American debt was a revolutionary masterstroke that helped launch a global financial superpower.

Believe it or not, U.S. debt was once a source of national strength, before becoming a sword of Damocles hanging over the federal government and the bond market.

As the nation celebrates the 250th anniversary of the Declaration of Independence, the origins of America’s financial power can be traced back to a controversial decision in 1790 to consolidate Revolutionary War debts.

Alexander Hamilton, who served as the first Secretary of the Treasury, is considered the architect of American finance because he designed one of the most important economic decisions in early U.S. history.

He recognized how debt can unlock resources that could transform the young republic. But first he had to sort out the mess created by the War of Independence.

To combat the British Empire, the Continental Congress borrowed heavily domestically and internationally through various instruments, while individual states accumulated their own war debts.

Under Hamilton’s plan, the nascent federal government assumed the state’s debts and consolidated everything into a single national debt. At the same time, he committed the United States to repaying the debt in full rather than claiming that the government established by the Constitution was not responsible for war loans.

For a fragile new country, this was a revolutionary idea that established its solvency early, as investors expected the United States to default on its debts or force it to cut its hair.

By building a reputation for reliability, demand for U.S. debt increased and Treasury bonds were quickly traded on European markets. It also allowed the United States to borrow more money at relatively low cost, with investors reassured by “the full faith and credit of the United States”, new debt helping to finance the Louisiana Purchase.

More than two centuries later, Treasury bonds support the global financial system and are considered one of the safest assets in the world.

They also fill central bank reserves and corporate coffers while bolstering the U.S. dollar’s status as the primary reserve currency, allowing the United States to exert its financial might wherever greenbacks are traded.

This “exorbitant privilege” allowed the United States to borrow more cheaply than its fiscal profligacy would otherwise allow.

The US debt now stands at $39 trillion, with public debt equal to the size of the economy as a whole. Interest costs alone amount to $1 trillion a year, exceeding the defense budget and adding to a budget that will soon head into territory not seen since the immediate aftermath of World War II.

The explosion of red ink, particularly over the past 20 years, has fueled growing and increasingly serious concerns that the trajectory is unsustainable. Meanwhile, lawmakers continue to cut revenue-draining taxes without addressing the biggest drivers of spending, Social Security and Medicare.

A close-up of the front of the U.S. $10 bill bearing the portrait of Alexander Hamilton, the first U.S. Treasury Secretary, is seen December 7, 2010 in Washington, DC.

PAUL J. RICHARDS/AFP via Getty Images

But for now, investors continue to buy new U.S. bonds, even though some recent Treasury auctions have required a higher yield to attract the necessary demand.

The Treasury market also remains the deepest and most liquid in the world, with more than $30 trillion in securities outstanding and more than $1 trillion in daily trading volume.

Although the precise level of debt that would trigger a crisis is unknown, Penn Wharton’s budget model recently set the threshold at more than 210% of GDP.

Beyond this “outer limit,” there is no feasible labor income tax that can finance interest payments on U.S. debt at returns acceptable to investors, PWBM warned.

According to PWBM, the outer limit of the federal debt is the solvency limit, beyond which default on Treasury debt or pay-as-you-go transfers like Social Security becomes a virtual certainty on an inflation-adjusted basis.

The debt-to-GDP ratio today is around 100% and the Congressional Budget Office forecasts that it will reach 175% by 2056, suggesting it will take decades to reach 210% on its current trajectory.

But depending on rising health care costs and increased Medicare spending, that threshold could be reached much sooner.

The United States still has 25 years in a low growth scenario, 22 years with medium growth and 19 years with higher growth, PWBM estimates. But even that could minimize the risk.

“Given the historical growth rate of health care costs, there is a 25% chance of reaching maximum debt within 14 years,” he adds.

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