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John Winthrop's sermon "A Model of Christian Charity" (which you can read online) is an extraordinarily famous sermon, which is referenced by American politicians to this day.

In this sermon, John Winthrop compares the American colonists to "a city upon a hill":

We shall find that the God of Israel is among us, when ten of us shall be able to resist a thousand of our enemies; when He shall make us a praise and glory that men shall say of succeeding plantations, "may the Lord make it like that of New England." For we must consider that we shall be as a city upon a hill. The eyes of all people are upon us. So that if we shall deal falsely with our God in this work we have undertaken, and so cause Him to withdraw His present help from us, we shall be made a story and a by-word through the world. We shall open the mouths of enemies to speak evil of the ways of God, and all professors for God's sake. We shall shame the faces of many of God's worthy servants, and cause their prayers to be turned into curses upon us till we be consumed out of the good land whither we are going.

What point is John Winthrop trying to make here by referencing "a city upon a hill"? How would this have been interpreted by his audience?

I'm asking this question because this passage tends to be interpreted by modern audiences as one of the first instances of American exceptionalism. I'm trying to get a sense of whether that is an after the fact interpretation or a reflection of how the sermon was interpreted at the time it was created.

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His listeners would have recognized it as a quote from Matthew 5:14:

You are the light of the world. A town built on a hill cannot be hidden. Neither do people light a lamp and put it under a bowl. Instead they put it on its stand, and it gives light to everyone in the house. In the same way, let your light shine before others, that they may see your good deeds and glorify your Father in heaven.

He is therefore telling them that they are to be a light to the world.

Edit: The exceptionalism here is not American exceptionalism (there was not America at the time), it is Christian exceptionalism.

true Christians are of one body in Christ (1 Cor. 12). Ye are the body of Christ and members of their part. All the parts of this body being thus united are made so contiguous in a special relation as they must needs partake of each other's strength and infirmity; joy and sorrow, weal and woe. If one member suffers, all suffer with it, if one be in honor, all rejoice with it.

The Puritans regarded themselves as representing a purified Christianity and hoped to establish a Christian society free of the corrupting influence of the old world. In doing so, he argues, they take on an exceptional responsibility: the reputation of God and his people throughout the world:

The eyes of all people are upon us. So that if we shall deal falsely with our God in this work we have undertaken, and so cause Him to withdraw His present help from us, we shall be made a story and a by-word through the world. We shall open the mouths of enemies to speak evil of the ways of God, and all professors for God's sake. We shall shame the faces of many of God's worthy servants, and cause their prayers to be turned into curses upon us till we be consumed out of the good land whither we are going.

The later doctrine of American exceptionalism seems to be a secularization of this idea: an exceptionalism based on civic virtues and the constitution rather than on love and grace. Modern liberalism generally is basically a secularized version of Christianity.

Thou must observe whether thy brother hath present or probable or possible means of repaying thee, if there be none of those, thou must give him according to his necessity, rather then lend him as he requires (requests). If he hath present means of repaying thee, thou art to look at him not as an act of mercy, but by way of commerce, wherein thou art to walk by the rule of justice; but if his means of repaying thee be only probable or possible, then he is an object of thy mercy, thou must lend him, though there be danger of losing it.

This, allowing for certain changes in rhetorical style over the years, could be Bernie Sanders. Except Bernie Sander would not likely quote Deuteronomy in support of this assertion.

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