Today, a country is technically in default as soon as it misses a single payment on any of the obligations that compose its debt stock.76 Sixteenth-century standards were much more flexible. Both the king and his lenders routinely deviated from the letter of the contracts. Payments and disbursements could be delayed or made only in part, with successive agreements compensating for the missed portions of earlier ones. The situation looked much like what Jeremy Bulow and Kenneth Rogoff (1989) call “constant recontracting”—contracts served more as guidelines than ironclad commitments to be honored regardless of the situation.77 Under these circumstances, the concept of default becomes somewhat blurred. Few contracts were fulfilled to the letter. Similarly, no contract was completely repudiated. Many fell in an intermediate category: some parts were observed as agreed, and others were renegotiated as needed. The structure of the contracts opens a window into how this uncertainty was managed. Given how casually clauses were treated once a contract had been signed, it is remarkable that both sides went to great lengths to stipulate what would happen in certain eventualities. A large number of loans contain clauses trying to account for contingencies that might arise—a delayed treasure fleet, nonperforming tax stream, or sudden need of liquidity on the part of the king. If the events triggering these clauses occurred, payments were rescheduled, and interest rates were reduced or increased depending on the situation.
Philip II and his bankers were contracting in a highly uncertain environment. They were fully aware that the future could bring a wide variety of situations, and had developed formal tools to deal with them. Some contingencies, like a delay in the arrival of a treasure fleet, could be reasonably expected, written down, and planned for. Others, like the riot of the Morisco population that destroyed the silk industry in Granada in 1568, were virtually impossible to anticipate. Yet others were distinct possibilities, but probably too damaging to set on paper. It is hard to imagine, for example, any royal official drafting a contract that began with, “Should our Great Armada be completely destroyed by our enemies….”
When a contracted-on contingency was triggered, payments were rescheduled and interest rates were modified. The essence of bankruptcies was no different. When Castile’s finances were affected by a major, unforeseen event, both the Crown and bankers understood that a restructuring was necessary. Just as with the contingency clauses, maturities were lengthened through a bond swap, while returns were reduced accordingly. The sovereign debt literature calls this type of default excusable since the ruler is not behaving opportunistically (Grossman and Van Huyck 1988). Such defaults usually result in moderate principal reductions and a quick resumption of lending; creditors do not hold the borrower responsible for the default, and hence do not exclude them from capital markets for lengthy periods. Excusable defaults must be triggered by observable events outside the control of the borrower. In Castile’s case, these were large shortfall in silver remittances or the combination of several military setbacks.
Bankers knew that they were financing risky military ventures and that large, negative shocks to the king’s fiscal position were possible. Anticipating them, they charged a premium for their loans. This generated relatively high profits in tranquil times. Once a bankruptcy was triggered, bankers could afford to postpone collecting on their loans and reduce the interest rates. In effect, the bankers offered insurance to the king, collecting premiums in good times and paying out in bad times. We show that Philip II’s defaults were excusable and, in all likelihood, largely anticipated by his lenders. This explains the moderate and quick settlements reached as well as the continued participation in the market by the same banking families over a period of decades.
THE MODERN ANGLE
Throughout our work, we have collected more data than could have ever been accessed by the king and his ministers at any given time. We set fiscal figures in relation to macroeconomic aggregates that were unknown at the time. We compute measures of debt sustainability and loan yields using methods that were not developed until centuries later. It is only fair to ask whether our findings suffer from a problem of perspective. Might our results be far from the mark because we use anachronistic tools to evaluate economic behavior?
Our first point is that the financial sophistication of the Crown and its bankers should not be underestimated. The clauses in the asientos, for example, make it clear that the concept of present value was well established. Compound interest, although seldom used because of usury restrictions, was similarly well understood. Annuities and perpetuities were correctly priced, and even took into account the partial period between issuance and the first interest payment. This should allay concerns over our use of present value formulas to calculate the profitability of individual contracts. Even if contemporaries could not work out the full valuation of the most complicated contracts due to a lack of computing power, all they would have missed out on is a fine ranking between alternative types of instruments. Whether a contract was profitable or not was apparent all along.78
Sustainability is a different matter. There was no obvious understanding of the relationship between aggregate debt and fiscal capacity, let alone of what constituted a sustainable debt path. It is, however, not necessary for decision makers to have been aware of these concepts. If Castilian debts were sustainable, the Crown should have found itself with enough cash to service them. If they were unsustainable, it would have run out of money. The appropriate fiscal adjustments could be directed by simple observations of the year-over-year financial requirements. Despite our modern tools, our conclusions are mere statements of fact, and hence do not rely on the state of knowledge at the time.
BEYOND FINANCE: POLITICAL AND ECONOMIC CONSEQUENCES
Our discussion so far has focused on understanding Castile’s system of sovereign finance and explaining the defaults of Philip II. In the last chapter of the book, we turn to the implications for the long-run development of Spain. Castile stands out among its peers because of its ability to issue a large amount of debt while preserving access to capital markets after each of its defaults. These feats, though, have often been singled out as one of the reasons that held back Spain’s economic development. After all, Castile entered the early modern age as a thriving economy and fearsome military power. Two hundred years later, it was a shadow of its former self, an economic also-ran, and its Crown was being fought over by rival European powers in the War of the Spanish Succession. Spain’s economic performance would not catch up with comparable European countries until the last third of the twentieth century. What went wrong, and did government finance play a role in it?
Despite stereotypes to the contrary, the government institutions of Castile in the early sixteenth century were better than those of most of its competitors.79 Kings were fairly constrained throughout the sixteenth and seventeenth centuries. There was no real feudal system, and the merchant elites of the Castilian cities wielded a large amount of power through the institution of the Cortes, their representative assembly. Among other prerogatives, the Cortes had the ability to veto tax increases and limit the issues of long-term debt.80 Without reaching the level of independence of English common law courts, the judiciary was also fairly independent, while dispensing justice effectively.81 Early on, the Castilian state exhibited all the markers that the new institutional economics associates with successful economic outcomes. Yet after a relatively brief period of splendor in the mid-sixteenth century, Castile entered a phase of long-term underperformance.
One line of argument blames the “decline” of Castile on the fiscal mismanagement of the Habsburgs and excessive imperial ambitions. This implicitly accepts the conventional wisdom about Castilian institutions. Unconstrained monarchs—the reasoning goes—were allowed to run up huge debts while spending the proceeds on unproductive wars. The resulting fiscal pressure distorted the economy, leading to an inferior long-run outcome. The problem with this story line is that its first premise cannot stand up to a closer look: Castilian kings were just as cons
trained as any other early modern monarch.
There was nonetheless a loophole. Medieval law granted the king exclusive control over the taxing and spending of mineral resources. While this was usually a prerogative of little consequence, the discovery of the silver mines in America made it critically important for Spain. Its kings suddenly gained access to a large source of revenue—one that was not subject to the control of cities, nobles, or merchant elites. Silver taxes could be pledged as a source of repayment for asientos, allowing monarchs to leverage themselves and undertake large military adventures without much supervision or challenge from the Cortes. Part of the institutionalist assertion, then, survives in modified form: Castilian institutions were not “bad” at the beginning of the sixteenth century, but their quality deteriorated because of the silver discoveries.
We next challenge the second premise of the contention: that the debt load of the state crushed the Castilian economy. Europe after 1500 saw only a few bids for supremacy; Habsburg Spain’s was one of the more determined ones. Paul Kennedy (1987) famously argued that imperial overstretch—an excessively ambitious program of territorial expansion and military buildup—doomed powers such as Spain (and many others). According to this view, the cost of empire eventually undermined the dynamism of the domestic economy. The growing gap between imperial ambition and fiscal resources led first to the accumulation of debt, and then to default. To test this claim, our starting point is a set of international comparisons. We take three other early modern powers—England, the Netherlands, and France—and analyze their fiscal situations at the height of their powers.82 In each comparison, Castile’s finances are either unremarkable or even appear in a favorable light. Notably, English debt burdens were always higher than Castilian ones, while sustainability indicators were lower. There is no evidence that Britain or any other early modern nation for that matter exhibited greater fiscal responsibility than Castile under Philip II. Even if institutions were far from optimal by the end of the sixteenth century, it is not clear that they produced fiscal outcomes that differed much from those of other powers.
If the fiscal situation of Castile was not fundamentally different from that of other early modern powers, why did the Spanish juggernaut lose momentum from the seventeenth century onward? Silver did much to stop the drive toward state building that lay at the core of British success (Brewer 1988). Equally important was the fragmented system of local and regional political power, which resisted each and every attempt at meaningful centralization (Grafe 2012).
A third, though equally crucial factor stands out: Britain won its wars, while Spain lost many. Battlefield success was not predetermined; luck—emphasized by Napoléon as the single most important attribute of a good general—plays a critical role. Both France and Spain defaulted frequently, while Britain did not—and it triumphed in the end. We argue that causality goes in the opposite direction of the one implied by imperial overstretch. Spain and France lost out as a result of military misfortunes, such as the Armada and the disastrous invasion of Russia. Britain, on the other hand, got lucky. Had Waterloo turned out differently, Britain—having accumulated debts equivalent to more than 200 percent of GDP—would have defaulted (and lost a good deal of its empire), too. Throughout the book, we explore some of the determinants of military outcomes and ponder whether better fortunes on the battlefield might have resulted in a different ending for the first empire on which the sun never set.
THE BOOK’S PLAN
In chapter 2, we provide a brief history of Castilian ascendancy from the late Middle Ages through the end of Philip II’s reign. Chapter 3 describes the fiscal institutions and borrowing instruments available to the Crown, and presents our asiento data in detail. Next, we start answering our four core questions. Chapter 4 addresses the sustainability of debt, while chapter 5 deals with repayment incentives. Chapter 6 looks at the profitability of banking families, and chapter 7 analyzes the role of contingent scenarios and nature of the defaults. Chapter 8 supplies international comparisons and examines the impact of debt leveraging on the long-run development of Castile.
1 The documentary basis of our story consists of the asientos signed in Madrid, the account book of the Di Negro–Pichenotti partnership, and Gio Girolamo’s master account book. These allow us to establish the dates and amounts we report, and calculate the various yields and rates of return. The remaining details, whenever not specifically referenced, are fictional. No letter exchanges between the Italian and Spanish bankers have survived.
2 The master account book—libro mastro—of Gio Girolamo is preserved in the Archivio Doria di Genova (ADG), Inventario Doria, 192. The capital and profit figures cited here correspond to the 1596–98 period.
3 Throughout the book, we will refer to the bankers by the names that appear in the archival documents. Most of these are Hispanicized names, like Nicolao De Negro. On occasion, the original Italian, German, and Portuguese names are preserved. The family name is always written in the Spanish form De Negro rather than the Italian Di Negro.
4 Several loans were concluded with bankers residing in Genoa and Lisbon. The Fugger, some of the best-known financiers of the time, did not have a family presence in Madrid for long periods. Even during the 1575 bankruptcy, they chose to conduct all negotiations through their agent, Thomas Miller.
5 Archivo General de Simancas (AGS), Contadurías Generales, Legajo 92. “El dicho Nicolas de Negro, asiento tomado con el sobre 379,039 escudos 11 sueldos 11 dineros que provee en Italia y 90,960 ducados 8 sueldos y 10 dineros en esta corte para servicios de su majestad.”
6 The ducat, named after a Venetian gold coin, was the Castilian unit of account. In sixteenth-century Castile, coins with a value of 1 ducat were seldom minted and did not circulate widely. The most common form of currency were silver coins, minted either in Spain or its New World colonies. Ducats remained the standard unit of account used in official business. The average loan was just under 200,000 ducats, while the Crown’s budget toward the end of the sixteenth century averaged 10 million ducats. Unskilled wages at the end of the sixteenth century in Madrid were roughly one-quarter of a ducat per day (Hamilton 1934). For more details, see chapter 4.
7 Agustín was a common name within the Spinola family. The one who partnered with De Negro was already lending in 1578.
8 This was Marshal Tribulzio’s advice to Louis XII as he prepared to invade Italy (Ferguson 2001).
9 Establishing separate partnerships for different ventures facilitated accounting, while offering some protection in a world without limited liability. The master account book of the Di Negro–Pichenotti partnership is found in ADG, Inventario Doria, 193. This book was first identified by Giuseppe Felloni (1978). Our description closely follows his account.
10 AGS, Contadurías Generales, Legajo 92. “Los dichos Agustin Spinola y Nicolas de Negro, asiento tomado con ellos sobre 90,000 escuds que se han de proveer en Milan y 112,500 ducados en estos reinos.”
11 Since the loan was delivered in Milan, these were Italian ecus, each equivalent to 1.065 ducats in 1596.
12 We calculate the rates of return on the basis of the cash flows implied in the contractual clauses. For a detailed description of our methodology, see chapter 6.
13 There is some evidence that exchange operation gains were excluded from the profits passed on to retail investors. In the Pichenotti–Di Negro account book, the ecus are valued at the exchange rate agreed to between the king and Madrid bankers rather than at their metallic content. This suggests that the Madrid bankers kept the profits obtained in the exchange operation.
14 Ambrosio Spinola was the largest lender at the time. With the ramp up in military pressure, he began to suspect that the Crown might default, and delayed or failed to make promised disbursements on existing loan contracts. Carmen Sanz Ayán (2004) used the correspondence of the Marquis of Poza with Cristóbal de Moura, Philip II’s closest minister, to document the maneuvers and threats used by Poza to make Spinola hand over the promised
funds.
15 For an excellent biography of Philip II, see Parker 2002.
16 On Philip II’s management of the Invincible Armada, see Mattingly 1959.
17 The structure and protocol of the Habsburg court was modeled on the Burgundian one, which had been imported by Charles V. The sumiller de corps attended to the personal care of the king, which included handing him a towel and water basin every morning, serving him dinner, and pouring him his cup of wine. Sumiller is, indeed, an adaptation of the French sommelier. Sumillers were far more than personal servants; all of them held high government offices. Their power and influence was greatly increased by the unfettered access to the king afforded by their court position (Martínez Hernández 2010).
18 Interestingly, Carl Schmitt illustrates his point by using a scene from Friedrich Schiller’s Don Carlos, in which the fictitious Marquis of Posa is allowed immediate access to Philip II. Thereafter, events take a tragic turn.
19 For a description of the role of Don Cristóbal de Moura in the last decade of Philip II’s reign, see Martínez Hernández 2010.
20 For contemporary accounts of the sack of Cádiz, see De Abreu 1866.
21 All summary figures for short-term debt are calculated on the basis of our asiento series, described in chapter 3. For alternative figures, together with a chronological description of events, see De Carlos Morales 2008.
22 “Cada día boy descubriendo contra estos jinobeses casos, que si a S. Mg. y a sus ministros no nos combiniese cumplir nuestras palabras, no me bería harto de su sangre” (cited in Sanz Ayán 2004).
23 The Spanish term, desempeñar, means to free up the revenue streams that had been committed to service asientos. Technically, since the loans were converted to long-term bonds, their service was merely switched to different revenue streams at lower interest rates. For a detailed discussion, see chapter 4.
Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World) Page 6