the birth of government debt -- 4/6/21

Today's selection -- from Why Not Default? by Jerome Roos. The birth of true government debt likely happened in the 12th century in the Italian city-states:

"Earl Hamilton, one of the founders of the discipline of economic history, once wrote that, ‘national debt is one of the few important economic phenom­ena without roots in the Ancient World.’ While premodern rulers and medieval monarchs did occasionally borrow and default, the amounts involved were generally small, and the obligations widely understood to be of a personal nature -- most kings and prices simply repudiated their predecessor's obliga­tions upon assuming the throne. It is only with the birth of the first merchant republics in the Italian city-states during the late Middle Ages that sovereign borrowing became properly public in character. Genoa was probably the first independent republic to float a municipal debt in 1149, followed shortly thereafter by Venice in 1164 and Florence in 1166.

"In subsequent decades and centuries, cities like Siena, Arras, Bremen, Cologne, and Barcelona all developed their own systems of public credit -- followed much later, from the sixteenth century onwards, by territorial states like Castile, Naples, France, the Netherlands and the Papal States. The earliest public loans were generally compulsory, involving the forced concession of a fixed sum by wealthy citizens, mostly merchants and merchant bankers, against a pledge of specific public income streams derived from future tax revenues and other sources of income. Over time, these loans became voluntary and more long-term, and from the second half of the thirteenth century onwards out­standing public debts began to be consolidated into perpetual obligations that could be sold to interested counterparties or passed on to future generations, thus giving rise to the development of an active secondary trade in government debt and laying the foundations for the rise of modern financial markets.

"The emergence of the public debt thus signaled a historic shift from the social order of feudalism to a protocapitalist international state system. As Marx would later remark in Capital, the birth of national debt ‘marked with its stamp the capitalistic era,’ giving rise to ‘joint-stock companies, to dealings in negotiable effects of all kinds, and to speculation, in a word to stock-exchange gambling and the modern bankocracy.’ While feudal sovereigns had mostly relied on demesne income to sustain their military campaigns and court expenditures, only occasionally engaging in short-term borrowing on a personal title, the Italian merchant republics developed complex tax and credit systems to finance their struggles for independence and subsequent military campaigns.

"The main driving force behind the emergence of public credit was therefore invariably the exigency of war. To gain independence, conquer overseas territories, fend off envious princes, and prevail in internecine conflicts with rival city-states, the early-modern republics had little choice but to raise sizable na­vies and militaries. With their small and mostly urban populations, however, maintaining a standing army made little sense: permanently mobilizing citi­zens for war would put far too great a burden on the local economy, and the wealthier city-dwellers in particular had long since ceased to take to the battle­fields. Moreover, a small homegrown army would be no match for the vast ter­ritorial empires that loomed large on the other side of the Mediterranean and the Alps. As a result, the Italian city-states increasingly came to rely on the costly war-making and empire-building services provided by mercenaries. The resultant expenses in turn fed into the need to develop complex systems of taxation and public borrowing.

"Over the centuries, this growing state dependence on private sources of financing generated lucrative opportunities for rent-seeking and speculation, spawning a class of wealthy financiers who became heavily invested in their own city-states’ debts. As Luciano Pezzolo notes, a structural change took place in late-medieval and early-modern Italy: ‘As long as state finance was not under severe and extended pressure, the system represented a “moneylender’s paradise.” Principal was paid back in relatively short time and interest was also paid regularly.’ This immediately raises the question why local rulers were so punctual about repaying their debts. Pezzolo argues that it was a result of the fact that the state’s creditors and its governing elite were often the same people: ‘The key feature that underpinned the system,’ he writes, ‘laid [sic] in the close permeation between major bondholders and [the] power elite. As long as this identity subsisted it would have been unlikely the government defaulted.’ Stasavage reaches a similar conclusion, finding that oligarchic regimes empowered the wealthy merchants who held government bonds and ensured the insulation of fiscal policy from popular pressures for default. As a result, city-states that ‘were more oligarchical in form tended to have better access to credit than did those with more open systems of political representation.’

"The power of the emerging creditor class reached its first apogee in renaissance Florence – the city that [gave] birth to modern banking. In 1427, the Tuscan city was drowning in what seemed like an unpayable debt. A protracted war with Milan had left the municipal government in dire fiscal straits, and citizens were growing increasingly restive about the heavy tax burden required to service the resultant financial obligations. A century later, the city’s historian Francesco Giucciardini would look back on the crisis and reflect that ‘either the debt destroys Florence or Florence destroys the debt.’ In an attempt to shore up the public finances, the Florentine city government decreed the most thorough and most innovative tax survey of the early-modern era, the Catasto of 1427, whose high level of detail has provided economic historians with an unprecedented insight into the nature of wealth distribution in one of early modern Europe’s most important cities. Interestingly, the Catasto reveals the extreme concentration of Florence’s public debt in the hands of a small creditor oligarchy: almost 60 percent of the republic’s bonds were held by only 2 percent of the population. This high concentration of the public debt and the acute state dependence on private credit had far-reaching political implications, directly feeding into the rise of the Medici as the city’s -- and eventually the continent’s -- dominant banking family. As Pezzolo notes, ‘to be creditors to the government meant sharing the destiny of the regime and, consequently, supporting it. In Florence, the Medicean regime [thus] tied to itself an oligarchy that profited from the management of the government debt.’

"It was in Genoa, however, that the private management of the public debt was first properly perfected. The founding in 1407 of the world’s first charted bank, the Casa di San Giorgio, proved to be a historic landmark in this respect. The Casa was essentially a consortium of private bondholders that established direct creditor control over the management of the public finances. Machiavelli famously referred to San Giorgio as a ‘state within a state’ -- and Genoa’s ruling elite needed it. The city was exceptionally fractious and was exceptionally fractious and regularly underwent popular revolts and shifts in the balance of power between competing merchant families. The Casa di San Giorgio served to effectively shield fiscal policy and public debt management from popular pressures and political instability, lowering the risk of default and enabling the commune to borrow at much lower rates than most of its rivals. As Michele Fratianni notes, the ‘top managers of San Giorgio were drawn from the same social groups from which sprang top decision-makers in government.’ Creditor control over public finances thus ‘ensured that San Giorgio's interests were aligned with the Republic’s. This, in turn, reduced the risk that the Republic would repudiate its debt. Low default risk meant greater access to credit, and the abundance of cheap credit in turn allowed Genoa to develop into a financial and maritime powerhouse over the course of the fifteenth and sixteenth centuries -- a period Fernand Braudel famously referred to as the ‘great age of Genoese finance.’"



Jerome Roos


Why Not Default? The Political Economy of Sovereign Debt


Princeton University Press


Copyright 2019 by Princeton University Press


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