Between 1557 and 1662, in the middle of dire fiscal crises, the kings of Spain were driven to acknowledge bankruptcy ten times. The default of 1647 throws light on the key operation that marked these events, while also revealing solutions that were astonishingly modern.
War had driven the royal government to the brink of a financial collapse. Even in the late sixteenth century, the enterprising Philip II, steeped in debt, had been unable at times to pay his servants. In 1647, Philip IV and his council of finance found themselves forced to suspend payment on loans from thirty-three contracting bankers (asentistas). The debt amounted to more than 14 million ducats. Now all the revenue which had been streaming out to them as interest on the loans was halted, in spite of the fact that binding contracts linked specific sources of revenue, such as particular taxes, to the loans. The contracts also called for repayment of the principal.
Panic ensued. There was next a general audit, and then negotiations stretching out for nearly eighteen months. The monarchy was “too big to fail,” too important to be allowed to go into an uncontrolled unilateral default, a financial collapse euphemistically known nowadays as “a credit event.” The bankers had too much wealth invested in Spain’s sovereign debt to stand by and do nothing, for in addition to the immense losses for them and the wrecking of their reputations, the failure would have caused a financial meltdown in the great seaport of Genoa, if they had all been Genoese. But as it turned out, only three of the bankers were from Genoa. One was English, one Flemish, and one a Florentine. All the others, twenty-seven of them, were Portuguese New Christians: that is, Portuguese Jews whose families had converted to Christianity in recent times.
Making distinctions, the king’s financial counselors worked to cut deals. The Genoese and two of the Portuguese bankers were exempted from the suspension of payments. Special arrangements with others were also made. But the general solution lay in the crown’s decision to convert the short-term (“floating”) debt to the bankers into a class of select government bonds (juros). Over the next fourteen years, payment on these special juros would go to redeem part of the principal. Thereafter, the payment of interest on the remaining bonds would begin. In effect, the short-term loans were converted into long-term debt. That conversion, however, eliminated the heavy payments on the high-interest loans, thereby freeing the mortgaged taxes that had been pinned to those loans. The freed taxes could now be used as collateral for the raising of new short-term loans.
Meanwhile, the special bonds issued to the bankers were meant to earn a yearly interest of 7.15 percent, rather than the flat 5 percent of the ordinary government bonds. The bankers were also given the right to sell their juros on the open market. But in this, apparently, they were not very successful. The interest of 7.15 percent was seldom paid. And James Boyajian, the historian of these proceedings, sees wholesale fraud in the affair. Toward the end of the seventeenth century, the heirs of the bankers were still creditors of the crown for princely sums.
Was it the case that the proceedings added up to little more than fraud? Possibly. Yet the solution had a completely modern spin. We speak of “managing” or “restructuring” sovereign debt. Spain’s bankers and ministers did just that: They managed a default. In our day, to manage a default is to convert the original debt into new debt with the same value. The new debt, however, now carries a lower rate of interest, and its maturity is extended over a longer period of time.
AUGSBURG’S TOP BANKERS, THE FUGGERS, lost money in their relations with Charles V, but it must have been a fraction of the profits garnered, over more than thirty years, from the rights that had been made over to them—rights over the silver and copper mines of the Tyrol, and over runs of taxes even in faraway Naples. The banker Hans de Witte committed suicide over his impending losses when his chief debtor, Wallenstein, was dismissed as the supreme commander of the Imperial army. The risk of loss was built into the nature and ventures of big banking, above all in dealings with powerful princes. But it was also the case that the resulting profits were fit for the ransom of kings, and no one knew this better than the bankers themselves.
From the time of his first bankruptcy, in 1557, Philip II of Spain made it clear that financial relations with him could be dodgy. His Genoese bankers saw the revenue that was meant for them—taxes linked to the repayment of their loans—exchanged for the government bonds known as juros. The revenue thus released, such as taxes on wine and salt, would then be used to raise new short-term loans of the kind that provided immediate cash and supplies for the Spanish army. Yet this high-handed procedure did not frighten bankers away, nor did the financial crunches of 1560, 1575, and 1596, even when it was claimed that their loans were mired in usury. In canon law they no doubt were. The Genoese clung to the king because they knew that over the longer term the profits to be realized from their ties with him would richly exceed any money lost along the way, or any that might be made from shipping and long-distance trade. More than two hundred years of banking know-how guided their handling of Spain’s royal debt: an expertise gleaned from the Venetians, the Florentines, and their own forbears. They knew about disaster in banking. It had a history. As early as the 1340s, the great Florentine banking houses of the Bardi and Peruzzi had crashed, owing to a run on their deposits: a run set off by rumors connected with the knowledge that they had made a loan of some 1.3 million florins of gold to the king of England, Edward III.
In the late sixteenth century, the reputation of Genoa’s bankers was unrivaled. They ran the international financial fairs at Besançon and then Piacenza. Held four times yearly, and peaking at Piacenza in the period from 1579 to 1627, these eight-day affairs served as clearinghouses for Europe’s biggest bankers and international merchants. Here they raised “baskets” of money, settled accounts, rolled debt over, and discounted foreign bills of exchange. Typically, in a deal, the main lending house—Centurione, Lomellini, or another—would give its name to the loan transaction and fork out the largest share of the sum to be lent. But other bankers and their capital were also brought into the investment, in order to spread the risk. When the kings of Spain defaulted, the bankers would then be forced to deal with depositors back home. But we need not weep for Genoa’s bankers: They flourished on the profits to be made from war. Their arrangements carried privileges not passed on to their depositors, one of the most lucrative being the right to export (and traffic in) specified amounts of bullion, notably silver from the New World. This specie was then profitably exchanged for gold, because silver was much sought after in the Near East. Next, the moneymen from Genoa could also count on the hefty profits from the fees imposed on exchange transactions, such as when they paid out their loans in Antwerp, Brussels, or Vienna. Here, if it was wage money for soldiers, their contacts frequently paid the loans out in kind, in food especially, but also in weapons and other supplies. Such payment also resulted in profit, and this was partly passed on, in the form of lower fees, to the bankers in Madrid.
The heyday of the New Christian Portuguese bankers at the court of Spain spanned the years from 1627 to 1650. Most of the Genoese banking firms, in 1626–1627, were pushed to one side, more or less suddenly. King Philip IV was straining to cut expenses on loans, and the new breed of men from Portugal made this possible. Relying on far-flung networks of relatives and acquaintances, these men could reach out for more favorable terms to distant Hamburg, Rouen, Amsterdam, Constantinople, Venice, and even Brazil, where Portuguese Jews and other new converts dominated the sugar and slave trades. With these informed contacts, Madrid’s New Christians were able to offer the crown better loan terms and lower fees for distant exchange transactions—reason enough to move the king’s banking business from the old Genoese houses into new hands.
But if the kings of Spain survived more than a century of warinflicted debt, the like could also bring regime change, particularly in smaller states.
One of the most famous of all Renaissance dynasties, the Medici, owed its origins to war and debt. In the early
1430s, the Republic of Florence, already in grave financial troubles, edged into a war of conquest with the neighboring city-republic of Lucca, plunging Florentines more grievously into debt. The war put a terrifying strain on the collection of income and property taxes, and cast the urban oligarchy into a political crisis. Florence’s richest banker, Cosimo de’ Medici, now came to be seen as a mainstay for the city. A strong faction gathered around him. Knowing how to deploy his money among leading citizens and supporters, he maneuvered untiringly to increase his personal political power. By working hand and glove with cronies in the city’s political councils, he and his followers manipulated elections to government office over the course of a generation (1434–1464), always drawing more and more power around the banker and his family.
Cosimo’s direct male descendants then used their inherited wealth and authority to devote themselves to politics full-time, to buy (with cash) princely position in the Church, to abandon banking, to control Florence’s chief offices, and to turn the Florentine Republic into a princely despotism. The most famous of them, Lorenzo the Magnificent (1448–1492), even pilfered large sums from the public till. The ascent of the Medici house and the snuffing out of Florentine republican liberty went back to an insane war with Lucca, to a credit crunch, and to a banker who also turned out to be a ruthless politician.
THE PUBLIC FINANCE MACHINE
The heart of Europe’s most effective public-finance machines was the consolidated or unified funded debt: a brilliant invention because it facilitated borrowing for war, while also drawing subjects or citizens into supporting the state by investing in it. Henceforth the state would be in debt to the more prosperous parts of its population, individuals as well as corporate groups. In practice, this involved the payment of periodic interest, not the doling out of large sums to redeem or buy back shares in the debt. Now, too, the state could raise short-term loans, issue high-interest bonds for these, and even pay back the principal by pledging particular taxes or rights to the short-term lenders. Specific streams of revenue, such as the excises on meat, salt, grains, or wine, were mortgaged for a year or two. This utilizing of the integrated public debt gave remarkable mobility to the state, as it rushed to employ the newfound cash (or credit) in the fighting of its wars.
There could be no funded debt without taxes and rights of the sort that generated income, for these alone produced the cash to pay interest on, or redeem, government bonds. Here, in tax revenue, was the other half of the public-finance machine.
Up to about the mid-thirteenth century, rulers had only the income from their domains: their own lands, feudal dues, and the sums reaped from the local administration of justice. Receipts from local tolls also entered this picture, and some princes, like many free cities, claimed a monopoly over the ancient salt tax. In Spain, a religious frontier, the crown was entitled to a large share of church income, intended for use in warfare against Muslims.
In the fourteenth and fifteenth centuries, the armed extension of territorial boundaries, animated by richer economies and swelling ambitions, raised expenses and demanded a thickening stream of revenue. But nobilities and urban elites used their political weight to avoid taxes on land and income, or to have these treated as levies of last resort. The galloping rises in public revenue thus came chiefly from the so-called indirect taxes: customs duties and levies on every kind of foodstuff, especially on beer and wine, meat and grains, as well as on manufactured goods, notably cloth. These were levies that always weighed heaviest on the poorer classes. A tax on flour, meat, salt, or wool more easily emptied the pockets of the farm worker or the urban craftsman and day laborer.
In generalizing about taxes, we must bear in mind that they varied considerably from one region or country to another. Denmark, Hungary, Bohemia, and parts of Austria and Germany, such as Brandenburg and Saxony, made a point of privileging noblemen and exempted them from direct taxation. The French and Spanish nobilities also enjoyed major tax immunities, and the tenure of office exempted many thousands of rich bourgeois from direct taxes. The French taille of the sixteenth and seventeenth centuries, a direct tax on property and income, was levied principally on rural landholders of non-noble status, and in Burgundy no nobleman was ever touched by it. Moreover, much taille income in France’s frontier provinces (the pays d’états) remained there, and did not begin to reach the king’s coffers in substantial sums until the 1630s and 1640s. One Castilian tax, the servicio, was paid solely by commoners (pecheros), marking a clean distinction between them and noblemen.
Moving hand in hand with the incidence and changing face of war, the rise of regular taxation began in the fourteenth century, with sales taxes that were meant to be temporary, such as the aides in France, the alcabala in Spain, the excise in parts of Germany, and their equivalents in the Italian city-states. All these raised the prices of food, drink, and goods. Here and there a hearth or poll tax also saw the light. The costs of war gradually turned the sales taxes into permanent levies, which came to be seen as constituting “ordinary” taxation. Parenthetically, since the ports on the Baltic Sea took in very profitable customs duties, they would be fiercely fought for by the Swedes, Danes, and Poles.
The wars of the sixteenth and seventeenth centuries led to an incessant quest for more revenue, as we have noted, so that at certain moments in wartime Spain, France, and Germany, even noblemen felt the fiscal pinch, such as in emergency “contributions” or the freezing of interest payments on their shares in the public debt. In Germany, the Thirty Years War had such an impact on princes, minor though they might be, that they began to hound their reluctant Reichsstände (territorial assemblies) for the funds to have their own standing armies: the most costly of all government undertakings. From this time on, in military matters, this would be the main fiscal direction for Europe, and Brandenburg-Prussia soon moved to the forefront of the quest for armed force. More than ever, taxes too came to hold the center point of concerns for the life of politics.
Here, in short, was the birth of the modern state: a tax-hungry polity. And it might be an absolute monarchy, best profiled in eighteenth-century Prussia, or a constitutional and limited monarchy, notably England after 1660, where Parliament was crucially involved in the business of levying taxes. Venice to one side, the new Dutch Republic was the outstanding example of a republican tax-seeking state.
Armies and taxes, then, were the cardinal concerns of the early modern state, and this of course would also include navies where called for. Tax money was the first and most urgent business of the state. With taxes it paid for war, and with its armies the state sought territory, security, influence, commercial interests, and new sources of taxation. Yet it farmed taxes out to financiers, thus putting one of the chief functions of the modern state, the collecting of taxes, into private hands. Here a crucial aspect of administration was alienated, and the state lost both income and degrees of control. To be sure, tax farming put cash up front for the debtor state, enabling it to get on with its war-making for a while longer. But the farming out of taxes was always an expedient, something of a short-term solution, a remedy—though not necessarily seen as thus—for administrative failure; and it was costly, because much of the revenue was drained away in private profit. In the late seventeenth century, England snatched taxes away from the tax farmers and made the collecting of taxes an integral part of the state’s expanding bureaucracy.
SPENDING
France’s Italian Wars (1494–1559) carried the crown’s expenses to unprecedented heights, even though its armies in Italy were meant to live largely off the occupied lands. The gap between revenue and spending widened inexorably, and from the early 1520s, agents of King Francis I began to seek cash from foreign bankers at the fairs of Lyon. Some of the sources of royal revenue were offered as collateral. At one point the king was in debt to eighty-seven different Italian bankers, among whom were forty-five from Florence and seventeen from Lucca. The government also started to finance long-term debt by selling rentes, bonds in th
e royal debt, promising a steady return of annual income for buyers. But neither these nor bankers’ loans nor the unencumbered taxes brought in the income to meet war costs. Now, with far-reaching consequences for the French state, ministers began to sell government offices, gradually turning this recourse into an important source of cash. Officials had already hit on this stratagem in the fifteenth century, but it became big business only after 1520 and went on to the eighteenth century.
Yet all the ready cash and credit raised by the different means fell far short of enabling kings to pay their way. In 1559, France’s public debt amounted to 43 million livres: three times its annual income, with interest eating up 8 million livres per year, or over half of yearly revenue. Just the year before, King Henry II had managed to field an army of nearly fifty thousand men, of whom more than twenty thousand were expensive German and Swiss mercenaries. Large numbers in that army, however, would go unpaid. No wonder, then, that in 1559 the crown was squeezed into halting the payment of interest to its creditor bankers and possessors of rentes. It was a declaration of bankruptcy. From this time on, periodically, the government would have trouble selling rentes or securing loans from bankers, unless it agreed to pay exorbitant interest charges.
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