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/
One mans take…….
Our current economic situation is analogeous (sp) to Vietnam. After the war is lost, as this one surely will be, both sides will claim their various “if only we would have done this” policy would have surely worked. Spend more money, screw the rich, live within our means, etc. Either way, we’re gonna be on a rooftop in Saigon eventually. If you think that the GOP answer of “cutting spending” doesn’t risk spreading the war, I think you minimize the soup we’re in. I’d comment on Dems, but I’ll hold my thoughts. They already know everything, and, more importantly who to blame.
WSM, I humbly submit that the answer to your question is there is NOTHING that can be done to balance the Standard Of Livings between “us” and “them”. I know that isn’t the exact question you asked, but isn’t that really where the rubber meets the road? It’s unfortunate (to me) that so many people choose to blame this inevibility on the well meaning policy (or grasping at straws) of others.
Anyway, good luck investing all!
wsm, I didn’t accuse you of anything. But I guess being called an idealogue beats being called an ASS so thanks for the upgrade.
Your link regards federal income taxes only. Your comment in the post to which I responded stated “Also, the top income earners already pay 80% of taxes collected. How much more should they pay? Should it be 90%? 99%?”
Your link does nothing to support that statement- it doesn’t even discuss “taxes collected”- it discusses federal income tax receipts.
And of course, you never did define top income earners so I guess you could have meant top 20%, and I guess if you only look at federal income tax receipts, your statement becomes more accurate, but I’m not sure it supports your implied policy prescription of tax cuts for the “top income earners” as a way to avoid going the way of the Spanish Empire, which, of course, was the topic of Jim’s post. I tend to think of top income earners as top 1% because that’s when the disparity gets so wide. Top 20% brings an awful lot of earners into the picture if your link’s stats are correct.
So if what you meant was the top 20% of income earners pay too much of the tax burden and should have their tax rates cut to make it more “fair” then I still disagree. Even if that makes me an ideologue (or an ASS).
@ southof8:
Again, please stop putting words in my mouth.
Once and for all, I absolutely did not even approach coming close to remotely insinuating that “the root of our national debt is that we over-tax the top income earners.” That argument (your quote, not mine) does not even make sense.
As for your accusation of my falsifying statistics, it is quite simple to go out and find any number of sources supporting this fact. Here is one example: http://www.ntu.org/tax-basics/who-pays-income-taxes.html
So yes, it actually is true.
Finally, I did not “demand to know” if top income earners should pay more. Rather, I rationally posed the legitimate question of what is the right percentage? Is it 80, 90, 99??
I am posing legitimate questions, seeking legitimate answers. You are accusing me of being an idealogue. Please look in the mirror.
My wife and I just returned from a 2 year road-trip through Central and South America http://chanatrek.com/. Throughout the trip, we saw the result of centuries of Spanish excess, built heavily from the blood and sweat of the often enslaved indigenous populations, and when too many of them died, some very unlucky imported slaves. We couldn’t help but notice the parallels between old superpower Spain and modern-day superpower USA. For old Spain, eventual decline resulted from misaligned priorities such as bloated expenditures on fabulous churches, gold and other wealth being funneled back to the Spanish crown while maintaining slow or non-existent improvements for most of the indigenous population, and in general, treating the rest of the world like it’s own personal treasure chest to be raided.
There are a few unpleasant parallels we drew with today’s USA: the super-wealthy becoming richer but contributing less, large projects that accomplish nothing for most people, sections of the economy out of balance with what people can actually afford such as the costs of healthcare, higher-education, or unsustainable entitlement programs. Lastly, just like Spain, we are an overextended, militarily active superpower. I’m sure there were many people in old Spain who also firmly believed their military expenditures and conquests were all absolutely necessary. History makes a different judgment. Jim, your parallels are right on the mark. Thank you for helping us to see we are not as smart as we think we are. Our country has all the answers it needs to continue to be great. I just wish our leaders would pay attention better, listen more, and actually lead us where we need to go.
Just want to include a quote from a great American common man. “With great power comes great responsibility”. Come on guys, Uncle Ben to Spiderman.
Jim; Wonderfull explanation of how power & money eventually leads to the downfall of great powers. I will certainly consider this aspect when reading history. Our spending is clearly out of control, and neither party wants to lose the entitlement vote, because there are so many votes there. I do not begrudge the wealthy, for they or their ancestors had vision, lack of modern societal laws, and guts. The most wealthy made fortunes, lost fortunes, then pulled themselves together to make new fortunes, all in a single lifetime. I can admire that. A lot of philantropy comes from wealth, Yellowstone & Acadia National Parks, Carnegie Hall, etc. America supports too large a military, imagine what a single naval aircraft carrier group costs, then multiply that by 12. We have a chance to fix one of our problems, Social Security. First, get the cheats out of the system, make it a supplemental retirement program for the workers who were forced to pay into it. Leave the caps in place, but have every dollar earned above the cap pay 3% by the employee, employer is exempt from taxation beyond the cap, benefits would be calculated based on the cap, no more congressional raiding of these funds either. The masses gat their wish to further tax the wealthy & we save a needed program. It does seem unfair that the common man/woman pays this 6.2% tax on all earned income, whereas the very highly paid presently pay that tax off within the first week of any year, then effectively get a 6.2% raise for the next 11 months. Our current path will leave America broke, strife with civil war, and our borders a lot different from what they are now, in 100 years. God Bless America. Fred
Easy read on Jim’s above history (and a few more examples – as it’s a book) in Niall Ferguson’s “The Ascent of Money – a financial history of the world” Penguin Press 2008 ~$14-16 in paperback or in the library…
Viwi, I generally agree with you. But note that it’s not just the poor who have had virtually no increase in their income- its the bottom 95% of the country. For 95% of workers, their incomes have been stagnant, but the cost of healthcare has risen 10-15% a year (as any small business owner can tell you who tries to provide health insurance to its employees), the cost of education is skyrocketing, gasoline prices have risen dramatically over the last ten years, and until 2007, the price of housing was rising dramatically.
The solution is simple- everyone has to pay more taxes and expect less from government, and the government has to spend less money. But when the top 5% of earners say the other 95% should bear a greater burden because “we pay 80% of the taxes” it’s a non-starter. Precisely where is the 95% goiing to come up with the money if they’re living on the edge as it is? There is a reason the average 55 year old has less than 100 grand in retirement savings. He doesn’t make enough to save And my friend, it is not just the factory workers. It’s 95% of the income earners- teachers, lawyers, engineers, nurses, everyone. And when they hear (I hear) someone complaining that the top 1% pay more than their fair share and shouldn’t be asked to pay a penny more, I wonder what kind of feudal society we’re becoming, and what we’re willing to leave to our kids to sort out.
So we add another trillion to the deficit and around and round it goes.
to southof8
All the numbers, which are quoted do make sense. Rich people get richer … However, let’s look a little bit deeper. The reason why poor people in this country do not get higher raises is because there is no reason for this. Manufacturing jobs in the US can’t compete with those in China, so all low-paid jobs stay low paid. If you want higher income in this country, get a better education (JD, MD, MBA, PhD). Not the one, which can be considered a hobby, but the one, which is in demand and requires special training. Sounds simple, however, I do not see too many people willing to do it.
I do not understand why taxes should be raised: they are reasonable in this country. However, I would argue that higher alcohol, tobacco and gasoline taxes are needed. First two are because the current loss (mostly, healthcare expenses) due to alcohol and tobacco is greater than the tax we get from those. The last one is just to encourage people to be more responsible. It will hurt in a short-term (that is why it will never pass through Congress, where people have 2-year term), but is good in a long-term.
How to manage the budget? We have to live in according to our means. I actually like the fact that banks stopped giving away money to people in the form of loans. They are still loaning money, but to those, who qualify. It is OK that some people do not qualify for those loans, and we have to start living with the idea that it is OK, if we do not get everything we want to. However, I doubt that this idea will be widely accepted, since for many years we were told that we can get everything now and paying (may be) sometime later.
Coming back to the subject of Jim’s article, I do not believe that anything good will happen to the US economy during the next 10-15 years. There is no magic: nothing will happen until the US takes a new strategic course of its economic development. That model, which is based on artificial stimulation of economy through “free” loans, is pretty much dead. Nothing else is on the table, or even being proposed. It will take 2-4 years for this new model to be developed, 2-4 years to be promoted, 2-4 years to be implemented, and X years to get results. Going back to a historical analogy, Spain never recovered to the level of its supremacy (the same is true about Rome, Greece, Egypt …).
I love reading comments on a topic like this, when the readers get really fired-up. It’s sad, but you can tell by reading the comments that Americans are still not at the point where we can have a rational conversation about this. We jump to conclusions about each other’s intentions and sometimes hear only what we want to hear.
Jim wrote another article this Fall that also triggered a lot of responses… most readers (myself included) seemed to think it was a great article.
For those asking Jim to share his plan for an economic strategy, I think he did so in the artice I’m referring to.
Here’s the link:
https://jubakpicks.com/2010/09/28/how-to-fix-the-u-s-economy-first-no-more-baby-steps/
I forgot to note, when I was in college, public university in England was free. So those that got a free education are balancing their books by charging their kids 15 grand a year. Nice.
Did anyone note the proferred explanation for the riots going on in london? It was because public university tuition was going to roughly triple, from something in the neighborhood of $5 grand to $15 grand.
When I was a freshman at the University of California in the mid-80s, the tuition was $453 a quarter- $1359 a year (they call it fees to keep alive the fiction that public university is free for state residents).
For the academic year started September, 2010 it is $11,300.
That’s the plan- pull up the drawbridge behind us, once we’ve reached the castle, while our children are fish food for the alligators in the moat. I think Milton Friedman called it the self intersted rational actor.
Call it what you want, just don’t raise my taxes.
There are many ways to fix this, but I think if you read Jim for any extended period of time, he hints at the issues, but won’t come out and say what govenments should do. He is just trying to make money off what they will do. But another Jim quote seems closely related to this article and the timing surrounding it.
“For U.S. bonds the proposal from the Obama White House and Congressional Republicans to add $1 trillion in debt over the next two years to the U.S. balance sheet by extending the Bush tax cuts has just put a capstone to the feeling that the U.S. government doesn’t have an inkling of a plan for dealing with the U.S. deficit.” – J. Jubak
sure you did wsm. First you called Dave and Scorp names because you don’t agree with them and then you complained that the top income earners already pay 80% of taxes collected (which is not true) and demanded to know if anyone was suggesting they should pay more. (Which, of course, I am demanding.)
At least have the courage to back up your argument once it’s challenged.
By the way, what makes you think the “top income earners” pay “80% of taxes collected”? I challenge you to post any publication that backs up your claim.
Given that the working class in this country pay all manner of taxes every day- sales taxes, payroll taxes, license and registration taxes, property taxes, etc., I very seriously am curious as to the source of your facts.
@ south
Nowhere did I even approach coming close to remotely to arguing that “the root of our national debt is that we over-tax the top income earners.”
I was simply rejecting kowloon & scorp’s premise of a “failure to impose adequate taxes on the wealthy & big business”. This is also the answer to your eloquently posed question of “WTF does corporate tax rates have to do with it?”
To be clear, the article discusses concentration of income, not concentration of wealth.
http://www.newyorker.com/talk/financial/2010/08/16/100816ta_talk_surowiecki
WSM, I don’t think Dave and scorp assumed anything. They commented on the obvious. Perhaps you haven’t noticed we’ve been embroiled in two fairly expensive wars the last 8 years or so.
I’m surprised it hasn’t occurred to you that jobs have been offshored because workers in china and India and other third world countries will work for ten times less than American workers. WTF does corporate tax rates have to do with it?
But keep convincing yourself that “social spending” is the cause of our $14 trillion national debt, not the tax cutting that started in 1980, when the national debt was barely $1 trillion.
By the way, in a summer New Yorker article, research by two economists revealed just how much income is now concentrated in the wealthy and super wealthy. Among other tidbits- the top .1% of income earners earn as much as the bottom 120 million peopole. Between 2002 and 2007, the bottom 99% had real income growth of 1.3% a year (no wonder we’re all living on credit) while the top 1% had 10% annual income growth, representing 2/3 of all income growth during that period. In 2007, the top 1% earned 27% of total income. That’s right, nearly 25% of all income earned in America in 2007 was earned by the top 1%.
The income among the top 1% has doubled the last 25 years. Among the top .1% it has tripled. During that time, the income tax rates for the top 1% has been cut by more than half- in fact, by almost 2/3.
The country (not just the government) literally lives on credit so the top 1% of all earners can live like Spanish monarchs. How much did Dick Fuld’s toilet cost? $800,000?
And you argue the root of our national debt is that we over-tax the top income earners. Wow.
@labradore:
Thanks for actually putting forth some suggestions. I think those are quite good.
As far as “I’ll give you TARP may have helped…” – I was never arguing that TARP was good. I agree that it has been an abject failure from a stimulus standpoint.
Also, “trillion dollar non-tax-increase…” I’m not even sure what you’re referring to here?
wsm:
I may be missing something, but we hear over and over again that most of the stimulus funds are located on big banks balance sheets. They’re not loaning the money out and therefore it’s not stimulating the economy. I’ll give you that TARP may have helped maintain confidence in the banks and keep them afloat, which has arguably forestalled further panic, but it’s not stimulating much of anything in the real economy. As for the trillion dollar non-tax-increase: Jim outlined in a previous post that the first-year return on that investment will most likely be $74 Billion in additional GDP growth and added growth will decrease with time. In other words we’re likely to lose 80 to 90% of that investment. The upper class has totally cowed the only government in the last 30 years that supposedly had any ambition to wrest some power away from it.
To answer the question about what needs to be done: the first thing that needs to be done to fix the looming debt and economic crisis, is to form a government that has some hope of actually making structural changes to the economy. That doesn’t just mean taxing the elites at a slightly higher percentage than the middle-class. Next, deregulate small business and level the playing field for middle-class entrepreneurs. Create an atmosphere where they can access capital and where working-class people can realistically attempt to build savings. Remove the huge twin pitfalls of healthcare tort liabilities. Stop distorting markets with huge subsidies in agriculture, energy, and elsewhere. Instead, invest in huge infrastructure projects that will grease the wheels of the economy. Build public transit, next-generation rail-roads and air-traffic control. The message isn’t new. It’s just more urgent now than ever before.
@ scorp & kowloon:
I was hoping Jim might respond, than you guys ASSuming what he explicitly calls for. I think both of you have it wrong.
Corporate tax rates in the US are among the highest in the world. This is why so much economic capacity has moved abroad.
Also, the top income earners already pay 80% of taxes collected. How much more should they pay? Should it be 90%? 99%?
Great read, thanks Jim. “Live within your means” – now there’s a concept!
I think kowloon dave got Jim’s underlying message right;
“You didn’t expressly connect the dots to our endless, costly wars in the Middle East & our failure to impose adequate taxes on the wealthy & big business, but you might as well have.”
I’m with wsm. I’d like to hear Jim’s take on what the proposed solutions are. Not much consolation to know someone’s been in the same situation in the past if we can’t learn from their mistakes and make the tough decisions to avoid the same result.
Thanks Jim for an incredible concise article. History is full in the Rise and Fall of Empires. The future should be no different.
When you have time, I would be interested to hear your views on which Empire in the next Rise.
Muy interesante, Jaime. Thanks for this historical perspective that is so relevant to the current US situation. You didn’t expressly connect the dots to our endless, costly wars in the Middle East & our failure to impose adequate taxes on the wealthy & big business, but you might as well have. The beauty of this historical example is the facts speak for themselves. Political ideologues cannot easily attack the messenger or twist the facts to advance their greedy agenda.
but using history as a guide means this will be one great bull market
Great work Jim. How does that old saying go – “Those who do not know history are doomed to repeat it”?
Definitely appreciate the insight gleaned from the history of Spain.
But just to be clear, since you did not specify any solutions in your article…are you prescribing that the Treasury and Fed should refrain from their stimulative and expansionary policies at this time, resulting in a deep recession?
I am not disputing that this may be the right answer (take the nasty hit now, and emerge in better shape in a few years), but just trying to understand what your proposed solution is, since none was offered.
Jim,
I really appreciate the time you took to research and write this.