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Spain’s 1575 Default

Mon, Aug 1, 5:53 PM ET, by Donald Marron

If all goes according to plan, the hoopla over the debt limit will soon recede. Policymakers and analysts will move on to the next new thing. And, sadly, some fascinating questions will forever go unanswered. For example, which president would appear on the trillion-dollar coin?

But if you are up for one last article about default, yesterday’s piece by Christophe Chamley at Bloomberg is a good one (ht: Donald M.). Chamley recounts Spain’s intentional bond default way back in 1575:

Spain, at the time, was the world's sole superpower. Contemporaries described it as an empire "over which the sun never sets." Yet the king needed the cities' consent to borrow at a reasonable rate. And he needed it for a reason: The cities collected the taxes.

Each of the 18 main cities of Castile levied a special tax earmarked for long-term debt service. The level of this tax was set every six years through negotiation with the king. Tax collections were used first to pay off local long-term bondholders, with the rest sent to the central government. The local long-term bondholders were, in large part, the elderly living in the area. So local taxpayers realized that if they didn't pay, their parents would be hurt. Thus, this precursor to Social Security had an effective enforcement mechanism — the ire of the elders.

But the king could only exploit this confluence of interests so far. The Cortes set the earmarked tax rate by majority rule, and that limited the king's issuance of what were, in effect, his AAA securities. The king also issued other bonds secured by other, non-earmarked revenue. These securities were of a lower grade and sold at lower price.

Thanks to Philip's expensive military adventures in the Netherlands and the Mediterranean, Spain's debt had reached half of gross domestic product by 1573. At that point, the cities balked at paying higher taxes. For the next two years, they refused to budge in their confrontation with the king.

Finally, in September 1575, Philip took a circuitous route to outmaneuver the Cortes. He suspended payments not on the long-term debt, but on the short-term debt, which was owed primarily to Genoese bankers. The people cheered. Resentment against bankers ran as high then as now — perhaps higher, because the bankers were foreigners. The upshot, however, was default and a full-blown credit crisis.

And then what? Well, as Chamley recounts, it wasn’t pretty.


SDI Glossary: "price" Definition
This Article's Word Cloud:   Chamley   Cortes   Philip   Security   Spain   Well   also   bankers   bondholders   central   cities   collected   debt   default   didn   earmarked   expensive   higher   king   local   long   lower   majority   military   needed   negotiation   next   other   over   plan   rate   recede   recounts   securities   sole   taxes   term   that   their   then   they   this   took   were   what   which   will   with   would   years

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