Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World)

by Mauricio Drelichman

  Asientos were a formidable tool in the arsenal of early modern finance. First used by Charles V to finance the bribes that secured his election as Holy Roman emperor, they were underwritten by German, Genoese, Spanish, and Portuguese banking families. They were short-term, largely unsecured loans, with maturities stretching from a few months to a few years. Although more expensive than perpetual bonds, asientos could be combined with transfer and exchange operations that allowed the Spanish kings to access large financial resources on short notice at virtually every corner of their European dominions. Bankers offered them eagerly. Behind the attractive promised rates of return stood the flood of silver that poured into Europe from the Americas through Seville, arriving on the fabled treasure fleets, and the tax revenues of the thriving economy of Castile.41 In a satirical poem, Francisco de Quevedo y Villegas wrote that money was born in the Indies, died in Spain, and was buried in Genoa. He forgot to add that asientos were its birth, death, and burial certificates.42 To explain how Philip II was able to maintain uninterrupted access to credit despite his four defaults, we will need to examine in detail the nature and function of asientos.

  DOCUMENTS AND DATA

  Paper, and yet more paper. The growing bureaucracy of Philip II’s empire produced it in droves, and still the Marquis of Poza happened to overestimate outstanding debt in the 1590s by a factor of two. To examine the basis of borrowing and repayment, to understand the rhythms of taxing and spending, requires information that contemporaries themselves did not have. Today, for countries with functioning statistical agencies, databases containing such information are available at the press of a button. They are vital to apply the standard tools of national accounting and international macroeconomics. Crucially, the underlying fiscal and financial data need to be reasonably complete, and be observed at regular intervals. This was beyond the administrative capabilities of decentralized fledgling national states during the early modern period. As the confusion of the Marquis of Poza illustrates, rulers and ministers often had very little idea of how much revenue they took in, how much they spent, or how much they owed. Our effort to provide a comprehensive assessment of the Castilian system of government finance therefore requires more macroeconomic data than would have been available to the president of the Council of Finance at any given time. One of this book’s central tasks was to assemble estimates of the national accounts of Castile and the details of debts outstanding. The resulting database forms the core of our study.

  Without the efforts of an earlier generation of scholars, our book could not have been written. Our series of revenue, for example, was constructed on the basis of Ulloa’s (1977) monumental effort; his almost 900-page account of royal finances under Philip II was essential for our work.43 Similarly, we compiled the first comprehensive view of Castilian military expenditures by aggregating data unearthed by several military historians, especially Geoffrey Parker.44 Measures of long-term debt and population as well as estimates of national income were also gleaned from the secondary literature.45 Finally, we incorporated into our analysis the results of the investigations that royal officials duly conducted after each suspension of payments—the last of which revealed the nature of Poza’s mistake.46

  Philip II never defaulted on long-term debt, and hence the analysis of his defaults must necessarily focus on short-term loans.47 While sixteenth-century asientos have been the subject of many studies, there is no authoritative source on their overall volume.48 Earlier authors, most notably Felipe Ruiz Martín and Ramón Carande, studied the workings of individual contracts. Despite their detailed explorations, we do not have a comprehensive analysis of asiento terms and conditions, or their evolution through time (Ruiz Martín 1965, 1968).49 These can only be understood by examining the primary sources in detail.

  The early modern Castilian state is known for generating massive amounts of documentation. Until 1561 the court had no fixed seat, and kings often took their documents with them wherever they went. Charles V was the first to find a permanent location for his personal papers, housing them in one of the towers of the castle of Simancas, near Valladolid. Philip II, who keenly understood the value of preserving state documents, decided to establish a proper archive in the castle. On his orders, the architect Juan de Herrera—also responsible for the design and execution of El Escorial—redesigned the building to serve as a repository for royal documents. The castle of Simancas thus became the first purpose-built government archive in the world; its operating instructions, issued in 1588, are similarly considered the first extant set of archival rules. Over time, until its closure in the nineteenth century, the Archive of Simancas became the resting place of all the documentation generated by the Crown.50

  The transfer of documentation to the archive was haphazard at first, and the records of the early days of Philip II’s reign are spotty.51 Starting in 1566, the archive began to work in a highly systematic fashion. Nine boxes, collected by the Contaduría Mayor de Cuentas, contain a copy of every asiento issued between 1566 and 1600, among several other papers. While earlier scholars have analyzed these documents, they mostly relied on the summary description found on the first page of every contract. As we began our research, no scholar had yet attempted a comprehensive coding of the loan documents, which in many cases run to twenty or more pages. In an effort that spanned six years, we codified almost five thousand manuscript pages, clause by clause. The results, presented throughout this book, offer unprecedented insight into the world of early modern sovereign finance.52

  THE ORIGINS OF SOVEREIGN DEBT MARKETS

  Before we turn to the debts and defaults of Philip II in detail, it is useful to ask why debt existed at all. Why did states need to borrow? And how did they acquire the ability to do so? Private individuals had used credit for millennia; rules against usury are among the oldest economic regulations known to humans (Glaeser and Sheinkman 1998). And yet government debt is a relatively recent invention. Neither Rome’s nor China’s rulers contracted government debt on a significant scale; the Ottoman Empire for most of its history did not issue debt either.53 Medieval kings did borrow and occasionally default on their obligations; Edward III allegedly ruined scores of Florentine bankers when he declared a payment stop in 1339. Those debts, however, were private in nature. It was only with the advent of the Italian republics that states themselves contracted debts. Late medieval Europe “invented” government debt as we know it.

  From the sixteenth century onward, states accumulated debt on a modern scale, reaching 20 to 60 percent of GDP. By 1800, the most indebted (and militarily most successful) country, Britain, had debts exceeding total national production by a factor of two. Our focus is on an early stage of the process that eventually allowed states to accumulate mountains of debt and build the fiscal machinery that supported them.

  THE EMERGENCE OF TRANSPERSONAL STATES

  Before there could be sovereign debt, there had to be sovereign states—states with clearly defined borders and a center of power, capable of asserting a monopoly of violence, administering justice, and raising taxes on a significant scale. They had to show persistence over time, control a clearly defined geographic unit, demonstrate stable, impersonal institutions, and successfully assert the need for loyalty from their subjects (Strayer 1970). By this standard, European states in 1500 were primitive. In the words of Charles Tilly (1990, 42), the continent was divided into more than five hundred “states, would-be states, statelets, and state-like organizations.” Princes frequently owed allegiance to other rulers—sometimes more than one.54 Rulers typically “lived on their own,” meaning that their demesne income was the principal source of revenue. Justice was administered by local courts and vassals; armed force often had to be hired from condottieri, military entrepreneurs who would provide armies of mercenaries to the highest bidder.

  David Stasavage (2011) analyzes the earliest issuance of long-dated debt in Europe. Autonomous cities succeeded in placing long-term debt well before territorial states did. The Repu
blic of Venice, for example, began to borrow in 1262, and continued to do so with no interruptions until 1785. Genoa and Hamburg, Siena and Florence, and Basel and Cologne were not far behind. In contrast, Castile was the earliest territorial state to issue annuities and perpetuities, called juros, starting in the fifteenth century.55

  Despite a lack of long-term instruments, medieval rulers could borrow, if only on a limited scale and for short periods, at high interest rates (Stasavage 2011, figure 2.2). For instance, Edward III accumulated debts from the Bardi and Peruzzi banking families in the fourteenth century (before defaulting). Medieval rulers faced two difficulties in borrowing: commitment and the personal nature of their debts. Divine rulers were not always inclined to repay. The solution to this problem was for a representative assembly to influence policy “just enough” to constrain abuses of power, while allowing the emergence of a strong executive and powerful fiscal machinery—for states to become “strong” and good at taxation, but constrained.56 Daron Acemoglu (2005) provides a theoretical discussion of this fundamental problem; empirical work by Mark Dincecco (2011) shows that constrained and centralized powers managed to raise the highest revenues in the early modern period. In effect, territorial powers ideally had to become more like the medieval city-states that pioneered borrowing: permanent, transpersonal entities with substantial resources and credible commitment.

  In addition to the commitment problem, another aspect merits consideration. Initially, royal debts were personal—debts of the king, not of the kingdom. Before territorial states could borrow on a massive scale and for the long term, they had to become transpersonal. Such debts could only be contracted by entities that transcended the individual. Cities had long solved this problem; the corporatist structure of the Republic of Venice, for example, ensured that debts would be serviced long after the reigning doge had changed.

  The problem for monarchs was more complicated. In a famous book titled The King’s Two Bodies, Ernst Kantorowicz (1957) studied the medieval origins of the idea of sovereignty. He argued that in medieval political theology, the king had two bodies: the “Body natural” and the “Body politic.” The former is mortal; the latter is everlasting. The death of one king implies that another one is immediately placed on the throne. This is reflected in the famous words “The king is dead! Long live the king!” originally used in the accession of Charles VII to the French throne in 1422. The same phrase was standard in England, Spain, and Denmark, among other places. Auctoritas—the power of the king—was instantly transferred from deceased to new ruler.

  Interestingly, institutional constraints on the monarch actually played against the emergence of a transpersonal state. Where monarchs had to be crowned, for instance, the transfer of auctoritas was not instantaneous but instead subject to a delay. The elections of rulers—as in the Holy Roman Empire—could cause a lengthy interregnum. The fundamental problem for early modern states was to find a sweet spot, balancing the need for resources with constraints on monarchical power so that repayment was a likely prospect, while evolving a permanent institutional structure. Absolutism—not the theater of it, but rather the legal doctrine of royal power as evolved by theorists such as Jean Bodin and Samuel von Pufendorf—produced a legal conceptualization of the state that allowed it to make near-permanent commitments.57

  THE NEED TO BORROW: WARTIME SPENDING AND THE RISE OF THE FISCAL-MILITARY STATE

  The need to borrow was intimately related to the cost of war. No other activity was nearly as costly. As the early sixteenth-century writer Robert de Balsac observed, “Most important of all, success in war depends on having enough money to provide whatever the enterprise needs” (cited in Ferguson 2001). The need for ample funding—and the ability to ramp spending up quickly—was caused by technological and political changes.

  After 1500, a “military revolution” transformed warfare in Europe (Parker 1976). The invention of gunpowder meant that old medieval city walls no longer offered protection; fortifications that had withstood long sieges could now be demolished in a matter of hours. The increasing use of cannon therefore required an entirely new set of protective walls, the so-called trace italienne. These walls typically consisted of massive bulwarks made of earth and covered with brick. The perimeter was highly jagged, as angled construction increased the resistance to an artillery attack. There was often an inner and outer set of walls, separated by a moat. The new fortifications also meant that wars became longer, with many sieges lasting more than a year.

  The rise of firearms translated into a need to train soldiers. Only permanent, “standing” armies could be drilled to the level of perfection that the use of harquebuses and muskets required. Often composed of groups of mercenaries in the beginning of the early modern period, armies became increasingly professional, officered by the nobility of the home country. They also expanded in size. Relative to the population, armies after 1500 could be quite large. For example, while imperial Rome and Byzantium had no more than 0.5 to 1 percent of the population under arms, Sweden under Gustav Adolph reached a ratio of 7.5 percent—ahead of Germany in 1914 (6 percent) and not far behind the United States in 1944 (9 percent) (Gennaioli and Voth 2012). Similarly, navies that were originally composed of refitted merchant vessels became increasingly large, centralized organizations with ships designed for one aim only: to prevail in naval battle. These were immensely costly; a British ship of the line in the eighteenth century cost more than the capital of the world’s biggest iron works (Brewer 1988).

  Table 1. Frequency of war

  Source: Tilly 1990.

  Note: A year is considered “under warfare” if there is at least one war involving the great powers taking place during any part of that year.

  Warfare was not only frequent after 1500; it became a near-permanent feature of the political landscape. Tilly (1990) calculates that for every hundred years in the sixteenth and seventeenth centuries, there was a great power war under way in ninety-five of them; the rate for the eighteenth century is only marginally lower. At the height of intensive warfare, during the Thirty Years’ War, close to half of the European population was affected by military conflict in a given year, as table 1 portrays. All these changes—the arms used, the rise of permanent, large armies and navies, new fortifications, and high frequency and great length of conflict—made wars vastly more expensive. Success in war depended in the early modern period on financial resources; infinite quantities of money constituted the “sinews of power,” in Marcus Tullius Cicero’s famous words.58 Successful European powers typically spent around three-quarters of tax revenue on war and related activities.59

  Warfare during the early Middle Ages had been a relatively cheap affair; armies were small, and a large part of the labor used consisted of vassals who were obliged to follow their prince into battle. Kings had generally been able to live “on their own,” using their demesne income (Landers 2003). Soon, however, rulers in the high and late medieval period began to use mercenaries on a significant scale.60 After the Hundred Years’ War, fiscal exigencies—partly driven by the increasing use of mercenaries—pushed kings to look for revenue on a much greater scale (Ormrod 1995; Verbruggen 1997). For example, Henry VIII’s dissolution of the monasteries helped to cover the expense of his French campaigns. Representative assemblies all over Europe were increasingly asked to approve additional funding in the form of excises and tariffs. While many taxes were farmed out initially, later in the early modern period, the more successful states started to centralize the administration of indirect taxes.61 No state (with the exception of England during the Napoleonic Wars), though, succeeded in introducing an effective income tax.

  Over time, most states raised more revenues. Figure 1 shows the distributions of total tax revenue for different European states at various points in time.62 Each box indicates the range from the twenty-fifth to seventy-fifth percentile at each point in time; the “whiskers” depict the entire range of the distribution, while the middle line inside the inner box show
s the median. Tax revenue overall surged dramatically, from 214 tons of silver per year in 1509 to 6,800 tons in 1789. Cross-sectional dispersion increased dramatically: some states were vastly more successful in raising tax revenue than others (Besley and Persson 2010). France increased its revenues tenfold during the early modern period; the Ottoman Empire did so by only 50 percent.

  While both inflation and population growth contributed a little to the higher figures, the single most important driver was taxation per capita. In 1509 the average European power extracted taxes per capita equivalent to 3.5 times the average urban worker’s daily wage; by 1789, this figure had risen to twelve days’ pay. Some states raised taxes even higher. In England, say, the eightyfold increase in total revenue occurred at the same time as a thirtyfold rise in taxes per capita. Most of this was not due to higher incomes.

  FIGURE 1. Distribution of total revenue for select European states. Source: Karaman and Pamuk 2010.

  Establishing an efficient tax administration was key for surviving as a state in the early modern period. Without the ability to tax, there could be no borrowing, and without the ability to borrow, there could be no success on the battlefield.

  Once rulers possessed a strong army, they could also eliminate domestic opposition. Charles V, to take one example, successfully suppressed the Comuneros Revolt in Castile in 1520–21. The royal forces vanquished the rebel militia at the Battle of Villalar, in April 1521; rebel leaders were beheaded. Castile went on to become by far the most taxed of the Habsburg territories.63

  For all the theater associated with it, absolutism did reflect a partial shift in power. After 1500, the tendency was firmly toward centralization, the monopoly of violence, and states that could enact binding laws for all their citizens. Ancient “liberties” and tax exemptions (for the clergy or nobility) came under attack. Internal customs barriers were replaced by external tariffs and consumption taxes. Progress could stall or go into reverse—as it did under Spain’s Bourbon kings—but “the tide was evidently coming in” after 1500.64