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Spain of the 16th Century was the wealthiest country in Europe as they capitalized on the New World Gold and Silver mines of Central and South America. This wealth was squandered through overspending. Spanish kings attempted to conquer Europe by conquering the Dutch, Italians, and other European wars. The Spanish Armada even tried to invade the British Isles in 1588. This military and political adventurism was a large part of the driving force behind the Spanish's multiple financial defaults with Northern European lenders. As the American debt servicing for the Fiscal year 2024 will exceed $660 billion, the United States of America might expect to see debt servicing become the most significant expense of the American government; the national debt rating is likely to decline as the rating agencies see debt continue to exceed GDP and worldwide debt holders of American treasury instruments are likely to experience increasing losses as the American economy struggles under the burden of ever-increasing debt and the bond market spirals into ever-rising interest rates.
"Philip II of Spain accumulated debts equivalent to 60% of GDP. He also defaulted four times on his short-term loans, thus becoming the first serial defaulter in history. Contrary to a common view in the literature, we show that lending to the king was profitable even under worst-case scenario assumptions. Lenders maintained long-term relationships with the Crown. Losses sustained during defaults were more than compensated by profits in normal times. Defaults were not catastrophic events. In effect, short-term lending acted as an insurance mechanism, allowing the king to reduce his payments in harsh times in exchange for paying a premium in tranquil periods."3
Spanish monarchs continued to get loans at what was considered typical market rates for the time; lenders earned an average 15.5% return; however, this strain and drain on the Spanish fiscal sphere inevitably led to decline by the 17th Century. Military setbacks and political overreach worldwide weighed down the once-great monarchy. Who knows where Spain and the world would be today had Spanish monarchs had more fiscal restraint?
The comparison between 16th-century Spain and the modern United States concerning fiscal policies, debt, and their consequences is intriguing. While the historical context differs significantly from today, today's leaders must learn from the folly of the past.
Spanish Debt Defaults in the 16th Century: In the 16th Century, Spain was indeed a global superpower, primarily due to the vast wealth it gained from the New World, particularly from gold and silver mines in Central and South America. However, this wealth was not used wisely. Spanish monarchs engaged in costly military campaigns, like the attempted conquest of the Dutch and the failed invasion of the British Isles with the Spanish Armada in 1588. These military and political ventures strained the Spanish economy, leading to the series of debt defaults mentioned above. Northern European lenders were already benefitting from Spanish profligacy by the end of the 16th Century as the Dutch and English were to become the new wealthy of Europe.
Who Were the Debt Holders:
Wealthy Merchants and Bankers: Wealthy individuals and banking institutions in Northern Europe, particularly in cities like Antwerp and Genoa, were crucial in financing Spain's ambitious overseas ventures. They purchased Spanish government bonds or provided loans to the Spanish Crown.
European Monarchies: Some European monarchies also lent money to the Spanish Crown, hoping to secure alliances or concessions in return for their financial support.
Losses Incurred:
Haircuts and Deferred Payments: As Spain repeatedly defaulted on its debts, debt holders suffered significant losses. The Spanish Crown imposed "haircuts," which were reductions in the principal amount owed to creditors. Debt holders had to accept less than the full value of their bonds or loans.
Delayed Interest Payments: Spain often delayed or missed interest payments, causing further financial distress to creditors. These delayed payments eroded their investments' value and disrupted their financial planning. However, recent scholarship indicates that these defaults may have been accounted for because lenders would continue to lend and later be made whole and profit. 5The embarrassing truth was that Spanish monarchs were spendthrifts.
Remedies and Responses:
Diplomatic Pressure: Some creditors, especially European monarchs who lent to Spain, used diplomatic pressure to demand repayment. They attempted to leverage their political influence and alliances to secure Spanish promises of repayment.
Debt Restructuring: Spain, faced with financial problems and an inability to repay its debts fully, attempted various forms of debt restructuring. These could involve offering new bonds, often at less favorable terms to the creditors.
Legal Actions: In some cases, creditors resorted to legal actions to recover their losses. They pursued claims through the legal systems of the time, which could be complex and time-consuming.
However, it's important to note that the remedies available to debt holders in the 16th Century were less standardized and well-defined than the modern legal and financial systems. Creditors often had to rely on the goodwill and financial capability of the Spanish Crown to honor its obligations, and their ability to enforce repayment was limited.
In contrast to today's more organized and transparent financial markets, where there are established legal systems and standardized procedures for addressing defaults, the experience of debt holders in the 16th Century was marked by uncertainty and a lack of well-defined remedies. Many creditors had to absorb significant losses, and their ability to recover funds often depended on their political and diplomatic clout.
This historical episode serves as a reminder of the importance of responsible fiscal management and honoring financial obligations, as defaults can have far-reaching consequences and erode trust in a nation's creditworthiness. It also highlights the evolution of economic systems and legal structures that have been put in place over the centuries to address and mitigate such risks in the modern era.
Modern American Debt Situation: In the 21st Century, the United States faces its own set of fiscal challenges. The American national debt has grown significantly due to various factors, including economic downturns, increased government spending, tax cuts, and substantial stimulus packages in response to the COVID-19 pandemic. The debt has reached unprecedented levels, and the servicing of this debt is becoming a significant expenditure.
As of 2023, the US national debt had exceeded $34 trillion. The debt-to-GDP ratio has also risen substantially. This debt has raised concerns about the sustainability of the US fiscal position, as an ever-increasing debt burden can lead to higher interest payments and a potential loss of creditworthiness. The World Bank estimates the US Gross Domestic Product in 2022 as $25.46 trillion6; thus, the debt to GDP ratio is now well over twice (120%)the ratio the Spanish monarchs dealt with in the 16th Century. The US Federal Reserve Bank and US Treasury have collaborated to create novel devices such as bond balance sheet purchases and zero to synthetically negative interest rates to keep the US solvent. These slick accounting maneuvers have kept up to $10 Trillion in debt off the books as interest need not be paid on debt obligations held by the Federal Reserve Bank. This debt anaconda will slowly unravel as Federal Reserve Bank Chairman Powell continues his return of these bonds to the public market. The flood of bonds will drive bond prices down and interest rates ever higher. Stay tuned for how Treasury Secretary Yellen decides to roll over maturing Treasury issues, as most will go from a near zero rate to the current market rate of 4 to 6 percent. This refinancing is where the debt servicing goes wild. $34 Trillion in debt could very quickly amount to a $ 1.3 trillion annual debt expense and ever rising. Spain could not maintain a 130-ship Armada because of debt, and the US will be unable to counter a Chinese Navy of 450 ships and growing.
The consequences of high debt Levels in the Modern Era are similar to the case of 16th-century Spain. Interest payments grow as the US debt continues to grow, and the government will have to allocate a more significant portion of its budget to service the interest on this debt. In the fiscal year 2024, the interest payments are projected to exceed $660 billion, which could divert resources from other essential government programs. Credit Rating agencies like Moody's, Standard & Poor's, and Fitch assess a country's creditworthiness. If the debt-to-GDP ratio continues to rise and the US fails to demonstrate a credible plan for managing its debt, these agencies may downgrade its credit rating. A lower credit rating could increase the US government's borrowing cost through a higher interest rate to attract investors. Economic Impact would be that a rising national debt could raise concerns about inflation, interest rates, and financial stability. It might erode confidence in the US dollar as a global reserve currency, potentially affecting international trade and the purchasing power of American consumers. Consumers' Amazon purchases of goods from China could drastically increase in price. The global implications are that the US has many international debt holders, including foreign governments and investors. Any signs of fiscal instability could reduce confidence in US treasuries as a safe investment, reducing foreign investment in US debt.
What strategies can mitigate the consequences of a burgeoning national debt? Fiscal discipline should be the first strategy implemented. Responsible fiscal policies include reducing budget deficits and reforming entitlement programs, which can help control the debt's growth. In days gone by, Federal Reserve Chairman Alan Greenspan was notorious for lambasting Congress for overspending, and during his tenure, there was an actual Federal government surplus. Economic Growth is a key. Encouraging economic growth through investments in infrastructure and education can help increase government revenues and reduce the debt-to-GDP ratio by increasing the productivity of the US economy. Debt Management is also critical. The US can employ more effective strategies to manage its debt, such as refinancing debt at lower interest rates. For example, Former Federal Reserve Chairman Yellen could have locked in trillions of dollars of debt for 30 years at essentially zero rates. The US Treasury historical data has long-term bond rates as low as -.22% at the nadir of the Great Recession7. What she was thinking the world would like to know. The great Peter Principle dictates that she has now been advanced to Secretary of the Treasury to administer the vast US debt at hundreds of times higher interest rates. Lastly, bipartisan solutions will be essential. Political consensus on fiscal matters is crucial to address the debt issue. Bipartisan cooperation can lead to more effective solutions. We are all Americans first, and our legislators must work together on this for us to survive as a nation.
The Spanish Golden Age lasted from 1492 until the 1680s. However, loan defaults were a part of the process of Spanish decline. No two periods of history are identical, yet we can hypothesize based on similarities. Given this, it appears an American debt default could make the U. S. a worldwide tourist destination for ruins of Disney and the Grand Canyon, just as Spain has become the place to go for wine and beaches. Today, no one looks to Spain for world leadership of any kind unless it would be to determine the best time for a siesta. Wake up, American leadership, or this will become the American reality in 10 to 100 years.
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Great article, Mr. Ross! I share every concern of yours as well. BTW...Did you work for Pan Am?