February 11, 2001

Riches to rags warning Playing lotto with our future

Posted in Celtic Tiger ·
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In 1540 Juan Acosta returned from his second trip to the New World with a galley laden down with gold. The voyage, notwithstanding a scare involving English pirates off the Cuban coast, had been relatively uneventful.

Eight years earlier Acosta had accompanied Pizarro on that fateful day in Peru when Atahualpa, the Inca King, was slaughtered. That week the Spaniards plundered more gold — as a ransom for the God King — than the entire continent of Europe produced in a year.

Acosta promised himself that this would be his last trip, and set about building himself the most extravagant villa in Cadiz. No expense was spared. Dutch tradesmen and expert woodcutters were transported from Amsterdam. Arab roofers and master tilers were shipped from Morocco. All carpets and curtains were bought at exorbitant markups from Genoese merchants whose original sources in the Levant were impeccable. By 1546 the Acosta Villa was the talk of Andalusian society, as was Juan Acosta, an amiable adventurer of humble origins.

Sixteenth-century Spain was awash with these rags-to-riches stories, and gold robbed from Latin America paid for everything. A monumental mass of gold and silver crossed the Atlantic between 1540 and 1580. In 1564, alone 154 ships, each carrying over 200 tons, docked in Seville. In the 50 years after the death of Atahualpa, the total amount of gold and silver in Europe increased fivefold. Almost every single ounce passed through imperial Spain.

One would have thought that, given their windfall, the Spaniards would have been the richest people in Europe by the end of the century. But amazingly, Spain blew it. The impact of the flow of gold was felt elsewhere. The Dutch, in particular, benefited enormously from Spanish gold.

There was hardly any lasting positive effect on the Spanish economy. How did Spain manage to waste one of the biggest financial windfalls in human history? And are there any lessons for modern Europe and Ireland in the history of the Spanish gold rush?

Spain went on an almighty bender. The Spaniards proved themselves to be better at spending money than saving the stuff, and acted like medieval lotto winners, blowing their new money on anything they could get their hands on. They bought spices from the Orient, clothes from Italy, guns and firearms from anywhere.

Gold flowed out of the country. With their new credit, nothing was too expensive. Even today, a stroll through any regional Spanish town reveals churches, great houses, palaces and ornate fountains built by Italian architects and paid for with Latin American gold. By 1590, 80 per cent of all goods shipped from Spain to its new colonies were goods that had already been imported from elsewhere in Europe. (This is in direct contrast to the British Empire, for example, which shipped British-made goods from Britain to its colonies.)

Pretty soon Spain forgot how to make things. Production of everything from food to clothes faltered. As one observer at the time put it, “Agriculture laid down the plough, clothed herself in silk and softened her work-calloused hands. Trade put on a noble air . . . went out to parade up and down the streets.”

Apart from general idleness, another far more insidious enemy emerged to face the Spaniards. Inflation had not been experienced in Europe until the great gold plunders of the Conquistadors. Up to the 16th century, the amount of cash in circulation was more or less determined by the amount of gold discovered.

Gold, the most precious of all metals, acted as a type of anchor for the entire monetary system. Goods — particularly ransoms, dowries and spoils of war — were measured in gold. For years there was stability in prices across Europe.

When gold was discovered in such vast quantities, it upset this delicate monetary balance. The new gold was like a new injection of credit and it had the same effect on the Spanish economy as a large, unexpected and externally-driven fall in interest rates has on an economy like Ireland today.

The Spanish rapidly went into debt with other nations, paying over good Spanish money for what, at the time, were called ‘puerilities’ — bangles, cheap glassware, playing cards and the like. Prices in Spain started to rise.

However, the rise in prices was not due to any economic shift in the economy but to the non-productive abundance of precious metals.

As inflation took hold in Spain, those Spanish manufacturers who had still managed to trade found themselves becoming increasingly uncompetitive. From being the richest nation in Europe, Spain experienced successive financial crises as it tried to pay for its gold-inspired extravagance.

Inflation was not limited to Spain. The more the Spanish spent, the more gold left Spain for the rest of Europe, causing all prices to jump and the more gold, the more money and credit that could be extended. This credit was issued not in response to a great increase in agricultural productivity but because of an abundance of a useless but valuable metal. In fact, Spain’s woes were experienced elsewhere in Europe. In England, the price of agricultural produce increased sevenfold in the late 1500s, while the price of manufactured goods went up by 300 per cent.

Another problem was the almost constant warmongering on the continent involving England, Spain and France, again driven by humanity’s rapacious desire for wealth and the spoils of the New World. As Tacitus wrote, ‘Pecunia nervus belli’, money drives wars, and these wars, which were arguably facilitated by gold, led to huge levels of government indebtedness and ultimately resulted in devaluations. Devaluations at the time were engineered by reducing the real gold component in coins. Henry VIII became known as ‘The Great Debaser’ when he sought to finance his wars with France by reducing the gold content in English coins.

With governments in such debt, countries in debt to each other and traders in debt to merchants, new forms of financing emerged in Spain and quickly swept through Europe: borrowing in the capital markets and, in time, debt trading. In fact, the irony is that debt trading backed by bank guarantees soon relegated gold to minor importance in the monetary system — but its destabilising impact in the 16th century was immense.

Fast-forward to today and we see Pedro Solbes, the EU Commissioner — possibly a direct descendent of a Conquistador — leading the charge for financial rectitude. Maybe his Spanish sensibilities are more acute than ours, for obvious historical reasons, but there is no doubt that he equates the Irish EMU windfall — where we get free money by being able to borrow German savings at no premium — as similar to the Spanish gold windfall.

More of a concern for him and the Commission is that other countries might follow our example, because then inflation would threaten the delicate balance needed to keep monetary union afloat. Economic history is full of riches-to-rags stories based on mismanaging unexpected windfalls. Maybe it is time we were civil, listened to our neighbours’ advice and stopped playing lotto with our financial future.