Published by EH.Net (July 2014)

Mauricio Drelichman and Hans-Joachim Voth, Lending to the Borrower from Hell: Debt, Taxes and Default in the Age of Philip II.  Princeton, NJ: Princeton University Press, 2014. xii + 310 pp. $35 (hardcover), ISBN: 978-0-691-15149-6.

Reviewed for EH.Net by Regina Grafe, Department of History of Civilization, European University Institute.

Why do investors lend to sovereigns? This is the central question that Lending to the Borrower from Hell addresses. A sovereign usually cannot be forced to make good on her commitments to foreign bankers. The historical regularity of sovereign default suggests that neither GDP-lowering sanctions nor the reputational damage to the borrower on their own are enough to avoid opportunistic behavior.

But avoiding defaults at all costs is also problematic. If the state’s fiscal woes are largely the result of an adverse shock to the economy, saving the state from default will drive the real economy further into recession. As the authors point out “state-dependent” debt contracts would be a solution. If the sovereign was not to blame for fiscal shortfalls, a default should be excusable. But how can lenders ever know for certain that the ruler is not faking it?

In this highly readable book Drelichman and Voth look at late sixteenth century Spain to investigate this puzzle. Their first step is to complement existing data on long-term borrowing and fiscal accounts with an in-depth study of every clause in short-term borrowing contracts. These so-called asientos were the means by which King Philip II dealt with the challenges that extremely volatile war spending posited to all European rulers.

Armed with an impressive amount of new data the authors pose four questions. 1) Were generations of historians and economists right in claiming that Spain’s debt was unsustainable? 2) Did Philip II only pay his debt because he had he suffered sanctions? Foremost was a brutal episode in the 1570s, when his lack of funding allegedly caused an infamous mutiny in Antwerp. 3) Did successive generations of lenders lose their shirts, as the historiography has claimed? 4) What actually happened during Philip’s four defaults?

The authors’ answers are surprising. Spain’s sixteenth century debt levels were sustainable. Philip II paid because the lenders imposed effective moratoria forcing him to negotiate, but they did not use other sanctions. The mutiny known as the Spanish Fury was not caused by lack of funds. Lenders made money throughout. Finally, “defaults” were effectively re-negotiations often anticipated in conditional clauses contained in the initial contract. In essence sixteenth century Genoese bankers succeeded at creating state-dependent debt.

Such financial success required a few specific ingredients. The first one was the transfer of banking acumen from first Southern Germany and then Genoa to Spain. The Fuggers were good at banking. Their European networks allowed them to borrow against their name in the service of the Spanish Crown. But the Genoese were better. On the back of almost three centuries of experience with sovereign finance in the form of Genoa’s Banco di San Giorgio they introduced two important novelties: overlapping lending networks and securitization.

Second, lender reputation was more important than that of the borrower. Because of cross-investments between Genoese houses Philip failed systematically in his attempts to entice individual lenders to cut a side deal when he suffered a liquidity problem. They were too worried that their business partners in turn would cheat on them. Philip reacted by expanding ordinary taxes, resulting in a consistently high primary surplus that kept the debt-revenue ratio virtually unchanged as debt levels expanded. Lenders in turn limited individual exposure by selling off participations in the loans insuring that liquidity crises could be managed. Short-term losses were offset by long-term profits.

Scholars from North and Thomas to Acemoglu, Johnson, Robinson have blamed Spain’s relative decline in the seventeenth and eighteenth centuries on poor fiscal governance. Drelichman and Voth prove them wrong. But if government finance was sound what was the problem? The authors support the recent literature that has zoomed in on political fragmentation limiting state capacity. But they add bad luck in military matters and silver inflows to the vector of causes of Spain’s decline. The reminder about the importance of military success is timely. What mattered was not war expenditure but winning.

What about the resource curse? Drelichman and Voth offer much needed perspective but their data may also question the importance of silver. Taxes on silver remittances accounted on average for 18 to 20 percent of annual revenue in the second half of the sixteenth century (Drelichman and Voth 2007). That was not to be sneezed at. Yet, when expenditures were subject to year-on-year changes that could reach multiples of two or three, no treasure fleet could sail to the rescue.

Philip’s Genoese bankers were rightly cautious. Only eight percent of asientos that mention contingent clauses refer to the fleet. Those that did carried a four percent risk premium. Given the sophisticated financial engineering, volatility was probably a lesser issue. But revenue from the 20 percent silver tax could not be leveraged up by using it as a guarantee for long-term bonds. And the state could not extend the fiscal base as it could and did with all manner of consumption taxes.

In its best years the share of mineral revenue in total revenue even exceeded oil revenues in today’s Norway. Yet, Norway’s state quota is 55 percent, Castile’s was well inside 10 percent. To put it another way: silver taxes amounted to 1 to 3 percent of Castile’s GDP at most. The Genoese for one seem to have preferred loans guaranteed by boring consumption taxes rather than dreams of Eldorado. Maybe silver is another part of Spanish history that is ripe for revision?

Lending to the Borrower from Hell is a wonderful example of what becomes possible when one takes economic theory on a trip to the archive and actually reads the small print of each contract. It provides for the first time an economically sound explanation for Spain’s ability to borrow in the sixteenth century that actually fits the facts. That is an outstanding achievement.

While lender irrationality is a favorite currently in the literature on sovereign lending, the authors show that continued lending and default could both be perfectly rational. Spanish monarchs were no systematic threat to private property rights. When they defaulted, they had a reason that was out of their control, and they duly compensated lenders. So the lenders kept lending.

Regina Grafe is the author of Distant Tyranny: Markets, Power and Backwardness in Spain, 1650-1800, Princeton University Press, 2012.

Copyright (c) 2014 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (July 2014). All EH.Net reviews are archived at