Philip II’s Lessons For America

The capital markets are infinitely larger and better developed now than they were for Philip II’s Spain. We also have central banks, which for a leading currency like the dollar can print money without immediate adverse consequences. However, it must be remembered that Philip II’s Spain equally benefited from enormous investor confidence in the early years of his reign. Investors saw the flow of silver from the Americas, and the other benefits of Spain’s leading position in colonizing a previously unknown, enormously wealthy continent, and believed it able to bear any fiscal burden in a way that not been possible for the impoverished states of the late Middle Ages.

Indeed, had somebody at Philip’s court come up with Modern Monetary Theory they would doubtless have been thought highly credible. After all, almost all Philip’s revenues came from the exploitation of Spain’s new colonies, only Castile of the lands under his control (which as well as Spain and Portugal included Belgium, the Netherlands, Burgundy, and parts of Italy) paid any money taxes at all to support his rule, although the non-Castilian parts of his realm did provide soldiers for his armies. Thus, in a sense, he was an early exponent of MMT, with the M supplied mostly by the Potosi silver mines.

However developed today’s capital markets, if the United States borrows like Philip II’s Spain, it will eventually meet the fate of Philip II’s Spain. Philip doubtless believed his defaulting to foreign bankers – initially German, then Genoese — would make little difference to the subjects he ruled, none of whom lived in either Germany or Genoa. This was wrong. Without the confidence of the international system, debt costs for Spanish businesses soared, equity capital became almost unobtainable except in small quantities, and the domestic Spanish economy atrophied.

The same will happen if the United States runs its debts up too far. Initially, its creditors – foreign banks and the liquid central banks of countries such as China and Japan – will scale back their willingness to participate in Treasury bond issues. That will drive up capital costs, not just for the U.S. Treasury, but for all American businesses and consumers. Multinational businesses will re-locate their major operations elsewhere, as they left Philip II’s Spain. Entrepreneurs and innovators will also leave — it is notable that Spain participated very little in the explosion of human knowledge and innovation of the 17th and 18th centuries, and in consequence got industrialization very late and not very intensively.

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(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of "sell" recommendations put ...

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