For the 244 years of the United States’ independent existence, few would have thought that the country had anything to learn from the ultimate Old World monarchical autocracy, Philip II’s Spain (he ruled 1556-98). Yet as politicians debate the merits of yet another public spending “stimulus” on top of a $3 trillion 2020 deficit, Philip II’s four debt defaults in 42 years of rule come uncomfortably into view. Philip II’s overspending wrecked the power and wealth of Spain, the greatest superpower of its day. No question, his unhappy rule has lessons for the United States today.
From about 1525, and certainly from 1545, when the gigantic Potosi silver mine in Bolivia was first worked, Spain’s was unquestionably the richest government in Europe, with only the Mughal empire in India surpassing it worldwide. Until 1556, Spain and the Holy Roman Empire were joined under Charles V, which raised expenses since the Holy Roman Empire had both domestic Protestant/Catholic strife and the need to defend itself against the aggressively expansionist Ottomans in Hungary. However, from Philip II’s accession in 1556, the Holy Roman Empire became a separate if friendly power under another branch of the Habsburg family. From that point, with Spain monolithically Catholic and the Ottomans only a distant naval threat in the Mediterranean, the country should have been magnificently solvent.
In the late 16th Century, the value of American gold and silver landed at Seville was around 11.6 million pesos annually, equivalent to 2.5 million 1600 pounds sterling, six times Queen Elizabeth’s revenues towards the end of her reign. Admittedly, the Spanish Crown did not have the right to all that revenue; the American mines were owned by Spanish nobles and other entrepreneurs who had been awarded concessions, and theoretically the Crown received only a “silver import tax.”
However, the Spanish Crown also taxed other trades relating to the Americas, such as the slave trade, where it issued taxed licenses to deliver slaves to the Americas and, more important, the excise on sugar grown in the Spanish West Indies and the large Portuguese colony in Brazil (Spain controlled Portugal in an “Iberian Union” from 1580 to 1640). Overall, the income to Spain’s Treasury in the 1590s was around 8.5 million pesos, almost five times that to the English Crown at that time, from an Iberian Union population about double England’s. Unfortunately, Spain’s debts in 1600, even after four restructurings, totaled 85 million pesos, around 10 years’ revenue, and most of them bore interest at double-digit rates.
The problem was not Philip II’s revenues, but his expenses. Having decided that he was Europe’s only reliable protector of Catholicism (of which he was a dour and fanatical adherent) he engaged in an expensive albeit successful naval war against the Ottoman Empire, a prolonged intervention in France’s 40-year Wars of Religion, an 80-year attempt to prevent the Protestant Netherlands claiming independence and an entirely unnecessary, expensive and unsuccessful 15-year war against England’s relatively pacific Elizabeth I. As a result, Philip II through the defaults early in his reign turned the Augsberg-based banking family of Jakob Fugger the Rich (1459-1525) which had traditionally financed the Habsburgs into Fuggers-the-barely-middle-class, after which his fourth bankruptcy in 1596 put the over-optimistic Genoese bankers in deep trouble.
Debt markets were more inelastic in Philip II’s day, and interest rates higher. It is likely that today, he could carry on overspending on multiple simultaneous wars for considerably longer before the bond markets dried up, and that interest costs would not rise to anything like the 15% per annum (in real money – there was little inflation) he was paying in the 1590s. But the effect of his overspending on Spain’s fortunes for the next 200 years would be the same today as it was then. His son Philip III ended most of the wars but was unable to balance the budget because of the excessive debt burden; then under his grandson Philip IV further bankruptcies occurred and Spain’s power went into rapid decline. From Europe’s most powerful country in the late 16th century, Spain became an unimportant appendage of an unsuccessful French foreign policy by the 18th century. Spain’s industries failed to develop, because there was little capital available after the state had sucked out its share, and by 1800 the country was impoverished and underdeveloped, its population largely illiterate and far poorer than they had been 300 years earlier.
The capital markets are infinitely larger and better developed now than they were for Philip II’s Spain. We also have central banks, which for a leading currency like the dollar can print money without immediate adverse consequences. However, it must be remembered that Philip II’s Spain equally benefited from enormous investor confidence in the early years of his reign. Investors saw the flow of silver from the Americas, and the other benefits of Spain’s leading position in colonizing a previously unknown, enormously wealthy continent, and believed it able to bear any fiscal burden in a way that not been possible for the impoverished states of the late Middle Ages.
Indeed, had somebody at Philip’s court come up with Modern Monetary Theory they would doubtless have been thought highly credible. After all, almost all Philip’s revenues came from the exploitation of Spain’s new colonies, only Castile of the lands under his control (which as well as Spain and Portugal included Belgium, the Netherlands, Burgundy and parts of Italy) paid any money taxes at all to support his rule, although the non-Castilian parts of his realm did provide soldiers for his armies. Thus, in a sense he was an early exponent of MMT, with the M supplied mostly by the Potosi silver mines.
However developed today’s capital markets, if the United States borrows like Philip II’s Spain, it will eventually meet the fate of Philip II’s Spain. Philip doubtless believed his defaulting to foreign bankers – initially German, then Genoese — would make little difference to the subjects he ruled, none of whom lived in either Germany or Genoa. This was wrong. Without the confidence of the international system, debt costs for Spanish businesses soared, equity capital became almost unobtainable except in small quantities, and the domestic Spanish economy atrophied.
The same will happen if the United States runs its debts up too far. Initially, its creditors – foreign banks and the liquid central banks of countries such as China and Japan – will scale back their willingness to participate in Treasury bond issues. That will drive up capital costs, not just for the U.S. Treasury, but for all American businesses and consumers. Multinational businesses will re-locate their major operations elsewhere, as they left Philip II’s Spain. Entrepreneurs and innovators will also leave — it is notable that Spain participated very little in the explosion of human knowledge and innovation of the 17th and 18th centuries, and in consequence got industrialization very late and not very intensively.
If the United States continues to spend as Philip II did, a debt default is inevitable, probably well this side of 2050. Should that happen, economy in government will no longer be enough to restore the United States’ position. Just as Philip III ended his father’s wars but found Spain’s economic and military power continued to decline, so after a U.S. default the long term drain of international influence for the United States government will be matched by long-term drains in innovation for the U.S. economy and in prosperity for the U.S. people.
Philip II was one of the worst of monarchs. His country had built up an amazing lead in colonization of an entire new continent, and had achieved an income from precious metals that was the envy of all contemporaries and could have been used to develop Spain’s economy and scientific potential and perhaps achieve the living-standards bonanza of industrialization 150 or 200 years before Britain. Because of pointless government overspending, in his case on a vain ambition to stamp out Protestantism and Islam, this happy future was denied to his people. Let us not, through equally pointless overspending on social programs and environmental boondoggles, force the same miserable long-term destiny on the United States.
It is time to balance the U.S. Budget, and keep it balanced.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)