure of necessity, to trade their future for their present. The government that emerged from the Constitution was stronger. It could pay its debts. But the men who had made that government possible—the officers who had created the crisis, the soldiers who had provided the pressure—were in many cases no longer the beneficiaries of the strength they had helped create.

The certificates were gone now, exchanged for bonds, canceled and filed. The paper that officers had carried in their pockets, the paper that had bought groceries and paid debts and kept families afloat during the years when Congress could not or would not act, was now museum pieces. The bonds that replaced them would circulate among investors, would be bought and sold and used as collateral, would form the foundation of American credit. The officers who had held the original certificates would receive, if they had held on, the face value plus interest. If they had sold, they would receive nothing more.

The Funding Act settled the debt. It established the credit of the United States. It created the financial system that Hamilton had envisioned and that the nationalists had sought. It closed the circle that had been opened at Newburgh, when the officers’ grievance had been transformed into political leverage, when the threat of mutiny had been used to force a stronger government into being.

But the settlement left unresolved the human question that had animated the crisis from the beginning. The officers had asked for justice. They had received, after seven years, a system that could pay what they were owed. Whether that system paid them, or paid the speculators who had bought their claims, depended on circumstances that had nothing to do with merit and everything to do with the grinding pressure of time. The government had become strong enough to honor its obligations. The men whose suffering had helped make it strong were not always the ones who benefited from that strength.

Among those who had watched from a distance in March 1783, preparing to use whatever happened for their own purposes, was Major General Horatio Gates. He had been the officers’ champion, the alternative to Washington, the man who might have led them if they had marched. Now, seven years later, he watched the resolution come from a farm in New York, far from the capital, far from the decision-making, his own certificate long since sold, his own stake in the outcome transferred to another hand. The major general who had almost become the figurehead of a military uprising was now a gentleman farmer, retired and quiet, waiting to see what the government would do about the promises it had made.