The joy of a four-day weekend – as well as cooking and gardening, I’ve read a thoroughly enjoyable economic history book with great relevance for the present debate on sovereign borrowing. It’s
[amazon_image id=”0691151490″ link=”true” target=”_blank” size=”medium” ]Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World)[/amazon_image]
Part of my enjoyment was that I studied this period for my history A level (and almost read history at university before economics captured me), and so was absorbed in 16th and 17th century Europe during those impressionable teenage years. It’s extraordinary that so many Europeans know so little about it now – certainly, British schoolchildren jump from the Tudors straight to World War II and the Cold War. For a sense of how turbulent and decisive a period it was, the novel
[amazon_image id=”1781681678″ link=”true” target=”_blank” size=”medium” ]Altai: A Novel[/amazon_image]
However, even if you don’t share my specific interest in the period, this is an essential book for economists interested in sovereign debt – and which of us is not at the moment? It fills in some important detail about an episode in debt history that features in the data set of the monumental
[amazon_image id=”0691152640″ link=”true” target=”_blank” size=”medium” ]This Time Is Different: Eight Centuries of Financial Folly[/amazon_image]
Philip II has the reputation of being the Borrower from Hell because of the frequency with which he defaulted – there was a payment suspension more often than one year in every five during his reign. As the authors point out, the
So the question is why he got the opportunity to do so; why did bankers continue lending to him? How can there be a ‘borrower from hell’? The book carries out an IMF-type sustainability exercise on the historical data set and concludes that the debt burden was sustainable although there were liquidity crises due to events – usually a military loss. It also argues that the structure of the lending meant there was a kind of balance of power between king and lenders. The form the lending took was syndicated loans provided by a relatively small and tight-knit group of families; 130 people from 63 families lent Philip money over the years but 3 families accounted for 40% of all loans and 10 families for 70%. The banking network was stable and dominated the available funds. So whereas two hundred years earlier Philip IV of France had executed those who lent him money (Jews, Lombards, Templars) when he couldn’t pay, Philip II of Spain had a long relationship with his financiers. The ‘absolutism’ of the 16th and 17th centuries was in fact constrained, a useful fiction for both monarch and elites.
The data indicate that despite the defaults, holidays and renegotiations, the average return on the loans was highly favourable. The book argues that the lending was understood to be contingent and that a renegotiation would ensue if events turned out badly for the king. The negotiations were typically speedy, as was the return to lending. The bankers were sharing the risk with Philip, their return amply compensating them for it. It sounds not unlike Robert Shiller’s proposal for event-dependent sovereign loans in his book
[amazon_image id=”0691120110″ link=”true” target=”_blank” size=”medium” ]The New Financial Order: Risk in the 21st Century[/amazon_image]
As for the resource curse, Drelichman and Voth conclude with a discussion of the reasons for later Spanish economic decline: “The inability to raise state capacity must ultimately be traced back to a resource windfall – silver. It kept the Crown fiscally sound without the need to strike a bargain that would have helped build a stronger, more capable state in the long run.”
A final note: this is a tremendously well-written book, a pleasure to read.
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Intriguing. Did this close network of lenders to the monarchy aka state mean that on the other hand they gained a raft of privileges and control over other areas of general finance and capital. So their access to other money and cash sources meant that in balance they gained more than they lost. This plus the amount of silver and gold going into The Church might account for the economic stagnation and deterioration of living and other conditions going forward to the 18th and 19th Century.
The rates paid were high enough to compensate for the risk of default or renegotiation.