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

  LENDING TO THE BORROWER FROM HELL

  THE PRINCETON ECONOMIC HISTORY OF THE WESTERN WORLD

  JOEL MOKYR, SERIES EDITOR

  A list of titles in this series appears at the end of the book

  LENDING TO THE BORROWER FROM HELL

  DEBT, TAXES, AND DEFAULT IN THE AGE OF PHILIP II

  MAURICIO DRELICHMAN AND HANS-JOACHIM VOTH

  PRINCETON UNIVERSITY PRESS

  PRINCETON AND OXFORD

  Copyright © 2014 by Princeton University Press

  Published by Princeton University Press, 41 William Street,

  Princeton, New Jersey 08540

  In the United Kingdom: Princeton University Press, 6 Oxford Street,

  Woodstock, Oxfordshire OX20 1TW

  press.princeton.edu

  Jacket photograph: Signature of Philip II, reading “Yo, el Rey.” Courtesy of the General

  Archive of Simancas, Ministry of Culture, Spain, PTR, LEG 24, 22.

  Jacket art: Titian (Tiziano Vecellio) (c.1488–1576), detail of King Philip II (1527–98), oil on canvas, 193 x 111 cms. 1550. Prado Museum, Madrid, Spain. Courtesy of Bridgeman Art Library, NY.

  All Rights Reserved

  Drelichman, Mauricio.

  Lending to the borrower from hell : debt, taxes, and default in the age of Philip II / Mauricio Drelichman and Hans-Joachim Voth.

  pages cm. — (The Princeton economic history of the western world)

  Summary: “Why do lenders time and again loan money to sovereign borrowers who promptly go bankrupt? When can this type of lending work? As the United States and many European nations struggle with mountains of debt, historical precedents can offer valuable insights. Lending to the Borrower from Hell looks at one famous case—the debts and defaults of Philip II of Spain. Ruling over one of the largest and most powerful empires in history, King Philip defaulted four times. Yet he never lost access to capital markets and could borrow again within a year or two of each default. Exploring the shrewd reasoning of the lenders who continued to offer money, Mauricio Drelichman and Hans-Joachim Voth analyze the lessons from this important historical example. Using detailed new evidence collected from sixteenth-century archives, Drelichman and Voth examine the incentives and returns of lenders. They provide powerful evidence that in the right situations, lenders not only survive despite defaults—they thrive. Drelichman and Voth also demonstrate that debt markets cope well, despite massive fluctuations in expenditure and revenue, when lending functions like insurance. The authors unearth unique sixteenth-century loan contracts that offered highly effective risk sharing between the king and his lenders, with payment obligations reduced in bad times. A fascinating story of finance and empire, Lending to the Borrower from Hell offers an intelligent model for keeping economies safe in times of sovereign debt crises and defaults”—Provided by publisher.

  Includes bibliographical references and index.

  ISBN 978-0-691-15149-6 (hardback)

  1. Finance, Public—Spain—History—16th century. 2. Debts, Public—Spain—History—16th century. 3. Taxation—Spain—History—16th century. 4. Philip II, King of Spain, 1527–

  1598. I. Voth, Hans-Joachim. II. Title.

  HJ1242.D74 2014

  336.4609′031—dc232013027790

  British Library Cataloging-in-Publication Data is available

  This book has been composed in Verdigris MVB Pro Text and Gentium Plus Printed on acid-free paper. ∞

  Printed in the United States of America

  1 3 5 7 9 10 8 6 4 2

  TO PAULA

  TO BEA

  CONTENTS

  ACKNOWLEDGMENTS

  ix

  PROLOGUE

  1

  CHAPTER 1

  Lending to the Sound of Cannon

  9

  CHAPTER 2

  Philip’s Empire

  45

  CHAPTER 3

  Taxes, Debts, and Institutions

  74

  CHAPTER 4

  The Sustainable Debts of Philip II

  105

  CHAPTER 5

  Lending to the Borrower from Hell

  132

  CHAPTER 6

  Serial Defaults, Serial Profits

  173

  CHAPTER 7

  Risk Sharing with the Monarch

  211

  CHAPTER 8

  Tax, Empire, and the Logic of Spanish Decline

  243

  EPILOGUE

  Financial Folly and Spain’s Black Legend

  271

  REFERENCES

  281

  INDEX

  297

  ACKNOWLEDGMENTS

  Blame the Midwest. Tender academic minds often need peace and quiet to get down to business. We first met in the delightful town of La Crosse, Wisconsin (also known as “Mud City, USA”), where distractions were few and far between. This is the place that the organizers of the annual Cliometrics conference had chosen as a venue in 2003. The authors got talking and quickly agreed that they should look into a joint project on the early history of sovereign borrowing. Philip II’s defaults are justly famous, but had not been given their due from an economic perspective, or so we felt. Explaining why everyone before us had been wrong also seemed the best way to use two characteristic virtues of our respective nationalities—modesty, for the Argentine, and subtlety, for the German.

  Money may be the sinews of power, but it is also the lifeblood of scholar-ship—and especially so if the project involves extensive data collection in the archives, plus the coding of hundreds of contracts written by hand in sixteenth-century script. This book would not exist without the financial support of several institutions. We have been fortunate in receiving funding by the Spanish Ministry of Science and Innovation (MICINN). Sadly, the annual treasure convoys from Madrid, laden with ducats earmarked for research and sailing, did not always arrive in full strength. Our applications almost floundered when we failed to specify whether the project required use of the Spanish research station in Antarctica, or if we would need an oceanographic research ship. The importance of linguistic accuracy was brought home to us when we discovered, minutes before submitting the research budget, that we were about to request cases of red wine (cajas de tinto) instead of ink-jet cartridges (cartuchos de tinta). Despite correcting this potentially embarrassing line item, our funding requests were often cut by 60 to 80 percent without explanation, even during Spain’s boom years, while receiving the highest marks for academic merit. We are grateful for the limited funds that did arrive; the firsthand insight into the intricacies of Castilian administration also helped us to understand the bureaucratic machine that takes center stage in this book.

  With Spanish treasure in variable and occasionally short supply, we moved a good part of the project to the University of British Columbia (UBC) in Vancouver, where we hired a large share of the Spanish-speaking graduate student population to transcribe and code up our data. As a result, we are now more convinced than ever that the mita, the forced labor service invented by the Spanish colonizers to exploit the rich silver mines of Potosí, had much to recommend it. In its absence, we are grateful that we could draw on generous funding by the Social Sciences and Humanities Research Council of Canada, the Canadian Institute for Advanced Research, and the UBC Hampton Fund, which did not find it odd to provide an Argentine scholar with an American PhD working in Vancouver with funds
to pay for Spanish-speaking research assistants so that we could code up data from Castile.

  Young scholars often imagine research as a glamorous, thrilling activity, combining exciting, Dan-Brown-like moments of discovery in dusty archives with joyful international jet-setting. Of course, this image is all wrong. Neither the siren calls of the Whistler ski resort, hiking in the Rockies and the Serra de Tramuntana in Mallorca, boating in Vancouver’s English Bay, nor long lunches by Barceloneta Beach distracted us from our labors (at least most of the time).

  We should also mention our gratitude for the many discomforts endured on interminable flights between Barcelona and Vancouver (as well as various conference locations), courtesy of Lufthansa, Air Canada, and a variety of American carriers. Without being confined to a narrow steel tube, rebreathing the same stale air for twelve to fourteen hours at a time, accosted by strange smells, offered inedible food, and without the front passenger’s seat firmly wedged against our kneecaps, we would have found it much harder to concentrate on data analysis and the writing contained in this book—a good part of which was completed high above the Atlantic and the Great Plains of North America.

  Seminar audiences at UBC Vancouver, Universitat Pompeu Fabra (UPF) in Barcelona, Northwestern, Harvard, Stanford, Caltech, Brown, the Federal Reserve Bank of New York, the University of California at Los Angeles (Anderson School and Economics), Carlos III, Rutgers, the University of California at Davis, the University of California at Irvine, the London School of Economics, Yale School of Management, New York University Stern School of Business, the Graduate Institute at the University of Geneva, the Free University of Amsterdam, the University of Minnesota, All Souls College (Oxford), the Asian Development Bank, the Banco de España, Sciences Po, IMT Lucca, ESSEC Business School/THEMA, Utrecht, Vanderbilt, the University of Colorado at Boulder, Universidad de San Andrés, Hebrew University, Copenhagen Business School, Universidad Autónoma de Barcelona, Bocconi, American University (Washington), and the University of California at Berkeley listened to our ideas. Scholars at the Allied Social Science Association meetings in San Francisco, Center for Economic and Policy Research’s (CEPR) Summer Symposium in Macroeconomics in Izmir, London Frontier Research in Economic and Social History meetings, Economic History Association meetings in Austin, joint Bundesbank–European Central Bank seminar, European Historical Economics Society conference in Lund, Vienna European Economic Association meetings, European Cliometrics meetings in Paris, two Paris School of Economics conferences on public finance, Centre de Recerca en Economia Internacional (CREI) and CEPR conference on sovereign debt in Barcelona, Warwick Political Economy Workshop, Royal Economic Society Conference in London, Bureau d’Economie Théorique et Appliquée Workshop in Historical Economics in Strasburg, National Bureau of Economic Research Summer Institute, Montevideo Congress of the Latin American Association for Economic History, Conference in Honor of Joel Mokyr in Evanston, the Canadian Network for Economic History meetings in Ottawa, Political Institutions and Economic Policy workshop at Harvard, and West Coast Workshop on International Economics at Santa Clara as well as at a string of Canadian Institute for Advanced Research meetings kindly gave us feedback. Without their continued patience and interest, sometimes bordering on excitement, we would not have had the heart to write this book.

  A few heroic souls read drafts of the whole manuscript before the miniconference in Vancouver in September 2012, braving our penchant for repeating the same quotes half a dozen times. This book would be much the poorer without the generosity and advice of Mark Dincecco, Juan Gelabert, Oscar Gelderblom, Phil Hoffman, Larry Neal, Jean-Laurent Rosenthal, and Eugene White. At various stages of the project, we also benefited from the feedback of Daron Acemoglu, Carlos Alvarez Nogal, Paul Beaudry, Maristella Botticini, Fernando Broner, Bill Caferro, Ann Carlos, Albert Carreras, Christophe Chamley, Greg Clark, Brad deLong, Sebastian Edwards, John H. Elliott, Carola Frydman, Marc Flandreau, Caroline Fohlin, Xavier Gabaix, Oded Galor, Josh Gottlieb, Regina Grafe, Avner Greif, Michael Hiscox, Viktoria Hnatkovska, Hugo Hopenhayn, Kenneth Kletzer, Michael Kremer, Naomi Lamoreaux, Ed Leamer, Tim Leunig, Gary Libecap, John Londregan, Alberto Martín, Andreu Mas-Colell, Paolo Mauro, David Mitch, Kris Mitchener, Lyndon Moore, Roger Myerson, Avner Offer, Kevin O’Rourke, Sevket Pamuk, Richard Portes, Leandro Prados de la Escosura, Angela Redish, Marit Rehavi, Claudia Rei, Maria Stella Rollandi, Moritz Schularick, Chris Sims, David Stasavage, Richard Sylla, Bill Sundstrom, Nathan Sussman, Alan M. Taylor, Peter Temin, Francois Velde, Jaume Ventura, Paul Wachtel, David Weil, Mark Wright, Andrea Zannini, and Jeromin Zettelmeyer. The series editor, Joel Mokyr, helped us with his insights, enthusiasm, and good old common sense. At Princeton University Press, Seth Ditchik put the book on a fast track to publication, smoothing the administrative process as much as possible. Three anonymous referees for the press provided us with detailed feedback. At short notice and with great taste, Valeria Drelichman gave us sharp insights on cover design. At CREI, Mariona Novoa smoothed many administrative wrinkles, facilitated our various visits, and provided support at critical junctures. To those who we will have inevitably forgotten on this list, we are doubly grateful—for their contributions and forbearance.

  Documents are the heart of any economic history project, but they do not surrender their secrets easily. Our efforts would have been fruitless without the guidance and advice of the archivists and scholars who helped us interpret sixteenth-century manuscripts. Among them, Isabel Aguirre Landa and Eduardo Pedruelo Martín, at the General Archive of Simancas, patiently guided us through the more than five thousand pages, sometimes written in impenetrable script; Andrea Zannini, from the University of Genoa, showed us the intricacies of early modern bookkeeping. Countless others—whose names we failed to note—facilitated our research on numerous occasions, clearing the path where we might have otherwise stumbled. To them all we extend our thanks.

  Some of the work contained in this book first appeared in journals and edited volumes. For the right to reproduce our findings here, we thank the Economic Journal, Journal of Economic History, Explorations in Economic History, and Journal of the European Economic Association.

  Our research assistants put in long days—and were sometimes called to duty with Skype calls in the middle of the night—to transcribe, code, and analyze reams of data that never seemed to end. At Pompeu Fabra, Hans-Christian Boy, Marc Goñi Trafach, and Diego Pereira-Garmendía mastered a wide range of crucial tasks, from archival research to complex financial modeling. At UBC, Marcos Agurto, Valeria Castellanos, Germán Pupato, Javier Torres, and Cristian Troncoso-Valverde all learned to read sixteenth-century Spanish and value early modern financial instruments, their pleas for mercy notwithstanding. When a heated discussion erupted in the graduate student lounge over the proper discount rate for juros de resguardo, we knew we had their fanatic devotion. Anthony Wray, the lone Anglo-Saxon on the team, became an expert in Spanish military history, tracing every last ducat used to pay the tercios in Flanders (or not to pay them, as the case might be). Without the professionalism, dedication to detail, and sheer hard work of all these promising young scholars, our project would not have been possible.

  We dedicate this book to our partners, Paula and Beatriz, who bore our extended absences, frequent absentmindedness, and the often-frantic work on weekends, during long-planned vacations, and late into the night with good humor and patience despite the rapidly growing size of our families.

  VANCOUVER AND BARCELONA, JUNE 2013

  LENDING TO THE BORROWER FROM HELL

  PROLOGUE

  Can government borrowing be made safe? As we are finishing this book, the world is grappling with the aftermath of the financial crisis of 2008. What began as a problem in the securitized market for US mortgages became a major crisis first of banks and then governments. All over the developed world, debt levels have spiraled upward in recent years. In Europe, the cost of sovereign borrowing has become sky-high for countries whose creditworthiness is in the slightest
doubt; several governments have already lost market access for their bonds. Financing troubles have spelled austerity, making the downturn worse and leading to unemployment rates in the double digits around the European periphery.

  One of the motivations for writing this book was to go back in time and examine a period that has long been regarded as synonymous with continuous fiscal turmoil. We sought to learn more about the origins of state debts and sovereign default. To paraphrase the now-famous book by Carmen Rein-hart and Kenneth Rogoff (2009), how different was last time? We discovered that the famous payment stops of Philip II—all four of them, making Habsburg Spain the first serial defaulter in history—were much less catastrophic than earlier authors had argued. By modern standards, defaults in the sixteenth century were on the whole remarkably mild. Only a relatively limited share of total debt was rescheduled; settlements were negotiated in less than two years (compared to an average of eight years today); terms were relatively generous; and lending resumed quickly. We also found few reasons to believe that Spain’s fiscal performance was responsible for its eventual decline as a great power.

  Instead of boom-and-bust cycles driven by the eternal overoptimism of financiers, we encountered a remarkably stable and effective system for financing government borrowing. There are two features at the heart of this system that may offer lessons for the present. The first concerns risk sharing between bankers and borrowers; the second involves how risks are taken and shed by financial institutions. Sovereign debt crises today produce enormous costs. In a typical debt crisis, GDP growth declines by approximately 2 to 3 percent (Panizza and Borensztein 2008).1 Unemployment surges. Exports slump. The financial system collapses or needs massive bailouts. Just when spending cuts become particularly painful, finance ministers typically have to unveil austerity packages; the lines of the unemployed lengthen.