The world has a fair deal of experience in dealing with small countries that can’t pay their bills. And the world is gaining more experience by the minute. Greece can’t pay its bills? Put together a funding package that comes at the price of domestic austerity and higher taxes. Ireland can’t pay its bills? (Or actually its banks’ bills?) Put together a funding package at the price of domestic austerity and higher taxes. And when the small countries can’t pay their bills again in a couple of years, go through the process over and then over again until creditors finally agree to take a haircut on their loans.
But what about a huge country, one that is at the center of the world’s economic and financial system, one that can be described as the world’s greatest power, one that controls the world’s supply of the global currency of exchange? What do you do with such a country that can pay its bills but shows no inclination to do so? And instead brazenly asks for more credit?
The world doesn’t have a lot of experience working its way through problems like that. But I think that’s the kind of problem that now confronts the world. The deal between the Obama White House and Congressional Republicans to extend the Bush administration’s tax cuts for another two years at the cost of adding another $1 trillion to U.S. debt says to the world that we have no intention of paying our bills. And pugnaciously adds, So what ya gonna do about it?
I’ve actually been able to find just one example in Western history that sheds any light on situation that the United States and the world finds itself facing. And that’s the multiple bankruptcies and economic decline of Spain in the sixteenth and seventeenth centuries.
In the sixteenth century the Spanish empire stretched further over the globe than any other previous empire. Starting from an Iberian peninsula unified under Castile and Aragon only in 1492, the Spanish empire grew to encompass first the island then known as Hispaniola, then Cuba, Mexico, the bulk of South America except for Brazil, and the islands of Guam and the Philippines. In Europe Spanish monarchs ruled the Netherlands, Belgium, much of Italy and parts of Africa.
And it was a fabulously rich empire. The great silver mines of Peru and Mexico began to deliver a river of that precious metal—supplemented by gold from conquest and mining—as early as 1511. Spain imported 260,000 kilograms of silver and 5,000 kilograms of gold from 1511 to 1550. And that was just the beginning. From 1591 through 1610 the country imported 4.9 million kilograms of silver and 31,000 kilograms of gold. The flood of gold and silver into Europe, a region previously starved for precious metals, was so great that the supply depressed the price for both metals and set prices climbing.
But less than half of this silver and gold remained in Spanish hands. About a third went to China to pay for Spanish imports of silk, porcelain, and other luxury goods. The remainder went to pay for Spanish imports from the rest of Europe. The Spanish economy itself was an increasingly uncompetitive hulk. Spain lived beyond its means supported on that wave of New World silver and gold.
And that included the Spanish monarchy. Silver and gold poured in but running an empire is expensive when it includes almost constant war in Europe with a constellation of national enemies that included France and England—plus local rebellions in the Netherlands and Italy—plus more than a century of land and sea battles against an Ottoman Empire that moved relentlessly westward after its capture of Constantinople in 1453.
The kings of Spain found it much easier to borrow money than to reform the Spanish economy. But the seemingly inexhaustible flow of treasure from the Western hemisphere encouraged Spanish kings to think they could borrow and repay any sum—and what bank would have had the courage to question the credit worthiness of the most powerful kingdom in Europe. The result was bankruptcy in 1557 that left the Fugger Bank in Augsburg holding the bag.
The circumstances of that 1557 bankruptcy may sound familiar. The bank made the classic mistake of mismatching assets and liabilities: The Fugger bankers took out long-term loans in Augsburg in order to make short-term loans to the Spanish king. Payments on the long-term loans were to come from payments on the short-term Spanish loans. Then in 1557 Phillip II of Spain decided that he had more use for two payments intended for the Fuggers than they did. In effect Spain declared bankruptcy and the bank renegotiated its loans with reduced interest payments and a longer payment schedule.
The same thing happened again in 1575 when Spain stopped paying on its loans again, and in 1596. That last Spanish bankruptcy ended the Fugger Bank and gave lucky Genoese bankers the opportunity to finance Spain.
In a desperate attempt to satisfy its creditors Spain debased its currency, replacing silver and gold in its coins with copper in 1599. That led to runaway inflation in the first half of the seventeenth century. From 1625 to 1650 prices climbed by 40%.
By the second half of the century the Spanish economy was in rapid decline as high taxes on peasant producers—just about the only class that could be forced to pay significant taxes—led to a decline of food and wool production, and high inflation made Spanish exports uncompetitive against imports from England, France, and the Netherlands.
And by 1675 Spain, once the greatest empire in the world, was ready to be picked apart by the France of Louis XIV.
No International Monetary Fund ever intervened to discipline Spain. No internationally coordinated action by the world’s central bankers ever stepped in to reset exchange rates or to restructure Spanish loans. No heads of state lectured the Spanish treasurer on the evils of an unbalanced budget. In fact there was hardly an international financial market at all in the way that we know it today.
But nonetheless today we recognize the mechanisms that worked during the Spanish crisis. Inflation punished the Spanish economy for its wild expansion of the nation’s money supply through massive inflows of bullion and bank loans from the Fuggers and the Genoese. Debasing the currency led to even more inflation, a general unavailability of investment capital, and the gradual loss of Spanish markets to foreign competitors. Massive budget deficits led to a dependence on foreign loans that further diminished access to investment capital and led to destructive government policies focused on nothing more than servicing the crown’s debt.
There’s no one great crisis that I can point to and say, See, that was the point at which Spain passed some threshold. I suspect that great, turning-point crises are reserved for smaller countries. Just because of their size big countries can absorb body blows and bounce back—part of the way anyway The pattern for Spain was one of repeated crises, almost monotonous in their similarity, and occurring just a decade or so apart.
The end result was a decline punctuated by failed efforts at reform that weren’t large enough to reverse the trend.
No other country or financial institution ever had to take Spain to task for its fiscal irresponsibility. No superior authority had to deliver the empire’s comeuppance. The kings of Spain were quite arrogant enough to do it all themselves and over the course of decades deliver their country to economic stagnation.
Was that inevitable for the Spain of the sixteenth and seventeenth centuries? Not at all. Spanish kings could have avoided stupid dynastic wars that exhausted the country, for example. Spanish finance ministers could have forced the aristocracy and the church to shoulder more of the burden of taxation. I can find a dozen potential turning points that led to roads not taken.
And that’s one of the few things that I find encouraging when I compare the financial history of the Spanish empire to the current moment in the United States. Big countries get to be stupid for a long time; they get lots of chances to correct mistakes. That’s not a particularly cheerful thought, but it is the best I can muster as I look out on the current direction in Washington.
But history also tells me that even the biggest countries don’t get to escape the consequences of their actions forever.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/