What if Alexander Hamilton had been Argentinean? A comparison of the early monetary experiences of Argentina and the United States

The paper explains Argentina’s early chronic inflation and the United States’ early price stability as the product of a common, deliberate fiscal-policy response to different wartime financing constraints, not – as the nineteenth-century Argentine writer Juan Bautista Alberdi argued – as the automatic and self-perpetuating consequence of a government having once resorted to paper money (Introduction, pp. 1-4). The paper opens with Alberdi’s warning that state paper money, once established, would “ruin and bury” the government that created it (p. 2), but the authors state explicitly that “unlike Alberdi, we do not believe – nor does the evidence bear it out – that the mere existence of paper-money is sufficient to put the inflationary process in motion”; instead, “long processes of high inflation may reflect the optimal response to specific circumstances” (p. 3).

Argentina’s inflationary reliance is traced to three interacting constraints: near-continuous external war layered onto continuous civil war, an unstable fiscal regime built on an easily-disrupted trade-tax base, and progressively less feasible long-term bond financing (Introduction, p. 4). The paper adds, without formally modeling it, that “successive banks of issue were forced to depart from their original intent of preserving convertibility and became engines of inflation,” and that political groups who benefited from the real exchange-rate depreciation inflation produced were “opposed to measures which would have allowed the government to rely on non-inflationary financing” (p. 4).

Hamilton’s 1790 program – funding the national and state debt into long-term bonds, a sinking fund, sufficient tariff and excise tax revenue, and the First Bank of the United States – is presented as the institutional foundation that let the United States bond-finance most subsequent wartime spending and retire debt in peacetime, in contrast to Argentina’s progressively narrower financing options (Section 3.2, pp. 14-18). Following a Revolutionary War financed in large part (85 percent) by fiat “continental” currency issue and inflation of over 65 percent per year, Hamilton converted roughly $40 million in federal debt plus about $12 million in foreign debt and $15-25 million in state debts into bonds resembling British consols, secured dedicated tax revenues (chiefly a tariff meant to raise about 10 percent of import values) to service them, and created a national bank able to extend short-term bridge loans to the Treasury (pp. 14-18); the paper credits this package, rather than any special Argentine incompetence, with the difference in outcomes.

Argentina’s government debt became progressively more money-like over 1810-1821, paper money issued from 1822 quickly became inconvertible, and repeated attempts at fiscal and monetary stabilization (1821, 1829, 1833) all failed, while the 1825-1828 war with Brazil and later blockades repeatedly collapsed trade-tax revenue and forced heavy reliance on money-financed deficits (Sections 2.3-2.8, pp. 6-13). During the Brazilian-war blockade, trade taxes fell from about 80 percent of revenue at the start of the decade to about 20 percent during 1825-1828, the money stock rose by a factor of 7.9 between 1826 and 1830 while the exchange rate depreciated by a factor of 7.3, and after defaulting on its 1824 London loan in 1827 (with service not durably restored until 1849), Argentina found long-term bond financing “more and more difficult” for decades (pp. 8-9); under Rosas (1835-1851), the government abandoned bond issue after 1840 and relied on money and trade taxes almost exclusively, with cumulative note issue rising by a factor of 8.2 between 1836 and 1851 (p. 11).

Households supply labor to produce a single good, hold both non-interest-bearing domestic money and an internationally traded bond, and use real money balances to economize on costly “shopping time,” so that the government’s inflation tax and its consumption tax both distort the household’s effective price of consumption in the same way (Section 4.1, pp. 19-21). The model is built so that, given the assumed preferences and a transactions-cost technology homogeneous of degree one, the household’s optimal choice of leisure turns out to be independent of both tax rates – a feature the authors note “will greatly simplify the optimal tax problem faced by the government” (p. 21), since the government need not weigh how its tax mix distorts labor supply.

With zero collection costs on the consumption tax, the optimal policy is Barro’s (1979) tax-smoothing result – a constant consumption tax financing permanent government spending and a zero inflation tax, because the inflation tax carries a resource cost while the consumption tax alone does not (Proposition 1); once collection costs are positive but constant over time, both taxes become positive and constant instead (Proposition 2), because both now carry resource costs and the government optimally spreads the burden between them (Section 5.1, pp. 25-27). Neither case gives the model a reason for the inflation tax to rise specifically during wars, since the collection-cost parameter is assumed constant in both propositions.

Allowing the cost of collecting the consumption tax to rise in periods such as wars produces Proposition 3: a higher collection cost implies a higher inflation tax and a lower consumption tax in that period, because taxing consumption becomes relatively more expensive at the margin (Section 5.2, pp. 27-28). The authors read Argentina’s experience as consistent with this channel because wartime naval blockades directly disrupted trade-tax collection: “the composition of tax revenues changed towards an increased use of the inflation tax during wartime, as Proposition (3) would imply” (Section 6, p. 31).

When the government faces a risk premium that rises with the size of its primary deficit – an increasing, convex function of borrowing needs, meant to capture imperfect access to international capital markets – Proposition 4 shows it is optimal to raise both the consumption tax and the inflation tax during periods of high spending, even without any change in collection costs, because unchanged taxes would otherwise let the deficit, and the associated risk premium, rise one-for-one with spending (Section 5.3, pp. 28-30). The authors argue that Argentina, having defaulted on its external debt in 1827, “faced increasing costs of borrowing abroad, thus forcing it to rely more on taxes during wars, as Proposition 4 suggests” (Section 6, p. 31), and conjecture that Argentina’s actual experience reflects a combination of Propositions 3 and 4 together.

Building on Calvo and Guidotti’s (1993) stochastic result, Proposition 5 shows that if the government cannot issue state-contingent debt but can use a lump-sum tax that collects no revenue on average, unanticipated inflation can finance only the unanticipated component of temporary spending shocks at no welfare cost, since it acts exactly like a non-distorting lump-sum tax chosen before the shock is known (Section 5.4, pp. 30-31). The authors argue this scenario, rather than persistently high collection costs or borrowing costs, best fits the United States, since “our reading of the historical evidence suggests that the United States did not appear to have faced special difficulties raising tax revenues during wars… nor did it face higher borrowing costs during wars” (Section 6, p. 31); with a small, constant collection cost, the model then predicts inflation during wars and deflation in peacetime with average inflation near zero – consistent with the finding that “the price level in 1900 was virtually the same as in 1774.”

The authors identify five contributing differences: Argentina’s foreign wars were superimposed on near-permanent civil war, unlike the United States’ clearly separated conflicts; both countries had broadly similar tax structures but the United States collected far more reliable revenue from them by 1790, while Argentina’s trade-tax base repeatedly collapsed in wartime; Argentina found long-term bond financing progressively harder to obtain after its 1827 default while U.S. credibility improved across its later wars; Argentina’s banks of issue, unlike the pre-1914 U.S. banking system, were quickly diverted from convertibility to serve as financial agents of the treasury; and dominant Argentine political groups, notably cattle-ranchers who profited from the real exchange-rate depreciation inflation produced, opposed measures that would have relaxed these constraints (Section 6, pp. 32-34).

The authors caution that although the model treats each country’s financing constraints as purely exogenous for tractability, in reality “such constraints should not be viewed as strictly exogenous” (Conclusions, p. 33): Argentina’s difficulty accessing world capital markets stemmed partly from its own earlier default and unwillingness to restore credibility, its narrow trade-tax base reflected policy choices, and both constraints persisted partly because the dominant political group – the ranchers – resisted being taxed, whereas in the United States “these constraints were avoided because of the recognition of Hamilton and others of the importance of sound public finance… for future wartime finance, attracting foreign capital, and economic development” (p. 34).

The paper concludes that “it is doubtful that had Alexander Hamilton been an Argentinean the inflationary outcome in Argentina would have been much different” (Conclusions, p. 34), because Argentina’s high inflation is presented throughout as the constrained-optimal response of a government facing its particular combination of near-continuous war, a fragile trade-tax base, defaulted-upon foreign credit, and politically entrenched opposition to conventional taxation – constraints the paper argues Hamilton himself did not have to overcome in the early United States.